When China Preached United States On How To Manage Its Economy

History can make things look very amusing! The recent downgrading of Chinese sovereign credit rating resulting from its unsustainably high national debt reminds one of the August 2011 reactions by Chinese spokesmen and media that strongly criticized US policy makers for excessive borrowing and preached them on how to manage the economy. The economic cycles seem to have completed a full circle so soon!
When China Preached United States on How to Manage its Economy
Source - Wikimedia Commons (https://commons.wikimedia.org/wiki/File%3AD%C3%A9ficit_commercial_(biens)_des_Etats-Unis.png)

It is not very often when recent events evoke memories of the past. It is rarer when such an event is a lowering of Chinese credit – something unheard of during the last three decades. Even rarer, however would be a scenario when lowering of US Sovereign credit led to China preaching the United States about how it should manage its economy.

That is what makes it worth remembering!

Recent Downgrading of Chinese Sovereign Credit Ratings

The year 2017 has seen Chinese sovereign credit rating suffering its first major setbacks since 1989, when Fitch in April, Moody’s in May and S&P in September

lowered its credit rating keeping in view its unsustainably high debt and falling economic growth rate. The credit rating agencies have been alarmed by the steep rise of Chinese debt, which has risen from around 150% of the GDP in 2007 to nearly 250% of GDP in 2017. Many experts estimate China’s actual debt burden to be even higher, raising significantly the chances of a hard landing, which can affect its economic growth.

The doomsday prophecies raise fears of what could be a Japan like stagnation or a financial crisis similar to that precipitated in the United States a decade ago. Indeed, it was in the aftermath of the consequences of the sub-prime crisis and the consequent economic downturn that the United States suffered, which led to one of those rare downgrading of US sovereign credit rating in August, 2011.

That was the event that led to China criticized the United States for poor management of its economy, and extending some pearls of wisdom on how it should take care of its economic health.

When China Lambasted the United States

In the week following the US credit downgrading, China fired what was perhaps its first ever economic salvo pulling down the US policymakers for messing up its economy, while also asserting its own right as a major lender to the US economy to seek corrective measures. For a country that has decided to adopt modern capitalist approach for its own economy only a few decades earlier, the Chinese reaction marked a historic milestone that transforms its defensive and silent stand to an offensive one, for the first time.

In a strong worded statement, Xinhua, China’s official communication channel wrote,

"The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone .... China, the largest creditor of the world's sole superpower, has every right now to demand the United States address its structural debt problems and ensure the safety of China's dollar assets,"

China also called for a new international currency for maintaining the global economic stability indicating that it might be moving away from the US dollar as the reservoir for its exchange reserves.

Chinese Reaction showed its Willingness to Assert Aggressively

For a country that had been under immense pressure from the United States for freeing its currency amidst widespread allegation of artificially undervaluing Yuan to promote its exports, the S&P downgrade of US debt rating from AAA to AA in August 2011 must have come as a great opportunity to turn the tables on its only real competitor for global hegemony. It was probably aimed at deterring the United States from attempting the kind of pressure tactics that it had deployed with considerable success with Japan, contributing to the upward rise of Japanese currency in the eighties and nineties. It also made it clear that unlike Japan, China will not buckle under US pressure. In hindsight, it was probably one of the smartest moves to ensure that its currency remained insulated from the pressures of its mammoth trade surplus.

It would also not be out of place to recall that the situation that US found itself to be in August 2011 was of its own making. Since the eighties, it had been following the policy of appeasing China by extending to it the most favoured nation status and the carrot of international trade. It goes to immense credit of the Communist Chinese Government that it grabbed the opportunity with both hands, combining the capitalist global entrepreneurship with a single minded exchange manipulation to make the most out of it.

In 1985, China had a trade surplus of $ 6 million with the United States. By 1995, the figure

had widened to $ 33 billion, but the major acceleration came around the turn of the century. The Chinese trade surplus crossed the $ 100 billion mark in 2002 for the first time, and doubled within the next three years to cross the $ 200 billion figure. After 2007 it was usually in excess of $ 250 billion, except 2009, when the subprime crisis brought it down a bit. The cumulative Chinese trade surplus with the United States during the last two decades is over two trillion dollars, and one of the primary sources of accumulated Chinese Foreign Reserve.

Role of Chinese Capital Infusion in the 2007 Economic Crisis

While the 2007 economic crisis has been labelled as ‘Sub Prime Crisis’ and blamed largely on the greed of financing executives and their innovative ways to sell mortgages to clients with subprime credit ratings, actually, that is only half of the story. The other half, which is probably more important part of this tale, consisted of the burgeoning US trade deficit, around half of which was with China. The Chinese investments in US treasury market had the duel effect of high bond prices and falling yields. More importantly, it sustained the dollar, kept the US economy growing and allowed the Fed to keep a very low interest – factors that eventually led to the asset bubble which created the economic crisis.

Thus, the Chinese reaction on US credit lowering, was rather ironical, to put it mildly!

Have We come a Full Circle?

History may record with surprise as to how the US policy makers failed to learn their lessons even after the 2007 crisis, taking refuge in faulty Keynesian economics, and allowing capital inflows to continue on the back of an undervalued Chinese currency and rising oil prices. A more stringent action to curb the unfair Chinese trade surplus could have averted the credit downgrading in August 2011.

Now, one may have thought that from thereon, China would be a far more difficult customer, and so it has been, until the weight of excessive capitalism seems to have finally caught up with the Chinese Economy as well. It took two generations of controlled breeding that enabled the Chinese society to generate an unprecedented demographic dividend by lowering the worker - dependent ratio, which, coupled with low wages, made it an ideal location for becoming the factory of the world. Its artificially low currency made its goods most price competitive in the world, thereby attracting massive foreign capital inflows.

However, the debt and investment driven economic growth model is finally showing signs of slowing down. The demographic dividend is not over yet, but wages have risen and dangers of ageing have begun to lurk on the horizon. Asset inflation may also have misallocated resources away from the most productive sectors, and the quantitative easing after the global economic crisis has led to unsustainable rise in debt. The economic cycle has its ups and lows, and with unprecedented downgrading of its sovereign credit, China seems to be threatened with what might be its worst economic downturn in nearly half a century.

In 2011, China took a bold stand in preaching the United States on how to manage its economy. It will need to take even bolder steps now to ensure that its own economy lands softly, and does not end in a worse mess.

History always seems to find unusual ways of getting recalled by those who make the mistake of forgetting it!

References

  • US credit rating downgrade prompts warning from China, The Guardian, Saturday 6 August 2011
  • Fitch cuts China local currency debt rating, BBC, 10 April, 2013
  • China’s credit rating cut to A+ by S&P over rising debt fears, The Guardian, Thursday, 21 September, 2017
  • China debt load reaches record high as risk to economy mounts, Financial Times, April 24, 2016


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