In the realms of popular science and theoretical physics, a China syndrome is the scenario by which an accident at a nuclear power station allows molten fissile material to breach its containment, burn through the power station, through the soil beneath the power station and then through the earth’s crust. Assuming it was an American nuclear reactor that melted down, you’d thus imagine the superheated liquid uranium carrying on, through the earth, ‘all the way to China’. (The reality being worse: it would reach groundwater first, and likely explode when it did).
On the subject of American meltdowns and their importance to China, the World Bank today released its China Quarterly Update.
Writes Brad Setser:
If you only read one thing on China this fall…
Make sure it is the latest World Bank China Quarterly.
David Dollar, Louis Kuijs and their colleagues have outdone themselves – and in the process provided a clear assessment of the sources of China’s current slowdown and the risks that lie ahead.
China is the most important country to the US. As Setser notes:
In broad terms – if oil stays at its current levels – China will be the only large surplus country in the world, and it will essentially be financing a US deficit of roughly equal magnitude to China’s reserve growth. It makes everything plain to see.
The decisions the Chinese take have a direct and powerful effect on the US economy. Take, for example, the shift in custodial holdings at the FRBNY between Treasury and Agency paper. It’s quite astounding:
…the internal imbalances of China’s economy are a reflection of its undervalued exchange rate… China’s surplus has implications for the world. It has to be balanced by large deficits elsewhere. …the Fed has been pushed to absorb risks that other central bank reserve managers now shun. Nothing illustrates this more clearly than the Agencies. Foreign central banks are scaling back their Agency holdings. The Fed is gearing up to buy. Big Time.
Which is perhaps why it’s more appropriate to start actually talking about The America Syndrome: whereby a crisis in China – political or economic – would spell disaster for the US economy. The worry sofar has been that as China seeks to redress its own pressing economic problems – namely domestic under-consumption – it will have to pullback from investing in foreign fixed-income assets. Creating the possibility of a buyers strike in the massively increased market for US Treasury bonds.
The good news is that in the short to medium term, it doesn’t look like that will happen. The World Bank’s forecast sees foreign exchange reserves rising all the way to $2,500bn by 2009:
Despite export volume weakness, China’s current account surplus is likely to increase further in 2009 due to the lower raw commodity prices. Even as import volumes are likely to outpace export volumes significantly, the large improvement in the terms of trade due to lower primary commodity prices is set to boost the current account surplus to almost US$ 430 billion, or 9 percent of GDP, in 2009.4
For our money, here’s the most illuminating graph from the whole report:
It basically shows the balance of liquidity within the Chinese economy. Until the yellow bar — domestic contribution — goes positive, China has to sterilise the liquidity glut in its economy by buying up foreign fixed income assets. So when it does go positive, China will need to buy far less foreign currency assets to sterilise the excess liquidity in its economy.
The risk then, for the rest of the world, is when does the yellow bar go positive? Making it so is certainly one of the Chinese authorities’ principle economic objectives – if not the key policy.
And China has a very good opportunity now to try and increase domestic consumption. As the World Bank report’s authors write:
The stimulus policies provide China with a good opportunity to rebalance its economy in line with the objectives of the 11th five-year plan. The stimulus package contains many elements that support China’s overall long term development and improve people’s living standards. Some of the stimulus measures give some support to the rebalancing of the pattern of growth from investment, exports, and industry to consumption and services. The government can use the opportunity of the fiscal stimulus package to take more rebalancing measures, including on energy and resource pricing; health, education, and the social safety net; financial sector reform; and institutional reforms.
The hope is that we are likely talking medium to long term here. The safety valve is China’s rightly held paranoia of inflation: sterilisation of liquidity by buying US Treasuries remains an attractive comfort blanket for policymakers.
Make no mistake though: the world is turning.
Related links:
‘Obama bonds’ – the new T-bills? – FT Alphaville
All the treasuries in China – FT Alphaville
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