6 March 2009

China Can’t Save America From Itself

The following was written by Kip Beckman, Principal Research Associate, Economic Services, Conference Board of Canada.

Some relationships succeed while others are doomed to fail. While the partnership between Chinese savers and American consumers lasted longer than most Hollywood marriages, in the end it was bound to turn sour since it was based on shaky economic linkages and phony prosperity.

The relationship went something like this: China used the dollars it earned from exporting tons of stuff to the United States to purchase U.S. bonds. These massive purchases by China’s central banks helped keep U.S. interest rates low and the Chinese currency under-valued, a development that encouraged Americans to buy flat-screen TVs, cars and homes. Households then borrowed against their new homes to buy even more consumer goods. These linkages enabled the Chinese economy to soar at double digit growth rates and American wealth to scale new heights.

According to Thomas Friedman, the Bush Administration and the Federal Reserve did its best to encourage this profitable relationship by telling Americans that they could have it all – obtain sub-prime mortgages with nothing down and nothing to pay for two years, borrow at very low interest rates, keep shopping until you drop and, to top it off, fight two wars without having to pay higher taxes.

This fruitful partnership between the two countries has come to an abrupt end. The housing bust in the United States has led to soaring unemployment. Americans can no longer afford to buy as many Chinese goods as before and they must re-direct their efforts to saving and investing more, consuming less and discarding their credit cards.

The world economy now needs Chinese consumers to pick up the slack, buy more of what their own country produces and also purchase more imports from the rest of the world. Increased consumption in China is the only way that the country can grow at the 8 per cent pace that many experts contend is required to avoid social unrest. Currently, rising unemployment in the major Chinese cities has forced many migrant workers to return to the countryside where prospects for earning a living on the land are decidedly grim.

The prospects for Chinese consumers cushioning the ongoing global downward spiral by increasing spending are not great, however. China does not have the type of social security, health insurance or unemployment insurance systems that we in the West are accustomed to. As a result, Chinese households could end up saving some of the stimulus that the government is currently providing, since they cannot depend on the government to help out if they lose their jobs. Also, prospective home buyers in China must put down at least 20 per cent to buy a home and the average down payment is 40 per cent. Moreover, if home buyers decide to walk away from their homes, Chinese banks can seize personal assets. Given the debacle in U.S. housing markets, these would appear to be responsible policies but they definitely don’t encourage home buying.

In the final analysis, China cannot save America. the United States will be forced to dig itself out of the current crisis, given that all the major economies in the world are currently in recession while much of the developing world is contending with sharply slower economic growth. It has been and will continue to be a painful adjustment as U.S. households save more and gradually pay down debt. Fortunately, the latest initiatives by the Obama administration, while not bringing an immediate end to the recession, will help dampen some of its negative impacts.