The Fed is NOT being nice to China

Baruch is scratching his head about the debate here  on Felix’s site, and here, over the limited bit of Quantitative Easing the Fed has just gone and done, and its effect on China. Felix’s reader thinks the Fed is somehow “bailing out” China, by offering a buyer for its vast holdings of agency debt. Brad Setser thinks it is neither helpful nor harmful:

China could use a large buyer for some of its Agencies. Now it was one. Though here the Fed isn’t so much bailing China out as substituting fro (sic) the falloff in Chinese and other central band (sic) demand. 

Baruch’s only a part-time, amateur economist; but what’s going on seems pretty simple. China Inc. has been squirelling away savings for years, in the form of IOUs from Americans. China was effectively financing US consumption of mobile phones, barbie dolls, notebook PCs and LCD TVs. Most of these were made in China. This curious state of affairs was thus partly a form of export finance, but it also played to national psyches: Americans consume. Chinese people save. It’s to do with history mostly, I think. Nothing really horrible has happened to Americans since the Great Depression, and even that was pretty OK. Baruch saw that movie Seabiscuit for the second time last week; Americans in the 1930s apparently had the time and leisure to worry about a plucky little horse. During the same period the Chinese were starving to death and being executed by the Japanese; if Seabiscuit had been around they would have eaten him.

Trusting that someone (ie Greenspan) would fix things in case anything went wrong, and not knowing what true hardship is, in 2006 Americans spent more than their household income on well, stuff largely made in China. There was a negative national savings rate. For their part, knowing from experience that some form of adversity at some point is a near certainty, the typical Chinese household saved 28% of their income. Think about this: if everyone in your household lost their jobs and went to zero income, how long would the money last if you carried on spending it at the same rate? I read somewhere the typical US household could go 77 days until broke. A chinese peasant, I hear, can probably measure the equivalent period in years (personally I try to keep enough in cash to make ends meet, in the manner to which I have grown accustomed, for 18 months).

This is, very slowly, reversing; the US savings rate just hit 5%, on the way back up to maybe about 12%. Chinese families are now being told to consume like American exurbanites who just remortgaged their McMansion, and they are seem to be responding. In rural areas the government will, no kidding, write you a check to help you buy an LCD TV.

Viewed this way, the vast Chinese holdings of US goverment and agency debt are a national piggy bank, savings for a rainy day. This rainy day has now arrived; the government is spending 15% of GDP to kickstart domestic consumption, understanding pretty clearly that the old path to riches, exporting knicknacks to Americans, is closed for a while. The piggy bank is denominated in US dollars, the world’s reserve currency, lovely and liquid, and safe as houses. Were I paranoid, and Chinese, I imagine I would not be overjoyed by significant unsterilised purchases of debt on the part of the US Federal Reserve. I would view it as an attempt by my debtor to defraud me by inflating my asset away.

This is probably why the Fed’s version of QE is limited, confined to agency debt, and proportionally smaller than the debt purchases of the Bank of England and the Swiss. China and the US are locked in a mutual embrace; if the Chinese don’t continue to finance the ballooning US government debt the US is screwed. If the US devalues its currency, the Chinese are screwed. We should be pleased about this; it means a destabilising global round of beggar thy neighbour devaluations is less likely, or at least the US joining in on one is. On the other hand, according to this reading China acts as a massive constraint on the Fed’s freedom of action. Savers tend to be the losers in reflations. Normally they are pretty meek, and don’t notice until it’s too late. In this case the biggest saver of all is well staffed with intelligent economists, and has tanks.

On that basis, I don’t think we can view purchases by the Fed of government agency debt as “bailing out” China; quite the reverse. It is an attack on their nest egg, the reward for years of hard work and thrift, and debasing it not a friendly act. I think the Fed knows this. Similarly, I would disagree with Felix when he says he’s “unclear on how exactly geopolitical considerations can make their way into FOMC meetings.” Fed discussions are probably more “geopolitical” right now than they’ve ever been. At least I hope they are.


7 thoughts on “The Fed is NOT being nice to China”

  1. “It is an attack on their nest egg, the reward for years of hard work and thrift, and debasing it not a friendly act.”
    Fresno Dan ain’t Chinese, and he thinks exactly the same thing.

  2. I disagree with the notion that Chinese are saving such huge amounts of cash. I also disagree with the whole Chinese consumption and ability of Chinese peasant to go on without income for years.

    Please, their medium GDP/Capita is 5K/year. Even with PPP (accounts for difference in price levels) there isn’t much you could consume. Same goes with their savings, you ve got to remember that in here we could build our wealth for generations. Chinese could not build much of the wealth just a dozen years ago. Majority of them were in barely survival mode. Also you forgot to take into account huge income difference between well connected and majority of workers in there. TO sum everything up, the only social niche in China that actually has substantial savings is GOVENRNMENT.

    In addition, Chinese are doing with their stimuli everything wrong. Majority of it went into supporting production and supply side of economy plus infrastructure. Since they ve been investing above normal resources into those two areas, they are facing huge diminishing returns. It would be wise for both us and Chinese to switch our stimuli structure, us spending majority of it on infrastructure and them spending majority of it on improving the demand. (government being wise I a lot of wishful thinking on my part I guess. )

  3. Baruch,
    I’m eager to hear your take on the Geithner plan. Yves: the looting continues. Stiglitz: robbery. You?

    BTW, in my last comment, I didn’t mean that Nvidia per se was going anywhere, but more that things like the TouchBook,
    which is an ARM-architecture box but is using a TI chip, not the Tegra.

    I already told them at Always Innovating that if they were public (and of course cheap), I’d go long on them.


    1. Sorry, Cash. I don’t know much about that sort of stuff, this Geithner hoohah. Haven’t looked at it in detail, I am sorry to say. I tend to think much more about wafer starts at TSMC and levels of semiconductor inventories than fiscal dodges.

      I am more of a strict deflationist, in the sense that Cassandra does Tokyo defines it. And were I a macro person, I would be an Austrian, and as such am not at all sure the Geithner plan matters. Does that help? I am contemplating a post on that very subject, and hope to finish it this weekend.

      Hey, NVDA is going places. Good places? Not so sure.

      Comrade, we will have to agree to disagree on the savings of the Chinese, my understanding is the savings rate is 28% of personal income. Agree that the player with the majority of the cash is still the government and state owned enterprises. This makes it even less likely they will be pleased about their savings being inflated away and the US devaluing their currency. The Chinese seem more balanced to me in how they are spending their stimulus, both infra and consumption. Am sort of impressed with them, they are not dumb.

  4. Baruch,

    I am staring at the output of an NVDA 8600m gs as I write. It soldiers on despite their travails, and despite the NVDA chip problems that came out last year (I bought puts at first rumor and made enough to buy a new laptop or two if this one is rendered junk by a dead graphics chip).

    I think small touch-screen devices with ARM-architecture cpus instead of x86s and free software instead of MSFT or AAPL have a real future. That could be wishful thinking on my part, as I’ve been a free software advocate since 1988. But I use my G1 every day, mostly as a palmtop, and already offered to alpha-test a TouchBook (they didn’t take me up on it).

    ARMH is fairly lackluster, but the Seeking Alpha article linked below, “ARM Processors Will Gain 55% of Netbook Market by 2012”, may be of some interest.

    And how ’bout that IBMSun merger, eh?

    1. Cash, don’t get me started on this stuff, especially ARM. If they want to have a go at INTC, walk through the bone-strewn field to that particular dragon’s lair, I wish them well. They won’t do it with any of my investors’ capital backing them up, though.

      Well done with your NVDA puts, and I am very pleased you have a G1. What is it like? I plan to get one too. What is a “palmtop”? Is it the same as a “smartphone”?

  5. Baruch,

    Not to pry, but it sounds like you may know a thing or two about the venture-capital wall I’ve run up against when I’ve come across things like “Always Innovating” and found that not only could I not invest in them, I couldn’t even invest in their backers, not that I have more than a rounding-error to play with anyway.

    The G1 is an ugly prototype that escaped Google Labs, an AK-47 if the iphone is some slick H-K SWAT weapon, a Jeep compared to a Jaguar. My Nokia 3133 (which I hacked into a 3131 to make usable) is a better phone. The G1 has two important things: a touch-screen and Free Software. The latter means that the software can rapidly improve regardless of what Google thinks about it. See for example:

    It appears Google’s attitude towards this is very different from AAPL’s attitude towards people trying to do anything with their hardware other than what they want done. The small-minded meanness of AAPL is entirely MSFT and in fairly stark contrast to what appears to be the GOOG approach
    (I live in fear of GOOG as should we all, but then they know that, as they already know more about me than I know about myself).

    You could get the developer version of the G1, which is completely unlocked, or you could get a stock version and unlock it.
    If you use T-Mobile, you could get a G1 from Ebay for considerably less than the off-contract T-Mobile price, and then they will give you an unlock code. Did I mention I’ve also made out with VZ and T puts? T-Mobile are good people: I’d never put DT and may buy some if they get really beaten up.

    As for “palmtop”: what I see happening is a lot of small devices, apparently ARM devices, with touchscreens and Wifi, ranging from G1 size up to maybe TouchBook size, things small enough to fit in a pocket or take up very little backpack room, light enough to carry around along with wallet and car-keys, with cell radios either built in or (for TouchBook-type things) addable as USB widgets (apparently
    the TouchBook people are considering it, see ). Basically, my laptop has replaced my desktop, and my G1 has to some degree replaced my laptop (I can read news and watch the market while still in bed, and am hoping that someday IBKR will have an Android client for the thing.

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