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.