America’s China Codependency

March 10, 2015

by Michael Edesess

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Sixty years ago Tennessee Ernie Ford recorded a song titled Sixteen Tons, based on an earlier recording by country-Western songwriter Merle Travis. Tennessee Ernie’s version soon hit number one on the music charts. The song is about a coal miner trapped in the system run by coal companies before the advent of the United Mine Workers union. Miners were paid in scrip that could be used to buy goods only at the store run by the company. When the miner didn’t have enough scrip the company store acted as a payday lender, advancing scrip on credit.1 Hence, the repeated lines in the song’s chorus: “I owe my soul to the company store,” and “another day older and deeper in debt.” (Travis said his coal-miner father used that last line often.)

Americans don’t work in Chinese coal mines.2 Yet I thought of this analogy as I read Unbalanced: The Codependency of America and China by Stephen Roach, former chairman of Morgan Stanley Asia. Odd as it may seem, Americans are the coal miners and China is the company store. Americans spend every last penny to buy goods at the company store that is China, and China advances us the money to do it.

The codependency of China and the U.S.

The mechanism is a little more complicated than the simple relationship between the miner and his company store. In the case of China and the U.S., U.S. citizens buy cheap goods from companies in China. China’s central bank trades China’s own currency, renminbi (RMB), for the dollars those companies receive from Americans. Thus, China’s central bank amasses dollars. China’s foreign exchange reserves rose, according to Roach, by a factor of 300 from $11 billion in 1990 to $3.5 trillion by mid-2013.

More than a third of China’s foreign exchange reserves are held in U.S. Treasury securities. There are two views about why China holds so much in U.S. Treasury securities, even though their yields are so low. One, which is undoubtedly part of the reason and may be the entire reason, is to prevent the kind of debt crisis that Southeast Asia suffered in 1997. In that year countries like Thailand, which had been receiving regularly rolled-over six-month-maturity dollar loans from U.S. creditors, saw a sudden stop to their credit when doubts about the Thai economy and the Thai baht spiraled. This brought about a crisis that drove down the value of the baht. If Thailand had had unlimited quantities of dollar reserves to repay loans, it could have weathered the crisis. China noted this and swore that, so as never to be vulnerable to such a crisis, it would massively stockpile foreign currency reserves.

The other possible reason for hoarding U.S. dollars – and the cause of much American China-baiting – is to keep the exchange value of China’s RMB low. That way, it will be cheap for Americans to buy goods from China. This promotes China’s export strategy. It would probably be difficult to separate those two reasons; you would have had to have gotten into the minds, or the smoke-filled rooms, of the top Chinese Communist Party decision-makers. Roach’s preferred interpretation is clearly that China amassed these foreign reserves because of an all-out effort to avoid the instability from which it had suffered so much in the past. Memories for example of the instability of the Cultural Revolution of 1966-1971 were still very fresh.

Once these Chinese dollars are invested in – loaned to – the U.S. Treasury, how do they get into the hands of American consumers, who then use the “scrip” to buy goods from China?

  1. Like so many other historical accounts involving money and markets, this one has been partially debunked by an academic economist.
  2. Some might think it fit retribution for the high fatality rates among Chinese railroad workers in the American West in the 19th century.

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