Lawrence Kramer, the South may have a comparative advantage in labor, but I am not sure this explains everything here. Aside from the fact that the exchange rate itself is part of the determinant of whether a country’s labor costs are higher or lower than its labor productivity would imply, Chinese growth is capital intensive, not labor intensive. This reflects the fact, in my opinion, that in China the price of capital is so heavily subsidized that for borrowers with access to bank lending it is practically free.

Anonymous, I think it is fairly well understood here that a higher RMB will raise living standards for those with incomes, but there is also the fear that in the short term it will come at the expense of rising unemployment. Aside from the political reform implicit in weaning the SOE and large companies off various subsidies, there is a real trade-off for Chinese households in which the optimal choice isn’t obvious.

Scheng, although I think your point is widely accepted in the press, I am afraid I don’t agree with it at all. It seems to me that you have only to look at other countries around the world to see that high savings are sometimes associated with strong social safety nets (mainly among countries that followed similar industrial policies as China) while there are many countries in the world with much weaker social safety nets and almost no savings. In fact unless you believe that conditions changed dramatically in the past decade or two, you would have a hard time explaining why the Chinese savings rate surged, especially corporate savings.

China Law, it depends on what other countries do. If China revalues and nothing else happens, there will be a small increase in US jobs at the expense of a small increase in the price of cheap goods. In that case most of China’s job losses will benefit other exporters. If a Chinese revaluation permits other Asian and developing countries to revalue (which they can’t now for fear of losing export competitiveness to China), the result should be a larger contraction of the US trade deficit, a larger increase in US jobs, as well as what is in effect a consumption tax on US consumption. This will reduce the real income of US households but it will also raise their savings rate. Unfortunately it is hard for one not to require the other.

I especially like your materialistic approach to something like Smoot-Hawley. As you say, the issue isn’t tariffs per se, but the efforts of a surplus country to boost its surplus. I am reminded of those apocalyptic wackos who talk about “signs” that the end is near. For me, a sure sign of coming trouble will be the rehabilitation or dismissal of Smoot-Hawley as either unimportant then or irrelevant now. I don’t claim to know about the former, but I agree with your view of the latter. Either way, without the “Smoot-Hawley Redux” argument, the free trade guys have way less ammo.

While policies certainly affect events, I want to offer a higher-altitude view. The South has a comparative advantage in labor over the North. Until recently in historic terms, logisitical concerns offset that advantage, in part by making the development of entrepreneurial skills and a capitalist legal infrastructure infeasible. But technology has now made distance irrelevant, and that has made entrepreneurial skills and a place to ply them worth the trouble to develop. As a result, the South has become the source of all things labor-intensive. Even if we could get China to end its subsidies, direct and monetary, we would still end up selling only the capital- intensive goods in which we have a comparative advantage. That’s no way to feed a workforce, especially one that thinks “progress” means two earners per household.

Tariffs are the only way that we can sustain industries that employ a lot of people. They are coming, and the Chinese better get ready for them.

Only two questions remain – what form will the “landing” take and what will the geo-political stress and requirements for global security and stability result.

There really is not much point in debating “bubble” or “imbalance” – if there is one thing we are all getting very good at is understanding what instability a la Minsky looks like these days and what a bubble looks like.

China is a bubble which has either already fully formed or is close to fully forming. The problem is that being an overshoot by definition and the lack of recognition by those which it will most impact as being a bubble being another attribute of a bubble – timing is always tough in these things. Could be in weeks, could be in years as the national will and strength of China is not questioned, so the current status could be maintained for years.

It seems the basic Chinese hope is that the USA gets back into the uncritical consumption game and “Chimerica” re-emerges and all are happy happy with the bubble cheerfully passed backed to the USA.

But even a cursory read of today’s financial press in the USA indicates that this is very very unlikely. Instead of continueing the funding of China’s emergence onto the world stage, the USA now is going to wrestle with domsetic funding of the new liberal programs in the setting of the current crisis damage control. Looks like just too much tax increase and deficit financing will result to allow the USA to sustain the massive trade imbalances that are required for China to give the USA back the bubble.

So, China will digest this bubble in the end and like Japan will find that basically the USA “took them”, taking goods which were priced incorrectly and too cheaply – likely even below costs – and accepting slips of paper of which China has no control in the maintaining of value. That as soon as the Yuan is adjusted to some semblance of “fair” value – China will almost immediately lose 30% or so of the wealth held in these US dollar assets. This is likely equivalent to the “value” the Chinese handed over to the US consumer.

In the end, balance sheets are double sided and any trade flow amount which was the results of an incorrectly set Yuan will eventually be booked as a loss on the Chinese national account. This was Japan’s fate, via a process to correct the yen value that was mandated, obvious in hindsight, by the USA since the Plaza Accord in the 1980s.

This will be China’s fate as well.

Mercantilism is always extremely unstable and usually untenable as it requires either an exploitation of a “colony” with a significant “hard power” to allow this policy to carry on and thereby is a statist policy whoch eliminates the Hyak like information from price changes. More often than not the mercantalist will be conducting trade with terms which are actually a net loss – this is Jane Jacob’s “transactions of decline”.

The USA allowed first Japan and the Asian Tigers to impose mercantilist terms on the USA to reach USA geo-political goals (fencing in USSR Eastern expansion, Maoist China’s exportation of revolution, North Korean craziness etc etc….) but since Japan and Asia Tigers were completely dependent on USA “hard power” so as to exploit USA consumption of their trade goods ( a bizarre first in world trade history) they had no choice when the USA decided the game was over.

Fortunately great parts of the industrial base of these emerging countries had achieved such levels of efficiency that while set back, much of the gains established since the 1950s were maintained. Most of those gains were from the establishment of complete industry, from raw commodities like iron ore to finished ships, rail cars, autos, and high tech goods. In fact the elimination of much of the favorable terms of trade helped these countries take the necessary and final step to self sufficiency and even greater efficiency and productivity required. Domestic consumption also started to have greater legs in these economies with the emergence of large middle classes – not in terms of numbers but in terms of proportion of the country GDP.

With China, the same mercantilist terms of trade with the USA were also allowed and basically are dependent on the setting of the Yuan to untenable cheapness versus the dollar. But unlike the previous Tigers and Japan, China is not completely lacking “hard power” and perhaps is in a dangerous phase where the hype as to the level of this Chinese hard power vis a vis the USA is actually believed in Beijing. Bismarck came across some plans created by the newly formed German General Staff of the Army which involved planning for a war with the USA – after all they had ones in place for every European power as well as UK, they felt they required one for the USA. This enraged Bismarck and he insisted the plans be destroyed stating that the USA is not just a country but is a continent. Japan’s Admiral Yamamoto had the same input after his decades in the USA working on behalf of Japan in all important areas of the USA from Detroit to Texas oil fields to Harvard – but he was not only ignored but charged with carrying out the fateful war plan to attack the USA (a war which was obviously “caused” by trade frictions).

China does seems more in the Japanese camp than Bismarck’s, with great pride expressed and some confidence emerging in their “hard power”.

Therefore when the USA decides that their own self imposed mercantilist exploitation by China of USA consumption is no longer in USA interest, the elimination of USA hard power supporting that mercantilism may not lead to China thinking they have to change their industrial model and will ty to continue the mercantalism with Chinese hard power threat.

So, with the “debate over” – realizing a bubble is a bubble is a bubble – and understanding the mercantilist aspects of Chinese success to date – the questions to ask going forward are ones of geo-political security, not economics.

If there was ever a time for the USA to run elaborate ‘war games” in the south Pacific, to show constant testing of high tech “interceptors” and other goods in the area – it is now. Not to be belligerent but to make sure China has a realistic idea as to their own hard power’s level. This is of course what the USA did to the USSR.

Furthermore, the transition the Asian Tigers and Japan had to make once mercantilist terms of trade were either eliminated or reduced, may not be so easily made in China where growth has been investment not so much in industry process but in infrastructure, raw goods, and semi-finished goods. China has acted often more like a merchant than a producer, assembling semi-finished goods from other efficient Asian economies into finished products and then exported to the USA. The other Asians, understanding the terms of trade China enjoyed, were only too happy to accept US dollars for semi-finished goods (they were no longer at risk fo their currency appreciating 30% aving already gone through that adjustment decades ago) and have the goods “laundered” into finished goods and sold at prices they could not realize for export to the USA. China will find that much of their exports that were these assembled goods will be replaced cheerfully by the other Asians who will just revert back to the final finished form for export to the USA. China has also not developed the middle class consumer which could step into the permanent drop in exports to the USA. I think this suggests what form of landing China will have.

Finally a brief word on Africa. It seems China is indeed behaving badly in Africa, especially in the “heart of darkness” of the upper Congo River basin. The model they are pursuing is not the hypocritical one of the Brits or French pre-1960s colonists – who at least had to give lip service to such concepts as “rule of law” or civilization – but rather the one of King Leopold which is that of total brutal exploitation.

Four million folks have died in this area of the Congo River since 1996, from war or the immediate consequences of war. It is a tribal war with the major players being stateless ‘war lords” for the most part. Often these people are the most fantastic, bizarre, and evil people imaginable. This is the land where mau-mau is not a just a poltiical groupu but a religious force. This war is funded for the most part by “artisanal mining” ( a poor damned miner with a pick axe and shovel who is worked to death under terms of slavery), as the minerals produced are the incredibly critical “rare earths” and cobalt required for the post-oil digital industrial age we are entering. Ironically the richest of these deposits of “rare earths” is in this Congo River basin. The Chinese have improved on King Leopold’s model, seeing his major mistake was in putting any Belgium personnel in the area which thereby forced accountability in the end. China merely backs the most powerful war lord in commercial transaction and then buys off the actual legal national setting with no strings attached “loans”. The war lords that China is financing make the Columbian drug cartel fellows look like choir boys. The old measures of hand chopping that Leopold implemented are now being repeated, along with mass rape, and even, a new twist or return to that which existed before Leopold, cannibalism as a form of terror. This is really as ugly a conflict as one can possibly imagine and is alreayd one fo the world’s most devastating conflict in history in terms of loss of life.

The importance of “rare earths” to exporters like China and to any country involved with the “digital age” industry, combined with the cloak of anarchy and horror that the Congo area provides, starts to present a clearer understanding of China’s interest in the area. The USA is also keenly interested in this area, nominally because of the terrorist risk from Somalia down to Kenya, with the creation of “AfriCom” in 2007 – a designated military command to define and allow “hard power” planning. But I suspect the real reason for AfriCom are the concerns of geo

I agree with you on the statement China is not on the verge of crisis. But not sure about the future. Could you please explain your rationale for believing China can avoid a crisis?

Also I’d like to learn the list of best stuff you’ve read on financial credit booms and crisis.

Thank you very much. It’s a great post.