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June 29, 2005

U.S. "Tribute" from China: Low Interest Loans and Underpriced Exports

Approximately three-fourths of the U.S. budget deficit is being funded by foreign investors, mostly Asian central banks. In a piece of commentary worth your close attention, Niall Ferguson, a senior fellow at the Hoover Institution and the author of Colossus: The Price of American’s Empire, explains why China’s central bank specifically is willing to be a U.S. creditor:

. . . Why are the Chinese monetary authorities so willing to underwrite American profligacy? Not out of altruism. The principal reason is that if they don’t keep on buying dollars and dollar-based securities as fast as the Federal Reserve and the U.S. Treasury can print them, the dollar could slide substantially against the Chinese renminbi, much as it has declined against the euro over the past three years. Knowing the importance of the U.S. market to their export industries, the Chinese authorities dread such a dollar slide. The effect would be to raise the price, and hence reduce the appeal, of Chinese goods to American consumers. . . A fall in exports would almost certainly translate into job losses in China at a time when millions of migrants from the countryside are pouring into the country’s manufacturing sector.

So when Treasury Secretary John Snow insists that the United States has a "strong dollar" policy, what he really means is that the People’s Republic of China has a "weak renminbi" policy. Sure, this is bad news if you happen to be an American toy manufacturer. But there are three good reasons that the administration is tacitly delighted by the Asian central banks’ support. (1) It is keeping the lid on the price of American imports from Asia (a potential source of inflationary pressure). (2) It is also propping up the price of U.S. Treasury bonds, which in turn depresses the yield on those bonds, allowing the federal government to borrow at historically very low rates of interest. (3) Low long-term interest rates keep the Bush recovery jogging along. . .

Ferguson argues that today’s Sino-American relationship has an "imperial character," as the U.S. collects "tribute" in the form of "underpriced exports and low-interest, high-risk loans."

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