U.S. and China — Falling in or Out of Love?

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

In the not so long ago “golden days,” it looked as if the U.S. and China were never going to fall out of love, as they kept coming up with one economic agreement after another. It was the climax of globalization, whereby the self-perpetuated and seemingly infinite circle of trade and capital flows fed the growth of a communist giant on one side of the equation and sped up the fall of one of capitalism’s angels on the other. Americans could not get enough of China’s cheap labor and products, the proceeds of which were hoarded by the industrious Chinese, only to be recycled back into the U.S. Treasuries to pay for most of America’s over-bloated tab.

This merry-go-round would most likely have kept on going unfazed had it not been for the Great Recession. The model is badly dented now, to say the least, while the likely return of triple-digit prices of oil is likely to demolish it beyond all recognition.

In case anyone is thinking of sinking Chinese container ships with tons of goods to fill the shelves at the friendly neighborhood Wal-Mart, hold your battle cries, because you may have the wrong culprit. The “Wal-Marts” of America were supplied by China, true, but they have not powered China’s amazing economic recovery, at least not significantly. As we all know, Wal-Mart and other retailer parking lots are largely empty these days as many Americans come to grip with the reality of double-digit unemployment. Rather, what have been driving China’s recovery were thriving surrounding economies and exports to the neighboring Asian trading partners, rather than North American or European partners.

This newly shifted reality may be just what will drive China to fall out of love with the U.S. China knows its huge trade surplus with the U.S. may eventually be the country’s undoing, unless China can take off the shackles put on its carefully controlled currency. Keeping the yuan-dollar exchange rate tightly reined as China finances the U.S. out-of-control debt makes sense only as long as Chinese can off-load its massive exports into the U.S. However, this is hardly the case these days.

Actually, having a stronger yuan makes perfect sense for China the way things stand right now. Americans are still stumbling under the massive weight of double-digit unemployment and may never walk in an upright position again. Moreover, huge energy costs are bound to make the domestic markets either too weak now or not strong enough soon enough to matter. Also, China could consider letting the yuan float freely, if for no other reason than to allow its people to finally collect some of the benefits of having greater purchasing power of foreign luxury goods.

In their love-hate relationship, perhaps the time has come for China to go its own way. But the one left behind, the U.S., may have huge reasons to worry. The People’s Bank of China already is the single largest owner of U.S. Treasury bonds and Washington still needs to hold Treasury auctions to keep up the pretence of a recovering economy. So, if the Chinese do not show up at the next Treasury auction, the scary question is: who will? Mind you, having printing presses working overtime is not an answer, while an expectation for Americans to start saving like the Chinese is unrealistic.

Are China and the U.S. falling out of love? Yes, their economic nexus is disentangling itself before our eyes. Is this going to have consequences? Yes, and serious ones at that — some potentially irreparable. What are the potential consequences? One path is inflation, the other is deflation, but either way, America’s economy is going to be vastly different, because de-globalization does not just redirects international trade, but it also redirects capital flows.