Wednesday, January 28, 2009

You Run Your House Differently?

If there wasn't enough already on Obama's inbox...

The Wall Street Journal has a must read article online on the U.S./Chinese relationship. Apparently the Chinese government had no idea how exposed it was to Fannie, Freddie and the U.S. financial system until last summer. Needless to say they are not too happy they took a serious financial hit as a result of the collapse of the U.S. financial sector. To make this point to the new administration -- especially after Treasury Secretary Geithner appealed to U.S. politist demand by blaming China for manipulating their currency (perhaps this was necessary for U.S. domestic constituencies, yet I disagree on Geithner's analysis and this clearly angered the Chinese) -- Chinese Premier Wen Jiabao became the first Chinese premier to visit the World Economic Forum. From the WSJ:
Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …

Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.

….. The Reserve issue “is causing a lot of concern with a lot of financial institutions in China,” said the Chinese official. Some officials expected that the U.S. and its financial institutions would better protect China from loss. “If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system,” the official said.

and:
Around October, a lengthy Chinese-language essay began circulating on the Internet excoriating Mr. Lou and other top CIC officials, along with Zhou Xiaochuan, China’s central bank governor, for being too close to the U.S. and then Treasury Secretary Henry Paulson. The diatribe quickly gained wide circulation in Chinese financial circles. One passage charged that Mr. Zhou “colluded with Henry Paulson to buy U.S. bonds, forced [Chinese yuan] appreciation, attached China’s economy to the U.S. and broke China’s economic independence.
Brad Setser, a fellow for Geoeconomics at the Council on Foreign Relations, discusses the article and his role in bringing to light the extent China invested in U.S. agencies and financial institutions in a must read blog post. In his own words:
China’s leaders have a major problem. They have accumulated an enormous quantity of US assets as a result of their efforts to manage China’s exchange rate But they don’t have a mandate to lose money investing the public’s money abroad. China’s losses have generated a public outcry. However, avoiding credit losses means piling into Treasuries and — well — that has risks of its own.
I don't think people realize how delicate political institutions around the world are right now -- especially China. With exports expected to drop off 19 percent and with a GDP growth rate of only 5-6 percent in 2009 (8 percent considered necessary to avoid social unrest), the Chinese people will not be in a forgiving mode as the country loses millions of jobs. As such, the situation in China could deteriote to the point:

1. The current Chinese government resorts to nationalism to stabilize their political power... threatening ties to the United States and Japan;
2. Civil unrest throughout China provokes a massive backlash by the government that has the whole world in an uproar over human rights abuses (think Tieneman, whose 20 year anniversary is this summer, ... yet potentially 25 times bigger; or even
3. A coup within China replaces the current leadership with a nationalistic military regime.

Alright, now this is all very pessimistic. The point is that we must work with the current Chinese leadership to try and stabilize the situation in China as much as possible. Stop the economic populist attacks in China -- your only going to get a response back from China that makes the situation worse!

While I firmly believe China must eventually open up its political system and become a democracy, now is not the time for us to be pushing this agenda. The alternative to the current Chinese leadership is not a constitutional democracy, it is something far nastier that would not only harm the people of China -- it would damage our national security interests and the future growth of the global economy.

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