• Real estate values declined 27 Percent last month.
• Inflation is increasing.

Their economic growth has slowed a bit, but it is still really high at 9.7, at least by the official numbers.  Still, China’s leaders have a problem.  Inflation can eventually create disastrous problems, but eliminating it would require raising the Renminbi, which would slow exports and economic growth.

The real estate problem is just a miss-allocation of assets, and has to work itself out, just as it is doing here.  Not much they can do about that.

China needs to maintain rapid economic growth to manage the migration from rural to urban areas that accompanies its becoming a modern economy.  Slow growth would lead to increased unemployment and political instability, and they don’t handle political instability well in China.

China has a population of 1.34 billion, almost 20 percent of the World’s population.  The United States population is 0.31 billion, less than five percent of the World’s population.  For the mathematically challenged, China’s population is 4.3 times the United States population.  Why should they have a smaller economy?  Ideally, they would have an economy about 4.3 times the size of the United States economy.

The United States economy was about 14.12 trillion in 2009.  Per-capita gross product was almost $46 thousand.  If China’s economy was the same size, its per-capita gross product would be less than $11 thousand United States dollars.  I don’t see any reason to be anxious about this.  In fact, I’d say it is good news when 20 percent of the World’s population increases their standard of living.

You would think that the United States savings rate would be high and rising.

China, by contrast, is in the midst of a real estate boom and its economy is growing at or near double-digit rates. The Chinese are also poor, with annual 2008 per-capita GDP estimated by the World Bank at $3,263 U.S. dollars, while ours was $46,716. Certainly, we’re better able to afford saving. Yet, the Chinese are saving half of their meager income.

What is going on?

One reason for the disparity is that China has no safety net, no unemployment insurance, no medical insurance, no social security, nothing. Also, the Chinese government is a potent source of potential volatility. The Chinese have seen a lot of bizarre behavior by their governments over the past 100 years or so.

So, the Chinese have a large precautionary reason to save. They have another reason. They are likely to keep or bequeath their savings. There is no indication that, as potentially volatile as it is, the Chinese government is likely to tax away its citizen’s wealth. They may end up in jail for visiting an unapproved web site, but the government is not likely to tax away their savings.

The Western World has safety nets. They are inefficient safety nets, and they are often burdened with questionable incentives, but safety nets exist. Most of us have insurance that pays for all but a small portion of our medical care. We have unemployment insurance. The precautionary motive to save is less.

There are other reasons for Westerners not to save. Our incentives are all screwed up (technical term). In the West, virtue (saving) is taxed and vice (profligate spending) is rewarded. We have programs for people who are at risk of foreclosure. We have bailouts for big businesses that took outrageous risks. We have bailouts for countries and states that have decades of making irresponsible spending commitments. These will be paid for by people who save.

The West’s incentives are to dis-save. Baby Boomers, in particular, know they have the votes to be bailed out and they see the momentum to have the “wealthy” (savers) and the unborn pay for the bailout.

This is very ironic. Capital is safer in the, presumably, communist China than in the, presumably, capitalist West.

 Given a peg, what is the correct of the level of the peg? In China’s case, there has been recent commentary from high level United States government officials that China’s peg-level is inappropriate.  There are two ways that China’s economy could adjust the peg to a level that would be appropriate to its critics.  One is through trade, where if China revalued their currency, their products would be more expensive and adjustment would occur.  This would require, however, a reduction in GDP growth, something the Chinese will not willingly do.  The other way that adjustment could occur would be if Chinese domestic demand increased.  Then, some Chinese products would more easily be sold internally, maintaining their GDP growth without requiring such a large trade surplus by decreasing their saving rate. 

 I support dialogue with China rather than accusations that, to China, will appear as meddling with an economic policy that has internal consequences.  The dialogue could include the peg-level as well as ways that China might approach stimulating domestic demand.  China will likely be more interested in the domestic demand discussions than the peg-level discussions, but dialogue keeps the door open for future discussions on any topic.  The Chinese household savings rate tends to be high.  Part of the reason for this is due to precautionary saving.  In China, there is relatively little in the way of social safety net programs like unemployment insurance, which induces precautionary saving.  Domestic demand discussions with China could include ideas for implementing unemployment insurance programs and other social safety net programs.  If China’s precautionary savings rate fell, domestic demand would increase.  They might just move that direction, and in that case we could still maintain dialogue with China on the peg-level issue.

Bernanke, though, has brought real and valuable innovations to monetary policy. For example, one aspect of the FED’s response was based on a modern concept of liquidity. During his years as an academic, Ben Bernanke’s research led him to the understanding that there are things the central bank can do even when interest rates are zero. The key action in this case is to pump cash into the economy. Since 2008 the FED has pumped a record amount of cash into the United States economy. They also made emergency funds available to institutions that were experiencing short-term cash-flow constrictions.

It turns out that these policy actions have had other impacts, collateral damage might be an appropriate term. They have provided safety for large institutions that were arguably mis-managed, like Fannie Mae and Freddie Mac. They have maintained low interest rates that preserve the values of existing bond-portfolios. Some say these policies have benefited foreign countries, particularly China. China’s relatively large investment in dollar-denominated assets, such as U.S. Treasury bonds and Government Agency bonds, is a popular topic. The concern is that China might unwind these investments, sending the dollar sharply lower. The concern is misplaced.

The Chinese economy is intertwined with the United States economy. Millions of Americans flock to Walmart every year to purchase low-cost household items. American consumers benefit from low prices and China benefits from export-augmented economic growth. One of the oldest and most accepted of all economic theories, Ricardo’s Comparative Advantage, shows that trade benefits both parties of a transaction. The size of trade between China and the United States implies that those benefits are huge for both countries. There is, therefore, no need for the United States to have any serious disagreements with China regarding economic policy. The benefits to their economy of trade with the United States are large enough that the Chinese could not quickly or massively unwind their holdings of dollar-denominated assets.

So, why are we hitting them with trade restrictions?