The way I see it, there are three different areas of concern that many Americans and Chinese have about the existing trade and capital flow relationship between the two countries. These are the current costs and benefits of the relationship, the balance sheet implications, and the question of sustainability.
As far as the current costs go, the way I see the relationship is that China is exchanging massive amounts of goods for US financial assets. Thanks to the undervalued RMB it is delivering those goods at a very low price and taking in assets at a very high price (by keeping US interest rates low). The US gets the benefit of high consumption at bargain prices. It does not pay the associated cost (of low savings) because, although its savings rate is low, and although most countries' invesment rates are constrained by their domestic savings rate, the US has such an open financial system that its investment rate depends on global savings, not domestic savings.
For the US this is a good trade -- buy cheap and sell dear. Of course this does not mean that everyone in the US benefits, and it is perfectly reasonable for Americans to demand that costs and benefits are shared fairly, but eliminating this relationship may help some parts of the country at the expense of the country overall.
For the Chinese, this trade relationship is in some ways less beneficial, but they have locked themselves into policies that allow them little room to manuever. Rising unemployment is a great concern for the leadership, and they are essentially willing to give away the shop in order to keep employment growth in the near term -- one way of looking at it is that they are paying to trade Chinese unemployment in the short term for US unemployment in the short term (which is maybe one way of defining mercantilism). Unfortunately however their currency regime has locked them into an out-of-control monetary policy that may eventually require a very sharp, and perhaps ugly, adjustment.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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December, 2007
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