Obama Disregards China’s American Debt

As the depreciation of the U.S. dollar seems increasingly likely to be a long-term trend, Obama is behaving as though he doesn’t care much about China’s American debt.

Obama has recently stated that America would take a tough stand on China to achieve so-called fair trade and to prevent American jobs from being stolen.

Selling weapons to Taiwan, preparing to meet the separatist Dalai Lama, threatening to put pressure on the RMB exchange rate — overnight, Obama seemed to alter that suave image he has cultivated since his swearing-in. The change in Obama’s stance is just like a GDP inflexion point in the American economy: he is a modest and mild peacemaker during the financial crisis and when the quarterly GDP growth is negative and he acts like an overlord when GDP appears to be steadily growing incrementally for two quarters in a row. More importantly, though he is trying hard to be a peacemaker, Obama is trapped in a no-win situation dealing with the economic rescue package, health care reform and national security. Because of his conciliating attitude, his supporters have become disappointed in him and the Republican Party has taken advantage of this opportunity to eat away at the power of the Democratic Party. With his approval rating declining rapidly, Obama needs an attractive issue to gain the attention of his supporters — namely, the RMB exchange rate.

We must realize that the dynamic relation between the economic trends of China and America in the future will be the key factor that decides the RMB exchange rate.

We can make a simple hypothetical assessment with some statistics. Assuming that the growth rate of the American economy for the next 10 years will be 1.9 percent and the unemployment rate will drop from the current two figures to below five percent (the long-term unemployment rate), what would be the necessary conditions to achieve this? First of all, the labor force participation ration needs to remain around 70 percent. Because the American population grows slowly, the increasing rate of the labor force will drop from 12 percent to eight percent, which means the labor forces cannot sufficiently stimulate GDP growth. Hence, capital and the development of technology are necessary to assure GDP growth. Let’s talk about the capital account. The stock of capital depends on the savings rate of American families. We assume that the American savings rate will gradually grow; however, the government deficit (negative saving) will cancel it out. An outside source of capital is needed. Lastly, the development of technology is an immeasurable variable. The total factor productivity in America stimulated GDP growth by 1.4 percent in 2001 and 2008, which is much higher than its influence in 1995 and 2000 and was said to be the result of the new economy. To say the least, we assume that a new technological revolution is unlikely to occur within the next 10 years, so the current total factor productivity will give the American GDP a push of about 0.75 percent.

Therefore, the conclusion is fairly simple — capital account is the keyword. Foreign investors are unwilling to hold onto American capital because of the country’s huge deficit, causing the flow of global capital in the American market to decrease. Raising America’s level of domestic savings, an efficient way to increase the number of American exports higher than its imports, will drastically depreciate the U.S. dollar of the next 10 years and force foreign investors to dump American dollars. The U.S. will then enjoy the resulting competitiveness of its exports. Economist Martin Feldstein concludes that, conservatively estimated, the actual trade-weighted value of the U.S. dollar will slump by 25 percent in the next 10 years. Devaluing the U.S. dollar in order to balance the economy in America is incompatible with China’s current policy. Chinese analysts now generally agree that the rapid growth of the American GDP will cause the amount of Chinese exports to rocket. America’s economic uptick last December gave China’s exports a 17.7 percent increase compared with a year-by-year basis. If such a situation continues, exports in the first quarter of this year will increase by 25 percent on a year-by-year basis, which may give China over 13 percent GDP growth during the first quarter.

Apparently, Obama needs a quick appreciation of the RMB to counteract China’s increase in exports; otherwise, he cannot meet his goal of sustaining low growth over the next 10 years or controlling the unemployment rate. Mr. Obama certainly doesn’t care much about China’s American debt, as dumping American debt during times of growth is not as likely as it was during the financial crisis. The depreciation of the USD is a long-term trend. Selling off the American debt will contribute to this trend only with the depreciation of the RMB.