China Ties Bernanke’s Hands
Finfacts, March 20, 2007
UPI Asia on Line, March 21, 2007
Peter Morici
Stagflation is rearing its head. The economy is dancing along the precipice of recession, and
inflation remains stubbornly high.
The Federal Reserve cannot do much. Cutting interest rates to boost growth would accelerate
inflation. Raising rates to slow inflation would be futile. Most pressure on prices stems from tight
global petroleum supplies, slowing productivity growth and labor shortages, all exacerbated by
Chinese abuses of globalization.
The current economic expansion began in the fourth quarter of 2001, and China was admitted
to the World Trade Organization in November of that year.
Membership gave China, with 100 million plus underemployed workers, unbridled access to the
U.S. market, and Beijing gave U.S. consumers an unlimited line of credit to buy whatever those
workers could make.
China’s strategy is simple. It encourages exports with subsidies and an undervalued yuan.
Beijing, recognizing the U.S. market for manufactures from cheap hands has limits, requires
foreign firms selling more sophisticated products in China to establish production and transfer
technology.
General Motors, Intel and Caterpillar are making cars, microprocessors and heavy equipment in
China, despite shortages of skilled labor and adequate suppliers. Their Chinese partners
acquire know how to move up the industrial ladder and ultimately export more sophisticated
products to Europe and North America.
Consequently, China’s trade surplus with the United States has grown from $83 billion in 2001
to $236 billion in 2006. Those imbalances create an excess demand for China’s yuan and
should push up its value, but China, to keep its currency cheap, sells yuan for dollars and
invests the proceeds, mostly, in U.S. securities.
Following China, other Asian governments pursue similar strategies, and the U.S. non-oil trade
deficit with the region now exceeds $350 billion.
All this affects U.S. and monetary policy in three important ways.
First, large trade deficits push U.S. workers out of manufacturing and service industries that
could export much more to Asia but for mercantilist trade practices.
Approximately two million U.S. manufacturing jobs, above those lost to labor-saving
technologies, have fallen victim to imports. Meanwhile, finance and other service industries go
begging for workers, because those displaced from manufacturing lack skills to handle the high-
paying jobs service activities offer. Productivity suffers, wages rocket for college graduates with
the right skills, and inflation bounces higher.
Second, China uses oil inefficiently to generate electricity. Every time a manufacturing job
moves to China, more petroleum is required to power factories and provide amenities for
workers that relocate from the countryside.
With global oil supplies and refining capacity tight, rising gasoline and electricity prices in the
United States are among the untallied cost of “inexpensive” Chinese imports. Again, more
inflation.
Third, the Federal Reserve, nervous about inflation, began pushing up short-term interest rates
in June 2004, but Chinese and other Asian central banks have frustrated U.S. monetary policy
with large purchases of U.S. securities to keep their currencies cheap and Americans spending.
Since the second quarter of 2004, the Federal Reserve, by purchasing U.S. short-term
securities, has added about $78 billion to currency circulation and U.S. bank reserves, which
back up loans to businesses and consumers. That is not much in a $13 trillion economy, and
the prime rate on short-term business loans has risen from 4 to 8.25 percent.
Meanwhile, Chinese and other foreign central banks have purchased more than $750 billion in
U.S. securities, and the rate on a 30-year conventional mortgage is still about 6.2 percent. That
has permitted housing prices to rise another 28 percent, kept consumers spending through
home equity loans, and pushed up prices for everything from apparel to zucchini. Again, more
inflation.
Now, the housing boom and consumers have finally run out of steam, the economy has slowed
substantially but inflation continues to nettle. Cutting interest rates to stimulate growth would
add to the liquidity provided by foreign central banks and inflation would soar.
That leaves Ben Bernanke with only his bully pulpit.
Instead of lecturing Congress and the President about the evils of budget deficits—they don’t
listen anyway—he should focus their minds on the productivity losses, needlessly wasted skills
and inflation provoked by Chinese mercantilism.
Without an effective U.S. response to Chinese economic nationalism, Bernanke can’t do much
to steer the U.S. economy to safety but talk.
Peter Morici, an occasional contributor, is a professor at the University of Maryland School of
Business and former chief economist at the U.S. International Trade Commission.