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On the Record

High Stakes in China

Kenneth Rogoff

On the radio program “On Point,” Brookings Visiting Fellow Ken Rogoff discusses the December 2006 high-level U.S. delegation to China and analyzes relevant economic issues. A partial transcript of remarks during this program follows.

Host: Why such a high profile visit? What are the stakes?
Rogoff: This is a dialogue that has been going on for a long time but has been moving very slowly. On the American side, there is a lot of dissatisfaction at the speed which China has been moving. There is a feeling that we have opened up to you – we let you join the World Trade Organization, you’re able to export your textiles without limit, you’re able to export goods anywhere you want, but we can’t get in. You’re not respecting our intellectual property rights, you have too nationalistic an economic policy, and there is a big protectionist pressure growing in Congress, in the public. I agree that it goes in ebbs and flows, but right now the Democratic Party in particular has seized on growing income inequality from globalization, it’s a big thing. So there’s a lot of pressure to deliver something.

Host: What is the risk presented by China’s currency inflexibility?
Rogoff: It’s an emerging market, developing socially, politically, economically, and stuff happens. You don’t just have smooth growth. We have hundreds of years of history with this and it’s likely that there will be a problem at some point. I don’t think that’s the immediate concern but the truth is that currency flexibility, which seems like a really technical, esoteric issue, we have learned over time often lies at the heart of international financial crises. Now, everything in China’s great. The economy’s growing strong. Everyone wants to be there. But the tables can turn.

Host: What would the effect be of increased currency flexibility, and does it really matter if China does it?
Rogoff: I think there are two separate points. One is to make it flexible so that if there’s a crisis, it can go down, instead of having the whole economy go with it. But there’s a separate point. Many people feel that China has low wages, that it is hypercompetitive, and they ought to do something to mitigate that. The truth is that small currency movement, like they’re talking about, is not going to matter that much, but it’s definitely going to throw Congress a bone. It’s become a big rallying point for those who want China to have a less nationalistic policy and that I think is the biggest reason they are under pressure to do something.

Host: What is most likely to bring China’s racing economy to a crash and what would the knock-off effects look like?
Rogoff: The biggest vulnerability in China is the political system. China has emerged. They have the people on the coast, about a third of the people, doing very well; and then there are the people in the interior, and this is an overstatement, but they’re doing a lot worse. A couple hundred million people, perhaps, who are effectively unemployed. You can go a hundred kilometers from Beijing, living in grinding poverty, and you have this authoritarian political system holding it all down. But as capitalism grows, there is inevitably power spreading, there are inevitably political changes and that is the fundamental weakness in the system. You could point at a lot of others. The banking system is from another century, very vulnerable; a lot of the state-owned enterprises still need to be reformed. There are a lot of issues in the economy. They are trying to juggle a lot of things at once to keep this moving and there could be an accident. Now, if China had a long-term problem, it would be the worst thing for the United States. The rise of China has been fantastic for the United States, overall, and a lot of what we see as our glory over the past ten or fifteen years – our huge productivity, our huge growth – has come in no small part because of trading with Asia and all the benefits we get. On the other hand, I think the reason the Cabinet secretaries are there, the reason they are so concerned, is that there is this feeling that these benefits are not being shared equally. And I just want to say in passing that Secretary Paulson is pushing for opening up the financial sector in China, and I applaud most of what he’s doing, but I find that this is a little tone-deaf, as Wall Street is making huge profits and that’s not really the sector where Congress is worried about.

Host: If Chinese support for American debt went away, what would the consequences be for Americans?
Rogoff: If we didn’t borrow at all from abroad, if we had to somehow tighten our belt, we’ve been borrowing about $800 billion a year, it would radically drive up interest rates on our mortgages, on our cars, everything. As Steven said, the dollar would tank and imports would start becoming a lot more expensive. So that would be very painful. It could lead to a financial crisis, because we have a lot of overextended hedge funds, banks that have a lot of complex bets, nobody understands what we know. If there is a big shift in interest rates or exchange rates, a lot of them are going to go belly-up, so a dramatic, sudden change in this relationship, which I agree is not a likely scenario but is a risk, it would be very painful for us.

Caller Question: This delegation to China from the US demonstrates that China is “driving the bus”, and that we will make no strong demands on the Chinese and will come home empty-handed. Chinese are protectionists, not us. Lack of IPR respect and employment standards need to be changed, not our policies. 40 percent of Chinese currency is manipulated.
Host: Ken, address the currency issue. Is it possible to calculate where their currency ought to be, to be fair, market-based, appropriate, etc.?
Rogoff: The short answer is no, that making it flexible in the market will tell us. I want to pick up on this point that it’s partly our problem. We’re going over there and saying ‘look, we’re borrowing too much, we’re got this big deficit, we’re living beyond our means, you’ve got to help us, you’ve got to appreciate your currency’ and of course the Chinese turn around and say ‘you’re telling us that you’re borrowing too much, you have a problem, why is that our problem?’ And of course they’re right, it’s complex. We could take actions that would lower the deficit, that would raise our savings too. I think the biggest problem in our relationship with China the last couple of years, on the economic side, is that we go over there, we lecture them, we tell them what we want them to do, but we don’t offer anything back. We don’t want them to pollute as much, well my goodness, we account for more of the world’s pollution still than they do. We need to treat them as the great power they’re emerging as; we’re not going to get anything out of them if we don’t offer something in return.

Host: Ken we keep coming back to American savings here, even as Chinese policy gets a look-over too. What exactly is it that we’re talking about here – is it federal deficit, household budgets, visa bills, what’s the majority?
Rogoff: Right now, the larger part of it is the private sector, but it’s close, it’s about half-and-half, if you look at the United States’ overall borrowing. The government sector you could change a lot, just by raising taxes or reducing spending. The private sector is way trickier, we’re spending a lot because a lot of people feel rich because of their houses. So, the savings rate of ordinary people will come up relatively slowly.

Host: If we could change the federal deficit situation, a big impact and easier to change, would you say (in the vein of the caller’s thinking) that the Bush administration’s spending has diminished national security?
Rogoff: No I wouldn’t go that far, and by the way, the short answer to Kelly’s question, I agree with Steve at a deeper level, but the short answer is that if you owe enough to the bank it’s the bank’s problem, not yours. The last thing on Earth, China holding a trillion dollars of reserves, the last thing China wants to see is a dollar collapse which is going to cost them a lot of money. In fact, it’s one of the reasons they’re having trouble diversifying. It’s much easier to do something with the federal government in order to reduce the current account deficit. But in regards to the security issue: there’s a real security issue with China. I think it’s been a good one so far. I think the fact that China is now our counterpart in the global system, as opposed to Russia, they’re a lot more constructive. They want to conquer our markets, but they’re not looking to conquer us. It’s a much easier situation to deal with.

Caller Question: Can we influence China to fix its currency, its labor standards, etc. without hurting the people, i.e. the people we are trying to help?
Host: Ken, what about China’s room to maneuver with its own social stability domestically when it’s under pressure from the US? What are the counter-pressures from inside this enormous country?
Rogoff: Steve hit the nail on the head – when we’re talking about labor practices, we’ve got to look at the life these people are coming from. The fact is that everyone is trying to get out of the rural area where they’re unemployed or underemployed and living in horrible poverty, and they’re trying to get into the city, trying to work in these factories. China is bringing on the order of 10 to 12 million people a year into the cities, building new cities, to try and take some of the pressure off. That is the big challenge. They’ve got to keep that machine going. If that slows down, if they have a couple years when that train is not moving, there’s going to be huge political problems. That’s the thing they want. They don’t want to have the economy slow down.

Host: So, if China responds to Paulson’s demands, are they looking at a cause and effect, they believe that if they respond to these demands they’ll have political problems at home?
Rogoff: I believe that if they say ‘yes’ and allow a bit more currency flexibility the effect is going to be very, very small and mostly good. There’s some risk, but by and large, Japan had their currency appreciate a ton since 1970, something like 300 percent or something like that, and they still managed to grow, managed to run surpluses. I think the risk is very overrated, but it’s reached this symbolism, that both sides are stuck – if China would do this, if they would give Paulson this, he’d come home a hero, they’d buy two years of peace, I think it would be a great idea. But I don’t think we’re going to see it.

Caller Question: No one mentions the hundreds of billions of dollars in revenues and profits that the United States makes from cheap Chinese projects, why doesn’t anyone discuss the positive end of this trade?
Rogoff: He’s absolutely right. As I said earlier on, the thing that’s fueled the US economy, that’s made us look so good, has been this growth in technology, this import of cheap goods from China, the combination of the two. But, there’s this tension that it’s made things turn very fast, people losing their jobs in states like South Carolina. The joke is what do you tell these people, that their unemployment checks can go further at Walmart thanks to China?

Caller Question: Why is it that the elected officials and these CEOs continue to send jobs to China, the thing that causes this trade imbalance, if it’s such a bad thing? It’s not China’s fault – we put ourselves in the boat and now we’re going to China and telling them to fix the problem of our creation.
Host: Ken, there is controversy around Ben Bernanke’s inclusion in the delegation – what do you think of his presence, and how do you think inflation and deflation hover around their conversations?
Rogoff: I think Bernanke is there simply to elevate the stature of the delegation, to lend Paulson support. Paulson has a lot staked on this – if he comes back empty-handed, if nothing’s happened after six months, his ability to persuade Congress of anything will be very weak. I think he has basically hauled in all his chips and told people that this is very important, which it is, and I think Bernanke has gone along in that spirit, to try and help out. By and large, I don’t think the Federal Reserve is a central player in what’s going on.

Host: What’s the power dynamic between the negotiators? What’s the fundamental thing on the table?
Rogoff: Well, I expect that the dialogue, when the mics aren’t on, is actually quite candid. I’ve found that the Chinese leadership to just speak very forthrightly, very candidly, and I must say very intelligently about what the problems are. I’m sure the dialogue is very good and very constructive, but the big question is what is the takeaway? Certainly, learning each other is very good. It is going to very tough on Paulson, however, if he doesn’t have something to show after six months.

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