First time on this blog? Beijing Traffic Lesson: Left Turn is probably a good place to start.

Saturday, August 4, 2007

The One-Way Money Valve

Today I am going to bore you.

As some of you may know, my roots are in business journalism, and I am fascinated by business and economics. Since getting here, I’ve read a lot about the Chinese economy and I’ve been trying to piece together some broader image of it in my head. Recently, I felt like I had a light-bulb moment where, at least to me, some chunks of the puzzle seemed to fit, and I thought that, since I’m here to learn about China, I might capture those thoughts here.

WHAT THIS MEANS TO YOU: Nothing funny today. If you want humor, I suggest you try the official Family Circus web site and check back with me later.

DISCLAIMER: I am WAY out of my depth here and I freely admit it. I have never taken an economics course. I state the following as if I know it, but the truth is this is just how I’ve pieced it together from reading Chinese and American news stories on the subject. However, I think it’s worth taking this stab at it, even if I don’t know what I’m talking about, because:

1.) This is a blog, and if there’s one thing blogs are good at, it’s misinformed pontificating; and

2.) My blog tracking stats indicate that fewer people visit on Saturdays, so this is a good time to sneak a long, boring post in.

With that out of the way, here’s my macro-view of China’s One-Way Money Valve.

Grossly oversimplified, but I think it goes like this: Chinese products are sold overseas. Those dollars and euros and yen are converted to yuan as they enter China and distributed to the exporter, and from there down the chain to the company, the marketers, and eventually into people’s pockets. Yay! More money!

They go to spend it, but it’s expensive to buy foreign goods (the government keeps their currency cheap – I won’t delve into the politics, but it’s true.) So THEY buy mostly Chinese goods too, which is good, because that means more local manufacturing, more taxes collected, more salaries paid.

Companies want to spend too, but the government makes it hard to invest overseas (you can’t grow if all the money flows right back out; hence foreign firms “in” China are really minority owners of joint ventures that are Chinese controlled), so they make many of their investments in locally made equipment or real estate – and suddenly there’s a real estate boom, meaning more work, more salaries, more of everything.

So somehow everyone’s getting paid, and it all traces back to exports. But every time money gets changed coming into the country, they have to print more yuan, and relatively little of the existing yuan is leaving the country to pay for imports. And as long as exports outstrip imports, it’s a spiral, with more and more money stuffed into the system and more and more internal spending.

Adding cash to a closed system means more money for essentially the same number of people who all want the same things. So if I’m a merchant, I can raise prices as high as the market will bear – capitalism, right? And it’s not evil - it builds wealth for the merchant and the merchant’s employees, so yay, more money for everyone again! And there you have inflation – the same stuff costs more today than it did yesterday. As a result of the system I described, inflation is very high here, and it spikes easily when there are shortages, as has been happening with food lately.

The government tries to lower inflation by soaking up some of that ‘excess liquidity’ – their term for cash – by forcing banks to essentially lock up huge amounts of cash rather than lending or investing it (which would put it out for someone to spend it, worsening inflation), or by raising interest rates so people won’t borrow so much and will keep more in savings (also to keep it from being spent).

One interesting side effect of turning all that foreign export money into yuan is that the Chinese government ends up holding the foreign currency, to the tune of more than $1.2 TRILLION in foreign cash. They’re trying to find ways to use it - remember a month ago when Blackstone went public and China bought a chunk? That was $1.2 billion or so of their foreign exchange reserves leaving the country.

Interestingly, if I read this story right, they’re going to let Chinese people buy bonds backed by the foreign currency the government holds. If the Chinese government investments (like the one in Blackstone) make money, it will grow the wealth of investors. But better still, the investors buy these bonds with their yuan, which takes more cash off the streets to help curb inflation.

Oh, what a tangled web we weave….

Basically, my impression of the whole kit and kaboodle is that it’s like a balloon being tended by a very smart but very nervous man. The government wants the balloon to fill as quickly as possible, because with it comes a high standard of living, wealth and economic power, so they hooked it up to an air hose. But they’re also trying to keep it from popping. They don’t want to slow the airflow (which in my tortured metaphor represents money), so a pinhole here, a piece of tape there, maybe a rubber band to constrict it over there. All very nerve-wracking and very much sweaty-brow kind of work, because too much and too little interference are equally catastrophic.

In China, of course, these decisions are made by a small group of people. Governments set a lot of the structure everywhere in the world, but in a freer market economy, well, if the Japanese can make cars better and cheaper and take U.S. dollars back to Japan, too bad for GM and Ford. (Yes, I know it’s not that simple, but you get my point.) Here, on the largest scale, it’s not the decisions of consumers at the cash register that decides where money goes and when. (Not that we usually think about it at all, of course.) It’s decided by MBAs and PhDs of economics who are working to a plan.

None of this is stupid, and none of it is crazy. These are very smart people who I actually believe are trying to better the lives of an entire country as quickly as possible. But because it’s never been done, and because it involves not only the interlocking and inherently unstable global economy, but also the psychology of billions – well, obviously, no one knows how this will end.

Why does this matter? Of course, because it’s not just the Chinese. On the other end of that air hose feeding into the Chinese balloon are other balloons that are being squeezed by purchase-happy consumers – the American balloon in particular. And the American government is trying to use ITS pins and ITS tape and – if worst comes to worst – a tourniquet to keep its balloon properly inflated. We're connected, so if the Chinese balloon pops or deflates, it'll affect the air pressure on our side too.

(And with that that, my metaphor groans weakly, rolls on its side, curses the cruel and unfeeling fate that brought it into being, and dies.)

To anyone who knows economics, any facts I may accidentally have listed above are obvious, but this has been kind of a revelation for me. I think I KNEW some of this intellectually, but something about living here has brought it into focus. (At least I think it’s in focus. I welcome corrections of fact, though not of my opinions.)

Here endeth the lesson!