America china be friends?

Since the end of the Korean War, China has acted to support its ideological partner in terms of military assistance, civilian aid, and political recognition, in what has largely been an ‘aid provider-aid receiver’ relationship that has seen China assisting North Korea for reasons of unity and political face. However, recent moves by Beijing now show clearly that China intends to expand this relationship to a new level, much to the chagrin America, which would see North Korea isolated from the world and resigned to the status of pariah state.

During a high level press briefing, welcoming Chinese president ??? (Hu Jintao) return from a three day ‘good will’ visit to North Korea, Wang Jiarui, the head of the International affairs department of China’s ruling central committee that China announced that China was now moving steadily to expand its dealings with North Korea to cover a broad range of area, and indicating that that Beijing soon hoped to develop the uneven Sino-North Korean relationship into a full two way economic relationship that would bring the two countries closer together than ever.

“China and the DPRK [are exchanging] views on developing domestic economy, science and technology and education.”

Wang Jiarui, Head, International Department of the Central Committee, China

Though Wang’s pledge of support comes as no surprise to even the greenest of China watchers, and mirrors numerous past statements of support for North Korea, it is also indicative of an increasing trend in Beijing’s foreign policy. Trends under which China is now increasingly seeking to transform its unproductive Cold War era relationships into economically viable relationships that see China gaining more than just face in return for its support.

In line with this change, from face to more tangible benefits, China recently moved to ‘restructure’ its relationship with Zimbabwe. Offering it assistance in the developing its economy in areas that China can either export to or import from, while investing in its mining and agriculture sectors in return for favoured access to Zimbabwe’s markets and produce.

Though still in its early stages, and currently limited in some part by the poor state of North Korea’s economy and industry, China’s future relationship with the North is likely to be based on similar footings to that which China is building in Zimbabwe, and has already been to cemented at some level with the joint stamping of a number deals to construct factories and conduct exchanges. Some of which have already been completed.

American debt levels have begun to fall, US households are reducing their consumption to repair their tattered balance sheets. The result has been a decline in the US trade deficit, a process that most experts believe will continue for several more years.

But in the global balance of payments, actions in any one place must be accompanied by equivalent reactions elsewhere. While economists argue fiercely over whether rising Asian savings forced the decline in US savings, or vice versa, no one disputes that one required the other.

When a country’s policies force rapid growth in production, as happened in China especially during the past decade, and implicitly constrain consumption growth, the automatic consequence is a rise in the savings rate.

For over a decade China’s rising savings rate offered the great counterpart to the US declining savings rate, just as its rising trade surplus – which as a share of global GDP has been historically unprecedented – corresponded to America’s equally unprecedented trade deficit.

So if the US must see its savings rate rise and its trade deficit decline, shouldn’t we also expect China’s savings rate to decline and its trade surplus shrink as sharply as the US trade deficit?

Maybe, but things might not work out as smoothly as that. China’s response to the global crisis has been an extraordinary expansion of credit – new lending in the first six months of 2009 was equal to 25pc of China’s GDP – along with a surge in municipal, provincial and central government deficits.

This seems to be exactly the sort of policy that John Maynard Keynes would have demanded, except that he argued that the purpose of fiscal and monetary expansion in a country with excess production was to drive growth in net consumption.

In China, most of this fiscal and monetary expansion is being channeled by the banking system into investment, with much of it ending up in increasing China’s productive capacity faster than it increases consumption.

The result? The measure of how much Chinese production exceeds Chinese consumption, its trade surplus, has not contracted at nearly the rate at which the America’s excess of consumption over production, its trade deficit, has contracted.

This means that the tradable goods sector in the rest of the world has suffered most of the contraction in global trade deficits. China’s Asian neighbors especially, but also countries like Germany, have seen a much more rapid contraction than they might otherwise have seen, and China’s share of the net export market has risen.

It is easy to blame this state of things on predatory Chinese behaviour, and many do, but this is an unfair charge. It ignores the tremendous difficulty involved in restructuring an economy whose growth has been powered by exports towards one powered by domestic consumption. Every country that has made a similar transition, whether the US in the early 19th century, Brazil in the 1970s and 1980s, or Japan since 1990, has done so as part of a slow, difficult, and painful process.

China is making every effort to increase its consumption rate and reduce its savings rate as efficiently as it can. It must do so – for the next several years, as the US trade deficit shrinks and no other country rises to fill its place, China’s long-term growth will largely be limited by the growth rate of Chinese consumption. But it will not be able to do so quickly. No country has ever managed to do it quickly.

So the world must find a way of dealing with the consequence of a decline in US net consumption and a much slower decline in Chinese net production. One way, of course, is to slow down the rise in US savings to give China more time to adjust, and by rapidly expanding the US fiscal deficit, whether intentionally or not, Washington is doing just that.

But most observers agree that not only is the rising US fiscal deficit insufficient to reverse altogether the decline in US consumption, it would be a mistake if it did. The existing imbalances that led to the crisis would not have changed, and the final resolution would be worse than ever.

For the next several years the world must deal with this difficult transition. The recent upturn in the global economy, and especially the sharp rebound in investment-led Chinese growth, has generated a great deal of optimism that the global contraction has finally ended and the world economy is about to recover, but this rebound is deceptive.

Especially in China and the US the imbalances that led to the crisis have not been resolved, and fiscal policies that created the rebound in some cases may even be exacerbating it. Until the opposing trends in the two economies that lay at the heart of the global imbalances resolve themselves, it is optimistic to believe that the crisis is over.