Wednesday, January 26, 2005

I respect immensely the work of Nouriel Roubini and Brad Setser and am honored to hash out ideas with them concerning the US current account deficit, the dollar and the fate of the global political economy. After a very long posting yesterday about why I think Nouriel and Brad overstate the case for the world going off its dollar asset diet, let me throw a note of discord into my own argument.

The big players in supporting the dollar -- Asian central banks -- have been doing so for two main reasons: [1] maintain access to the US export market; and [2] maintain access to the Chinese export market. Thanks to the Chinese peg, [1] and [2] go together like Mary-Kate and Ashley. The Chinese have their own [2], namely to promote domestic financial stability. All told, a pretty heady mix of interests aligned to support the dollar.

Yet the biggest players -- Japan, China, Taiwan, Korea -- move in a bloc. They support the dollar together, and they could also defect together with the potential of sending a giant financial tsunami across the Pacific. What prevents them from doing so has long been their dependence upon the US market for their exports. If that changes, the days of a dollar asset diet are surely numbered. Now of course we all know these days are numbered, and as a non-believer in Bretton Woods II, I think the fall will be a hard one rather than a calm and orderly adjustment. Those days may be slightly fewer than I thought.
China overtook the US to become Japan's biggest trading partner in 2004, according to numbers released by Japan's Finance Ministry on Wednesday.

China accounted for 20.1% of Japan's trade in 2004, compared with 18.6% for the US. In 2003, the US was ahead with 20.5% and China came second with 19.2%.

The change highlights China's growing importance as an economic powerhouse.

In 2004, Japan's imports from and exports to China (and Hong Kong) added up to 22,201bn yen ($214.6bn;�114.5bn).

This is the highest figure for Japanese trade with China since records began in 1947. It compares with 20,479.5bn yen in trade with the US.

Trade with the US during 2004 was hurt by one-off factors, including a 13-month ban on US beef imports following the discovery of a cow infected with mad cow disease (BSE) in the US.

However, economists predict China will become an even more important Japanese trading partner in the coming years. On Tuesday, figures showed China's economy grew by 9.5% in 2004 and experts say the overall growth picture remains strong.
The high-end consumer power of China is growing remarkably. Bloomberg reports
``If you look at household income, as opposed to individuals, by 2020, there will be 100 million households with disposable incomes equivalent to western Europe today,'' said Yuwa Hedrick-Wong, economic adviser to MasterCard International Inc., the world's second-biggest credit-card network by number of cards.``That's how powerful the demand side driver is.''
So this is where the rubber meets the road. When does Japan, Korea, Taiwan and the south-east Asian NICs decide they can cut loose from the US market and turn to China instead? The answer has to be coordinated with China's answer to the question of when it feels its banks are strong enough to live without the peg. China's favorable access to the US export market won't be affected much by a revaluation of the renminbi since it's costs of production are so low that a 10-20% rise in the currency won't perceptibly change matters.

There are dicy political-military issues in the mix as well, not the least of which being that most everybody in East Asia is scared to death of China even as it cozies up to the country economically. Strangely enough, Bush's best bet for forcing East Asia to eat more and more US debt is to cultivate China, and secondarily North Korea, as existential threats to Japan, Taiwan and Korea. China's best bet to end US power in East Asia would thus be to make nice with Taiwan while pressuring North Korea to behave "or else".

Strange brew . . .

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