Matthew Klein at The Financial Times recently noted that the Very Serious People are now worried that China’s economic troubles – which have caused the country to switch rather suddenly from being a buyer of Treasury bonds to being a seller – will cause interest rates in the United States to spike. Mr. Klein rightly found this argument unconvincing, but what he didn’t note was that we’re looking at another instance of an economic zombie in action.
For the new concern about China is, in economic terms, the same as the old concern – that the Chinese could destroy the American economy by cutting off funding, either for political reasons or out of disgust over our budget deficits. This anxiety has always reflected a fundamental failure to understand the economic logic, as was pointed out many times years ago not just by yours truly, but also by people like Dan Drezner, a professor at Tufts University, in 2009.
But scare stories about our supposed financial dependence on China just keep shambling along, propounded by people who don’t even realize that there are other views out there, let alone that they’re talking nonsense.
1998 in 2015
The economist David Beckworth recently posted a good, if possibly overelaborate, discussion on his blog about China’s flirtation with crisis. What I find striking is the extent to which China has managed to get itself into a situation similar to the one faced by many of its neighbors in the late 1990s. China’s currency “wants” to depreciate, partly because of a slowing economy and monetary easing, and partly because of a crisis of confidence and capital flight. But Chinese authorities aren’t willing to let the renminbi drop all the way, perhaps because of fears of trade conflicts, but also perhaps because state-owned enterprises and the private sector now hold a lot of foreign-currency debt.
What happened in 1997 and 1998 was that depreciations in Asian countries turned into balance-sheet disasters because domestic firms were highly leveraged and had lots of dollar debt. This debt soared as a share of gross domestic product, not because of massive new borrowing, but because the denominator crashed as currencies plunged. I and others wrote about this at the time. You can see, by the way, why I’m annoyed at assertions that economists paid no attention to debt until the 2008 crisis, but also why I’m annoyed at myself for not realizing how a housing crash in the United States could produce balance-sheet stress just as currency crashes did in Asia in 1998.
Anyway, it’s time to dust off the extensive analysis that took place back then. Obviously, there are some important differences between China in 2015 and Indonesia in 1998, including the former’s huge foreign exchange reserves and what looks like a much bigger, more problematic overhang of internal debt. But we do have a lot of material to draw on – no need to reinvent everything from scratch.