In effect the Chinese are using quantitative easing to support the US?

This is really turning into a very pervasive myth! It is basically a simple process, but it nevertheless isn't easy to explain. I think Michael Pettis does a fairly good job here, but I think we need some graphics.. or something.

http://mpettis.com/2009/04/new-trade-and-reserve-numbers-from-china/

...But if holding more than 44% of a country’s reserves in dollars distorts the global balance and creates excessive currency concentration, why do the People’s Bank of China and other central banks willingly do just that? Dark mutterings about US hegemonic power notwithstanding, there are no legal or physical restrictions on the ability of central banks to choose the assets they purchase. For the past decade they could easily have purchased fewer dollars assets and more euro, sterling and yen assets.

The answer has little to do with geopolitics. It is a necessary requirement in global trade that capital and trade flows balance. Countries running trade surpluses must recycle their surpluses to the countries running trade deficits. Normally this is done through private investment flows, but following the 1997 Asian crisis a number of central banks, especially in Asia, began accumulating such large amounts of international reserves that their purchases of foreign assets completely dwarfed private investment flows.

Assets which the central banks of trade surplus countries purchase will to a significant extent determine which countries run trade deficits. If central banks mostly buy US dollar assets, the US will run the corresponding trade deficit. Contrary to popular opinion, financing flows do not necessarily follow trade flows. It is often the other way around..

Let us assume that over the past decade Asian central banks had decided to acquire reserves in the amounts described by the composition of the SDR. This means, assuming trade surpluses were constant, that they would have purchased between one-half and two-thirds the amount of dollars they actually did. The balance would have gone into euro, yen and sterling.

One likely consequence is that with less demand the dollar would have been weaker relative to the other three currencies then it has been. This would have cause a relative expansion in the tradable goods sector of the US, and a relative contraction in the tradable goods sector of Europe and Japan. With the expansion in the US tradable goods sector, and its positive impact on employment, the Federal Reserve would have kept interest rates a little higher, and US consumption would have been a little lower relative to GDP. Of course the exact opposite would happen in Europe.

Lower consumption means lower imports, and vice versa, in which case the US trade deficit would have been lower and the European and Japanese trade deficits higher by roughly the difference in the amount of dollar reserves purchased. By choosing to buy euros instead of dollars, in other words, Asian central banks would have forced a large part of the US trade deficit to migrate to Europe.

But could Europe have sustained a large trade deficit for any long period of time? For both political and economic reasons too complex to discuss here, it is reasonable to assume that Europe would not have been able to bear the burden of a substantially larger trade deficit. Most Asian policymakers know this.

That is why the US dollar is the world’s reserve currency, and most especially the reserve currency of Asian countries using foreign demand to boost domestic growth. In the distorted trade environment of the post-1997 world, the US was the only economy large and flexible enough to absorb the trade deficits that Asian countries required for their growth. US hegemonic power or deliberations had very little to do with it. Asia had to accumulate dollars if it wanted foreign demand to power domestic growth, and SDRs would have prevented this from happening. That is probably a good thing for the world, but a bad thing for China and Asia.

Doc,

Great comment.

The confusion is not just in the media. The article says "And last month, the administration declined to officially name China as a currency manipulator -- something that could have led to stiff new tariffs imposed on Chinese imports."

The administration refuses to admit that China manipulates its currency - so it won't have to take real action to stop this manipulation. Obama administration policy is apparently being run by the same people who have run it for many years - those who benefit directly from China trade. Clinton supposedly had some ideas about how the US had to be competitive internationally, but in practice winning this competition means money in the pockets of financiers rather than improvement for US workers.

Another great post, Dean.

The Chinese government has to buy the dollars from China's exporters at the pegged rate, because no one else in their right mind would pay 6.3 yuan for a US dollar, and if the exchange rate adjusted to a ratio at which private parties in their right minds would buy the dollars -- a rate reflecting the true relative buying power of the two currencies -- a great many of China's exporters would be out of business overnight, because in fact they have no true comparative advantage.

The Chinese currency peg makes a mockery of the economic concept of comparative advantage, and massively distorts the entire world economy.

The only thing forcing China's leaders to keep buying dollars (which they then have no place to invest except in US financial instruments) is their own basic dishonesty. What they are doing amounts, basically, to the most enormous vendor-financing fraud in world history.

"If China Stops "Manipulating" Its Currency It Will Stop Buying U.S. Treasuries"

I think this is backwards. Shouldn't it be: "If the US Wasn't 'Manipulating' Its Currency It Would Stop Selling U.S. Treasuries"?

Who's forcing the US to sell its bonds? No one. It's entirely the US' choice. It sells them because it wants to and needs to, and it sells them at the current rate because that is the current market value.

In the end, it's always the seller that sets the sale price, not the buyer. The seller can always, always walk away. Or if it feels that it could get a better price elsewhere, it would do so. Basic economics.

Let's face it, the US economy model is a big Ponzi scheme that depends on suckers like China to hold it together.

But, US already in the vicious cycle of buying its own bond, something that George Soros had proved to UK government years ago.

Money doesn’t grow on trees for most of America. We sit down at our kitchen tables and write out checks to the phone-company, electric company, credit card-company, mortgage-company, and auto finance company every month. We clip coupons and go to the grocery store every week to put food in the mouths of our children. This is what our parents did before us.

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Economic literacy at the WP truly is abysmal.

The other side of the coin is the use of export growth by the Chinese governement to keep the people satisfied, and thus maintain the power of the Communist Party.

I'm not suggesting anything conspiratorial, simply people wanting to maintain their power.

It will be interesting to see how the political and economic needs of China and the US interact over the next few decades.

The United States has been manipulating its currency for over 90 years. The main reason for the manipulation of all currencies is for the strongest manipulators in the world to have all the power that they can get and eventually there will be one currency and no one will have anything except those that are manipulating the currencies. All of the central banking systems start with the FEDERAL RESERVE and everyone needs to understand that there are certain people that run the FED besides the guy you see on the TV (the ultimate manipulator) Mr. Bernanke. They will get what they want from every man, woman, and child before it is all said and done. I think that the US is about to see what it is like to be 2nd instead of 1st in the world all because of our wonderful FEDERAL RESERVE.

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