A Balance of Financial Terror

By January 10, 2008Trade

A fascinating article in the latest issue of The Atlantic (Jan/Feb 2008) about China by the inimitable James Fallows sheds abundant light on our mutually dependent relationship with that country, “The $1.4 Trillion Question.” We buy their under-priced manufacture goods by the boatload enabling them to shift seas of people from farms to cities. They flood our country with low cost goods and, more importantly, accumulate a $1 billion a day worth of our bonds and currency, enabling us to live beyond our means year after year without explosive inflation.

But of course this devil’s bargain exacts a price. Millions of U.S. manufacturing jobs are lost; U.S. politicians come to believe endless deficit spending is acceptable; China accumulates enough U.S. money and bonds to disrupt world markets; and the Chinese do not get to use the wealth they have earned – either through decent living standards, medical care, or basic environmental protection.

The big question looms – what happens if a political crisis should rupture this cozy arrangement. Without access to the U.S. market, China’s factories would sputter to a halt. Without China’s $1 billion daily loan, the U.S. could not keep its economy stable or forestall the dollar’s collapse (which would also wipe out a major part of the value of Chinese foreign currency reserves).

Fallows says Lawrence Summers, former U.S. Treasury Secretary and President of Harvard, compared this to our cold war standoff with the Soviet Union in which each side could not dare launch a nuclear attack on the other for fear of retaliation. Summers calls it “the balance of financial terror.”

Sleep better everyone.

[Fallows also blogs about the issue here, implying it might be a worthy topic for discussion by the presidential candidates.]

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