A Plan for China to Bail Out the US

This proposal by Arvind Subramanian in the Financial Times makes quite a lot of sense, but given the collective denial in the US about how bad things are (despite the cratering of the markets, neither Presidential candidate was willing to say the economy would get worse, when that is a given) and our dependence on China. And by the time we might be ready to ask for help, it will probably be too late. Americans are too wedded to the idea of our superiority, wrapped in the only slightly less offensive packaging of “exceptionalism” to realize that our economic crisis will lead to a permanently diminished standing.

I am not in agreement with the focus on helping homeowners in the proposed plan (I agree with the idea of extended social safety nets, particularly since that money will be spent, providing a cost-effective boost), but directionally, the idea has merit.

From the Financial Times:

The financial rescue plan passed by the US Congress is viewed as flawed but necessary to head off panic in financial markets and loss of confidence in the economy. It seems a holding operation, a Plan C or D that might need augmentation via a Plan A.

A vital component of a Plan A is likely to be additional money,,,

Where will this additional money – perhaps as much as another $500bn – come from? …

Enter China. Ken Rogoff of Harvard cheekily characterised the vast Chinese accumulation of US Treasury bonds over the past five years as the biggest foreign assistance programme in history. Why not push that further? Here is a thought experiment.

The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector. Its previous assistance – buying US bonds – was indirect and unconditional. Not so in this case.

China’s loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of western donors since the postwar period, would now be embraced by China.

What would be the nature of the strings – or “conditionality” as the US Treasury, a longtime practitioner of this art, has called it? Conditionality as imposed by the World Bank and International Monetary Fund was underpinned by an ideology that favoured markets and globalisation. But there was also an assumption that either borrowing third world governments did not understand their benefits or the reformers there needed a “spoonful of sugar” to help overcome any internal opposition.

China would impose two conditions. First, it would declare that the offer of money was conditional on the US government’s adopting a particular approach to rescuing the banks, namely to favour in the next round the use of government money to recapitalise the banks. Europe has been using this approach and evidence suggests it is the most effective way of dealing with large-scale financial crises.

The US government – like third world governments in the past – has been unable to adopt the most efficient course of action. This stems from an ideological obsession against “socialising” banks or because inducement is necessary to overcome any domestic opposition to it.

The second condition would relate to “social safety nets”, which had become standard embellishments to World Bank/IMF adjustment programmes. China would stipulate that monies be devoted to cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership. Chinese conditionality on this front would achieve an outcome that several economists on the left and right have argued for on grounds of fairness, and also to address the fundamental problem in the housing market.

For China, this offer of help would have three virtues. First, it would be riding to the rescue of a situation partly created by its own policies of undervalued exchange rates, which led to lax global liquidity conditions. Second, its economic interest would be served because successful US efforts at rescuing its financial sector could help avert an economic downturn, protecting China’s exports, its growth engine.

Perhaps most important, it would seal China’s status as a responsible superpower willing to deploy its economic resources for the sake of protecting the world economy. And if the means for achieving that are by providing the current hegemon with the largest aid package the world has ever seen with a healthy dose of sensible conditionality, well, what could be more statesmanlike than that?

7 Responses to "A Plan for China to Bail Out the US"

  1. Jalex   October 8, 2008 at 9:12 am

    Wait a minute. Let me get this right:a structural adjustment programme (SAP) imposed by the South to the North (i.e. by the East to the West). What a difference a decade makes.

  2. Leoncio K   October 8, 2008 at 11:25 am

    Great idea! But I have a good question. What shoud be more difficult, convicing China or US about this rescue?Ok, we have had a good example when Russia, another big US’s rival, send a loan to Iceland. But… US, let me thing better. And waht about the Taiwan’s weapons question? And the chinese help to Sudan and Iran? Hummm…

  3. Wilson   October 8, 2008 at 11:45 am

    As an economist also, I agree the mentioned above is correct statement giving the interlinked economic interest by both parties(nations). Having said that, there are two problems complicated by politicians. One of the problem you have already stated in the beginning of the essay.The second one: On face value by president Bush, US having been supportive to one China policy. But this week US have decided to sell US$6bn plus amount of advanced military weapons ( the propaganda way to say it would be “mass weapon of destructions” )to Taiwan. This annual recurrent back stabbing is quite annoying to Chinese leaders( the propaganda way would be “communist Chinese leaders” with a negative connotation. Give me a break, it really is a market economy for 20 years already. )The overall US policy has been complicated by politicians in three sectors. A) Politicians who look out for the overall total sum of the US economy supporting free trade. B) Politicians looking out for a specific sector in the economy for protectionism. C) Politicians whose goal is a balanced of power in the world or the goal of having US stay in dominance power on purposely or indirectly (will not get into the details).2.By arrogant medias. Artile title: China and Wal-Mart Stores Inc. should take the blame for the U.S. bond market’s recent woes Jun 17th 2007By Gertrude-Chavez-Dreyfusshttp://www.reuters.com/article/InvestmentOutlook07/idUSN1219064220070612The funny thing is that while the average American Newspaper would make fun that everything in the American Home is made in China, (With obvious negative connotation)if one would buy him/herself a round trip economy class ticket to visit China, one would see Macdonal’s, KFC, Pizza Hut, Burger King, Dan Ryan’s, on every street corner. Then in every major supermarket, one finds 1) tooth brush branded Colgate or Johnson and Johnson or Oral B 2) Soft drinks all being Coca Cola, Pepsi, Seven Up, Sprite and What not. 3) In Hong Kong, everywhere you see Citibank, Bank of America, JP Morgan, Goldman Sachs and what not.The difference is that 1) while the product of US good is produced in China, the profits are all sent back to NYSE or Dow Jones, but not counted as an “export”.2) the average media do not make negative connotations to the phenomenon of having all these American goods in China.This to a certain extent has to do with what the author of the above article expressed ” wedded to the idea of our superiority”.Having been a student studying in the states ( note undergradute school the foreign cannot get scholarship and apy full tuition, in a sense the system work in a way such that foreign students in undergraduate school subsidies partial of the tuition fee paid in form of scholarship to the fellow US classmate),”the idea of our superiority” is less so in West coast and East Coast because of culture and more inter exchanges with the world, but much higher for the Mid West ( where Bush is from).Economics, politics and respect have always been interlinked ever since the beginning of the most primitive form nations.The conclusion of the statement here is that one agree with the direction of the author, but since economics are unfortunaely also much influenced by “politics and respect”complication of the politicians often lead to unwanted results.

  4. leoncio K   October 8, 2008 at 12:31 pm

    Ooops, have I to change my mind? I read few minutus ago some interesting (and warning aswell headlines: 1) –US treasury sells US$ 20 bi in notes; 2) –treasuries’s sell was unexpected and press the markets; 3) –5 years and 10 years t-note rates strongly up after treasury’s sell.Perhaps I will have to agree with Yves proposal… Welcome chinese money, but hurry up!!!!!!

  5. Guest   October 8, 2008 at 9:27 pm

    Interesting idea on purely economic terms. But impossible to ignore the political and idealogical implications. The idea of US government bailout was unpopular by 100-200 to 1. Imagine bringing this idea up. “We are borrowing $500 billion from China and they have dictated the following terms……………” This has less chance of happening than Barney Franks getting caught with a female hooker.

  6. Guest   October 9, 2008 at 12:24 am

    Also, please remember that Chinese owned financial institutions had NPL ratios of nearly 50% in 2000. It was a confluence of a host of structural factors that gave them such a windfall fx reserve. I wouldn’t trust China with owning so many banks.

  7. 3.1415   October 10, 2008 at 10:50 am

    There is no sign that China will do such a thing. Justin Lin, China’s top guy at the World Bank, said in an interview with a Chinese newspaper that China will have to increase its internal demands when the export-driven economy is significantly affected by the global financial crisis. Since China is mostly exporting cheap stuff that you need to use everyday, it is uncertain how bad the financial crisis will hurt China’s export economy. People still need to buy underwares in Walmart. China will not stop buying US treasuries, but that’s about it. And it is not for saving the US. China still needs to buy the US fiat to keep the RMB low.The conditionalities proposed by Subramanian sound really strange to this Chinese poster. Why would the Chinese want those things? Here is a short list of things that China wants:(1) Stop selling weapons to Taiwan, which is part of China as US always agrees. What would the US react if China sells weapons to some secessionists in Hawaii or Vermont? China has always promised not to invade Taiwan if it does not seek independence.(2) Stop the aggressive military buildup against China. The US is now deploying so much military forces against China as if it is going to war at moment’s notice.(3) Let China buy US companies or properties to the same degree that China lets US buy hers. You show me yours and I will show you mine, if both parties really want to do business.The principle is very simple: What oneself does not desire, do not impose on others, according to Confucius. Or Quid Pro Quo according to Western utilitarianism. As for winning the good will of the American people, it is highly overrated considering that the US Government, which represents the collective good will of American people, has done all the things that China does not desire. A democratically elected government is only as good as the people it represents. The track record of the American government in terms of the atrocities it committed on foreign soils makes one wonder whether it is doublespeak to talk about “good will of the American people”.In a land that believes “War is peace”, debt must be wealth.