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Market Turmoil Highlights China’s Impact on U.S. Economy

January 23, 2008 at 6:20 PM EDT
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Global stocks largely rebounded on Tuesday after concerns over a weakened U.S. economy sent international markets tumbling. Jim Fallows of the Atlantic Monthly discusses how China's lending and asset buying impact the U.S. markets and economic stability.

JIM LEHRER: Now, the China angle to the world markets story, and to Jeffrey Brown.

JEFFREY BROWN: For the past year-and-a-half, James Fallows has been living in China and reporting on the vast economic and social changes there for the Atlantic magazine. His latest article, titled “The $1.4 Trillion Question,” looks at China’s increasing ties to U.S. financial markets.

Jim Fallows is back home for a visit and joins us now.


JAMES FALLOWS, Reporter, The Atlantic: Thank you very much.

JEFFREY BROWN: And it’s quite a week to be here.

JAMES FALLOWS: It certainly is.

JEFFREY BROWN: How does what we’ve been seeing this week, all that volatility, look to the Chinese? What do they see?

JAMES FALLOWS: Well, of course, I’ve been away for four days now so my impressions may be out of date, but I think it’s a very interesting change of mood for the Chinese.

You know, China has terrible economic problems, as everybody knows. It has rich and poor; it has pollution problems. But there’s been a very striking economic confidence, at least during the year-and-a-half I’ve been there.

The stock market has gone up and up and up. I think the Shanghai Exchange almost tripled in value during the time I was there. And so there’s been a sense that everything could be managed in a positive way.

And time and again, I heard people say, “Oh, yes, the stock market will keep going up all this year because of the Olympics or because it’s a lucky year or whatever.” So they have suddenly this experience with real financial markets and their ups and downs. I think there’s a certain loss of innocence for the Chinese.

China feels pull of U.S. ties

JEFFREY BROWN: Does it feel new to them? I mean, they're realizing how tied they are to these global markets.

JAMES FALLOWS: Yes, there had been a lot of discussion in the Chinese press over the last year of so-called decoupling. America could have its problems; it could talk about its subprime crisis. But the Chinese investors thought they had so much momentum and they'd been careful enough in where they put their money that somehow this wouldn't spread and affect them. So it is, again, this loss of innocence.

JEFFREY BROWN: This goes to your article, of course. I mean, explain in what ways they are tied, for example, to a subprime crisis here. Why do they feel it?

JAMES FALLOWS: Well, there is kind of the immediate tie, which a lot of their investment vehicles, especially the People's Bank of China, now has probably $5 billion, I think is the latest exposure, the latest estimate of their exposure to subprime loans. That's not a lot by American standards, but it's a lot more than they thought they had.

In a larger sense, the mystery I tried to explain in this article is, why is it that a country which is still on average so poor, where public schools have no heat, where people live in these kind of very impoverished circumstances, and you see, you know, people pulling ox carts along the street with their human power, why these people are sending Americans $1 billion every day in money for us to use, borrowing from them?

I had a statistic that, on average, every American owes somebody in China about $4,000.

JEFFREY BROWN: All right, let's explain that. You call this "The $1.4 Trillion Question." You just told me before we started it's up to $1.53 trillion.


JEFFREY BROWN: What does that amount of money represent?

JAMES FALLOWS: This is essentially China's accumulated trade surpluses really over the last five or six years, that, as we all know, China has a trade surplus with the U.S. They sell more stuff to us than we buy back. And the question is, what happens with those dollars?

JEFFREY BROWN: The dollars that we send their way, what do they do with them?

JAMES FALLOWS: The dollar that you give to Wal-Mart and it makes its way to some kind of supplier in the south of China -- I have a little voyage of a dollar story in there.

And, essentially, what happens is the Chinese government, instead of doing what other governments would do, which is spending it internally on things that its people need or just exchanging it for other currency, it basically has been lending a lot of it back to the U.S., especially in treasury notes and the U.S. stock market.

It's kept American asset prices much higher than they would otherwise be and American interest rates lower, but so they have been subsidizing us in kind of an invisible way for much of the last decade.

Balancing swift growth

JEFFREY BROWN: You give an example of a recent investment in the Blackstone Group, for example, which did not go well.

JAMES FALLOWS: Indeed. I think the Blackstone may be about the best-known company, the best-known American company in China right now, in a negative way, because a new China investment corporation, which has several billion dollars -- you know, hundreds of billions of dollars -- that it's investing in the U.S., this was its first big bet. And it went bad. And this has been discussed a lot in China.

JEFFREY BROWN: So what's the answer? Why are they plowing all those dollars back to our markets or investments in U.S. companies?

JAMES FALLOWS: Well, it's because the Chinese government -- you know, all governments try to resolve conflicting pressures. The main conflict the Chinese government is trying to resolve is this one.

On the one hand, they don't want the value of their currency to go up too high, because they want to keep their factories going as, you know, as full-bore as they can. They want to keep having jobs for these people pouring out of the countryside.

In the countryside, they make $100 a year, let's say. In the factories, they make $100 a month. And so it's a big improvement.

So by keeping the value of their currency relatively low, they can keep that export going. On the other hand, so to do that they have a variety of controls that they impose.

They want to keep -- they essentially keep their interest rates low to keep the value of their currency down. On the other hand, they're worried about having too much inflation internally. You know, they want to keep people employed, but not have too much inflation.

I described in the article the fine line between historically very rapid growth and disastrously inflationary growth. That's the line they're trying to walk right along. And so the main way they do this is try to park the extra spending power back in the U.S., rather than using it internally.

JEFFREY BROWN: And the impact, you're saying, for us, for Americans, has been very positive.

JAMES FALLOWS: It has been -- we simply live a lot better than we otherwise would. And, again, I quote Larry Summers, former treasury secretary and president of Harvard, as saying it is, from a distance, very strange, indeed more than strange, that a poor, young, dynamic country should be shipping to a rich, older, more established country about $1 billion every single day that they could use, but we are using.

And so in almost every way that affects Americans, we have been living better because of the money that's sent to us.

JEFFREY BROWN: Because I remember talking to you back in the late '80s, when you were reporting on Japan, and then we were worried about Japan buying America. This is different?

JAMES FALLOWS: It is quite different. It's different, because, in a way, the Chinese have learned from what happened with the Japanese. There are new investment corporations studying carefully the role of other sort of sovereign wealth funds in the Japanese example, too.

And they know the Japanese encountered severe backlash, because the Japanese were buying trophy properties. They were buying Rockefeller Center. They were buying Pebble Beach Golf Course. Those investments didn't turn out so well, but they created a lot of backlash in the U.S.

So the Chinese are trying to do it as sort of quietly as they can, putting in treasury notes, being the second or third investor in an organization. When they went into Blackstone, even though so far it's now losing investment, they tried to buy only non-voting shares and only a small share of it, because they wanted to sort of soft pedal their way.

U.S. and China depend on each other

JEFFREY BROWN: Well, one of the key points now that I take from your article now is that you're saying that the average Chinese citizen is beginning to realize what's going on and realizing that they may not be getting all the benefits of the trade imbalance.

JAMES FALLOWS: Well, you know, the Blackstone investment has caused a lot of discussion inside Chinese. It's been mainly at elite levels. You don't find peasants out in the countryside saying, "Oh, this Blackstone, they've taken our money. Our latest harvest went to Blackstone."

But university students and people in the cities do know about this. And so the question is, is it somehow, have we been giving the Americans even more money just to amuse themselves with? Have we been getting big paydays for these CEOs?

Although, interestingly, I think the main tension inside China, as the markets have been volatile, is against their own government, because there's the assumption that the government will be able to provide for people.

JEFFREY BROWN: Is there a growing sense of their economic and financial power, vis-a-vis the U.S., because of these dollars that they control?

JAMES FALLOWS: There is some of that, but I think interestingly less than Americans would assume. We often talk about China as the rising superpower, and we talk about their leverage, and they have an x, and y, and z role.

I think there's much more internal focus inside China. And I think fewer people talk about the leverage they might have over the U.S. than we seem to discuss here, which is interesting to me.

JEFFREY BROWN: How much danger is there discussed there -- or you talk to people back here -- of them stopping investing all those dollars? And what impact would it have on our markets?

JAMES FALLOWS: There's an interesting analogy to the situation of the Cold War. Again, I quoted Larry Summers as saying, "During the Cold War, we had a balance of terror between the U.S. and the Soviet Union, where neither side would attack the others with nuclear weapons because of the certainty that both sides would be destroyed."

There's something a little bit similar now with the financial balance. You know, China has been financing us to an extraordinary degree over the last decade. It would hurt them to stop doing that, because so much of their wealth is held in dollars.

If they pulled it out and ran down the dollar very dramatically, they would be hurt. Their assets would evaporate. But so the question is -- this is a bargain that works out well, as long as both sides believe in it, but it's fundamentally unstable, if there's some kind of shock.

JEFFREY BROWN: You mean they rely on us, obviously. I mean, they rely on our economic growth to buy their products.

JAMES FALLOWS: Sure, we're their main customers. And I think six months ago, if you'd asked people in China, they could say, "Well, the U.S. might struggle and suffer, but still we'll be fine," because, on the whole, they sell more collectively to Europe than they do to the U.S. now.

But I think the turmoil of the last month has brought home to China again the fact that there is this kind of mutual vulnerability. The American market fluctuations can affect them, too.

Chinese people drawn to investment

JEFFREY BROWN: How much do you feel this among average people, to the extent you're able to get around? I mean, even on last night's program, when we were talking about the volatility in the markets, and I interviewed a couple of investment advisers, because so many Americans are in the market through 401(k)s, is there something analogous to that, or is there a growing sense of being part of this global market?

JAMES FALLOWS: Well, there's a growing sense of being part of financial markets. And it was remarkable.

During the last year, when my wife and I were living in Shanghai, where little investment -- sort of investment parlors were opening up every place. And you'd see these people bringing in their handfuls of dirty money and money they'd brought literally out of the mattress, and putting their shares in the China telecom or the China whatever the bank was.

And so there's been a huge surge in the number of small Chinese people who borrowed money even to put it in the stock market. So I think there's a lot of pain right now by just unsophisticated, small investors who thought this was the way to get rich very quickly.

JEFFREY BROWN: Right, well, that's my last question here. I mean, back to the turmoil. For them, this is the first time, the first experience of that?

JAMES FALLOWS: It certainly is. I mean, Chinese people in general are very shrewd commercial people, but there's not been really real exposure to financial markets of the kind that we've been used to over the shocks of the last 20 or 25 years.

So I think this -- we'll see how this awakening and this introduction sets into China now.

JEFFREY BROWN: All right, James Fallows of the Atlantic magazine, thanks.