Beyond Rebalancing: The collapse of Chimerica

Alejandro Nadal

In 2006 Niall Ferguson and Moritz Schularick invented the term ‘Chimerica’ to illustrate the economic linkages that connected China and the United States. The new term summarized the fact that the world economic order was dominated by the combination of these two giants. Ferguson and Schularick also used the notion to explain the evolution of the asset price bubble in the US between 2002-2006. Their conclusion was that this new entity was an unsustainable chimera that should one day disappear. The time for this may be here.

In 1978 China started implementing the reforms that were to transform it into a market-based mixed economy. In the eighties, the leadership in Beijing decided that export led growth would be required to rapidly improve living standards of China’s population. Opening the economy to foreign direct investment became a priority. Rapid growth of the export platform since 1980 led to high current account surpluses. In order to avoid the appreciation of its currency, China bought US dollars and ended up building huge reserves in US dollar denominated assets (approximately half in US treasuries).

Of course, the other side of this coin shows China’s main trading partner carrying the burden of a chronic deficit in its trade balance. So when the present crisis exploded, it was no surprise that Chinese worries emerged about the health of the US dollar (and the value of Chinese reserves). After all, China has amassed reserves of more than 2.6 trillion USD.

As the crisis unfolded, protectionist pressures appeared. The debate has centered on the undervaluation of the renminbi as the key source of international competitiveness for China’s exports in the global marketplace. Evidence of this is abundant. It is widely believed that the renminbi is 30%-40% undervalued vis-à-vis the US dollar. An analysis comparing the renminbi against a basket of currencies arrived at a similar conclusion.

Not everyone agrees. The US-China Chamber of Commerce thinks an undervalued renminbi is not the source of the US trade deficit. It blames the dismal trade performance of the US on lack of exports from the high-tech sectors due to security concerns. The USCCC has been very vocal in fighting the surge of protectionist measures because many of its members are US firms that have transferred their activities to China. In fact, there has always been good evidence that US direct investment in China’s exporting industries is closely correlated with the American trade deficit. This explains why talk about applying tariff surcharges on Chinese exports is frequently met with skepticism.

One can venture the following hypothesis. During the seventies, the secular drop in the profit rate continued in the US economy. Corporations felt extra pressure to lower labor costs, so they looked at China’s immense labor force. They started to move operations to China in the late eighties, but this process intensified in the nineties. Interestingly, profit rates increased in the period 1983-2002. Exporting jobs to China may have been behind this evolution of the profit rate. If this is so, it means there are strong corporate interests in the survival of Chimerica. Research is of course needed to validate this point.

As Chimerica unravels China has three options. First, it can try to maintain the status quo. But this is going to be difficult. The US household sector has been hit and will not return any time soon to its previous role of consumer of last resort. This is not a viable option.

Second, it can engage in a process of meaningful revaluation of its currency, something Germany and Japan carried out with success. Beijing is concerned that a fall in exports might lead to slower growth, unemployment and even political instability. But this could be avoided with a different policy package, and China could stop unloading its unemployment problems on the rest of the world.

Third, China may try to diversify its assets. China knows the euro is far from being able to perform as a viable international currency. But it will probably continue developing alliances with emerging markets, negotiating swap agreements. In the meantime, it will intensify its purchases of large commodity producing assets such as oilfields and mines. But this doesn’t really address the undervaluation issue. What it really needs to do is to develop its domestic market and engage in meaningful reductions in inequality. The US needs to understand the time for a new international monetary order has arrived.

Comments are closed.