A master plan for China to bail out America

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. For one thing, there is suspicion that the amount of toxic assets is considerably greater than the rescue plan provides for. For another, more money may be required to address the problem in the housing market by providing relief to subprime and marginal borrowers. And finally, further fiscal stimulus could become necessary if recessionary forces take hold.

Where will this additional money – perhaps as much as another $500bn – come from? The US taxpayer is wary. Joe Six-Pack has ponied up a lot already, and done so with no great confidence that the money was for a worthwhile cause or that it will be well spent.

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?


Originally published at FT and reproduced here with the author’s permission.

14 Responses to "A master plan for China to bail out America"

  1. Guest   October 8, 2008 at 3:18 pm

    I doubt that China would be willing to participate in such a plan.China is right now in a position to use its dollar reserves to scoop up, at fire sale prices, valuable assets being dumped by holders of cratering mortgage-backed securities. Whether such purchases are made in the dollar zone or the Eurozone or wherever, so long as those selling are doing so to get liquidity to pay down dollar-denominated debts, there will be no net negative effect upon the dollar.For example, if a European bank owns MBS and is trying to pay down short-term dollar indebtedness that it can no longer roll over, then if it sells euro-denominated assets to get liquidity, it will immediately convert the euros it receives to dollars to pay down its dollar-denominated debts.That means that China or other nations holding large dollar balances can take their dollars and convert them to euros in order to buy those assets, knowing that those euros will be converted right back into dollars by the distressed financial firms receiving them. This means that there will be no net downward effect upon the dollar while this process is occurring, and therefore no devaluation of China’s remaining dollar assets.Also, China is politically not the good buddy of the U.S. This crisis is not as distressing to them as one might think. They can come to own a lot of U.S. and European assets through the deleveraging process, as just described, and they can start to re-direct their own productive capacity toward building up a larger middle class in China itself.

  2. Guest   October 8, 2008 at 3:50 pm

    I would add that the comparison to the control-oriented, abusive lending programs of the IMF and World Bank is right on the mark. But that is describing what has already occurred. China has lent money to a corrupt U.S. regime that has squandered it on its cronies, creating a controlling level of indebtedness that undermines national sovereignty, just as the IMF lends to corrupt regimes that spend the money to build up internal systems of repression and control, while squandering the rest on an affluent lifestyle for themselves.That horse has already left the stable, and so I don’t think China would jump at the chance to tighten the reins further when they are already in the saddle. Now, they can directly own large chunks of the economy as the U.S. stumbles.While your IMF analogy is apt, you seem to have an overly sanguine view of what that model actually is. The IMF was never really about “social safety nets.” It was the economic leg of a system of political, military and economic control that replaced old-style Imperialism. And, like the IMF, U.S. creditors have absolutely no interest in “cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership.” Read John Pilger’s “Confessions of an Economic Hit-man” for additional insights on this topic.You should be careful what you wish for. Do you really want a U.S. under foreign control? From a foreign policy standpoint, I admit that this has its good aspects, because the U.S. Administration has been such a menace to the world. But every nation should have its own sovereignty, so far as its domestic policies are concerned, even the United States. And so we should no more wish vassalage upon the people of the U.S. than we should have allowed the U.S. to promote such serfdom in Latin America or other areas formerly under its influence.

  3. Guest   October 8, 2008 at 3:58 pm

    Oh, and as for “tied aid,” China has all the leverage it needs on the U.S. If it pulls out its investments now, the house of cards comes down. Similarly, capital flight was always a potent threat in the IMF’s economic serfdom model. Formal “IMF conditions” of austerity need not be spelled out in loan repayment agreements when you have that kind of power.

  4. Guest   October 8, 2008 at 4:18 pm

    Just checked out your bio, and see that you used to work for the IMF. I guess that explains your affinity for the IMF approaches. That is a vile model, sir, and I shudder to think of it being applied to the U.S. No matter how much poetic justice there might be in that, two wrongs do not make a right. There are absolute moral standards valuing respect for diversity, and cooperation between diverse parties. The model of hierarchical control has proven to be an exceptionally destructive one thus far, and if continued on its present global scale I fear that it will lead to the extinction of civilization, including its parasitic controlling elites.

  5. Anonymous   October 8, 2008 at 6:24 pm

    Surely you must be a mad man…..The world still needs a Superpower and it does not need a ball and chain on its ankle.

    • Phalanges   October 9, 2008 at 5:12 am

      Indeed. But what makes you think the US has by default the right to be the Superpower? Current events would indicate that the era of US hegemony is coming to a (rapid) end.

  6. Guest   October 8, 2008 at 7:04 pm

    Thank you for these wise comments.Were China to exercise such a role in the U.S. economy, they would hardly act to “cushion the impact on vulnerable homeowners, so that [we] would not be forced into forgoing the American dream…” Nor would China argue for “fairness.” Just the opposite would occur.As described in Gabriel Kolko’s “A Century of War,” China experienced tremendous depredation at the hands of the colonialists as well as their own leaders. Now, Western investors are pouring vast sums into China and we recognize that the 21st Century will become the “Chinese Century.” This is their time; they have waited centuries for this opportunity.Those who act now will “own the future” – technologically, economically, and politically. To protect their own future, and to return to their previous glory, they will not hold back for comfortable Americans or anyone else.Were they given a substantial influence over the U.S. economy, they would exercise that power exactly as the IMF does in its structural adjustment programs, i.e., they would compel the U.S. to redirect its economy in the interests of China – exactly as we did to all those poor African countries. The structural adjustment programs the IMF imposed on Africa removed any “social safety nets” so those countries would be at the mercy of Western entities, who took out the best and left the rest to fall into decay.In fact, having lived in the “rust belt” of America, I can tell you first hand what it is like when the money leaves and the protection ends. In the 1980s, I lived in Johnstown, Pennsylvania. It was once a prosperous manufacturing community. In 1970, the city had a population of about 60,000. In the 1980’s there was severe “demand destruction,” and at one point the unemployment rate was 24.6%. Clearly depression era levels. Nothing was being repaired. The population of Johnstown is now about 22,000 or 24,000 people. That’s what happens – the people leave and the infrastructure decays.For the sake of the American people, most of whom have nothing to do with the current financial crisis, I hope this will not happen again.

  7. Anti-nonesense   October 9, 2008 at 2:39 am

    This is absurd. You say that “The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government,” but do you really think this money is held in the form of dollar bills in a large piggy bank? In fact it is held in the form of obligations to the US government.In order for China to offer the money it would first have to take it away, which hardly seems like the kind of offer anyone would value very highly. At any rate as long as China insists on running a current and capital account surplus, it has no choice but to lend the money to the deficit country. Refusing to do so would wipe out its current and capital account surplus, which would be devastating for China.

  8. Sanjay Negi   October 9, 2008 at 3:09 am

    Since the excess 3.5 million homes were built mainly using foreign money including Chinese money(part of US national debt which percolated to housing eventually it would seem), the customers for these homes must also come from the same domain. This would extinguish all fires in one sweep. This surplus horribly unproductive asset inventory must be sold to the Japanese, Chinese, Russian, Gulf millionaires and sweetened with the prized US citizenship…The work in progress solutions have the demerit of borrowing from US(foreigners are already exhausted, though they may bite in small nibbles if rates are attractive) to channelize to housing lenders for the bailout. It is a zero sum game…someone will be deprived of liquidity besides the costs of servicing which can lead to a debt trap…else they will print money which is even worse…the dollar will collapse.Your solution is somewhat good in direction but needs to go much further. There is no use trying to prop up home ownership in US. The basic premise is flawed. The excess 3.5 million homes need to be removed from the market for American buyers and everything else will be OK. China can strike a deal with the US Administration to buy all foreclosed homes at fire sale prices and release them in the international markets at a vast profit. While the US and European economies will quickly recover, China’s exports will escape getting jeopardized, the Dollar imminent fall will get prevented and US will move further to becoming internationally cosmopolitan.

    • Anonymous   October 9, 2008 at 6:03 pm

      Would feel like great Irish migration in past.

      • Guest   October 9, 2008 at 6:04 pm

        US has done this a couple of Centuries ago.

  9. Anonymous   October 10, 2008 at 1:27 am

    Interesting to see that the IMF policies are really designed to destroy rather than rebuild a country’s financial system. This whole notion that somehow one can buyout their way with just money is flawed and none sense, the only way is to have cash and confidence by all participants in the system, otherwise any other rescue plan will fall on its face. Currently there seems to be no confidence no matter how much money is being pumped into the system, and that is why stock markets worldwide have not received any governmental intervening in the US and Europe very favorably since there is no confidence in the system.What you miss to indicate, is that China with all its cash reserves has a lot to lose if the world goes into a recession. Every year, China must create new jobs for 23 million new graduates from its Universities, a formidable task and extremely difficult to achieve in face of recessionary economies for its biggest customers in Japan, Europe and finally but not least important the USA. Even with slightest unrest in China for rising unemployment could be the straw that breaks the camel’s back for holding so many diverse different people together. Yugoslavia, USSR rings a bell?So China and India have a lot to lose, since these two economies heavily depend on exports for their economic growth, since their populations cannot feasibly consume all of their manufactured products nor can most of them afford such products. While 23 million might not seem a lot for 1 billion population, but it is still a huge burden on these governments to achieve and cannot be under estimated as a problem in the 21st century, where individuals have been exposed to better standards of living which everybody wishes to achieve. Depriving these 23 million people their rights to be successful and prosperous should not be taken lightly.So your analysis really lacks a lot of details and sounds more of a promise of current presidential candidates full of promises without details or transparency who would benefit or how it will be done. No wonder nothing works anymore.Anti_Morons ATA

  10. RJM   October 10, 2008 at 2:08 am

    This article is an embarrassment to its author. It presumes China has US dollars, which it doesn’t, and it presumes that a unified world solution cannot overcome the problem over time. The Chinese are enslavers of their own people, and try to achieve a domination that is not marked by a willing spirit of cooperation or through reciprocal trade.

  11. Anti_Morons   October 21, 2008 at 12:27 am

    Read this and you might see the writings on the wall, http://www.rgemonitor.com/asia-monitor/254091/the_great_crash_of_china . And yes,China does not have the currency in hand, it is` only in IOUs. We would not borrow if we had the money in the first place. But the problem in the US is this bad attitude to overspend or spend more than we earn is really a threat to our security. Enough lies, we need to be honest and take hard decisions to retain world leadership, otherwise we will lose it, because other countries are catching up. Anti_Morons ATA