A Stimulus Plan for China

The Chinese economy is slowing rapidly. The latest estimates show declines of several percent in official Chinese growth rates, which might be indicative of an actual recession. The Chinese government, like many around the world, is responding with a large economic stimulus plan. Official estimates are that the plan will cost roughly 14 percent of one year of China’s GDP, or well more than double the relative size of the proposed plan in the U.S. While some of the proposed stimulus spending may be worth doing anyway, the idea of a stimulus plan is to spend and build more than is worth doing in an economic slowdown. In the rush to stimulate the economy, there will surely be some waste and investments undertaken that in retrospect may be worthless.

The risk of this stimulus strategy for China is the same risk that the U.S. and European countries face: that the government spending and transfers do not get the economy moving and instead provide a drag on future growth as bloated government deficits and debt levels lead to lower spending or higher taxes in the future.  China has only to look across the sea at Japan for one of the world’s best examples of this terrible outcome.  But there is a much better way to stimulate the Chinese economy while perhaps even improving the governments’ fiscal position.

The main cause of the Chinese slowdown is reduced exports, primarily to the U.S., but also to much of Europe. And the primary cause of the global slowdown in demand is the U.S. financial crisis and deep recession which has the U.S. and global markets battered. So the most direct solution for China is to address the problem at its roots, in U.S. markets.

Now I do not propose that the Chinese government send out stimulus payments to U.S. households. Instead, we need to turn to the history of the crisis. Like serving alcohol to an alcoholic, the Chinese government provided cheap credit to the debt-hungry U.S., fueling its consumerism. The Chinese government did this by purchasing U.S. Treasury debt, and now holds about ¾ of a trillion dollars in Treasury debt, an amount increased by recent appreciation as global investors have sought out safe investments. Unwinding this position would significantly worsen the crisis, increasing interest rates in the U.S. and putting downward pressure on the dollar, both further slowing Chinese exports.

So my proposal is that the Chinese start to sell Treasuries and buy a broad index of U.S. equities. For China, this has several advantages. First, this would raise the U.S. stock market, and help to cheer up the American consumer while increasing Chinese exports. Second, if this “stock market stimulus” starts a rally or spreads to the confidence of global investors, there may well be a multiplier effect to the global economy, helping Chinese exports to much of the world.  Third, the yield on Treasury debt is very low, partly due to its convenience yield or liquidity. China does not need this liquidity, so why pay for it in terms of lower rates of return? Finally, the U.S. stock market is actually a pretty good buy right now – both Warren Buffet and myself have invested heavily based on the idea that returns will be strong just from the underlying dividends given such low prices.

Are there downsides or complications?  Yes, I see two. First, the Chinese would increase their exposure to some U.S. risks. While holding Treasury debt exposes them to inflation risk, holding equities means their government wealth declines when the U.S. does poorly, which is exactly when China might need money to prop up its economy in the face of falling exports.  Second, the U.S. could get nervous about the scale of foreign government control rights over its own corporations. This could probably be circumvented by buying index mutual funds, perhaps with special low fees, or worked out at high levels. On Saturday, Chinese President Hu and newly elected U.S. President Barack Obama spoke and reportedly discussed a coordinated response to the global slowdown. My advice to my new President is to try to sell President Hu some stocks.


Originally published at Everything Finance – Kellogg School’s Finance Department Blog and reproduced here with the author’s permission.

6 Responses to "A Stimulus Plan for China"

  1. Guest   February 19, 2009 at 10:26 am

    Sorry your analysis is pie in the sky theory. Under US national security regulation, Chinese purchases of US natural resources, high-tech, or transportation sector equity is prohibited. CNOOC purchase of Unocal was blocked by Congress. Recently Huawei purchase of 3COM was also blocked. A Hong Kong business group was prohibited from US port acquisitions.

  2. Guest   February 19, 2009 at 9:55 pm

    “The Chinese economy is slowing rapidly. ” is my favorite news–Tamper evident seals

  3. Anonymous   February 20, 2009 at 8:13 am

    “The Chinese economy is slowing rapidly. ” is my favorite news–Dare to explain what is the base of your thought like that?

  4. Joe the Plummer   February 20, 2009 at 9:48 am

    My favorite line in this is ‘China is in RECESSION!!!’. Wait a minute, China is still growing right? 5% growing rate would be exhilarating to most western countries, but it seems dooms day for China. Gime a break.There is a Chinese old saying: There is no endless party. Chinese people has been meditating that for tens of centuries. And they’ve also learned ‘No pains, no gains.’Here is what a normal Joe from China is thinking right now:The country has been growing fantastically for decades. There must be some low time following these high years. No biggie. Bring it on. It won’t be worse than twenty years ago, even ten years ago. Besides, during these fast growing years, there are many issues have been neglected. Maybe it’s time for us to slow down a little bit, release the stress in the system, and make every body enjoy the benefit. Not necessarily equally distributed, but everyone, who works their butts off, should have a share, big or small. Moreover, the commodity price is really dropping fast, maybe it’s good time for us to build some stuff, which would be very expensive one year ago or one year later.As for the suggestion of buying US stock market. Are you kidding? CIC bought BX, what happened? For the good of the stock and Chinese money, They’d say ‘No thanks, unless we can get deals as good as WB get, or allow to buy GE and Boeing.’ It might be better to leave it alone for the US to sort it out before to persuade other people to reinvest in. The reason of the Chinese government still buying US funds is simple: No short term better alternatives. The rest of the world is hecked up even worse. I guess that’s another reason of their plan of invest in infrastructure, like the ‘Buy America’, they ‘Invest China’.Here is my two cents for those economists who want to talk about China issues. Visit China once or twice every year, since things are changing really fast, and get to know some people there. It’s hard for me to believe the way US people consume, especially the way they treat their house like milking a cow, before I came here and know some people here. Learning Chinese would really helpful, but it’s kinda hard.With due all respect, I’d like to say ‘Thanks, but NO.’

  5. sportpic   February 20, 2009 at 10:54 am

    This suggestion is just another way to prop up US asset values so that our consumers can borrow against them and keep the US and world economy going. Rather than encouraging the US consumer to take on more debt shouldnt we be explaining to them that we have lived beyond our means for far too long and now must be willing to face an inevitable lower standard of living. Meanwhile, the Chinese should spur as much demand from their own consumers rather than continuing to rely on exports even if this means slower growth for some time. The impact to the Chinese worker could be somewhat softened by cheaper prices (especially on food and energy) through a rising Yuan, higher interest rates paid on their savings, increased FDI and an enormous stimulus package in productive investments. They should also encourage more imports which would help the rest of the world and would eventually come back through exports because of the Chinese competitive advantage.

  6. Guest   February 23, 2009 at 11:33 am

    re: “5% growing rate would be exhilarating to most western countries, but it seems dooms day for China. Gime a break.”The reason it is different is western countries are already rich, and their growth is off a high base. China is poor and so is coming off a low base. The Chinese government has previously stated that growth of around 8% is needed simply to provide jobs for the many people entering the labour market each year. Strict comparison of percentage figures is incredibly simplistic and results in an inaccurate perception of the situation.In respect of Chinese, it’s easier to learn than English, with particularly simple grammar and pronunciation. The problem is most people will never bother when English is the world language.