Army Post Road

     Fed Chairman Ben Bernanke wants China to do more to help strengthen our economy. They need to save less and consume more. SPEND SPEND SPEND! MORE MORE MORE! Below is Professor, and former Chairman of the Council of Economic Advisors, Greg Mankiw’s take on the situation:

Bernanke to China: Stop Saving
Ben Bernanke says the Chinese should stop saving so much:

Today, about half of China’s GDP is devoted to investment and to producing net exports for the rest of the world, and thus only the remaining half is available for consumption, including government consumption. In particular, household consumption in China last year was only 38 percent of GDP, down from 45 percent in 2001. In comparison, household consumption was about 60 percent of GDP in India in 2004, according to the most recent available data. China’s low share of consumption in GDP is, of course, the counterpart of its high national saving rate.

Policies aimed at increasing household consumption would clearly benefit the Chinese people, notably by improving standards of living and allowing the fruits of economic development to be shared more widely. Such policies, by reducing saving and increasing imports, would also serve to reduce China’s current account and trade surpluses.

The positive economics here is impeccable, but the normative economics is open to debate.

If a friend of yours is saving a high fraction of his income, how can you tell him he is saving too much without knowing his personal rate of time preference and his desire for precautionary savings? Judging another person’s saving rate is difficult. Judging another nation’s saving rate cannot be any easier.

     Yes, it’s true that China lessening it’s savings rate and strengthening it’s currency would help us. A lot possibly. But is it really reasonable for us to expect the Chinese to weaken these advantages they have for us? Especially on the savings rate. If you had become determined to save fully a quarter of your income and keep it in a savings account at the bank down the street, would you find it very reasonable if the hardware store owner whose store was between your house and the bank cajoled you as you walked by about buying more tools and saving less just to help prop up his business?

     What we do need to do is make consumption of American goods by the Chines more appealing than whatever investment vehicles they’re choosing. Open more American store fronts in China. Build Wal-Marts and McDonalds and KFCs and Home Depots in every size market we’d build one here. But even that is a double-edged sword for us. One of the favorite savings tools the Chinese have is American Treasury bills, notes, and bonds. If the Chinese did decide to start spending more and saving less, there is no doubt at all our interest rates would rise. Probably a lot. There’s also a certain lack of coherence to the “buy more of our stuff but strengthen the yuan” argument. If Chinese demand for American goods goes up, in turn Chinese demand for American dollars will go up and the yuan will likewise weaken. There is no way we can manipulate the situation 100% to our advantage. It’s the classic problem with economists: there’s always something on the other hand. We want them to buy more of our goods but on the other hand that will likely lessen their demand for our bonds and drive up our interest rates. We want them to strengthen their currency but on the other hand we want them to buy more of our goods and thus drive up the demand for our currency and thus, weaken theirs.

     We aren’t going about financial, commercial, and economic relations with China in a very coherent manner. We need to come up with a better plan.