China and the US Common Interest in Funding Fiscal Stimulusby Adam S. Posen | February 23rd, 2009 | 09:25 am
Yesterday, Secretary of State Hillary Clinton told a Chinese television audience that they and their government are "making a very smart decision by continuing to invest in Treasury bonds." Legitimate point. It is true, President Obama’ s package to rescue the economy, including the stimulus plan and one hopes capital injections to the banks, will require large deficits, in the trillions of dollars. And some of the money will be lent by China.
But, ultimately, the money comes from US taxpayers in the future. That can be some of the US households borrowing against their future earnings when times will be better, or some shifting of burdens to their children. In the short-term, the cash may come from surplus countries (not just China, but Japan, Germany, et al.) or from crowding out private investment funds in the US, given the available short-term cash. But in the end, the money is from future US tax payments, since whoever provides the cash will be paid back with interest.
There is no conflict here with China deciding to spend at home, despite the apparent diversion that would mean from investing in US treasuries. It would be a good thing if surplus countries such as China invested more in their domestic economies. Then their wages, productivity, consumption, and currencies would rise, and global imbalances would be reduced. The US government would then face slightly higher interest rates at present, in order to attract the needed cash from other sources, but in the near future would be able to export more to those surplus economies. This is why I am a big supporter of the Chinese government’s stimulus plan, including the increased expenditures on health insurance for the Chinese people. And this is also why no Obama administration official including Secretary Clinton sees any conflict or threat from the Chinese (or Japanese or German) government spending more at home. They encourage it, in fact.
Yes, the US federal government deficit will be huge for the next 2-3 years, around 9-10 percent of GDP. If it stops being so huge when the economy recovers, and the expansion of spending and tax cuts are only temporary, I am not too worried about it. The US net debt to GDP level will still not be too high even after this (around 70 percent of GDP or less). There will of course be some costs to do doing so much borrowing. Interest rates will go up on average, leading to less private investment at the margin, and we will not be able to do such massive emergency spending again if we do not pay down the debt when times are better. But as an emergency measure, the negative impact will not be all that great and will be outweighed by the benefits.
That said, I think there is a need for some global coordination on fiscal stimulus. It is a good moment for China and the US to show joint leadership, because our two governments are leading the world in the area of sizable and sensible stimulus policies. Other countries, particularly other surplus countries like Malaysia or Germany, should be called upon to do their share. That will make the stimulus more effective. It also will help to reduce protectionist pressures against free trade. If people in the US and China think that other countries are free-riding on our respective stimulus packages, by exporting to us both without stimulating their own home economies (and thus importing, too), it will be harder to stop resentment and then bad trade politics. The way to coordinate is through the G-20 in April, publicly providing a list of how much real stimulus each country is doing, controlling carefully for what is new money that will be spent soon versus old or future plans, on a consistent basis. Then the G-20 can shame those countries not doing their parts.