1050 Implications of the Hong Kong Protests

Implications of the Hong Kong Protests

Newsletter published on September 3, 2019

(1) Implications of the Hong Kong Protests
(2) China justifies Theft of Trade Secrets as Payback for
Western/Japanese imperialism
(3) NSA Chief: Cybercrime constitutes the "greatest transfer of wealth
in history"
(4) Middle Eastern governments turn to China for energy, economic
relations & defense
(5) Pettis: US should tax Chinese capital inflows; US savings rate is
low because it has to absorb so much foreign capital

(1) Implications of the Hong Kong Protests
- by Peter Myers, September 2, 2019

The Protests in Hong Kong have already had many unforeseen effects.

There has been an upsurge in emigration from Hong Kong to Taiwan. And in
applications for "millionaire" visas giving Permanent Residence in
Australia (yes, our beneficient rulers sell Citizenship).

Sydney, which was white when I grew up in the 1950s & 60s, is now an
Asian city, with large populations of Chinese, Koreans and Arabs.
Indians are on the make too.

One can expect that many Hong Kongers plan to migrate here one day.

There's a big Buddhist Temple near Port Kembla, south of Sydney - Nan
Tien Temple, as I recall. Quite beautiful and peaceful. A Vietnamese
Buddhist told me that it was built by Taiwanese. "They will go there if
there's a war," she said.

Taiwanese are watching the Hong Kong situation very closely. The
Protests have already had a big impact on the "One Country, Two Systems"
doctrine. Basically, no one believes it any more.

The likelihood of China peacefully regaining Taiwan is now zilch.

Another effect of the Protests is that Hong Kong is losing its position
as a Financial Centre and Gateway to China. It will be replaced by
Shenzen and Shanghai.

Hong Kongers will thus lose many lucrative jobs.

Many reports say that a small number of oligarchs own most of the
apartment blocks in Hong Kong, and are squeezing the people with high
rents and high real estate prices. These oligarchs are cutting their own
throats; their exploitation is the unseen reason for the Protests.

(2) China justifies Theft of Trade Secrets as Payback for
Western/Japanese imperialism

https://www.foreignaffairs.com/articles/china/2019-08-27/chinas-long-march-technological-supremacy

China’s Long March to Technological Supremacy

The Roots of Xi Jinping’s Ambition to "Catch Up and Surpass"

By Julian Baird Gewirtz August 27, 2019

Aly Song/REUTERS

Until recently, American perceptions of Chinese technology tended to be
either hopeful or dismissive. On the hopeful side, the information
revolution was taken as a sure drive of greater freedom. "Imagine if the
Internet took hold in China," George W. Bush said in a presidential
debate in 1999. "Imagine how freedom would spread." Some observers noted
considerable theft and imitation of U.S. technology firms, but Chinese
technology was generally thought to represent little or no competitive
threat, with analysts explaining—as a 2014 Harvard Business Review
headline put it—"why China can’t innovate."

But China has quickly moved up the value chain, creating world-class
industries in everything from 5G and artificial intelligence to
biotechnology and quantum computing. Some experts now believe that China
could unseat the United States as the world’s leading technological
force. And many U.S. policymakers view that prospect as an existential
threat to U.S. economic and military power. "Very dangerous," President
Donald Trump said recently when talking about the Chinese
telecommunications company Huawei; National Security Adviser John Bolton
has warned of a "Manchurian chip."

Yet if China’s rapid technological advance came as a shock to most
observers in the United States, for Chinese leaders it reflects a drive
that dates to the origins of the People’s Republic. President Xi Jinping
has described a formidable objective for Chinese tech: "catch up and
surpass." But that ambition, abbreviated as ganchao in Chinese, has long
been one of the Chinese Communist Party’s defining goals; it remains the
essential framework for understanding China’s ambition to become a
technological superpower today, bringing together the legacies of
Marxism, Maoism, and the tortuous pursuit of modernization by the
Chinese Communist Party (CCP). In the minds of China’s leaders, from Mao
Zedong to Xi Jinping, technological progress is not only a means to
economic and military prowess but also an ideological end in
itself—offering final proof of China’s restoration as a great power
after decades of struggle.

"CATCH UP AND SURPASS"

Long before Donald Trump and Xi Jinping began their trade war, the CCP’s
historical fixation on advanced technology emerged from a combination of
nostalgia for China’s lost imperial glory and awe for Soviet
modernization. Mao, like other Chinese revolutionaries and reformers,
blamed the country’s having fallen behind partly on its inability to
keep up with international technological advancements. And he watched as
leaders in Moscow carved their own path to technological progress.

Initially, Mao’s China received extensive technological and technical
assistance from the Soviet "elder brother." In 1957, Soviet Premier
Nikita Khrushchev declared that his goal was to "catch up and surpass
the United States." Mao took the idea and made it his own, putting the
Chinese variant of Khrushchev’s goal—ganchao—at the heart of CCP
ambitions. He envisioned the socialist world’s "overwhelming
superiority" in science and technology and came to see technological
strength as central to economic, ideological, and geopolitical power—the
view of catch up and surpass that CCP leaders continue to hold today.

The Chinese adaptation of catch up and surpass quickly turned fevered
and utopian. Mao, impatient to develop faster than the overbearing
Soviet Union, announced in early 1958 that China would take a Great Leap
Forward, in which "politics and technology must be unified." The Great
Leap Forward—a massive campaign to rapidly industrialize and
collectivize the country—ended in a catastrophic famine that killed tens
of millions of people. Yet even then, the CCP did not abandon ganchao.
Continued concerns about China’s military backwardness, as Evan
Feigenbaum has written, motivated repeated pushes for technological
advancement. In 1975, Premier Zhou Enlai introduced the concept of the
Four Modernizations: modernizing "agriculture, industry, national
defense, and S & T . . . to the front ranks of the world" by the year
2000. And when Zhou and Mao died in 1976, their successors, Hua Guofeng
and Deng Xiaoping, attempted "a new leap forward," aiming to help China
"catch up" by importing more than $15 billion worth of advanced
technology from abroad.

When this new leap also foundered, due to soaring debts and sloppy
decision-making, Deng took a new approach to ganchao, this time relying
on market reform, industrial policy, and economic opening. The CCP
rehabilitated those who had been purged during the Cultural Revolution,
increased investment in S & T research and training, sent delegations
abroad to bring new ideas and technologies back to China, and encouraged
foreign firms to set up shop in China and share sophisticated equipment
and know-how. The rise of information technologies became a particular
fixation of the Chinese leadership in the 1980s. In 1983, Premier Zhao
Ziyang gave a speech on the "global New Technological Revolution,"
invoking the need to "catch up and surpass" and citing the writings of
American futurist Alvin Toffler, whose The Third Wave predicted the rise
of a new Information Age. Zhao and Deng sought " ‘leap-frog’ development
in key high-tech fields" such as information technology, automation, and
bioengineering.

In the marketizing economy, newly emergent private companies also served
the national goal to "catch up and surpass." Liu Chuanzhi, an engineer
at the state-run Chinese Academy of Sciences, started a side business
that grew into Lenovo, one of the world’s largest makers of personal
computers. Ren Zhengfei, formerly an official in the People Liberation
Army’s engineering corps, began importing and reverse-engineering
foreign network hardware and electronics, establishing Huawei in 1987.

In the 1990s and 2000s, the pursuit of advanced technology involved
several strategies of varying degrees of legality and publicity.
Fostering the private sector remained a crucial part of the CCP’s
strategy; Huawei especially won high-profile endorsements from senior
Chinese leaders and tens of billions in loans from state banks, becoming
a national champion as it expanded overseas and partnered with foreign
companies. Information technology firms boomed, but the CCP assiduously
managed the perceived political and cultural risks that accompanied the
rise of the Internet. While building up the Great Firewall, China’s
rulers also took advantage of the more open networks in developed
countries: aggressively recruiting overseas Chinese experts to return to
the PRC, obtaining foreign intellectual property by mandating the
transfer of technical know-how in joint ventures, and engaging in
industrial espionage targeted at high-value technologies.

SILICON MARXISM

In 2013, shortly after being appointed CCP general secretary, Xi laid
out his vision for China’s future in a series of remarks centered around
the goal of national rejuvenation—regaining wealth, power, and glory for
China. Alongside the problems of corruption, pollution, debt, and
military competition, he worried openly about the lagging state of
Chinese technology. Advanced technology had been key to the West’s "sway
over the world in modern times"; Beijing would need an "asymmetrical
strategy" to "catch up and surpass," he said, explicitly invoking this
decades-old CCP ambition.

That long-standing view, reflecting a single-minded focus on ganchao,
explains the intensity and persistence of Chinese theft of trade
secrets, involving both conventional spycraft and cybercrime—what former
National Security Agency Director Keith Alexander called "the greatest
transfer of wealth in history." It has been reinforced by a belief that
China’s thefts were part of rectifying imperialist misdeeds by the
Western countries as well as the linkage of technological advances to
the ideology and identity of the CCP. It also reflects a paradox in the
CCP’s relationship to technology: pursuing an ultimate state of
self-reliance has relied above all on foreign technology and expertise.

By the time Trump came into office, China’s rulers could see that their
focus on ganchao was bearing fruit. Barring a major crisis, China will
become the world’s largest economy by gross domestic product well before
the hundredth anniversary of the People’s Republic’s founding, in 2049.
Its rulers, accordingly, are already shifting from "catching up" to
"surpassing."

Xi argues that indigenous technological innovation is necessary to
surpass the West, even if copying has been mostly sufficient to catch
up. He calls innovation "the primary driving force of development,"
giving a Silicon Valley–friendly gloss to the Marxist idea of historical
"driving forces." Working closely with private companies and
universities, the CCP has positioned fields such as chipmaking,
bioengineering, telecommunications, and artificial intelligence (AI) as
test cases of whether China can "surpass" the United States. A
state-supported flood of discounted capital, world-class researchers,
"civil-military fusion," and less constraining norms give Chinese labs
an edge. In the race to develop next-generation wireless service, 5G,
Huawei is leading the pack, with one of the biggest R&D budgets of any
tech company and revenues roughly equal to telecom competitors Nokia and
Ericsson combined. And when it comes to the data powering AI, according
to a report from the think tank MacroPolo, China may benefits from
having fewer constraints on experimenting with new systems. (The Uighurs
have experienced what this is leading to in the chilling
techno-authoritarian model implemented in Xinjiang.) Because the CCP
already engages in large-scale surveillance and limits personal
freedoms, innovations in big-data systems for smart cities and social
credit point in a startlingly dystopian direction.

To Xi, innovation is good for both maintaining social control and
growing national power. His Made in China 2025 demonstrates the breadth
of Beijing’s ambitions. Made in China 2025 aims to bolster Chinese firms
and ensure that they control the domestic market in advanced
technologies such as robotics, new-energy vehicles, medical devices,
quantum computing, and AI. One Chinese official told The Wall Street
Journal that the plan has undergone cosmetic changes "because the
Americans don’t like it." But it endures in substance, and other senior
officials insist that the CCP "will never give an inch" on this scheme’s
broader goals.

Top-down, CCP-led technological innovation brings its share of
challenges. Many observers correctly cite the risks of misguided
government-steered investment, which has led to waste and massive
oversupply, or the challenges of supporting small entrepreneurs and
researchers without heavy-handed interference. But the record of the
past several decades shows that CCP leaders will, in their pursuit of
technological advancement, display persistence and ingenuity in
responding to those obstacles. China’s leadership has certainly been
prone to exaggerating its achievements throughout a long history marked
by leaps, rushes, and "asymmetric steps"—but they also have a record of
doing whatever it takes to make the hype real.

A RACE AGAINST TIME

The goal of surpassing other countries technologically does not mean
that China’s rulers seek global military supremacy. But even in
best-case scenarios, China’s transition from catching up to surpassing
will be destabilizing, as other countries confront Chinese ambitions for
greater prosperity and security and feel their relative power decrease.
And for China, building 5G networks for other countries and making AI
breakthroughs clearly advance CCP aims far beyond narrowly construed
self-reliance. Even if firms such as Huawei and ZTE are not
incontrovertibly compromised by the state, their work clearly serves CCP
interests.

Technology will remain at the heart of U.S.-Chinese tensions well beyond
the end of the current trade war. Technology, to the CCP, is power in
practice—it is historical change in material form. The roots of "catch
up and surpass" demonstrates that the CCP’s approach to technology is
far more deeply entrenched than many analysts realize. If China’s rulers
feel their technological rise is under threat, they are likely to react
more forcefully and uncompromisingly than policymakers may expect—as the
Chinese response to Washington’s effort to block Huawei’s global 5G
dominance has demonstrated.

(3) NSA Chief: Cybercrime constitutes the "greatest transfer of wealth
in history"

https://foreignpolicy.com/2012/07/09/nsa-chief-cybercrime-constitutes-the-greatest-transfer-of-wealth-in-history/

NSA Chief: Cybercrime constitutes the "greatest transfer of wealth in
history"

BY JOSH ROGIN | JULY 9, 2012, 6:54 PM

The loss of industrial information and intellectual property through
cyber espionage constitutes the "greatest transfer of wealth in
history," the nation’s top cyber warrior Gen. Keith Alexander said
Monday. U.S. companies lose about $250 billion per year through
intellectual property theft, with another $114 billion lost due to cyber
crime, a number that rises to ...

(4) Middle Eastern governments turn to China for energy, economic
relations & defense

https://www.project-syndicate.org/commentary/china-middle-east-closer-economic-ties-by-galip-dalay-2019-08

Why the Middle East Is Betting on China

Aug 22, 2019 GALIP DALAY

Chinese foreign policy in the Middle East is highly transactional,
focusing on energy and economics, and avoiding sensitive geopolitical
issues. In a region as volatile as the Middle East, however, the
question is how long such an approach can be sustained.

DOHA – Middle Eastern leaders seem to be in a race to gain favor with
China. While the region buzzes with criticism of US policy, its
political elites are busy showering China with accolades and heading to
Beijing to sign a wide variety of bilateral agreements. Egyptian
President Abdel Fattah el-Sisi, for example, has visited China six times
since 2014.

Although most engagement between China and Middle Eastern governments
still focuses on energy and economic relations, cooperation increasingly
covers new areas such as defense. Furthermore, Saudi Arabia and the
United Arab Emirates have recently announced plans to introduce
Chinese-language studies into their national educational curriculums.
More tellingly, both countries (and others in the region) have defended
China’s persecution of its mainly Muslim Uighur population, a crackdown
that has been widely condemned in the West.

All of this raises two questions. Why are Middle Eastern states betting
on China? And to what extent can China fill the political vacuum in the
region created by America’s diminishing footprint?

At first glance, Middle Eastern governments’ newfound love for China is
puzzling. Conservative Arab regimes were historically suspicious of
communist China, and established diplomatic relations with it only in
the 1980s or early 1990s. Moreover, many countries in the region have
longstanding defense ties with the United States. Yet some of these US
allies, most notably Egypt, the UAE, and Saudi Arabia, have now signed
comprehensive strategic partnership agreements with China.

These developments are causing growing unease in Washington. The US
government has even conveyed its concerns to Israel over cooperation
with China concerning sensitive technologies. The entry of the Chinese
tech firms Huawei and ZTE into the Israeli market has been a particular
source of concern.

Such episodes reveal one of the major differences between the US and
China regarding alliances and partnerships, at least in the Middle East.
Mindful of its regional inferiority vis-à-vis the US, China is avoiding
placing itself in situations that would require governments to choose
between the two powers. America, by contrast, often wants its allies to
make precisely such a choice. Most Middle East governments must now
perform a balancing act between the two countries, which will likely
generate friction with both.

Several factors currently make China an attractive partner for Middle
Eastern governments. For starters, China has a dynamic, fast-growing
economy and leaders who are highly suspicious of popular uprisings and
democratization. Their top foreign-policy priorities are economic
connectivity, a secure flow of energy resources, and protecting regional
investments. China wants to export goods and commodities, not political
ideas, to the Middle East.

Moreover, like China, many Middle Eastern regimes are trying to
strengthen their legitimacy through economic growth and development
rather than real political reform. Still mindful of the 2011 Arab Spring
uprisings across the region, several governments have announced
ambitious national development plans aimed at boosting living standards
– such as Saudi Arabia’s Vision 2030 and Kuwait’s Vision 2035. China’s
so-far successful track record of economic development without political
reform understandably holds great appeal for Arab autocrats.

Finally, stronger ties with China – and Russia – are an attractive
option for Middle Eastern rulers as they navigate difficult relations
with the West. Saudi Arabian Crown Prince Mohammed bin Salman’s trip to
Asia earlier this year, just a few months after the murder of Washington
Post columnist Jamal Khashoggi in the Saudi consulate in Istanbul, was a
case in point. Shunned by the West, MBS tried to normalize his
international image through Asian summitry. A similar logic applied to
Sisi’s Chinese forays in the aftermath of his bloody coup in Egypt in 2013.

And although Iran is a qualitatively different case, the country’s
growing isolation from the West is pushing it, too, to cooperate more
closely with China. Since the US withdrew from the 2015 Iran nuclear
deal and reimposed sanctions, closer relations with China have been a
matter of necessity, not choice, for the Islamic Republic. China, in
turn, has taken full advantage and forced Iran to accept its terms for
bilateral engagements and trade.

At the same time, China seems aware of its limited ability to play a
meaningful role in addressing the Middle East’s intractable political
and security issues, such as the Israeli-Palestinian conflict or the
Syrian crisis. Here, the US is still the primary extra-regional player.

But American strength isn’t necessarily bad news for China: in
principle, there should be no major conflict between Chinese and US
interests in the region. Despite having naval bases in Djibouti and in
Gwadar in Pakistan, China does not aspire to any great political role in
the Middle East. Moreover, America’s declared goal of ensuring regional
stability, in particular via its security umbrella in the Gulf, also
helps to protect China’s economic and energy interests.

Unlike the US, China has no special relationship with any Middle Eastern
country. As a result, its approach is highly transactional, avoiding
sensitive geopolitical issues and capitalizing on rulers’ discontent
with US policy in order to advance Chinese economic interests. In a
region as volatile as the Middle East, however, the question is how long
such an approach can be sustained.

Galip Dalay is a visiting scholar at the University of Oxford and a
former IPC-Mercator Fellow at the German Institute for International and
Security Affairs (SWP).

(5) Pettis: US should tax Chinese capital inflows; US savings rate is
low because it has to absorb so much foreign capital

Michael Pettis is here referring to the PBOC creating NEW Yuan with
which to buy USD from Chinese exporters, then buying US Treasury Bonds
with those $, in order to keep the Yuan from rising. - Peter M.

https://www.macrobusiness.com.au/2019/08/pettis-us-tax-chinese-capital-inflows/

https://carnegieendowment.org/chinafinancialmarkets/79641

Washington Should Tax Capital Inflows

MICHAEL PETTIS

Taxing capital inflows is a far better way to balance trade than
imposing tariffs. This would address the root causes of trade
imbalances, improve the productive investment process, and shift most of
the adjustment costs onto banks and speculators.

August 06, 2019

TACKLING TRADE IMBALANCES THROUGH INVESTMENT

On July 31, 2019, U.S. Senators Tammy Baldwin and Josh Hawley submitted
a bill "to establish a national goal and mechanism to achieve a
trade-balancing exchange rate for the United States dollar, to impose a
market access charge on certain purchases of United States assets, and
for other purposes." According to an earlier memo that further explains
the bill:

The Competitive Dollar for Jobs and Prosperity Act would task the
Federal Reserve with achieving and maintaining a current account
balancing price for the dollar within five years. It would create an
exchange rate management tool in the form of a Market Access Charge
(MAC)—a variable fee on incoming foreign capital flows used to purchase
dollar assets. The Fed would set and adjust the MAC rate. The Treasury
Department would collect the MAC revenue. The result would be a gradual
move for the dollar toward a trade-balancing exchange rate. The
legislation would also authorize the Federal Reserve to engage in
countervailing currency intervention when other nations manipulate their
currencies to gain an unfair trade advantage.

Whether or not this bill is passed, it marks the beginning of a
necessary reappraisal of the forces driving international trade and U.S.
trade imbalances. The heart of the bill would be a stipulation that the
Federal Reserve levy a variable tax on overseas capital used to buy U.S.
assets whenever foreign investors invest significantly more capital in
the United States than U.S. investors send abroad, which has been the
case for more than forty years. The purpose of the tax would be to
reduce capital inflows until they are largely in balance with outflows.
A country’s capital account and current account must always match up
exactly, so a balanced U.S. capital account would mean a balanced
current account, and with this the U.S. trade deficit would disappear.

PUTTING THE INVESTMENT CART BEFORE THE HORSE

Some might think that imposing tariffs on imported goods is a more
effective way to reduce U.S. trade deficits than levying duties on
imported capital, but that’s the wrong approach. The key is to
understand what drives the trade imbalances. If the recent Senate bill
had been proposed in the nineteenth century—when trade finance dominated
international capital flows—the proposal to tax capital inflows wouldn’t
have made much sense. But today, as I have explained before (including
here and here), the global economy is overflowing with excess savings.
The need to park these excess savings somewhere safe is what fuels
global capital flows, in turn giving rise to trade imbalances. As I
explained in a recent Bloomberg piece, "Capital has become the tail that
wags the dog of trade."

After all, even though interest rates are historically low and U.S.
corporate balance sheets are amassing heaps of nonproductive cash, the
U.S. economy is still absorbing massive sums of capital from overseas.
Clearly, this isn’t happening because U.S. firms need foreign capital.
The reason for these imbalanced capital flows is that foreign investors
need a safe place to direct their excess savings. With the deepest,
best-governed, and friendliest capital markets, the United States is the
obvious destination.

Economists who contend that the U.S. economy needs foreign capital to
compensate for low domestic savings rates are mostly confused about why
U.S. savings rates are so low and how they respond to capital inflows. A
fundamental requirement of the balance of payments is that net capital
inflows must boost the gap between investment and savings, and if
capital inflows do not cause domestic investment to rise, they must
cause domestic savings to decline. There is no other possibility, and as
I’ve explained elsewhere, capital inflows force the U.S. economy to
adjust either by increasing unemployment or, more likely, by setting off
conditions that cause fiscal or household debt to grow. Put another way,
the United States doesn’t absorb foreign capital because the country has
a low savings rate—the country’s savings rate is low because it has to
absorb so much foreign capital.

This is why it is a mistake to think—as many do—that Americans need
foreign capital to counter low domestic savings rates, or even that the
U.S. current account deficit is driven in part by a burgeoning fiscal
deficit. If one country saves more than it invests, another country must
save less than it invests: that is how the global balance of payments
works. Americans automatically tend to assume that it must be the United
States that sets the savings schedule of the whole world, but this is
unlikely. The high savings rates of countries like China, Germany, and
Japan are too obviously a function of the distribution of domestic
income (see here and here for why), making it far more likely that
excess savings in those countries drive down savings elsewhere.

TAXING CAPITAL INFLOWS IS THE SMART PLAY

If it is excess savings in surplus countries that drive capital and
trade imbalances globally, then taxing capital inflows is not just the
most efficient way to rebalance the U.S. trade ledger—it may perhaps be
the only way. And there are more reasons why the United States should
consider restricting the capital account. If designed well, a tax on
capital inflows could have at least five other advantages:

Balancing trade flexibly: A well-designed system of taxing capital
inflows would help broadly rebalance the U.S. current and capital
accounts over several years. Having the Fed impose a variable tax on
capital inflows at its discretion would give the United States a tool
for managing trade imbalances that is far more flexible than WTO
interventions, trade negotiations, tariffs, or subsidies. At the same
time, this approach would allow for the temporary trade imbalances that
are a normal feature of any well-functioning global trading system.
Enhancing financial stability: Because it would be a one-off tax on
transactions, this tax wouldn’t treat all investment equally. It would
more heavily penalize short-term, speculative inflows while barely
affecting returns on longer-term investment into factories and other
production and logistics facilities, much like a Tobin tax. Among other
things, such a tax would not require huge shifts in the value of the
dollar because it focuses so effectively on the most damaging kinds of
capital inflows. For example, if the tax were 50 basis points (or half
of a percentage point), the annual yield on a three-month investment in
the United States would drop by more than two percentage points, making
short-term investment a losing proposition. A one-year investment would
fare better, but annual yields would still drop by just more than half
of a percentage point.

A ten-year investment, on the other hand, would reduce expected yields
by a mere five to seven basis points, hardly enough to matter to an
investor interested in building a factory in the United States, while a
twenty-year investment would see yields drop even lower, by three to
four basis points. The impact of the tax, in other words, would be to
skew foreign investment away from short-term, speculative inflows.
Long-term investments in productive facilities, however, could even
become more attractive to the extent that the measure would lower the
value of the dollar. In effect, this would enhance the stability of the
U.S. financial system.

Treating economic actors more efficiently: Whereas tariffs subsidize
some U.S. producers at the expense of others, taxing capital inflows
would benefit most domestic producers with the costs borne primarily by
banks and speculators. Major international banks would lose out on a tax
on capital inflows because they profit from the intermediation of
capital flows into and out of the country, and because they fund
themselves with cheap, short-term money that they redirect to borrowers
at higher rates. This is why the biggest opponents of a tax on capital
inflows are likely to be major international banks. But to the extent
that these banks, many of which are considered too big to fail, are too
large and have an excessive role in the economy and in policymaking,
forcing them to pay for the benefits accrued by U.S. producers might
actually create a further benefit to the U.S. economy. Avoiding broader
economic disruptions: Unlike issuing tariffs, levying a tax on capital
inflows doesn’t disrupt value chains to anywhere near the same extent or
distort relative prices on tradable goods. Tariffs favor some sectors of
the productive economy over others, so they can be highly politicized as
well as highly distorting to global value chains and the role of U.S.
producers. Taxing capital flows works by forcing financial
adjustments—by adjusting the value of the dollar, for example, or by
reducing debt—so such a tax is likely to be both less politicized and
less distortionary to the real economy. In fact, to the extent that
trade imbalances are driven by distortions in global savings, taxes on
capital inflows will even drive prices closer to their optimal level.

Allocating capital more efficiently: Some observers might argue that, by
reducing the capital available for U.S. investment, a tax on foreign
capital inflows would distort productive investment and make the capital
allocation process in the United States less efficient. This would be
true if most international capital consisted of sophisticated investment
capital seeking its most economically efficient use, but only academic
economists believe this is the case. In fact, much of the flow of
international capital is driven by temporary investment fads, capital
fleeing from political or financial uncertainty, reserve accumulation
strategies by foreign central banks, debt bubbles, and speculative plays
on currency or emerging markets. For that reason, a variable tax on
capital inflows would actually improve the capital allocation process by
discriminating against nonproductive uses of capital and so preventing
them from distorting the financial markets.

The biggest risk of a tax on capital inflows is that the U.S. economy
might indeed experience periods when there are capital shortages and
U.S. businesses are unable to access cheap capital. At such times, of
course, the Fed would simply set the tax to zero.

The trade shortfalls that plague the U.S. economy are chiefly a product
of imbalanced capital flows, which are driven by distortions in global
savings. Selectively restricting capital inflows is the best way to
address these imbalances. Tariffs are a far less effective tool: they
mostly just rearrange bilateral imbalances and distort the underlying
economy without addressing structural issues. Whether it passes or not,
the recent Senate bill is the right approach and an encouraging sign
because it is the first time lawmakers have sought to address the
persistent U.S. trade deficit by way of capital imbalances.

My Twitter account is @michaelxpettis. Aside from this blog, I write a
monthly newsletter that covers some of the same topics. Those who are
interested in receiving the newsletter should write to me at
chinfinpettis@yahoo.com, stating affiliation.

This post is based on a recent piece that the author wrote for Bloomberg.

https://www.bloomberg.com/opinion/articles/2017-05-08/actually-americans-don-t-spend-too-much-and-save-too-little

Actually, Americans Don't Spend Too Much

Foreign money, not greed, is driving down U.S. savings rates.

By Michael Pettis

May 8, 2017, 9:00 AM EDT

Michael Pettis is a professor of finance at the Guanghua School of
Management at Peking University in Beijing.

Why does the U.S. run large trade deficits? As Harvard professor Martin
Feldstein recently explained, the answer seems obvious: Americans save
too little and consume too much. As a result, they must borrow from
abroad to fund domestic consumption binges. Until Americans become a lot
thriftier, Feldstein warns, U.S. trade deficits will remain high.

But this view is based on a model of global trade that has long been
obsolete. In the 19th century, it's true, an unstable banking system
left Americans saving far too little to fund the investment needs of a
rapidly growing economy. Fortunately, that fast growth helped the U.S.
offer the high returns needed to attract capital from Europe.

Today’s deficits are different. Since the 1980s, they've risen even when
interest rates have fallen, suggesting foreigners are more eager to lend
than Americans are to borrow. The need to deploy excess savings is
driving countries to send capital to the U.S.

This flood of money has in turn suppressed U.S. savings. To understand
why, it's important to note that for nearly a century U.S. financial
markets -- the world's deepest and most flexible -- have automatically
adjusted to resolve global savings imbalances. After the first and
second world wars, for instance, when devastated economies were being
rebuilt, they generated high savings as the U.S. became the leading
capital exporter in the world. Over the subsequent five decades, when
the world needed to sell goods and services, they produced low savings
as U.S. trade deficits soared.

Consider what would happen today if the rest of the world suddenly
increased the amount of capital it exported to the U.S. Would U.S.
investment rise to accommodate the increased inflow? Certainly not.
Interest rates have been close to zero for years, and yet U.S.
businesses, flush with enormous amounts of cash, seem determined not to
invest until profit opportunities reemerge. Simply making more foreign
capital available is unlikely to change their minds.

This is what makes Feldstein’s model obsolete. It is true that in the
19th century, the U.S. was a net absorber of foreign capital, just as it
is today, and that therefore domestic investment exceeded domestic
savings, just as it does today. In the 19th century, however, because
U.S. investment was constrained by the lack of capital, the inflow of
foreign savings allowed capital-starved businesses and governments to
invest more in infrastructure than they otherwise could. Foreign inflows
pushed U.S. investment above U.S. savings.

This is no longer the case. In today’s world, the U.S. economy no longer
faces a savings constraint. Businesses have more capital than they need,
so additional foreign capital won't cause investment to increase. But if
investment doesn’t increase in response to more foreign capital inflows,
then of necessity savings must decline.

There are many ways foreign capital inflows can depress savings. They
can inflate asset bubbles that encourage spending through wealth
effects, for example, or they can strengthen the currency. They can
reduce interest rates on consumer credit, or weaken lending standards,
both of which boost borrowing by more profligate households. They can
force up trade deficits that increase unemployment.

There are countless examples besides the U.S. in which this has
happened. After Germany’s 2003 labor reforms caused German savings to
rise, for example, German capital poured into the rest of Europe,
quickly generating asset bubbles, real currency appreciation, low or
even negative real interest rates, collapsing credit standards and
eventually soaring unemployment. In every case, local savings rates
collapsed, just as they had in the U.S.

There's a great irony here. One hundred years ago, Lenin described
imperialism as an economic process in which the great industrial powers
forced their colonies to sop up excess domestic savings and run trade
deficits with the motherland. As economist Kenneth Austin noted in 2011,
the U.S. now plays this role, absorbing nearly half of the world’s
capital outflows, and so runs the corresponding trade deficit.

In today’s world, in other words, the U.S. trade deficit is not "caused"
by Americans saving too little, nor will deficits disappear because
Americans decide to spend less. As counter-intuitive as this may seem,
foreigners, rather than U.S. thrift or profligacy, determine U.S.
savings rates. If Americans tried to become thriftier, and foreign
capital inflows remained at current levels, the economy would adjust to
depress savings in some other way, probably through higher unemployment.

U.S. savings will automatically rise when foreign capital no longer
pours into the country. Only then will the U.S. trade deficit decline.

This column does not necessarily reflect the opinion of the editorial
board or Bloomberg LP and its owners. To contact the author of this story:

To contact the editor responsible for this story: Nisid Hajari at
nhajari@bloomberg.net