During the past 25 years of relentless growth, China has done well, becoming the world’s second largest economy and boosting its GDP on a purchasing power parity basis tenfold, to 75% of that of the United States.
China has also been a major factor in promoting global prosperity and pushing up the value of U.S. financial assets. Now, however, it is hitting a bump in its growth, dragging down world economies and markets. China’s business model is changing, and investors are asking how those changes will be felt beyond the country’s borders.
In 2006, Niall Ferguson coined the term “Chimerica” to describe a symbiotic economic relationship between the United States and China. Those two economies have been melding together since China began to open up in the 1980s. Bilateral trade grew by a factor of 15 since 1990 and imports from China, at $480 billion last year, comprised 17% of total U.S. imports.
But it’s not only trade volumes that shape Chimerica. America’s trade deficit vis-à-vis China stood at $365 billion last year and averaged around $300 billion over the past decade. In other words, America pumped $3 trillion into the Chinese economy in that time period from its trade imbalance alone. Direct investment by U.S. companies into Chinese manufacturing, chemical, retail and other industries added another $500 billion.
China saved while the U.S. consumed a lot more than it produced. China accumulated dollars and invested them into U.S. financial assets, notably Treasury bonds. Chinese hard currency reserves measure well over $3 trillion and holdings of U.S. Treasuries are to the tune of $1.3 trillion.
Thanks largely to its close business relationship with the U.S., China has grown wealthy and highly industrialized. Disposable personal income of its citizens, which averaged $189 in 1990, has jumped twentyfold and stood at around $3,600 in 2015.
The relationship looks somewhat like the one Spain had with England and Holland in the 16th and 17th centuries, when Spain spent its American gold on imports from those two rapidly developing economies, fueling their growth with transfers of wealth.
However, it is a false parallel, because both China and the U.S. are highly productive economies. Their symbiosis has triggered massive wealth creation in both countries — and in the world economy as well since Chimerica makes up a quarter of the world’s GDP and dominates commercial and financial flows.
For starters, by investing its surplus savings into the U.S. economy, China supported the dollar. In essence, it has been lending money to Americans to keep buying its products. China obviously did so for selfish reasons, to further its own development goals, but in the process it also made America richer.
Plus, the transfer of production to China reduced the prices of goods, resulting in lower consumer price inflation. Inflation in the U.S. was further undercut because high-wage manufacturing jobs disappeared, and wages of remaining jobs came under pressure, hitting demand for goods and services. Lower inflation in turn allowed the U.S. Federal Reserve to keep interest rates low and pump out dollars. Lower costs for U.S. companies, meanwhile, meant higher profits and, therefore, higher stock prices.
Finally, as China spent more money on food and industrial commodities from third countries, those nations too increased their consumption of American goods and services.
To sum up, China has experienced a quarter century’s worth of dramatic productivity growth and an equally massive growth in consumption, the benefits of which were, to various extents, shared with the rest of the world and certainly with the U.S.
All Good Things End
The system worked beautifully but it contained the seeds of its own destruction — on both shores of the Pacific. The Great Recession of 2008–09 was the first major alarm bell. Easy dollars created asset price bubbles, the largest of which occurred in residential real estate; Americans increasingly used their properties as personal ATM machines, withdrawing accumulated equity to make up for stagnant wages.
Even though the real estate bubble burst calamitously in 2008, and financial catastrophe was only narrowly avoided, the Chimerica economic model did not change. The crisis, engendered by plentiful liquidity at historically low rates, was remedied by even more liquidity at even lower rates — actually, with free money and, now, even with negative interest rates.