Socialist‐​Market Virus Threatens US and China

July 31, 2009 • Commentary
This article appeared in the South China Morning Post on July 31, 2009.

The Sino‐​US Strategic and Economic Dialogue sought to find areas of mutual interest so that both countries could co‐​operate on economic, security, environmental and foreign‐​policy issues. Nothing of substance came out of the meeting, but a “Memorandum of Understanding” was signed to further consider environmental and energy policy, and participants discussed steps needed to rebalance the two economies in the interest of global prosperity and to avoid destructive protectionism.

As the largest holder of US debt, China would suffer large losses if the Fed engineered a policy of inflation to reduce the real value of US debt. Although there is no immediate threat, China is already talking about a new “super‐​sovereign” reserve currency to replace the dollar.

While leaders of both nations discussed conventional issues, they did not acknowledge the significant policy mistakes on both sides that helped bring about the most serious recession since the 1930s.

Rather than allowing market forces to rebalance their respective economies, both Beijing and Washington are engaging in the very politicisation of investment decisions that is the hallmark of a socialist economy. Unfortunately, little mention was made of that fact during the dialogue. No one seemed concerned about the drift from market principles toward state planning — with the consequent socialisation of risk.

Vice‐​Premier Wang Qishan did lecture US officials on the need to reduce the growth of government debt and to “balance and properly handle the impact of the dollar’s supply” — that is, to avoid inflation. Both sides agreed that any move towards protectionism would severely damage the global economy and should be avoided, and both agreed to work to restore global balances: the US by increasing saving and China by increasing consumption.

The irony is that China’s own policies — pegging the yuan to the dollar at an artificially low rate, spurring exports and accumulating large foreign exchange reserves — have allowed the US to live beyond its means and fuelled US federal spending, thus spreading the socialist‐​market virus.

China’s own stimulus programme is creating asset bubbles in the stock and housing markets. Current money and credit growth are not sustainable and could well increase inflationary expectations. The People’s Bank of China, like the Fed, needs an “exit” strategy.

Beijing’s overriding desire to maintain growth at any cost could end up spoiling the Communist Party’s 60th anniversary. There are considerable distortions in China’s financial markets. The government‐​led stimulus programme may lead to short‐​term growth, but only at the expense of further distorting capital markets and slowing down real reform. The danger is that the dynamic non‐​state sector will recede while the state sector gains ground.

Non‐​performing loans at state‐​owned banks could mushroom, corruption associated with the political allocation of capital could worsen, and inflation could lead to wage and price controls that impede economic and personal freedom. Such setbacks would shift the balance of power further in favour of the party, just as it has shifted to Washington during the current financial crisis.

Indeed, the legacy of the global financial crisis, which was due in large part to government failure, may be the permanent increase in the size and scope of government — both in China and the US.

About the Author
James A. Dorn

Vice President for Monetary Studies, Senior Fellow, and Editor of Cato Journal