China as Seen from a Glass House

Stephen S. Roach



NEW HAVEN – The removal from the Chinese constitution of the provision limiting presidents to two five-year terms came as a shock to many. For China, the institutionalization of leadership succession was one of Deng Xiaoping’s most important legacies, signaling an end to the wrenching instability of the chaotic leadership cult of Mao Zedong. For the West, the term limit was an ideological bridge that led to a path of engagement. Could its abolition be the tipping point for an already precarious Sino-American relationship?

Start with China and what the move means for its future. To figure out what will change under a different framework for leadership succession, it is important to cut through the authorities’ opaque rhetoric – the “moderately well-off society” transitioning into the “new era” – and stress-test their basic development strategy.

While anything is possible, and there is always a risk of mistakes, my bet is that China stays its current course. Succession or not, there can be no turning back from a transition that has brought a large, poor developing country to the brink of prosperity as a modern, high-income economy.

Initially, China’s leadership – responding to former Premier Wen Jiabao’s surprising 2007 critique of a Chinese economy that had become increasingly “unstable, unbalanced, uncoordinated, and unsustainable” – made its case from an analytical perspective. Last October, in a speech to the 19th Party Congress, President Xi Jinping made the same point from an ideological perspective, reframing the so-called Marxian principal contradiction around the pitfalls of “unbalanced and inadequate” development.

Significantly, these two perspectives – analytical and ideological – take China to the same destination: a prosperous economy and society with a thriving middle class. To get there, China must go through a transformative rebalancing, from manufacturing to services, from export dependence to domestic consumption, from state-owned to private, and from rural to urban.

By now, all of this is well understood. The current debate in China is less about strategy design and more about implementation. This, in fact, was Xi’s highest priority on assuming office in late 2012, and it formed the rationale behind an unprecedented anti-corruption campaign aimed at dislodging deeply entrenched power blocs that have stymied the transition.

But now, five years later, the Chinese leadership is poised to tackle the next phase of the implementation challenge. There is a palpable sense of urgency to this task. Behind the public façade of a confident leader, Xi has owned up to the possibility of failure. From an analytical perspective, this has been expressed in terms of a Japanese-like stagnation if China mismanages its economy. From an ideological perspective, an endgame of chaos and revolution looms if the “principal contradiction” is not resolved.

Given these mounting concerns, implementation risks are now being presented in a different light. At the World Economic Forum in Davos in January, Liu He, China’s new vice premier for economic policy, hinted that upcoming reforms would be carried out with surprising speed. In a recent signed commentary published in People’s Daily, he also noted that, “Strengthening the party’s overall leadership is the core issue.”

These views do not come out of thin air. Liu, a master tactician, seems to be underscoring the link between leadership power and the pace of reforms. The perceived need for greater leadership power – reflected in the elimination of the presidential term limit – has become a key element of the authorities’ implementation efforts. Consistent with Xi’s early instincts, this may well be the only way for China to avoid the “blind alley” of which Deng warned in 1992.

Yes, viewed from the perspective of liberal democracies, China’s constitutional revision is a disappointing governance setback. From China’s perspective, however, it may well be the only option to address its daunting implementation imperatives head-on. And the recent experience of other countries, particularly the United States, certainly cautions against the Western tendency to conflate succession and leadership quality.

America’s leadership deficit is, in fact, pushing the US and China to the brink of a trade war.

The plight of the US middle class has been framed as a blame game, with China and its alleged unfair trading practices singled out as the culprit. Yet the evidence points elsewhere: to a dramatic shortfall of domestic saving that leaves America dependent on surplus saving from abroad to fill the gap. The result is a multilateral trade deficit, with China and 101 other countries, required to provide the foreign capital needed for the balance of payments.

In other words, China is actually an important part of America’s “solution” to its saving-short growth problem. Yet US leaders find it expedient to make China a scapegoat. And the situation is going from bad to worse. The large tax cut enacted at the end of 2017 will expand the US federal budget deficit by $1.5 trillion over the next decade, pushing domestic saving even lower – an outcome that will lead to even wider trade deficits.

As if that’s not bad enough, a protectionist Trump administration has elevated anti-China tariffs to a central role in its international policy agenda. Yet protectionism in the face of widening trade deficits spells nothing but trouble for frothy financial markets and a saving-short US economy. And it risks the most serious rupture in the Sino-American relationship since 1989.

No one knows how long Xi will remain in office. If China stays the course, the succession question is inconsequential – at least for the time being. If China slips, the verdict will be very different. While the US has a very different political feedback loop, accountability also matters.

In the end, the quality of leadership is what matters most for both countries. Sadly, those living in glass houses always find it easiest to throw stones.


Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management. He is the author of Unbalanced: The Codependency of America and China.

The economic damage from a trade war

Economists are taught trade wars are almost always damaging. The question for investors is: how damaging?

Gavyn Davies 

A worker operates a furnace at a steel plant in Anhui province, China © Reuters



President Donald Trump’s threatened escalation of trade tariffs has moved to the centre of investor concerns. So far, the levies announced on steel and aluminium imports affect sectors so small that they will have almost no macro effect on US inflation, growth or employment. However, they could represent the thin edge of a very large wedge.

The focus now shifts to the Article 301 investigation into China’s practices in technology transfer and intellectual property. The White House is likely to take action on that soon. With hawks like Peter Navarro and Wilbur Ross in the ascendancy, and modifying influences fading after Gary Cohn’s resignation as chief economic adviser, the president may soon follow his instincts and announce tariffs on imports from China.

Although Navarro and Ross see tariffs as a means of forcing Beijing to abandon unfair distortionary practices, they could just as easily result in retaliatory trade controls, and even a global trade war.

That may seem improbable, but hostile rhetoric is building, and such an outcome can no longer be ignored.

This week, I will discuss the analytics of trade tariffs, and their macroeconomic impact on the country that imposes them. Next week, I will turn to the global effects of a full-scale trade war.

The bottom line: a global trade war, though still unlikely, would administer a negative shock to world GDP of perhaps 1-3 percentage points in the next few years. Although investors might see this as a manageable hit to growth, there is a downside to the distribution that could turn out to be much worse.

Economists are taught early on that trade wars are always damaging. Memories of the Smoot-Hawley Act in 1930 loom large. But what are the mechanisms involved?

When tariffs are imposed, the increase in the costs of cross-border trade obviously reduces global imports and exports, relative to output. This is what drives the welfare gains and losses in the longer term.

On this, there are some centuries-old results from international trade theory (see the leading textbook by Paul Krugman et al). In these partial equilibrium trade models, almost no one disputes that the decline in trade flows will reduce the scope for the law of comparative advantage to work, and for technology to flow easily across borders.

The reduction in these gains will hurt productivity and damage global welfare.

However, if a large country imposes a steel tariff, that might force Chinese producers to absorb part of the losses by cutting their prices to maintain a foothold in the American market.

In turn, the US might improve its terms of trade, and even see an overall welfare gain as the price of its steel imports declines. This favourable net outcome for the US is generally thought unlikely. Furthermore, smaller countries cannot achieve such offsetting gains, because they have to accept the global price. Their welfare is therefore unambiguously decreased.

Further cases that may justify tariffs are the protection of infant industries, and the correction of market distortions (eg export subsidies) imposed by other governments. However, most economists think it is better to attack these distortions head on, rather than indirectly through “offsetting” import tariffs.

Moving into macro-economics, many variables can change in response to tariffs, including the exchange rate, inflation, monetary policy and unemployment. This becomes much more complicated.

In old-fashioned Keynesian models (with fixed prices and exchange rates), a tariff is viewed as an expenditure-switching intervention, not necessarily an expenditure-reducing one.

US tariffs on steel imports could cause an increase in domestic production as foreign products are priced out of the American market. As a gross over-simplification, expenditure is, in the first instance, switched from China to the US, leaving global steel production unchanged. Mr Trump seems to believe all this.

But the effects on aggregate demand are complex. When the US imposes its tariff, China at first loses net income. In the US, steel producers might gain from greater output, but consumers, both households and other companies, lose. The government gains from tariff revenues, though these are probably distributed across the economy.

The initial effects on aggregate demand therefore depend on how all these gains and losses are translated into expenditure. Such redistributions are similar to the effects of an oil price increase that shifts income away from consumers and towards producers. If the losers cut demand immediately, while the winners spend their gains more slowly, global demand and output will fall in the short term. But none of this is obvious without much more empirical work.

In his classic 1960s work, Robert Mundell argued that, in a world of flexible exchange rates, a new US import tariff will tend to improve the country’s trade balance, which will increase the dollar’s real exchange rate. This real exchange rate rise dominates the effect on the American economy, producing an overall decline in US output and employment, despite the (smaller) gains from the tariff’s expenditure-switching effect.

This remains the standard result. Maurice Obstfeld, the International Monetary Fund’s chief economist, wrote in 2016 that a 20 per cent US tariff on imports from East Asia, would (without retaliation) raise the dollar by 5 per cent, and cut US output by 0.6 per cent over five years.




In these models, Mr Trump’s trade agenda could back-fire on the US economy. Furthermore, all these results would be worse if we allow for temporary effects of tariffs on global supply chains, which could disrupt production, and the damage to confidence from uncertainty about trade policy.

These effects skew the possible outcome markedly towards the downside.

And there is the danger of retaliation from trading partners. Next time, I will try to quantify these serious global threats.

Reviving the Weimar Triangle

By Jacob L. Shapiro

What a difference an election can make. A few weeks before German federal elections last September, German Chancellor Angela Merkel threw down the gauntlet and accused the Polish government of undermining the foundations of the European Union with its controversial constitutional reforms. On March 19, a much weakened and far friendlier Merkel traveled to Warsaw to meet with the Polish prime minister and president in an attempt to woo Poland’s support for Franco-German efforts to reform that very same European Union. The foundations of the EU are still the topic of conversation, but the particulars are not about what Poland is doing to undermine them but about how crucial Poland is to their defense. A Different Tone Merkel’s trip to Poland – her first foreign trip since being confirmed as chancellor for a fourth consecutive term on March 14 – was not done without careful planning. Merkel was preceded by her new foreign minister, Heiko Maas, who made a revealing statement at a news conference following a meeting with his Polish counterpart: “Despite divergent points of view on various issues, Poland and Germany are irreplaceable neighbors, friends, and important partners.” When Merkel castigated Poland’s government back in September, she used many of those same words, but her tone was unambiguously critical. During Maas’ visit, however, the foreign minister was downright solicitous. It’s not the words you use but the way you use them that makes all the difference. The shift in tone is indicative of a change in Germany’s position toward Poland. Merkel did not emerge from elections unscathed, but she emerged nonetheless, and now that she has, she must throw the full weight of her limited powers into halting the EU’s slow decline into irrelevance. No country is more dependent on the EU than Germany, and the EU is in trouble. The U.K. is leaving. France would like to rewind history and go back to when it dominated the EU. Italy is a circus. Eastern Europe has defied the EU and is no worse for wear – in fact, it does not have the migrant integration issues the more generous Germans are facing. And now a chorus of anti-EU voices – represented by the nationalist Alternative for Germany, or AfD – is rising in Germany itself, arguing that perhaps Berlin would be better off cashing in on its massive trade surplus and going it alone. (click to enlarge)   Merkel has one thing going for her. The European economy has defied the odds and continued to improve, with better-than-expected growth figures across the bloc. Growth has been higher in Eastern Europe, but even in Germany it has exceeded government estimates (and our own forecasts). This is not to say that the European economy is healthy. Inequality is increasing. Quantitative easing continues. From across the Atlantic, the winds of a trade war are blowing, and from across Eurasia, cheap Chinese goods and piles of Chinese money are readily available. But right now, the situation is stable, and if the EU is to make a change, now is the time. Once a crisis comes, it is usually too late to fix it. Germany’s missteps with Greece’s 2009 sovereign debt crisis and the migrant issue have damaged its credibility in the EU, but Germany remains powerful. It is, after all, the economic behemoth upon which the EU’s prosperity (and peace) has been built. Germany’s dependence on exports is its Achilles’ heel, but Germany depends on exports only because it has profited from them so greatly. And much of Europe has shared in those profits. The supply chain for German goods is inextricable from the economies of Eastern European countries, which means, for now, the economic fate of Eastern Europe remains tied to Germany’s own fate. As for the rest of Europe, it is easy to forget that Greece was not the only country to gorge itself on debt to buy new-fangled German goods; it was just the worst offender, and also the European country weak enough to be used as Germany’s scapegoat. Power Sharing The problem facing Merkel is that Germany cannot transform the EU alone, and her list of allies has grown thin. As long as Emmanuel Macron governs France, Merkel has a willing partner in Paris, but much of Macron’s domestic support came from protest votes against a national pariah, not from genuine pro-EU sentiment in France. The realities of politics are already descending upon Macron, whose domestic support is declining. And to the east, Germany has not only failed to find a willing partner – it has pushed its would-be partners away for fear of diluting German power inside the EU’s vast and laborious bureaucracy. Beggars can’t be choosers, however, and so Germany must work with what it has. Enter “the Weimar Triangle.”   (click to enlarge)   Originally a grouping of the foreign ministers of Germany, France and Poland founded after the collapse of the Soviet Union, Germany is now touting the Weimar Triangle as a salve for the EU’s bitter problems. The grouping has not met since 2015, when Poland’s current government came to power, but not because Poland wasn’t interested: Poland has previously raised the possibility of meeting with Germany and France in the Weimar format. Now it appears Germany is willing to let bygones be bygones and assemble the group once more. Germany’s foreign minister made explicit mention of the Weimar Triangle during his visit to Poland, identifying its resurrection as integral to fixing Europe’s problems. In other words, Germany needs Poland’s help, if it isn’t already too late. It remains to be seen whether this is just talk, or whether Germany is prepared to compromise. Poland is not staunchly anti-EU – in fact, most polls show the population supports the bloc. But more than that, Poland is pragmatic, and it might be open to German proposals if they are accompanied by real concessions. After all, Poland derives many benefits from EU membership. Besides the economic benefits that come from being a part of the German supply chain, Poland receives much-needed investment funds from the EU. In 2016, the latest year for which full data is available, Poland received 10.6 billion euros ($13.1 billion) from the EU budget while contributing only 3.5 billion euros. Poland also values EU support against Russia, both in military and economic terms (like the Nord Stream 2 gas pipeline). Whatever Poland’s long-term interests, in the short term, Poland would like to be part of the EU if it is truly a European union. What Poland won’t tolerate is German economic colonialism masquerading as a union of Europe, a bloc in which Germany gets to set the rules and threaten to take away funds from anyone who doesn’t play the way it wants (which has been Germany’s position on Poland during the past three years). The question then becomes: Is Merkel willing to share power with Paris and Warsaw, and can she survive politically if she does? If talk of the Weimar Triangle is not accompanied by concessions that allow Poland more of a say in European decisions, this diplomatic overture will be short-lived. But if Germany is really talking about sharing power, Poland would likely be open to using its position as the largest country in Eastern Europe to bring some of the current EU renegades, like Hungary, into the fold. It may even be willing to tolerate Berlin’s self-righteous criticism of its government, as long as the criticism is rhetorical and not used to hold the Polish economy hostage. The Weimar Triangle is a seductive idea, and it has some geopolitical logic behind it. It would unite the three most important countries in the three regions of continental Europe – western, central and eastern – into a powerful force for EU reforms and political change. And if the EU is to survive, that change is badly needed. These reforms can proceed in two basic directions. Either the EU can be granted far more substantial powers, or its powers can be stripped away, ending the half-cocked experiment of European integration and preserving the all-important free trade zone. The current French proposal tries to do both, creating two tracks within the EU – one integrated into a more unified, centralized system, and another that is content with participating in the free trade zone – but no one is listening. The devil is in the details, and once you start examining the details, you begin to concur with Merkel’s pre-election sentiments: Berlin and Warsaw want different things.

Gold: The Religion Of Currency

It’s been said that Bitcoin has no true value. Fair enough. But neither does cash—and neither does gold. In fact, nothing in this world has value beyond that which human imagination gives it.

The designer gold pills that some obnoxious celebrity just swallowed have no real value, medicinal or otherwise, even though they cost $425 a piece. They’re designed simply to make what goes in, come out … gold. The imagination knows no limits.


(Click to enlarge) The gold you can eat, such as the $28,000 cupcake originating from Abu Dhabi, has no real value, though slightly more than the gold pills in the form of nutrients (sugar be damned). 


The gold you can drink in Goldschlager, or smoke in the Dominican gold cigar, means nothing, either--not even in terms of taste.

The value of the gold bullion stored away in a safe somewhere is also elusive and a product of the imagination.

Value, then, does not exist beyond vanity.

Human beings like gold because someone a very long time ago decided that it would be a suitable token of trade, a thing with which to barter that wouldn’t tarnish, rust or fade away.

Plus, it was shiny, and that always helps. 
It also helped that while rare, there seemed to be enough of it to make it sought-after, but not oversupplied. Something that’s exceedingly rare wouldn’t work, nor would something too easy to come by. Gold struck the perfect balance.


But since those ancient times, our obsession with gold has become something much more. Now it’s solid 24K.

As the late, great British author Terry Pratchett wrote in Small Gods, “Belief shifts. People start out believing in the god and end up believing in the structure.”

He also wrote: “You can’t inspire people with facts. They need a cause. They need a symbol.”

And that is exactly what gold is for humanity today: An almost unshakable structure that is thoroughly symbolic, as is its value.

Now, not for the first time in history, the advent of a new type of currency is threatening gold’s status as the most powerful small god of our age-old barter system.

True believers in gold will argue that cryptocurrencies—whether they be bitcoin, ethereum, ripple or 1,500 other variations—aren’t real. And they are right, but they’re hoping that no one realizes that gold also lacks ‘true value’.

Having divined a currency through our own imaginations, the only way to place any sort of value on it was to see how many people wanted it and what they were willing to pay for it. (What one might, in the modern day, call the ‘market’).

Crypto challenges the idea of ‘value’ even further by boldly claiming to exist without existing. Floating around in the cryptosphere like an intangible promise of payment—like a precious metal on a virtual reality tour—digital coins are easy targets for gold fundamentalists.

These are two small gods vying for believers, because without believers they don’t exist. It’s frightening for gold, because this one small crypto god is actually hundreds of gods banning together to slap reality in the face.

Gold might also argue in its own defense that it is rare, and there are limits to how much the Earth has to offer—adding to its natural allure. But Bitcoin has limits, too: They are written into the code, making the number of coins that can ever be ‘mined’ finite.

And they are real. We’ve made them real. We’ve given them value, even if we can’t decide whether it should be $20,000 a coin or $8,000—or something entirely different. Volatility is the process of humans deciding whether they’re ready to convert.

Make no mistake. Currency is a religion, but there’s room for more than one.