Robert Mundell: Don't Pressure China Into a Large Revaluation

Robert Mundell says a large revaluation of the yuan in a short time period is not the best way to address the trade imbalance problem the U.S. has with China:

Don't push China to revalue currency, Canadian Nobel economist Mundell says, by Steve Mertl, CBC: Fear of China's growing economic power is pushing its competitors in potentially dangerous directions, says economist Robert Mundell, the Canadian-born Nobel Prize winner... U.S. politicians and some business leaders accuse China of keeping its currency ... at an artificially low fixed exchange rate with the U.S. dollar to make its exports more attractive.

Mundell ... has been critical of U.S. government and International Monetary Fund pressure on China to revalue its currency ... or let it float. "I don't think China will accept it," said Mundell. "It's ... not a good policy for the United States or the IMF to push because it would do countless damage to the poorer parts of the Chinese economy." ...

China ... still has 80 million people living on less than $1,000 US a year. Boosting the yuan by the 40 to 50 per cent that some have demanded would make their products instantly uncompetitive, Mundell warned. "Appreciation would be devastating to those people," he said.

Mundell noted the Japanese economy ground to a halt for most of the 1990s and its banking system collapsed after Japan agreed to boost the yen. Removing exchange controls by allowing China's currency to float would be equally damaging as Chinese demand for dollars exploded and the yuan tanked...

There is a legitimate concern with China's balance of payments as it accumulates huge foreign exchange reserves, he said. "That's a problem that the United States and other countries have a right to complain about...," said Mundell. But the solution lies in getting China to invest more abroad and to open its domestic market wider so consumers can buy more imported goods...

China did respond to pressure last July by boosting its currency by two per cent and increasing its value in tiny monthly increments since then. "I think they still accept my view that a big appreciation would be very harmful to them," he said, but noted there have been mixed messages from the government and China's central bank...

[A] U.S. perception of China as an economic threat should not be discounted, Mundell warned. "I think it would be a mistake to discount the threat of a clash between the United States and China," he said. "Whenever one power starts to challenge the power of a super economy or the existing power structure, that often leads to world war. "We did that in 1914 and we did that in the 1930s with Japan, and the 1940s again with Germany."

There are distributional issues within the U.S. to consider also. Recall what Paul Krugman had to say about this just after China revalued by 2%:

China Unpegs Itself, by Paul Krugman: One way to grasp how weird this policy is would be to think about what a comparable policy would look like in the United States, scaled up to match the size of our economy. It's as if last year the U.S. government invested $1 trillion of taxpayers' money in low-interest Japanese bonds, and this year looks set to invest an additional $1.5 trillion the same way.

Some economists think there is a deep rationale for this seemingly perverse policy. I think it's something the Chinese government stumbled into as it tried to protect itself from the 1997-1998 crisis, and it is reluctant to change because ... China's leaders don't want to mess with success.

But ... China's dollar purchases are ... feeding a trade surplus that is creating a growing political backlash in America and Europe. ... The question is what happens to us if the Chinese finally decide to stop acting so strangely.

An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs. But if the Chinese stopped buying all those U.S. bonds, interest rates would rise. This would be bad news for housing - maybe very bad news...

In the long run, the economic effects of an end to China's dollar buying would even out. America would have more industrial workers and fewer real estate agents, more jobs in Michigan and fewer in Florida, leaving the overall level of employment pretty much unaffected. But as John Maynard Keynes pointed out, in the long run we are all dead.

In the short run, some people would win, but others would lose. And I suspect that the losers would greatly outnumber the winners.

And what about the strategic effects? Right now America is a superpower living on credit - something I don't think has happened since Philip II ruled Spain. What will happen to our stature if and when China takes away our credit card? ... On the first day of the new policy, the yuan rose only 2 percent, not enough to make any noticeable difference. But one of these days Chinese dollar purchases will trail off, and we'll find ourselves living in interesting times.

Update:

US to boost high-tech trade with China, chinadaily.com.cn/Agencies: The Bush administration is to revise laws to facilitate export of hi-tech equipment to China under a new policy designed to narrow its ring trade gap with the world's fastest growing economy.

The United States said it would revise laws to facilitate export of sensitive high technology equipment to China under a new policy designed to prevent such products from being used for military purposes. The new policy will spare the need for US exporters in such sectors as semiconductor equipment and electronics to apply for licenses for sales to Chinese companies...

The new policy, McCormick emphasized, would prevent exports of US technologies for incorporation into the weapons systems in China...

Comments

[anne]

After the Plaza Accord of September 1985, the 40% to 50% increase in value of the Yen had the pernicious effects of slowing demand for Japanese exports and gradually slowing the economy while setting off a speculative increasae in stock and real estate prices. The effects were masked for several years as the strong currency and asset price increases gave a feeling of well-being to the Japanese. When the Japanese central bank failed to understand the speculative boom and in breaking the boom broke the economy there was still a lack of understanding. China will not make Japan's mistakes.

[China Law Blog]

Mundell makes a very good point and it is this point which would almost certainly cause China not to revalue the Yuan in any event.

[anne]

The sense I have is the dollar will weaken little not only against the Yuan but against the Yen. Japan will not repeat the mistake of the Plaza Accord, though Japanese manufacturers-exporters are located far more internationally now and can more readily adjust to changes in currency value and hold market share.

[anne]

http://www.msci.com/equity/index2.html

National Index Returns [Dollars]
12/30/05 - 6/8/06

Australia 8.6
Canada 6.9
Finland 13.7
France 10.5
Germany 8.5
Hong Kong 3.9
Japan -3.3
Netherlands 6.5
Norway 20.1
Sweden 6.7
Switzerland 7.0
UK 9.7

http://www.msci.com/equity/index2.html

National Index Returns [Domestic Currency]
12/30/05 - 6/8/06

Australia 6.2
Canada 1.3
Finland 6.0
France 3.0
Germany 1.2
Hong Kong 4.0
Japan -6.8
Netherlands -0.6
Norway 9.4
Sweden -2.2
Switzerland -0.1
UK 2.2

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 6/8/06

S&P Index is 1.1
Large Cap Growth Index is -2.5
Large Cap Value Index is 4.6

Mid Cap Index is 2.2

Small Cap Index is 4.1
Small Cap Value Index is 5.6

Europe Index is 8.6
Pacific Index is -1.6
Emerging Markets Index is -0.2

Energy is 8.2
Health Care is 0.2
Precious Metals is 17.3
REIT Index is 11.3

High Yield Corporate Bond Fund is 1.5
Long Term Corporate Bond Fund is -3.8

http://flagship2.vanguard.com/VGApp/hnw/FundsVIPERByName

Sector Stock Indexes
12/31/05 - 6/8/06

Energy 5.4
Financials 4.4
Health Care -3.4
Info Tech -6.1
Materials 2.2
REITs 11.3
Telecoms 10.5
Utilities 4.5

[anne]

Interestingly, as the stock market has weakened long term Treasury interest rates have steadied at about 5%, making for a completely flat to inverted yield curve. The stabilizing of long term interest rates at fairly low levels has evidently left real estate in fine shape if the Vanguard REIT index is a proper marker. The index is up 11.3% so far this year.

[Alejandro]

Anne,

What do you try to tell us with those numbers? I've seen you post them dozens of times.

[anne]

"Numbers" give me all sorts of ideas about economic direction, while have given me all sorts of investment ideas. Through the years, I have been impressed both by price patterns that persist when theory would have the patterns regress to the norm and price patterns that allow for questioning economic analysis. I find long term value, and short term movements. Paul Krugman has now and again used stock price patterns to develop incisive economic analysis. Robert Rubin teaches us to pay attention to the bond market in telling of the health of the economy, though how to read the current bond market is a puzzle :)

The comments you make are always interesting...

[anne]

These last few years, there have been continual warnings, frantic now and then, about American internal and external debt, a speculative boom in real estate and long term bonds and a dollar that were much too pricey. Should we worry, what to do? I have no use for end-of-the-worlders who never suggest simple ways to protect ourselves. There is considerable doomish comment on American debt, but long term Treasury bonds are at 5%. Why?

[dryfly]

China ... still has 80 million people living on less than $1,000 US a year. Boosting the yuan by the 40 to 50 per cent that some have demanded would make their products instantly uncompetitive, Mundell warned. "Appreciation would be devastating to those people," he said.

All I can say is welcome to the global economy.

They have the same dilemma we all face and they have to decide... are we going to protect our 'weakest links' or exploit our greatest strengths? Because the rest of the world will NOT let them have it both ways forever.

[anne]

Paying attention to numbers, by the way, no matter economic analysis will be immensely helpful in avoiding investing idiocy. I am repeatedly surprised at how foolish economic analysis can be when market numbers show where sense is :)

[Bruce Wilder]

One thing, which is usually missing in these journalistic narratives is the Chinese domestic price structure. The whole Chinese domestic price structure is hostage to the exchange rate policy; it is how they keep domestic peace, while keeping labor costs so ridiculously low that labor costs overcome all the other disattractions of manufacturing in China, USING CAPITAL INTENSIVE TECHNIQUES.

China is not offering the world a comparative advantage in cheap labor; China is saving and investing 40+% of GDP and investing in world-class, high sunk-cost, capital-intensive manufacturing, which, actually uses relatively little labor. Those 80 million desperately poor Chinese Mundell is worried about, and still vaster pools in State enterprise and the domestic agriculture and service sectors, are hostage to the need to keep the domestic price structure low, with lots of people available to produce non-tradeable goods and services, so that even wages, which are low in international/exchange rate terms, will still attract the best and the brightest to export industries, and also allow them to live passably decent lives.

Wages in manufacturing are made low in international terms by the exchange rate policy, and those wages make investment in capital-intensive manufacturing profitable by compensating for the cost disadvantages of manufacturing in Chinese (skill deficits, infrastructure deficits, shortages of reliable electric power, transportation costs, communication problems, unreliable parts and industrial services supply, etc.).

Krugman is right that China kind of stumbled onto their current policy. It is a dynamic psuedo-equilibrium -- all trade/exchange rate stability rests on the psuedo-equilibria of persistent dynamic balance, and not on any thing resembling a long-run static equilibrium (which is why the common practice of reasoning from a framework of long-run comparative statics can be so unreliable in its prediction of events).

China is working very hard to reduce the disattractions to manufacturing in China, which make ridiculously low wages necessary to attract investment; as they succeed, they will be willing and able to allow the yuan to rise relative to the dollar, AND they will be willing to allow wages to rise in Yuan-terms domestically, which will tend to drive up the domestic price structure, and with it, domestic Chinese consumption. A rising Yuan will aid the rise in domestic Chinese consumption, by reducing the cost of imported commodities, like oil, copper, etc.

China's economy is clothed in a fixed exchange rate policy, which makes it look like Clark Kent. The Chinese Clark Kent economy, valued at current exchange rates, is roughly equivalent to France in size. Using the x-ray vision of Purchasing Power Parity, we can see that, in fact, China is growing into Superman-on-steroids. Already, in PPP terms, China's economy is larger than Japan's and almost three times the size of Germany's!

Journalistic descriptions, framed by a comparative statics analysis, make smooth transitions sound more plausible than they are. China has been investing 40+% of GDP and growing at a rate of 8-9% per year for a remarkably long-time -- not all of that investment has been wise; moreover, the policy of keeping the domestic price structure low, which is an intrinsic part of the exchange rate policy, means that there are vast pools of resources -- whole regions of the country, large sectors of the economy -- which are not part of this new world. Asset price inflation is out of control -- you think house prices are inflated in northern Virginia or West LA, try Shanghai. China builds a city the size of Philadelphia every . . . wait for it . . . month(!). Not all that construction is wisely planned.

China is going to need to have a major recession at some point, maybe not soon, may not until 2010 or 2012, but when China adjusts, it will have to let the domestic price structure and resource allocation adjust as well as the international exchange rate. Managing a recession has got to be really scary for the Chinese political leadership, so, big surprise, they are putting it off.

I don't think exchange rate adjustment, whether it comes gradually over the next few years, as part of the currency basket policy of the Chinese, or as part of the Chinese recession/crisis of 2011, will be at all pleasant for the U.S. A rising yuan/falling dollar will mean rising commodity prices in the U.S., i.e. rising oil prices.

Marginal labor productivity in the U.S. is tied directly to energy consumption, so rising energy prices means falling labor compensation. In short, a falling dollar means falling wages.

Maybe a rising yuan will mean rising prices for manufactured goods at Wal-Mart, as well, but I doubt that this will go far enough or fast enough to help much in rustbelt Ohio; for one thing, the biggest price impact of Chinese re-valuation is likely to be on clothing, which the U.S. makes relatively little of, and the impact will mostly be to drive Wal-Mart and J C Penney to shop for clothing in India and Burma.

China is rapidly repairing the deficits, which made low wages necessary in high-value-added manufacture, and the repair of those deficits of infrastructure, etc., will more than offset the rise of wages in total manufacturing cost. Chinese manufacturing will become more vertically integrated, and less dependent on importing designs and parts from the West. The $50 of direct labor in a $1000 refrigerator is not going to be enough leverage to result in a shift of manufacturing refrigerators from China back to Michigan or Ohio, from an exchange rate change. Manufacturing, today, is all about sunk cost investments and increasing returns; once the plant has closed, all the exchange rate adjustment in the world will not help. Imported Chinese automobiles will eventually arrive to compete with the Japanese autos made in Tennessee, probably about the time GM and Ford finally close their doors.

As vertical integration replaces the pattern of importing tools and parts to do assembly for export, the Chinese will be a position to allow domestic consumption to rise, diverting some of the growth in manufacturing output from exports to domestic consumption. They might allow a smidgen more imports from the U.S. into the domestic market, but that effect will be offset by the reduction in the imports of designs and parts for the manufacture of export goods -- the primary effect of increasing vertical integration.

Moreover, the Chinese are taking the advice to use their accumulated dollar reserves to invest internationally in distribution. The Chinese "multinational" is upon us. The Haiers and Lenovos, very shortly, are going to want higher margins and more of the rents, currently going to Sony and Wal-Mart and Dell and Hewlett-Packard.

When I add it all up -- the expected shift in clothing trade, vertical integration reducing Chinese parts imports, the effect on commodity prices, the insensitivity of low labor/high sunk cost manufacturing to exchange rates -- I don't see much reason to put faith in the comparative statics analysis that sees an exchange rate adjustment solving all of our problems. The Chinese may choose to soften the blow by buying airplanes from Boeing and paying a bit more to Disney and Microsoft, but I don't see anything that would offer hope to the rustbelt.

The U.S. is headed toward an unpleasant recession, after an unpleasant recovery. Under Bush, the U.S. has reduced our savings rate to negative numbers, and invested heavily in housing we don't need (much of the new construction in places no one can afford to drive to), in a health care sector already swollen to twice the size of European counterparts, and in the black hole of a stupendously costly war in Iraq. We cannot export our housing, no sane person would want our health care, and the only ones getting a return from our Iraq adventure are Halliburton, Exxon/Mobil and Dubai.

No amount of China envy justifies focusing on the dollar/yuan exchange rate. We've got bigger problems, and a rising yuan is only going to further reveal those problems.

[calmo]

Bruce writes at length [and agreeably for me who needs to read more China] (where are you 'a'?):

investing in world-class, high sunk-cost, capital-intensive manufacturing, which, actually uses relatively little labor
Sorta ignores those strategies to maximize labor use at the risk of underutilizing those machines and putting up with some over-capacity in order to have less civil unrest, no?

[save_the_rustbelt]

Why are the intelligenisa and our politicians so determined to toady to the Chinese. Sort of the Neville Chamberlain school of economics.

Nothing like working from a position of weakness.

I suppose it could have something to do with the current trend to transfer wealth from Main Street to Wall Street.

[ilsm]

Old Chinese blessing: "May you live in interesting times".

Define 'interesting'!

[anne]

What a fine comment, Bruce :) Though I rather agree with the ability of Chinese planners to respond in subtle and effective ways to changes in markets conditions and look to a continuation, my sense of the American economy is that there is enough flexibility to allow for a quick enough response in demand to a reversal of Federal Reserve policy to prevent a recession. I am still taken with Alan Greenspan's focus on flexibility in our economy from the early 1980s.

[Bruce Wilder]

"Why are the intelligenisa and our politicians so determined to toady to the Chinese. Sort of the Neville Chamberlain school of economics."

Economics is not a zero-sum game. China's growth, on balance, is enriching us, not impoverishing us. Just to see a concrete example, go buy some clothes; prices are low and the quality is excellent. Ditto for many electronics.

What do you imagine is analogous to China asking for the Sudetenland?

"I suppose it could have something to do with the current trend to transfer wealth from Main Street to Wall Street."

The U.S. is controlled by a greedy and short-sighted business and political elite; the Repubican Party is completely dominated by the interests of the corporate executive class, who are paying themselves millions and billions, while pressing tax policies, labor policies, environmental policies, social security and health care policies, and, yes, trade policies designed to enrich 1/2 of 1% at the expense of the rest of us.

Thousands of Americans have been wounded or died in Iraq to prevent Iraq from producing enough oil to dampen world prices. Lee "Fat Bastard" Raymond, after financing psuedo-science to obscure the threat of global warming, retires from Exxon/Mobil on $400 million! Bush, who never fires anyone, recently had to fire the top three CIA officials for corruption. China gives me a lovely $20 cotton blend shirt, a great $600 computer and a $10 toaster.

Somehow, China trade is not what gets me most exercised. YMMV.

[anne]

There is so much that is absurdly aimless or contrary to American tradition from the Administration, but foreign policy is especially contrary or aimless. The idea however that we need to be rough and tough with China lacks any understanding of how much the countries rely on each other and how much good will there is in China for Americans. What we need is a more cordial and consistent diplomatic focus on China. We have also already tried being warlike with devastating consequences.

[anne]

"What do you imagine is analogous to China asking for the Sudetenland?"

Never ever leave such suggestion lying around for fear they will be taken up, although come to think of we might just ask for the Sudentenland. Nice for vacationing :)

[dryfly]

Somehow, China trade is not what gets me most exercised.

We know what gets you exercised. If you competed directly with China, or had your personal standard of living tied to competition against China you might feel differently.

I have mixed emotions - I agree China trade can raise our overall standard of living - on average. But averages can be deceiving.

Take two series of numbers... 5,0,0,0,0 and 1,1,1,1,1... both have the same 'average'(1)... but are VERY different series of numbers. I feel the 'China Trade' is far more like the first series than the second and if it isn't 'leveled' somehow it will be 'ended'. That is political reality.

I was at a business meeting this week and that was the topic... that China will really float eventually because it has to... but not until it has to and probably not until 2008 or later. After the next presidential election.

Meanwhile the company I was visiting said they were going to make hay in China while the sunshines... and they were making a whole lotta hay.

[slink]

i was taught by bob m

i love his soul

and we all know
his early work was immortal

but by the time i sat at his knee...
ie
by the time
he arrived at the university
on morningside heights
the man had gone ...well
playboy pent house

not that he couldn't still strike you out

but ...
let me put it this way

the fellah had
lots of fun
cutting a big wake

gold bug spoofery and euro touting
included

so i see this patent
china forex dribble
and my heart knows...

bob's having fun over there

big time fun...

prolly got a glass curtain skyline view
and all the..... refreshments
he wants

curtesey not only of the top PRC boys

but his friends back here
on wall street too

all the bankers and suck
who want like the dickens
to run the usury op scams
on
all them
400 million hard jobbing
credit hungry householders

the diff:

for the hi fi's
its all

'some day... some how ....some way ...'

but for bob mister excitement
mundell

its all happen
right now .....

[STS]

Bruce Wilder:

Very thought provoking commentary. For a Sudetenland analogy, one need look no further than Taiwan. Unclear how aggressive China will decide to be about that.

[slink]

you folks might want to look a little further back

to the 70's

the yen was low but rising fast

and yes bruce is right

it wasn;t enough

so the japanese used restraint

watch when the water boils too much
same story will repeat itself

one huge diff

the 70's japan led invasion was by japanese owned corporations

this one from china has
a very huge trans nat and specifically american ownership component

so the cut in may hurt more
since a bigger chunk of the pie is...ours any which way its made

errr
long as you own a piece of corporate america
and don't just sell your job hours

[a]

Prof. Thoma did a great service by linking the three articles. The effect of revaluating Yuan to the Chinese (maybe Americans don't care that much, but the Chinese government HAS to care a lot), to American domestic market, and lastly, the "probably" main cause of trade imbalance...

Last Sunday, there is a great article,

ollution From Chinese Coal Casts a Global Shadow
, By KEITH BRADSHER and DAVID BARBOZA, NYT: about the other side of globalization --- pollution. And that seems to be China's export now. It is very worrying. Part of the story is China's coal mine onwers' (my view) reluntance to import western technology.

Again, in my view, there is no excuse that the government is not acting strongly to protect the environment. The coal mine owners, from what I heard, are filthy wealthy. Yet the accident rate of the coal mine workers are staggering, and the pollution is just so bad. They are making too easy money, at the cost of the worker's safety and environment.

Yes, the financial industry in China is fragile, much worse than that of Japan's, so yes, I agree that forcing China to make the sacrifice for the trade balance is, not only bad, but in the end both countries may suffer.

Relaxing hi-tech restriction with China is a better way to address the trade imbalance. But meanwhile, China has to also make strategic investment, perhaps at the cost of the new capitalists class. I wonder if the Chinese government has the guts and vision to do it. I only wish they do!

[anne]

http://www.nytimes.com/2006/06/11/business/worldbusiness/11chinacoal.html?ex=1307678400&en=3583e58e4f9ef89d&ei=5090&partner=rssuserland&emc=rss

June 11, 2006

Clouds From Chinese Coal Cast a Long Shadow
By KEITH BRADSHER and DAVID BARBOZA

HANJING, China — One of China's lesser-known exports is a dangerous brew of soot, toxic chemicals and climate-changing gases from the smokestacks of coal-burning power plants.

In early April, a dense cloud of pollutants over Northern China sailed to nearby Seoul, sweeping along dust and desert sand before wafting across the Pacific. An American satellite spotted the cloud as it crossed the West Coast.

Researchers in California, Oregon and Washington noticed specks of sulfur compounds, carbon and other byproducts of coal combustion coating the silvery surfaces of their mountaintop detectors. These microscopic particles can work their way deep into the lungs, contributing to respiratory damage, heart disease and cancer.

Filters near Lake Tahoe in the mountains of eastern California "are the darkest that we've seen" outside smoggy urban areas, said Steven S. Cliff, an atmospheric scientist at the University of California at Davis.

Unless China finds a way to clean up its coal plants and the thousands of factories that burn coal, pollution will soar both at home and abroad. The increase in global-warming gases from China's coal use will probably exceed that for all industrialized countries combined over the next 25 years, surpassing by five times the reduction in such emissions that the Kyoto Protocol seeks.

The sulfur dioxide produced in coal combustion poses an immediate threat to the health of China's citizens, contributing to about 400,000 premature deaths a year. It also causes acid rain that poisons lakes, rivers, forests and crops.

The sulfur pollution is so pervasive as to have an extraordinary side effect that is helping the rest of the world, but only temporarily: It actually slows global warming. The tiny, airborne particles deflect the sun's hot rays back into space.

But the cooling effect from sulfur is short-lived. By contrast, the carbon dioxide emanating from Chinese coal plants will last for decades, with a cumulative warming effect that will eventually overwhelm the cooling from sulfur and deliver another large kick to global warming, climate scientists say. A warmer climate could lead to rising sea levels, the spread of tropical diseases in previously temperate climes, crop failures in some regions and the extinction of many plant and animal species, especially those in polar or alpine areas.

Coal is indeed China's double-edged sword — the new economy's black gold and the fragile environment's dark cloud.

Already, China uses more coal than the United States, the European Union and Japan combined. And it has increased coal consumption 14 percent in each of the past two years in the broadest industrialization ever. Every week to 10 days, another coal-fired power plant opens somewhere in China that is big enough to serve all the households in Dallas or San Diego.

To make matters worse, India is right behind China in stepping up its construction of coal-fired power plants — and has a population expected to outstrip China's by 2030....

[anne]

http://www.nytimes.com/2006/06/08/world/asia/08desert.html?ex=1307419200&en=f5f4295e2338f5d6&ei=5090&partner=rssuserland&emc=rss

June 8, 2006

A Sea of Sand Is Threatening China's Heart
By JOSEPH KAHN

MINQIN, China — China's own favorite military strategist, Sun Tzu, surely would have warned against letting two mighty enemies, the Tengger and the Badain Jaran, form a united front.

Yet a desert pincer is squeezing this struggling oasis town, and China's long campaign to cultivate its vast arid northwest is in retreat.

An ever-rising tide of sand has claimed grasslands, ponds, lakes and forests, swallowed whole villages and forced tens of thousands of people to flee as it surges south and threatens to leave this ancient Silk Road greenbelt uninhabitable.

Han Chinese women here cover their heads and faces like Muslims to protect against violent sandstorms. Farmers dig wells down hundreds of feet. If they find water, it is often brackish, even poisonous.

Chinese leaders have vowed to protect Minqin and surrounding towns in Gansu Province. The area divides two deserts, the Badain Jaran and the Tengger, and its precarious state threatens to accelerate the spread of barren wasteland to the heart of China.

The national 937 Project, set up to fight the encroaching desert, estimated in April that 1,500 square miles of land, roughly the size of Rhode Island, is buried each year. Nearly all of north central China, including Beijing, is at risk.

Expanding deserts and a severe drought are also making this a near-record year for dust storms carried east in the jet stream. Sand squalls have blanketed Beijing and other northern cities, leaving a stubborn yellow haze in the air and coating roads, buildings, cars and lungs.

Prime Minister Wen Jiabao traveled to the northwest in May to offer aid to drought-stricken farmers and order provincial officials to supply more water to Minqin.

But while local officials have tried grandiose projects to rescue the outpost, environmentalists say it will probably have to be at least partly abandoned and returned to nature if the regional ecology is to be restored....