China playing with fire

[Ballinvarosig Investors]

http://www.eurekareport.com.au/iis/iis.nsf/pages/E5935276FE03EFDDCA2576E7001A3509?OpenDocument

PORTFOLIO POINT: A trade war with the US would ruin China’s economy, and therefore Australia’s.

 

Chinese Premier Wen Jiabao is playing a dangerous game by upping the ante in the Cold War of words with the United States over exchange rates. And it’s a game in which Australia, and Eureka Report members, are more than interested spectators: we are on the field, in danger of being trampled by elephants blinded by rage.

 

China seems to have persuaded itself that it’s already a superpower that doesn’t need anyone else, least of all yesterday’s superpower, America. Over the weekend Premier Wen lashed out at the world over the pressure on China to let its currency rise: “We oppose all countries engaging in mutual finger-pointing or taking strong measures to force other nations to appreciate their currencies”.

 

He claimed the yuan is not undervalued and accused other countries that are trying to get their currencies to fall, of “protectionism”.

 

This escalating conflict between the US and China is by far the most important and dangerous development for Australian investors in 2010, far more significant that the bankruptcy of Greece or the prospect of a crazy political bidding war in Australia as the 2010 election approaches (both of which are quite significant, let’s face it).

 

China is not as strong as it thinks, and is extremely vulnerable to a trade war with the United States. It is not, as is often believed, the financial equivalent of the Mutually Assured Destruction (MAD) that underpinned the nuclear standoff of the Cold War between the Soviet Union and America. This relationship is far more one-sided: China needs America far more than America needs China.

 

China’s domestic market – that is, the average wealth of its vast population – is not yet sufficiently developed to support the massive investment China has now made in production. There is massive over-capacity in China even with the American market open to it; if the US West Coast ports were closed to it, China’s economy would go into a deep recession and its demand for our iron ore and coal would collapse.

 

This is an especially delicate moment for Australia on this score because negotiations are getting under way for new contract benchmark prices for iron ore and coal. In each case, the spot prices are about double last year’s contract prices because of Chinese buying.

 

That buying has not been driven by consumer demand for products, either domestic or export. It has occurred because of debt-funded stimulus spending by the Chinese government designed to maintain GDP growth and keep its citizens employed.

 

In other words, the increase in iron ore and coal spot prices have been associated with the increasing over-capacity of the Chinese manufacturing sector.

 

BHP Billiton and Rio Tinto need to be mindful that increasing the contract price by the full extent of the spot price increases would put more pressure on the Chinese economy and worsen any crash caused by a trade war with the US.

 

In about a month, the US Treasury will formally rule whether China is a currency manipulator, which would trigger trade sanctions under US law. With unemployment at 9.7%, and the broader measure of unemployment, called U6, which includes the under-employed, at about 17%, the issue may not be put to one side this time, especially after Wen’s inflammatory comments at the weekend.

 

It is simply not true that China’s foreign currency reserves of more than $US2 trillion – an outcome of years of currency manipulation producing trade surpluses – give the Communists the strength to outmuscle the United States, and to threaten selling US government bonds and thereby destroy its economy.

 

This is the basis of the idea that China and America are in a Mutually Assured Destruction stand-off which means neither will do anything that turns the Cold War into a hot one.

 

Ambrose Evans-Pritchard, writing in the London Telegraph, points out that only two nations in history have amassed such a stash as China has now, equal to 5–6% of GDP: the US in the 1920s and Japan in the 1980s. Each time preceded a Depression.

 

In fact, Michael Pettis of Beijing University argues that reserves of that size are a weakness, not a strength. “The … reserves cannot be used in China. They cannot go to pay doctors’ salaries, to build bridges, to lower taxes or to subsidise consumption. They can only be used to purchase or pay for things from outside China.”

 

China manipulates its currency by buying and selling US dollars, not by passing a law that sets the value of the yuan and making it a crime to trade a different value. The Peoples Bank of China simply offers to buy or sell unlimited amounts of yuan at the desired rate.

 

This means that if it wants to set a certain value for the Chinese currency, it must take the opposite position to the market. Since the rest of the market is a net seller of US dollars, China must be a buyer – all the time.

 

And this means, according to Pettis, that the PBoC has a balance sheet consisting of dollar assets on one side and yuan liabilities on the other.

 

“Here is where things get interesting,” he says. “China’s reserves are often thought of as if they were a treasure trove available for spending. They are not. They are simply the asset side of the mismatched balance sheet. If the PBoC wanted to ‘spend’ $100, for example, to recapitalise a bank, it could do so, but this would automatically create a $100 hole in its balance sheet – it would still owe the RMB [renminbi, or yuan] that it borrowed originally to purchase the $100. To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes. Reserves are effectively borrowed money.”

 

It means China cannot use its reserves without increasing its indebtedness. And although China can theoretically exert influence on the US because it is its largest creditor, America’s power to shut down the Chinese economy by closing its ports to Chinese imports is far greater.

 

It’s true that, in general, a retreat into protectionism now would be a very bad thing. The common wisdom is that the protectionist Smoot-Hawley tariff in 1933 worsened the 1930s Depression and made it Great. That may be true, but tariffs have a far worse effect on surplus countries than deficit countries; it just happens that the surplus country then was the United States, and tariff did, indeed, devastate its economy.

 

A trade war now between America and China could ruin China’s economy, and therefore Australia’s.

 

This is no longer a distant theoretical threat, but an increasingly real one because after the weekend display from China’s leadership it’s clear that they are becoming deluded.

 

Wen Jiabao said China’s biggest threat is inflation and that the survival of the Chinese Communist Party is at stake. “If there is inflation plus unfair income distribution and corruption, it will be strong enough to affect our social stability and even affect the stability of state power,” he told yesterday’s press conference.

 

He is, typically for a politician, taking a narrow view based on his own party’s interests. Inflation is not a serious problem for China and given the overcapacity built up over the past 12 months is very unlikely to become one.

 

The biggest problem is the Communist Party’s increasing arrogance and belligerence.

Human psychology is a funny thing. Things that seem ridiculous in hindsight can be perfectly acceptable at the time they're occurring to the mainstream. Honestly though; what are investors thinking when they place their fate in a fascist, centrally planned dictatorship driving economic growth? Do they not remember the Soviet Union? 50 years ago Nikita Khruschev took off his shoe and banged it on the table at the UN General Assembly, proclaiming to the United States; "We will bury you", referring to 10%+ growth rates in the Soviet Union. 30 years after those comments, the Soviet Union was in collapse.

 

Today, we have an investment community that has an almost singular outcome for China - the next superpower. I'm certainly not convinced ;D

[abyli]

I do not understand your point. If you compare China and US economically, China is more pure capitalism and US is socialism. And in this world, there is only one country who has the power to manipulate currency and does it all the time: US. It is US who wants to have a economy war, not China! US is moving in the wrong direction. Serious, I do not see any hope here in US.

 

"America’s power to shut down the Chinese economy by closing its ports to Chinese imports is far greater." who is arrogant here?

[Guest Bronco]

Abyli - the U.S. is loaded with issues and problems, but your comment is the most ludicrous comment I have seen on this board.

 

Can a U.S. citizen buy Chinese currency on the open market?  Can I own the same shares as Chinese citizens?  Is there the same level of intangible protection in China?  Which country has bigger stakes in publicly traded companies? 

 

I can go on and on...but I bet 90% of the readers here get the point and would agree.

[Guest ValueCarl]

Throughout the ages, at the core of human conflict and turmoil resides "The Bank." This Bank shows no loyalty to man, woman or country. Its embedded owners who run these international fiat machines have believed and been taught that, the world's resources inclusive of "PEOPLE RESOURCES" are theirs to own by DIVINE RIGHT. They subscribe to the German philosopher, HEGEL's methodologies for attaining synergy across their global assets. Create conflicts, support opposing parties, conclude in synergy before repeating the process over and over again, i.e., lather, rinse and repeat or thesis, anti-thesis, synergy.

 

In the US, this back and forth battle with these "Money Changers" is well documented. When you think "Money Changer," think gold to paper, and back again for the proper visual in your minds. 

 

Rather than waving patriotic flags, tied to countries or peoples where ultimately, death and destruction as a result of their war machines will ensue, it would be better to address the underlying owners of these dubious institutions, by naming them, trying them, incarcerating them, and then dismantling their institutions forever! Too much power, influence and control in the hands of a few, is NO GOOD for the people of this planet whatever be their race, color or creed.

 

The Money Changers have penetrated the Far East with their form of capitalism for greater than twenty years now, at the same time debilitating America with one hand, maybe two, tied behind their backs up until now. They will NOT STOP by having a Red Government, truly a dictatorship at its core, maintaining dominion over "THEIR RESOURCES."

 

To all capitalists, want to be or otherwise, aspiring upon misguided "belief systems" carrying their PENT UP BIASES for country or peoples, I suggest you REVISE your belief systems by addressing the CORE CAUSE of this globe's problems head on. Start naming the names, many whom are descendants of great wealth before their own existence. Then, the trials of the earth's real war criminals can begin!

 

Otherwise, we will continue to be dealing with "straw man" arguments many layers below the SURFACE of where the PROBLEM resides! 

 

A war with China, trade or otherwise, has always been part of their PLAN! IMO     

     

[alertmeipp]

I don't think US can afford a trade war either. Inflation will shoot up if no more import from China.

US currencies will tank when China starts selling treasuries heavily. (Russia will happily follow suit).

 

China and US need each other and they know it. Don't take what you see in face value. :)

[Myth465]

I do not understand your point. If you compare China and US economically, China is more pure capitalism and US is socialism. And in this world, there is only one country who has the power to manipulate currency and does it all the time: US. It is US who wants to have a economy war, not China! US is moving in the wrong direction. Serious, I do not see any hope here in US.

 

"America’s power to shut down the Chinese economy by closing its ports to Chinese imports is far greater." who is arrogant here?

 

We must have drastically different definitions for pure capitalism. Even so I doubt anyone would want to live in a purely capitalistic society, perhaps you would though.

[Guest Bronco]

IMO - trade war = Lose/Lose (lose for U.S., lose for China, lose for ROW)

 

 

[Myth465]

I think its a slight loss for the US and a big loss for China. Plenty of other countries in Latin America and Asia would love to be our workshops.

 

We have them over a barrel. We want a weaker dollar (Look at Bernanke), so that currency treat doesnt mean much.

[eggbriar]

 

Even so I doubt anyone would want to live in a purely capitalistic society, perhaps you would though.

 

I know I would love to live in a purely capitalistic society!

[twacowfca]

Is this thread about a tempest in a teapot, brewed by an Australian writer with an not unreasonable concern for his country's dependence on China's buying their ore?

 

Objectively,  if the codependence in trade and exchange between the US and China survived the 08, 09 financial crisis,  why should it become critical now?

[SharperDingaan]

Isn't this really just a debtor (US) saying to their lender "If I go [because you didn't revalue], you go", & the lender telling the debtor "I'll survive, but you will not". Lots of threats & grandstanding, but behind the scenes ... they eventually reach a compromise.

 

No one can get anywhere by publicly calling the other guy an idiot.

 

SD  

[Ballinvarosig Investors]

Can a U.S. citizen buy Chinese currency on the open market?  Can I own the same shares as Chinese citizens?  Is there the same level of intangible protection in China?  Which country has bigger stakes in publicly traded companies? 

Chinese capital control goes to those, and much, much deeper levels.

 

I recently read that the largest telecoms company in China (China Telecom) has taken a stake in a large Chinese bank. Considering that China Telecom is 75% owned by the Chinese government; who do you think was reasonable for this absolutely ludicrous allocation of capital?

 

I fear that investors who entrust their capital to the hands of the Chinese Politburo are going to sorely regret their decision in the future.

[Myth465]

Isn't this really just a debtor (US) saying to their lender "If I go [because you didn't revalue], you go", & the lender telling the debtor "I'll survive, but you will not". Lots of threats & grandstanding, but behind the scenes ... they eventually reach a compromise.

 

No one can get anywhere by publicly calling the other guy an idiot.

 

SD  

 

Very true, but Buffs do get called. Ask Sadam Hussein. Sometimes the big stick comes out for better or worse.

 

Can a U.S. citizen buy Chinese currency on the open market?  Can I own the same shares as Chinese citizens?  Is there the same level of intangible protection in China?  Which country has bigger stakes in publicly traded companies? 

Chinese capital control goes to those, and much, much deeper levels.

 

I recently read that the largest telecoms company in China (China Telecom) has taken a stake in a large Chinese bank. Considering that China Telecom is 75% owned by the Chinese government; who do you think was reasonable for this absolutely ludicrous allocation of capital?

 

I fear that investors who entrust their capital to the hands of the Chinese Politburo are going to sorely regret their decision in the future.

 

Thats what makes these things so interesting. The same people who say the bailouts were anti capitalistic (They were) also look up to China, a country where the government has its hands in everything.

[20ppy]

It's funny that I've seen this type of discussion thread, more and more recently. My views on this follows, not that is means much to you or it matters:

 

1. Most part of US population lead by polititcians are arrogant towards China. In the similar fashion that they believed in the recent wars.

2. Whatever labels people use for different people only show their own limited views of the real world. Being it capitalism or socialism they use in this case.

3. The whole situation will continue just like religions do.

4. If you notice, WEB and Charlie Munger never framed a nation with these big words, they take things as are. They truely have objective mindset in judging things. We as investers need to learn this skill.

5. It was a mistake for the Chinese 30 years ago to have believed that all capitalism was bad. It proves a bigger mistake for the US to think that all capitalism is good.

 

[Guest kawikaho]

When you owe a little bit of money, the bank owns you.  When you owe alot of money, you own the bank.

[gokou3]

Nice points, I agree with you.  I think the only winners of a RMB revaluation are the manufacturers in other asian countries.  Americans can dream all they want about "getting back THEIR (basic) manufacturing jobs" while paying xx% more for stuff at Walmart.

 

It's funny that I've seen this type of discussion thread, more and more recently. My views on this follows, not that is means much to you or it matters:

 

1. Most part of US population lead by polititcians are arrogant towards China. In the similar fashion that they believed in the recent wars.

2. Whatever labels people use for different people only show their own limited views of the real world. Being it capitalism or socialism they use in this case.

3. The whole situation will continue just like religions do.

4. If you notice, WEB and Charlie Munger never framed a nation with these big words, they take things as are. They truely have objective mindset in judging things. We as investers need to learn this skill.

5. It was a mistake for the Chinese 30 years ago to have believed that all capitalism was bad. It proves a bigger mistake for the US to think that all capitalism is good.

 

[arbitragr]

Author of that article is wrong about Australia.

Doesn't matter what happens to China, they still are going to want to build the infrastructure they need. And that takes resources.

There's only 2 main places they can get it; Australia or Brazil.

 

If China doesn't take all the resources, India is waiting in line. Same with all the other emerging markets.