China Better Have a Plan

Big Brother in the form of an increasingly powerful government and in an increasingly powerful private sector will pile the records high with reasons why privacy should give way to national security, to law and order, to efficiency of operation, to scientific advancement and the like.
- Justice William O. Douglas (1898-1980), U. S. Supreme Court Justice

Those who take the most from the table, teach contentment.  Those for whom the taxes are destined, demand sacrifice. Those who eat their fill, speak to the hungry, of wonderful times to come. Those who lead the country into the abyss, call ruling difficult, for ordinary folk.
- Bertolt Brecht (1898-1956) German dramatist, stage director, and poet

Idealism is the noble toga that political gentlemen drape over their will to power.
- Aldous Huxley

China Better Have a Plan
The fact that the Central Planners in China are basically standing around like deer in headlights as their economy plunges into the abyss is nothing short of astounding.  Sure they have lowered the bank Reserve Requirement but so what?  That is an epic joke of a move in light of the gargantuan problems that economy is facing, and is blatantly pathetic in its irrelevance.  I’m not going into detail for the thousandth time why China’s economy is nothing more than a Keynesian Centrally Planned house of cards on steroids with mal-investments that make the U.S. housing market look benign.  I have done that too many times over too many years to exert energy on that topic once again.  That said, what I do want to do is look back at the post 2008 period and try to figure out why they never really took polices to rebalance the economy away from fixed asset investment toward consumption.  In fact, not only did they not rebalance but they doubled down on the prior strategy!  Well now the chickens have come home to roost and we are about to find out if China has any real “long term” plan to get themselves out of this mess.

Although I never bought the “China bull” story over the last few years, where I did agree with a lot of these pundits was the notion that the Chinese currency, the yuan, was inevitably going to strengthen materially.  The primary reason that I agreed with this notion was the fact that I believed it to be the most effective means for the government to transfer global purchasing power to their citizens and also rebalance its economy more toward consumption.  Well the yuan did appreciate from mid 2010 to December of 2011, but the appreciation was a measly 8%.  That is basically nothing and in no way could have done anything to rebalance the economy in any way shape or form.  The lack of appreciation has been one of the biggest surprises to me, and indeed, now represents one of the scariest aspect of the macro backdrop globally.

As I mentioned recently in another piece, the cessation of the strengthening trend in the yuan back in July 2008 foreshadowed the collapse of the global economy.  Is the same thing happening now?

Chart of the Chinese Yuan (inverse so a decline represents strength vs. the U.S. dollar).

I have thought over and over again in my head why they didn’t allow the yuan to appreciate more, and at the end of the day, it comes down to one main point in my mind: Political Power.  As we all know, China is run by a very small group of bureaucrats that are fabulously wealthy and fabulously corrupt.  As is the case back here in the United States of Banana Republic, the Central Planners, politicians and financial/corporate oligarchs have made themselves fantastically wealthy and powerful through the parasitic controlled crony capitalist economy that they have put in place.  This is why they fight tooth and nail against reform.  Reform would restore power to the people and away from them; and of course, they don’t want that.  China and the United States are exactly the same in that regard, and since the old model has worked so well for the few in power they have been reluctant to change the model.  Indeed, they haven’t.

So here we are today and things are much different for China.  In fact, from a fundamental perspective it is now difficult to argue for a yuan appreciation.  The terms of trade have started to go against China and go against it strongly.  The entire export model was driven by the mobilization of rural workers from the interior to the coasts.  This seemingly endless cheap labor coupled with an undervalued currency made the cost of mass producing manufactured good exceedingly cheap relative to the rest of the world.  Factories in the West packed up and moved to China, the trade surplus boomed, and the rest is, well, history.

Those days are over.  Chinese wages have been skyrocketing and with global commodity prices elevated China’s trade surplus is not what it used to be.  There may even be a dollar shortage in China as the government foolish put its dollars into treasury bonds for some insane reason.  Why the government there would take a currency that is doomed in the long run and then put it in to an asset they will never be able to liquidate in an orderly manner is beyond my comprehension, but that is what they did and now they are stuck with that garbage.  There was a great article on this topic yesterday at FT Alphaville by Izabella Kaminska that I suggest everyone read.  You can find it here.

The following paragraphs I consider to be the most important part of the article:

The sad truth that many don’t realize is that these moves to internationalize the currency have less to do with Beijing’s wish to modernize and much more to do with a need to draw dollars into the system to cover the country’s growing “dollar short” position.

But what happens if the strategy fails? What happens if foreigners decide the last thing they want is yuan exposure (due to China economic bubble fears), and would much prefer to keep hold of their US dollars?

What happens if instead of a dollar inflow you get a mass capital outflow from China, with as many Chinese as possible converting yuan-denominated assets into dollars, seeing the yuan fall in value versus the dollar due to what is now an over-valued position?

Recent developments in offshore/onshore markets and forward markets, unfortunately, seem to suggest this is exactly what’s happening.

Wow, so if this article is correct then we have just made a 180 degree turn from where we were just a few years ago.  Rather than the market assuming a major appreciation in the Chinese currency, it seems as if financial players are becoming terrified of the currency considering the reversal in the terms of trade and the much more negative prospects for the economy going forward.  Believe me when I tell you that this is an absolutely terrifying scenario to be faced with for all of us.  If this is correct, the risk from China is likely to be as great if not greater than anything happening in Europe.  Here’s why.

The reason I say this is because I think there are two options from here, and both of them would have seismic effects on the global economy for the foreseeable future.  The first scenario assumes that China has a plan to deal with a loss of faith in its currency.  That plan in my view would be that they would come out with a gold backing to their currency.  This is something many people have written about for many, many years, including myself.  If China has enough gold to pull this off, they would immediately become the one currency in the world that everyone wants.  Capital would flee to China and the Chinese consumer would receive an overnight boost in purchasing power that will be written about for centuries to come.  This fits into the theme that I wrote about last year in my piece “Does China Need the U.S. to Collapse.”  The basic premise is that in a resource constrained world the only way China can ever actually utilize the massive excess capacity it has built is through a massive transfer in purchasing power to its citizens.  The West could collapse into third world status if this were to happen (it’s already on that path anyway).

Then there is the second outcome.  This relates to the idea that China does not have such a plan, or more importantly, its leaders are too corrupt and scared to implement such a plan.  In that case, I think the Chinese economy is likely to continue its spiral downward into what could be a depression like state.  In this outcome the yuan could easily collapse in value versus other global currencies, which would spark the greatest worldwide currency war and print fest the world has ever seen.  We would be looking at a global Zimbabwe scenario.

I believe that either of these outcomes would be massively bullish for precious metals and considering this market has already discounted the mega global economic slowdown currently in place this would be a good time to increase exposure to the sector.  The Dow/Gold ratio to me looks like it has put in an important top at around 8x and could collapse from here.

Congress:  Always Working Hard for You!
I want to end this piece with another quick example of how criminally stupid and corrupt our members of Congress are.  They have absolutely demonstrated clear as day that they in fact do view “we the people” as their subjects and indeed their enemies.

While I am not in favor of people renouncing their citizenship as soon as they are about to get a massive payout, such as what is happening with Facebook co-founder Eduardo Saverin, I want to ask everyone to ponder a question.  If the U.S. Congress hadn’t been passing laws to detain citizens without trial (the NDAA), and consistently attempt to pass bills to censor the internet (SOPA, PIPA, CISPA), or put in place measures for 30,000 drones in America by 2020; if the American leadership wasn’t actively putting in place a police state, do you really think he would be fleeing?  I am not so sure and let’s not forget that the number of Americans renouncing their citizenship has been skyrocketing recently.  They are not all Facebook co-founders.  They are people that see the writing on the wall; that Congress has been taken over by thugs.  You gotta love how Schumer is acting like he is the protector of the people!  Populist anger!  He never seems to notice populist anger about the police state bills Congress passes.  Ever notice that?  These guys are the lowest humanity has to offer.

So read this article and think.  Think about where we are going.  Did the United States get to the position it was in by bullying its citizens around with threats or by opening doors and allowing freedom to flourish?  I think you know the answer to that.

Peace and wisdom,

Mike

8 Comments

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  1. ah ! if you could only sustitude the word China with Australia.Plus to outdo our own
    stupidity we will be the first to impliment a CARBON TAX,just as China IS IN THIS POSITION
    and our biggest resource buyer.
    CHEER`S
    JOHN
    AUSTRALIA

  2. Followed the link on Severin. Ouch, the idiocy of our national dialogue is painful!!

    So Severin is of Brazilian origin, became a US citizen as a minor, is now 30, and has been in Singapore since 2009. And he doesn’t feel obligated to be a bomb-buying, bank-bailing US taxpayer for life, and thinks paying a $365 million exit tax was adequate compensation for all we’ve done for him? Ingrate. And Schumer wants a new law that will tax FUTURE capital gains?!? Will they refund it if the gains don’t materialize, or evaporate later? Maybe we should just confiscate all ex-pats wealth, or just not let them leave, period.

    ‘Despicable’ is too good a word for Schumer. That he can make a proposal like this without being hounded out of public office speaks volumes about the current state of the US.

    • Having lived most of mt life in NY I can say Schumer is nothing short of a clown. Sensationalizing headline whore. Ridiculously out of touch and not a small reason NY may be the most over taxed and over regulated state in the US.

  3. I’m pretty dubious about the whole “China is in trouble” meme going around recently. The rules of the game are changing, and it’s a mistake to analyse the Chinese situation in terms of the old rules. For example, why would China ever want to switch over to a consumption based economy? Just at a time when supply of all kinds of commodities is tightening? That would be foolish. Instead, they’ve been stockpiling commodities of all kinds. This shows foresight. Why would China want to make their working class fat and lazy and used to being coddled with comforts and toys? The Chinese masses, as they are, are easily mobilised to war, or back to the countryside to farm, if need be.

    I just don’t get Kaminska’s argument for Yuan weakness. Call me stupid. For example, here: “If the situation worsens, and the dollar shortage gets more extreme, there will come a point where Chinese dollar liabilities will be stretched to the limit, and potentially defaulted upon.” What Chinese dollar liabilities is she talking about? The article discusses what we all know about already – the massive Chinese position in US treasuries and other dollar denominated assets. The article makes brief mention of “some Chinese corporates even finding themselves short of dollars”. What’s the big deal? Unless we are talking about hundreds of billions, the Chinese government could easily exchange dollar denominated assets for non-dollar assets of these Chinese corporates, without causing a major impact in the US bond markets.

    • China has a three point plan in its agenda. Economic growth, development and territorial integrity. I agree that the chinese consumer is not spend crazy like the American consumer. But I will say this: If everyone in America has an Ipad, Iphone, etc. Then it would be wise to note that 90% of my school in Australia are Chinese exchange students. 75% of them have something close to an Iphone/Ipad. That said, the chinese do spend money, they just spend it frugally.

      I envy and respect the Chinese and I understand their hatred of western imperialism. I would not like the west either if someone came into my country and took what they wanted. China has not forgotten this, but China has also not forgotten that the West has only ruled for a few hundred years and they believe and know it will be temporary. China will return to the top of the world as the strongest economy in the world and she will get her respect.

      It will just take time for this to happen since they are playing catch up with the world similar to how the Western Europe played catchup with the Mongol Empire during its reign and benefited from the relative safety from the Mongol empire’s imperialistic growth.

      The way I see it, is if you can’t talk the talk, then don’t walk the walk. You need to build up the country first and make it sustainable and powerful in order to exercise power in the 21st century. The good thing about the infrastructure led spending spree is that at least there is something to be had rather than a consumer led spending spree that would be temporary and wasteful. You can’t live in an Iphone, but at least you can live in apartment.

      • “The good thing about the infrastructure led spending spree is that at least there is something to be had rather than a consumer led spending spree that would be temporary and wasteful. You can’t live in an Iphone, but at least you can live in apartment.”

        Exactly! Much of the hand-wringing about China’s “ghost cities” and “misallocation of resources” is ignorant rubbish. Overall, the are allocating quite wisely. The “ghost cities” ARE ghost cities, at the start. But they do not REMAIN ghost cities; they fill up. China is building a nation for the 21st century. They know they are going to need tremendous capacity on all fronts, and they’re working on it. Infrastructure investment is critical; it is the precondition of all growth. And it must be financed in that evil evil “Keynesian” (i.e. public) way. There’s no way that the private sector would ever have made the infrastructure investments that made the U.S.
        ascendent in the 20th century. Likewise for China in the 21st.

        An “infrastructure led spending spree” would be a great thing for the U.S. But we’re too stupid and addled for it. We would rather piss away the money on trivial consumption, financial fraud, the military/industrial/”security” establishment, etc. That’s why we’re doomed to a long decline, while the East ascends.

  4. Well one needs to remember the crisis of 1873. We were still on the greenback standard for another two years. So Gold was not a mean of payment. During this very deep crisis, while the quantity of Greenback increased during this period, the price of Gold went down. Why? The usual, as there is an acute of means of payment people had to sell their Gold in some cases to get the means of payment. So if Bernanke is really behind the curve, first Gold and Silver go down if the liquidity need is overwhelming.

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