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SPEAKING
FREELY
Politics,
jobs and the yuan
By Jack Crooks
Speaking Freely is an Asia Times Online
feature that allows guest writers to have their say.
Please click here if you are interested
in contributing.
Money
couldn't buy friends, but you got a better class of
enemy. - Spike Milligan
America's gaping trade deficit with China
is becoming a flash point for a political class that
must deal with the problem of a "jobless recovery".
Granted, the United States is losing jobs to China. But
this isn't a new problem and tinkering with the yuan is
no quick fix. The US administration knows this.
But the election year looming on the horizon
takes precedence. Thus was the purpose and timing of
Treasury Secretary John Snow's trip to Thailand. China
is lined up in the crosshairs as the major scapegoat for
what ails the US economy. It's a dangerous game to play,
especially when your prey can shoot back. The
implications for the US, China, and global capital
markets are significant.
Dollars piled on
dollars
We must recognize that the relationship
between the US and China is complementary, complicated
and at times precarious. Jim Grant, editor of Grant's
Interest Rate Observer, summed it up this way:
China sends us merchandise, produced for
an average annual wage equivalent to perhaps US$875,
or $3.37 a day; and we send them dollars, produced at
a marginal cost of essentially nothing. Empty shipping
containers from Asia pile up outside deepwater
American ports because there isn't enough westbound,
American-made merchandise to fill them for the return
voyage home. And the dollars pile up on the balance
sheets of the Asian central banks because the
governments of those countries would rather hold
dollar and dollar-denominated securities than suffer
an export-crimping rise in their exchange
rates. China gets unfettered access to the
world's largest consumer market and a huge supply of the
world's reserve currency to spend or invest as it
pleases. China chooses to invest those dollars back into
US Treasury and agency paper. It wants to keep the game
going.
China and the rest of Asia owned an
estimated $696 billion in Treasuries at the end of June,
up from $512 billion in December 2001, according to data
from the US Treasury. It means that China is carrying a
big pretty big stick. There's a strong argument being
made that China has no other place to go with all those
dollars. That argument seems to be playing within the US
administration. It could explain why the US seems ready
to deal the jobs card from the bottom of the deck.
'Where have all the jobs gone?'
About
3 million jobs have vanished in the US over the past
couple of years. There is no doubt a huge number of
manufacturing jobs have been lost in the United Nations
as its multinational corporations have transferred
production platforms to China. A floating yuan won't
help this problem - those jobs are not coming back.
But this should be no surprise. After all, the
US has been out in front beating the drums for universal
acceptance of "free trade". And it's precisely the
efficiencies of trade and global sourcing that are
opening up the labor forces of competing countries to
head-to-head competition. It's a competition that the
American worker will lose. He faces a worker in China
increasingly turning out higher-quality products in
shining new plants surrounded by state-of-the-art
infrastructure built by Western and East Asian
multinational corporations for about 40 times less that
an American worker. Of course it's a bit more
complicated than that, but it captures the essence of
why China is being lined up as a scapegoat.
US
economists still seem perplexed about why the job market
isn't rebounding, even though the economy is. They've
yet to awaken to the new reality of the "globalization
of the US business cycle" as described by Stephen Roach,
chief global economist for Morgan Stanley. He explains
the "extraordinary shortfall" in US job growth this way:
Courtesy of IT-led breakthroughs, goes the
argument, increasingly efficient US businesses are
able to make do with less - especially workers. In my
view, this explanation seriously oversimplifies the
story. There are, in fact, far more important forces
at work. At the top of my list is what can be called
the globalization of the US business cycle.
Significantly, this is the first cyclical recovery in
the United States that has unfolded since the advent
of the Internet in 1995; as such, it has been driven
by IT-enabled outsourcing as never before. Now, with
the click of a mouse, increasingly high-value-added
labor input can be extracted from low-cost production
platforms in Asia, central and Eastern Europe, and
Latin America. Not only is that true with respect to
foreign sourcing of manufacturing input, but it's
increasingly the case in services as
well. Those are the facts. The US government
must either accept or change them. It cannot have it
both ways. In economics, as in life, there are always
some unpleasant tradeoffs. The United States is getting
a continuing stream of low-priced goods and a ready
buyer of US government paper. The tradeoff is jobs.
Treasury Secretary Snow's trip was supposed to prove
that the administration of President George W Bush is
"starting to get tough with China". Implicitly it said,
"We only want the good part of our relationship with
China, so you guys need to act, and act fast."
But instead of appearing tough, the market saw
it as weakness. The dollar has tumbled since Snow's
appeals were rejected by Asia Pacific Economic
Cooperation (APEC) foreign ministers. Of course that
rejection was well timed with an unexpected plunge in
the US payrolls.
Protectionism
lurks
And though the secretary stuck to the
script by saying he wants the "free market" to decide
the proper rate of exchange, his trip ratchets up the
political heat and raises the specter of protectionism.
"We should see all this as part of the same
weary old protectionism to which politically astute but
economically illiterate and morally bankrupt office
holders usually stoop when things get tough at home,"
writes Sean Corrigan, editor of Capital-Insights.
It means the "goods for paper" relationship
between China and the US could be in jeopardy. It seemed
to work so well during the financial boom in the 1990s,
as Wall Street leveraged the paper to create even more
paper and profits.
If the United States decides
to rock the boat in China, it will reverberate
throughout all of Asia and feed quickly into US capital
markets. That's because there is a lot more to the
exports from China than just China.
China's
export boom is a collective affair
According to
Morgan Stanley economist Andy Xie, China shouldn't be
demonized for the ballooning trade deficit in the United
States because China's gains are a reflection of a
redistribution of exports from other East Asian
economies to China. "In the first half of 2003, overall
imports in the US rose 10.3 percent from last year.
However, its imports from East Asia increased only 7.4
percent even though its imports from China rose 25
percent in the same period," writes Xie. "The US deficit
with East Asia has been stable since 1999 [near 33
percent after peaking at 40 percent in 1994] even though
its overall deficit has risen sharply."
China in
fact runs a deficit against every other East Asian
country. This is why some economists believe the yuan
won't be devalued or floated before 2005. Though Chinese
exports have tripled over the past 10 years, exports
from China's "foreign invested enterprises" represent
about 65 percent of the increase. And it seems clear to
some that China's currency has little to do with the
corporate decision to manufacture in China.
Wages should remain low for years, regardless of
how high the yuan appreciates. That's because China has
such a vast pool of labor, and those moving into the
workforce are much more productive than those leaving
ones that have only known the grinding inefficiencies of
state-owned enterprises. And as more and more Western
manufacturing technology is integrated into China, this
labor force will only become more productive compared
with the West. It means multinationals will keep coming
to China, exchange rates be damned.
And besides,
if exchange-rate policy had such a big impact on trade,
why is the US still running a huge trade deficit with
Japan? The yen surged in value against the US dollar,
going from 360 to the dollar in 1971 to about 117 today.
There is also the matter of institutional
profits being skimmed on the goods hitting US shores.
For every $1 in product value China receives from
exports to the US, that same product is resold in the US
retail market at $4-$5. This represents a huge profit
margin for distributors and US retail establishments.
Morgan Stanley economist Xie estimates that more than $1
trillion of US market capitalization depends on
inexpensive Chinese imports.
Beneath all this
growth in China, a bubble is building. The dollars
piling up in Chinese banks are juicing the money supply
and creating oceans of credit in China. As China
accumulates more and more of the dollars printed by the
US Federal Reserve, to pay for the shipping crates of
goods, it in effect leads to a direct expansion of
China's monetary base. Foreign-exchange reserves
increased by $60.1 billion, pushing total reserves to
$346.5 billion - that's a 42 percent increase over the
prior year. It seems there's liquidity everywhere you
look.
The broad money supply grew by about 21
percent during the first half of 2003 compared with the
same period last year. The People's Bank of China (PBC)
is working overtime to mop up all this credit. So far,
it is behind the curve. The risk of overheating is
rising rapidly.
Besides the flow of funds from
foreign direct investment, there is plenty of hot money
flowing into China. And a lot of hot money is being
manufactured internally thanks to the huge reserve
balance.
According to the Wall Street Journal,
some of China's banks are using an estimated $16 billion
of "easy liquidity", generated by the massive $122
billion in US Treasury holdings, to bet on a yuan
revaluation. Borrow dollars in China at 1.5 percent and
convert to yuan and invest in local treasuries at 2.7
percent. (This trade is typically off-limits to
foreigners.) Financial engineering at its finest - the
more you borrow, the more you make.
Outstanding
loans grew 23 percent through June. Banks are rushing to
make new loans as the PBC mandates "tighter" credit.
Banks know that if they can expand their base of
lending, the percentage of non-performing loans on the
books will decline as new loans are by their very
nature, performing. Thus, we are seeing the unintended
consequences of trying to cool credit growth.
But pure and simple, Chinese banks are sowing
the seeds of loss. China is in the midst of the
credit-induced boom stage of the cycle. The next step of
course is "malinvestment", as the Austrians say. The
rush to China is creating enormous amounts of
manufacturing capacity in a world that wasn't exactly
lacking in supply.
This credit expansion will
end when it ends. Some believe the cycle will run until
the Summer Olympics in 2008. But there is a clear and
present danger on the horizon - US politics - that could
short-circuit that cycle in a hurry.
The
risks of misjudgment are real
The catalyst that
could set this process of mutually assured economic
destruction in motion is a misjudgment on the part of
the Bush administration. As I said earlier, it stems
from the belief that China has nowhere else to park its
reserves. If that is the belief, we could see a threat
of some type of trade retaliation. Even though China is
now a World Trade Organization member, never
underestimate the creativity of a politician fighting to
be re-elected.
Given the precarious nature of
the financial position of Chinese banks, even a threat
of limiting market access to the United States could
quickly crater the credit bubble, causing the standard
"rush to liquidity". And in order to generate that
liquidity, banks would need to sell reserves - read sell
US paper and the dollar.
US interest rates would
rise, probably soar, and that shining new recovery, not
the garden-variety kind, but the Fed-induced recovery,
would quickly vanish. The $1 trillion of stock-market
wealth tied to the Chinese imports would take a huge
hit. And a large percentage of market cap unrelated to
Chinese imports would likely follow.
And let's
not mention that little problem in North Korea that the
Chinese are helping to solve. In the words of Stephen
Roach, "Economic weakness and politics make for strange
bedfellows." The global economy can hardly afford a
breakup now.
Jack Crooks heads Black
Swan Capital, an independent research and trading firm
based in Florida. Visit
his website,
BlackSwanTrading.com.
Speaking Freely is an Asia Times Online
feature that allows guest writers to have their say.
Please click here if you are interested
in contributing.
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