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3 Careful what you wish
for, China may grant it By Julian Delasantellis
In Greek mythology, one of the most
effective methods the gods used to punish impudent
and hubristic humans was to grant them their most
fervent desires.
Inevitably, the weak and
feckless mortals would find that getting
everything they ever desired would lead to their
total ruination, as befell King Midas when granted
the wish to have everything he touched turn to
gold. The implicit lesson to be learned from these
stories was that mortals must
temper their wishes and desires, lest they suffer
the same fate.
Is the administration of US
President George W Bush learning the same fate as
regards its trading policy with China?
The
big news currently roiling the financial markets
is the rapid rise in yields for long-term
government bonds issued by the world's major
industrial powers. The benchmark US Treasury
10-year note has risen 0.85 percentage points in
yield, from 4.50% to almost 5.35% (in bond trader
lingo, that's 85 "basis points") from early March
to early June, with most of that rise coming since
just late May. This represents the highest level
of US 10-year rates since 2002.
Other
major-traded government debt issuances have risen
in yield (and thus fallen in price) along with US
notes. After yielding about 1% for the better part
of a decade, Japanese government bonds have risen
more than 50 basis points over the same period to
yield just under 2% now. British government bonds,
called gilts, have risen 70 basis points.
Euro bonds, called "bunds" (from their
origins as debt obligations of the German Federal
Republic, the Bundesrepublik) have also risen more
than 80 basis points since late winter. There is
concern that these interest rate hikes, by raising
the price of investment capital, will finally act
to cool down the current white-hot global economy.
In my March 6 article Rocking the subprime house of
cards, I explained how the issue of
causation, of "why" something happens in the
financial markets, is frequently hard to answer,
especially when analyzing something other than
individual stocks. This is the case with the
current government-debt rout.
When
bond-market investors hand over their money to buy
a government bond they have to hold for an
extended period of time, be it one, five, 10 or 30
years, they want to be confident that inflation
will not eat away at the purchasing power of what
they will receive back at the bond's expiration.
If they think that might be the case, they will
demand higher interest rates of return before
forking over their wealth.
However, in
this case, the standard explanations/conventional
wisdom for rising interest rates, a spreading
market perception among bond investors that
economic growth is accelerating, soon to be
followed upon by rising inflation, don't seem to
have been sufficient to have engendered
interest-rate rises this high this quick.
US economic growth for the January-May
period was a measly 0.6%, the slowest rate since
late 2002. As the US economy gets pulled down by
the heavy weight of the subprime mortgage crisis
(explored in my March 6 article, as well as in my
March 16 article The subprime dominoes in
motion), recent reports are showing
that growth has not merely slowed in the US
real-estate sector, it is now in full-throttle
reverse, as some localized real-estate markets are
showing double-digit average price declines from
last year.
The problems in the real-estate
sector, along with the fact that anemic sales
reports from many US retailers seem to be
indicating that the once super-avaricious US
consumer seems finally to have been banished from
the malls by high energy prices, do not seem to
portend the rapidly accelerating economic growth
that could be causing the rising government-bond
yields, neither in the United States nor in the
other major industrial capitalist economies.
The "economic growth causing rising rates"
argument is not confirmed by certain internal
market indicators, either. There are three major
traded instruments that professional traders watch
to see if inflationary fears are seeping into the
markets. These are the so-called "TIPS spread"
(the difference between standard Treasury bond
yields and newer, inflation-indexed TIPS -
Treasury Inflation-Protected Securities - bonds),
the price of gold, and the levels of various
commodity basket indices.
You would expect
the prices of all three to be appreciating should
inflationary fears be spreading, but,
surprisingly, all three have in essence been
stable to minimally higher throughout the
worldwide bond-market rout. Something has been
causing the recent rising bond yields, and it has
nothing to do with the conventional wisdom.
It may not seem so now, but in the future,
George W Bush will probably go down foremost in
history as the US president who sat by with his
cowboy boots up on the table (as he shoveled what
will probably turn out to be the better part of a
trillion dollars into the bloody furnace called
Iraq) as world economic dominance passed from the
US to China.
At first, the corporate elite
class that put its man in the White House probably
thought the rise in Chinese economic power was at
least serendipitous, since its main cause, US
manufacturers offshoring production to China, was
putting intense pressure on wages; this is a
central factor in the fact that a proportion of US
national income going to owners of capital
(business and stock owners), as against labor, has
now skewed dramatically in favor of capital.
No one saw it at the time, but a central
manifestation of the freedom revolution that
spread across the world upon the fall of the
Berlin Wall in 1989 was that First World employers
were now free to put their employees in an
employment pool to compete for their jobs with
about a billion other employees from nations with
much lower standards of living, especially China
and India. Wages might be being pressured
downward, but on the other side of the seesaw,
profits were soaring.
As economists
Lawrence Mishel and Jared Bernstein of the
Economic Policy Institute put it, "Over prior
business cycles, profits (including interest
income) have accounted for 23% of the growth in
corporate-sector income, on average, with total
compensation accounting for the remaining 77%. In
the current business cycle, the distribution is
almost reversed: profits have claimed nearly 70%
of total growth in the corporate sector, while
increases in compensation (from increased
employment and higher hourly compensation) have
received just over 30% of total income growth."
This is the dynamic that has fueled
China's explosive recent economic progress, with
first-quarter year-over-year economic growth a
more than healthy (in fact, a rather inflationary)
world-leading 11.1% rise in gross domestic
product. The GDP growth rate has been in
double-digit territory since early 2005; figures
for industrial production growth, currently at
18.1% year over year, also lead the world. This
growth is far and away export-led; Chinese
internal consumption, while growing steadily, is a
very small part of the story of the Chinese
economic miracle. In May, China reported a $22.5
billion trade surplus, up 73% from the previous
year. More than half of that trading surplus is
with the United States.
Naturally, this
has resulted in a tremendous shift of wealth from
the US to China. Chinese economic officials would
not allow this tremendous surge of First World
wealth to be loosed upon a Third World economy,
with the limited domestic consumption
opportunities of the Third World. It was feared,
probably correctly, that this tremendous wave of
cash hitting the underdeveloped
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