China Swallows Obama Stimulus Meant for U.S. Economy: Andy Xie

Commentary by Andy Xie
Aug. 18 (Bloomberg) -- The global economy is like fried ice
cream: If you don’t act fast, it turns into a mess.
American pundits, Nobel laureates included, are predicting Japan-style deflation for the U.S. and Europe. They are urging the Federal Reserve to pursue another round of quantitative easing to stop the onset of an Ice Age for Western economies.
The Fed didn’t oblige at its last meeting, but it threw a bone to the deflation crowd by promising not to pull money out of its previous round of asset purchases to stimulate a recovery.
On the other side of the world, consumer prices are surging. Emerging markets as a whole now have an inflation rate of more than 5 percent. India is registering price increases of more than 13 percent. China’s are more than 3 percent. But it surely feels a lot higher for average Chinese.
Much of the “heat” comes from the property market in emerging markets. Million-dollar flats in Mumbai have panoramic views of the city’s slums. Hong Kong’s real-estate prices have almost reclaimed their 1997 peak, though the economy has barely grown since then in per-capita terms. Overpaid bankers who pay
15 percent income tax in Hong Kong are stretched to buy Beijing or Shanghai properties. Moscow is somehow always near the top of the list of the world’s most expensive cities.
The emerging markets are on fire.

Rude Awakening

Deflation prophets in the West are in for a rude awakening.
Eastern fire will turn Western ice into a mess, and 2012 looks like it will be the year of melting. The fuel for the fire is coming from deflation-fighting stimulus programs, such as that of U.S. President Barack Obama.
Stimulus is prescribed as a panacea for recession. In today’s global economy, it isn’t effective in the best of circumstances and is outright wrong for what ails the West now.
Trade and foreign direct investment total half of global gross domestic product. Multinational corporations drive both.
They shop around the world for the lowest-cost production centers and ship goods to wherever the demand is. Demand and supply are dislocated. So when a government introduces stimulus, the initial increase in demand doesn’t necessarily boost local supply. More importantly, if multinationals decide to invest somewhere else, there wouldn’t be an increase in jobs to sustain the growth in demand beyond the stimulus.
Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.

Ideal Scenario

How will this all end? Ideally, before inflation takes hold in the U.S. and Europe, the costs in emerging economies will rise high enough for multinationals to invest and hire in the West again. I wouldn’t count on that. The average wage in the developed economies is 10 times that in emerging markets. There are five people in the latter for one in the former.
A more likely scenario is that the West will have to stop stimulus programs when inflation spreads to it from the emerging economies. The most immediate channel is through rising commodity prices. It’s a tax on the West to benefit emerging economies that produce raw materials. That’s the irony: The stimulus in the West can immediately bring harm to itself. It’s also the magic of globalization.
The prices of imported consumer goods will rise with increasing labor costs in emerging economies. China’s nominal GDP is growing at about 20 percent per year. The odds are that its labor costs will surge as its worker shortage bites.

Wage Blowout

Lastly, labor in the West will demand wage increases to compensate for current and future inflation. One may argue that high unemployment rates will keep wages in check. Think again.
In the 1970s, the U.S. suffered a wage-price surge even with high unemployment because workers saw through the Fed’s “growth first and inflation be damned” intention.
In 2012, the Fed will run out of excuses not to raise interest rates. As the excess liquidity in the global economy will be gigantic by then, the tightening will probably trigger a global crisis as asset bubbles burst.
What really ails the West is declining competitiveness.
Globalization is pitting the Wang’s in China or Gandhi’s in India against the Smith’s in the U.S. or Gonzalez’s in Spain.
Multinationals such as General Electric Co. or Siemens AG decide on whom to hire. The Wang’s and the Gandhi’s offer productivity but have little money. So they are willing to accept low wages to accumulate wealth. The Smith’s and the Gonzalez’s have wealth and won’t accept Third World wages. When their governments give them money to spend, their demand just makes the Wang’s and the Gandhi’s richer and themselves poorer with rising national debt.
The West must wait for the Wang’s and the Gandhi’s to become rich enough so that they demand Western wages and spend like the Smith’s and Gonzalez’s.
It is a long and painful process for the West. And there is no way around it.

(Andy Xie is an independent economist based in Shanghai and was formerly Morgan Stanley’s chief economist for the Asia- Pacific region. The opinions expressed are his own.)

Great read decorated with Art of War references


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By: Russ WInter
Seekingalpha.com

“There is little reason to fear a wholesale pullout by China from U.S. government bonds." - Former Federal Reserve Chairman Alan Greenspan

The conventional wisdom is that China will keep tolerating the buying and ownership of bloated US Treasury Old Maid cards and MBS, because it's "in everybody's best interest" to subsidize the US. This symbiotic relationship idea supports the status quo and static history view of events.

I offer up a "dynamic history" alternative that should be food for thought. This holds that China is now in a perfect position to knock the US off its pedestal. Understand that I think the motivation here is not to destroy or even dominate the US, but instead to diminish its power and influence and bring it down to size. This is happening in due course anyway, but China has a real opportunity to hasten and control the process. It makes sense for China to play its cards, because the US still has a strong military combined with an inept and corrupt political class.

First, there are plenty of reasons for China to do this, for sound economic reasons that are separate from strategic ones. There is also plenty of cover and chatter within China for this to happen.

“I do not think U.S. Treasuries are safe in the medium and long-run,” Yu, a member of the state-backed Chinese Academy of Social Sciences, wrote yesterday in an e-mailed response to questions. China is unable to sell the securities in a “big way” and a “scary trajectory” of budget deficits and a growing supply of U.S. dollars put their value at risk, he said.

Beyond this sound reasoning , Sun Tzu's book "The Art of War" is instructive in considering this philosophy. I recently reread this work, and the comparatives pop up constantly throughout. Elizabeth Brinsden discusses the following stratagems:

Stratagem # 15 - Entice the tiger down from the mountain. Here the humiliation of the debtor, the USA, towards the creditor, China, forces the economic superpower to descend from its throne to a level playing field with the so-called lesser power.

Stratagem # 19 - Withdraw the wood from under the boiling pot. Ceasing to purchase US bonds must eventually have an impact on the debt-driven economic growth of the borrower.

Stratagem # 28 - Entice onto the roof and then pull away the ladder. The easy sale of US bonds to the naive purchaser must automatically lull the debtor into complacency whilst the ladder (i.e. bond sales) is removed.

Stratagem # 30 - Reversal of roles in which the guest becomes the host. This stratagem must be considered to be the most important for the purposes of this article, whereby the once economic superpower is forced to assume a role of subservience to the newly emerging power of the creditor, China.

Stratagem # 4 - Await at one’s ease the exhausted enemy.

The last strategem is where we are today and is the key to understanding the Sun Tzu Art of War strategy. The ease in which China could tip the US into crisis is easy to visualize and construct. Would this put self-inflicted damage on China, too, you may ask. I would ask, "in what sense?" and "compared to what?". Nations have gone to war and there has been self-inflicted damages of unfathomable consequence throughout history. There is nothing new whatsoever in that. In this instance, China and the US do not even go to war. To answer the question of what they do with the dollars, the answer is, relatively nothing, or recapitalized their soon to be busted banks. Therefore, the cost to China would be relatively minor compared to true war.

If the threat of actual military conflict materialized, China has enormous industrial capacity and stockpiled resources and have nearly monopolized rare metals (use for high tech weaponry) now to support conventional modern war, as the US has a first-punch, high-tech, pyrotechnic capacity and little follow through. China would absorb the first blows, and then it would be a new ball game. This is not going to be necessary as China has the financial leverage.

Although China has been a financial creditor and enabler, there has been much self-inflicted damage to the US. China would be in a position to dictate terms in much the same way as the IMF has dictated terms over the last several decades. But now the roles are reversed, and one key term of the Chinese dictate is completely consistent with what happens generally in fiscal crises throughout history (read Lessons of History). Military spending of the impacted country is one of the first casualties, especially when big foreign creditors dictate the terms.

Get used to it.