East vs. West: China Plays a Better Long Term Hand

As Peter Schiff and I have long warned, America's reliance on borrowing and consumption to fuel economic activity would result in the wholesale destruction of national wealth. Until recently, the dissipation was largely invisible to most consumers. However, the ongoing plunge in real estate and equity prices and newly released statistics concerning retail sales, consumer confidence and employment have now made it plain to most Americans that their own wealth has been seriously, and perhaps permanently, degraded. In response, they are now hoarding cash and reevaluating their spending habits.

The immediate result is that the large retailers, such as Circuit City, Best Buy and Mervyn's, have gone under completely or have closed a significant percentage of their locations. Indeed, on November 17th, Moody's warned of an epidemic of corporate bankruptcies. America is facing a severe recession that, if wrongly handled, will likely lead to a depression as bad, if not worse than those of the South Sea Bubble (1720) or the Great Depression of the early 1930's.

Such a depression will affect most of the developed world. But countries will not suffer equally. In a depression, wealth vanishes. Therefore, wealth accumulation will be even more acutely divided between those nations that are, like America, net consumers and those who, like China, are producers. The contrast will become increasingly stark and will likely be reflected in the value of equities within the two economies.

For instance, contrast the recent economic stimulus packages of the two countries.

In America, President Bush's first stimulus package amounted to some $172 billion. However, it was geared 87 percent to consumers and only some 13 percent to producers. This was in keeping with the fact that consumption accounts for 72 percent of the American economy, as measured by Gross Domestic Product. In contrast, China's stimulus package is to be some $600 billion, roughly four times larger than the equivalent program in the United States. However, the American economy is five times the size of that of China, so in relative terms the Chinese package is the equivalent of some $3 trillion. In other words, to stimulate its economy China is spending some 17.4 times more than America, on a relative basis.

Furthermore the Chinese spending package is far more likely to have counter recessionary benefits than the American stimulus programs. Whereas the American package was geared to consumers, the Chinese package is geared to productive infrastructure projects that will add to the long term competitiveness of its economy. In China, real wages will filter down to consumers in the form of real wealth, as China's economy gears itself up to become an increasingly effective challenger to American superpower status.

Whereas the Bush Administration has spent only some $22 billion on economic production, it spent some $150 billion on consumers and a staggering $2.8 trillion to bail out the financial industry. The strategic emphasis of the Administration's spending of taxpayers' funds is clear for all to see. If you lend money we will support you, if you make things, you are on your own.

In America, the government both encouraged and allowed the financial system to engage in highly leveraged lending. In addition, the financial industry was permitted to hide the risk by using 'off-balance-sheet' accounting and fictitious capital asset classification. A classic example of the latter was the classification of a tax credit as 'capital' by Fannie Mae. This allowed Fannie Mae to leverage its mortgage investments by some one hundred times its 'true' capital, while disclosing only some fifty times in its accounts.

China allowed no such deceptive 'financial engineering'. It has therefore not had to spend on salvaging its banking system.

In the meantime, both the American and Chinese stock markets have suffered falls of some 50 percent. But given the far wiser policy initiatives of their government, Chinese equities appear to offer much better growth prospects than their American counterparts.

Comments

[Andrew Ster...:]

Execellent article one of the best I read in a long while too bad most Americans can not get their short term political problems out of the way to realize the same rational understanding as was presented in this article.

I am glad the libertarain period that started with the idiocy of the Reagan Era has ended it never worked, and panned out in coincide with my statements that once government is reduced corporations and the private sector take over but then as tyrants as foxes in the hen house.

2008 Nov 20 06:12 AM

[investor88:]

Economically China's economy is better managed with common sense. China will suffer along with the world in this recession but longer term its relative strength should be greater.

2008 Nov 20 07:42 AM

[Here's a th...:]

All this and communism too ! I bet the quality of life there is great.

2008 Nov 20 11:37 AM

[nmelendez:]

US will recover in about 20 years. Been there, done that. Many will suffer but that's the price of putting drunkard C+ students as presidents. I bet all redneck, bottle guzzling individuals will be happy that so many will join their ranks.

Mark Twain once was asked by a reporter "What's a patriot?"
His answer:
"A patriot is one who is loyal to his country always...and to the administration when it deserves it!!!"

2008 Nov 29 02:13 PM