CautiousInvestor

Is China Really Such a Great Investment?

All in all a good article.

The missing piece of the puzzle is internal spending or consumer spending; expanded consumer spending is the only possible offset to contracting exports. China fully realizes it must cultivate internal growth to compensate for flagging exports.

China watchers believe more of the stimulus program should have been focused upon areas essential to increasing consumer spending such as healthcare, unemployment benefits and retirement insurance. In addition to having ingrained tendencies to save, the Chinese enjoy few social safety nets which exacerbates the normal inclination to save.

The road to a consumption driven economy will be anything but smooth because of ingrained habits to save and the need for China to balance the social tensions between the prosperous coastal areas of the south with the poorer agricultural areas that make up much of the inland interior. As an aside, some China observers believe retail sales numbers are being fudged to make them look better than what they really are.

U.S. vs. China: Has Trade War Begun?

The view of economists: pretty stupid.

Economists and others react to President Obama’s decision to impose a tariff on imports of certain Chinese tires.

-“It certainly does not look good. [P]rotectionism is driven by the desire to protect jobs. Unemployment has not peaked in the US, and some analysts suggest that China’s job losses are far worse than the 20 million often bandied about, more on the order of 30 to 50 million. So political pressure is set to intensify.” –Yves Smith

-“A victory for the protectionists. Disappointing news”. –N. Gregory Mankiw

-“Barack Obama does something really stupid: tire tariffs. [..] The Trade Act, Section 421, gives the U.S. the right to impose tariffs in response to a surge. It doesn’t make the surge a crime, or a violation. And it doesn’t require the U.S. to impose tariffs–especially if imposing them would be a really bad idea for U.S. consumers.” –J. Bradford DeLong

-The “macroeconomic impact is not enough to warrant an escalation of such a trade dispute to such levels that would threaten the strategic relationship between the two countries,” Wang Qing, chief Asia economist for Morgan Stanley in Hong Kong told Bloomberg News.

-“While there’s friction, I suspect that the two nations will keep any disputes under control,” David Cohen, an economist at Action Economics in Singapore, also told Bloomberg. “They understand that they’re increasingly dependent as trading partners.”

-“I think within the next 60 days you’ll see some pretty significant price increases,” Jim Mayfield, president of Del-Nat Tire Corp. of Memphis, Tenn., a large importer and distributor of Chinese tires told the WSJ’s Timothy Aeppel. He estimates prices for “entry-level” tires could increase 20% to 30%.

-The timing of the tensions is unfortunate, James Brander of the Sauder School of Business at the University of British Columbia told the Globe & Mail. “It’s a fragile time,” he said. “It looks like most economies in the world are just turning the corner.”

“In an environment where it looks like global trade will not recover to the levels we saw before the crisis for quite some time, the last thing we need is any sort of inkling of protectionism,” Glenn Maguire, chief Asia economist with Societe General in Hong Kong, told Reuters.

-”Over 7 days right before and after the Smoot-Hawley act was passed in mid June 1930, the DJIA fell 15% but got most of the decline back by late July before falling more than 30% into year end. Let’s hope the just announced tire tariff on China and their possible response is just a one off spat but global stocks are down as a result.” –Peter Boockvar, writing for The Big Picture.

-“In 1930, the Republican controlled House of Rep, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the…Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act which, anyone? anyone? Raised or lowered?… Raised tariffs, in an effort to collect more revenue for the federal gov’t. Did it work? Anyone? Anyone know the effects? It did not work, and the US sank deeper into the Great Depression.” – Ben Stein, in Ferris Bueller’s Day Off (via The Big Picture)

U.S. vs. China: Has Trade War Begun?

This decision was based upon the 2012 elections; not economics. Hostage to the interests of organized labor, Obama seriously miscalculated and made an issue out of a non issue, exposing a smoldering tinderbox to a flash point and the escalation of a trade war.

The timing could not have been worse: our borrowing needs are high and our dependence upon China is well established and, secondly, with a depreciating currency expanding exports is an increasingly viable platform for growth if the world's economy gains traction. There are growing protectionist sentiments across the world; this could easily be something larger than a spat between two giants.

Furthermore, most of the tires imported by China are what the industry refer to as third tier replacement tires; US manufacturers, based here and in China, have no interest whatsoever in producing these low margin tires. Accordingly, US manufacturers do not support the tariff.

This craven and intellectually stunted decision will, in addition to risking a trade war, simply transfer production of these tires to another low cost producer; raise replacement tire costs; hurt those in the business of distributing and retailing replacement tires; hurt consumers; and NOT produce more jobs in the industry.

The decision is impossibly stupid, inspired only by a desire to placate organized labor and fails to take into account risks and our broader national interests. Once again, special interests trump national interests.

Can China Convert Itself into a Consumer-Based Economy?

Moving to a consumer driven economy will be transformational and require many structural changes within China.

Frugal by nature, the savings rate is close to 40%; changing ingrained habits will take time and additional social services.

If the Chinese are to spend, they must be assured that they will have health insurance, unemployment insurance and retirement assisitance.

Steps are being taken on all of these safety nets but much remains to be done.

How Much Leverage Does China Have?

I have pasted below two passages from the article I would like to comment on. First, I believe the managed float of the yuan is a bit more complicated than what has been described; were it simply a matter if buying dollars it's tempting to think the dollar would be getting stronger when, in fact, it has been weakening.

And secondly, I believe China is less concerned about return on assets and more concerned about return of assets. And as others have noted, the Chinese have many options with respect to its dollar holdings and lately they have been on a global shopping spree, stockpiling commodities and buying equity interests in companies of strategic interest.

After being invested, these dollars do not simply vaish from the planet; upon completing a transaction, the new holders of the dollars may choose to invest in Treasuries. Your prescription for monetizing debt should be reconsidered as there is already too much of it with the Fed to purchase $300 billion of Treasuries this year.

It might solve one problem but would spawn other, larger problems.


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Each month China buys dollars with yuan printed by the People’s Bank of China to keep the value of the yuan low. In turn, this creates two things—a huge trade surplus with the United States and a large addition to China’s dollar holdings.

If China chooses to buy U.S. Treasuries with its monthly additions to its dollar hoard, it gets interest. If it chooses not to buy U.S. Treasuries, it will be stuck with dollars that do not pay interest and those dollars will be removed from circulation. In turn, the Federal Reserve can simply replace those dollars in circulation by buying the Treasuries that China chooses not to purchase.

Economic Talks with China: Not Likely to Accomplish Much

Last night I read some material released by Reuters proclaiming significant discussion, mutual understanding, identifying issues and ground of agreement and setting the stage for further discussion.

This, when reduced, means very little will be accomplished but we should not take our eyes off of two big issues that are of mutual benefit: dollar stability and fair and balnced trade.

As much as China stands to benefit from a stable dollar, we stand to gain more by enjoying lower borrowing costs and encouraging private capital expenditures. Should increase rates increase, the threshold for private investment would increase and decrease aggregate investment. This offers us a clear incentive to better mange our fiscal house.

On the matter of trade, it's essential we work out a bi-lateral framework for expanding trade as China will be our most important trading partner for the forseeable future. Export opportunities abound and we should not compromise this real and concrete opportunity in favor of environmental policies built upon shaky science.

This will require China to allow appreciation of its currency and retool its economy to a structure less reliant on exports and more reliant on consumption. This will be a long-term undertaking.

China's Well-Prepared; We're Not

Because they are a nationalistic mercantilist state, China has gone out of its way to expand its holdings of international reserves and gold.

Unlike the US, it has the cash to spend on investing for the future and its current purchases are directed towards diversifying out of the dollar and into hard assets and commodties that are likely to be used in the future and appreciate at the same time. Something of a win-win.

Unlike China, the US.....who under the liberal mindset should atone for its wealth.......is more concerned with propping up failed countries, states, businesses and families. Broke and preoccupied with other concerns, we choose not either think about or invest in the future.

China at the G8 (Or, What Happens When Your Banker Says No)

The current discussion simply suggests the not-exactly-controversial thesis that Asian and other developing countries have systematically undervalued their currencies as a strategy to generate employment growth.

It also suggests that these central banks that worry about the impact of dollar weakness on their reserve holdings are in the funny position of having created the dollar overvaluation at the same time they were actively accumulating those overvalued dollars.

The inevitable has come and now China and others are doing what they can to preserve the value of their dollar portfolio amid irresponsible and ineffectual US fiscal policy that will hasten the decline in the value of the dollar.

The playing field has changed as fast as the housing market collapsed; the moment of reckoning has arrived. From all appearances China will pursue a short-term strategy to protect the current value of its dollar holdings while, at the same time, accumulating fewer dollars by directing purchases towards commodities, gold and business interests. Their longer-term strategy is more complex but appears to center about the creation of a supranational reserve currency.

Because they are pursuing short-term and long-term strategies in parallel, we should expect occasional statements that are odds with one another. One day the dollar is OK and the next it must be replaced by another reserve currency; in truth the messages are not inconsistent but bear upon strategies with different time frames.

In setting about to protect their portfolio of US Treasuries China may be in a unique position to impose discipline and constraint on our reckless fiscal policies while at the same time implementing equally reckless bank lending policies at home.

I’m not suggesting it will restrain our unchecked spending but there is a beautiful irony in China lecturing us on spending while their lending is spilling into Macau casinos and the Shanghai stock market.

China Signals End of Commodity Stockpiling

All of the dry bulk containers ships are bound for China, with demand arising from strategic stockpiling, stimulus spending and speculation.

Surprisingly, in my view, this has been viewed as an indication of economic recovery when it is clear there is no final demand beyond China's borders.

China' State Board, who is anything but dumb, will not continue to compete against itself and bid up prices in abundant commodities. And speculation owing to stimulus lending spilling unto the hands of arbitrageurs is certain to end.

Together these developments will remove the pricing floor beneath the commodities China has been hoarding.

Mr. Geithner Goes to China

We are going to need to borrow another $10 trillion to cover our fiscal deficits through 2019; I have no idea what our trade deficit might be but we usually run in the hole.

China presently holds around $2 trillion of our debt which pales besides what we need to support our addiction going forward.

The critical question is not what China is going to do with its present holdings but what it is going to do as we move forward; from China's perspective all of the scenarios are interlocked through feedback loops.

If they help us going forward, the hole get deeper and they are more exposed to the dollar; if they buy nothing going forward, there is greater likelihood of debt monetization which would depreciate the value of their present holdings. They are facing Morton's Fork......two unattractive options.

And, of course, all of this is further complicated by their desire to keep the factories humming and shipping products to WalMart until they become more consumption driven which will requires years.

Chinese Economy Down; U.S. Home Prices Still Falling Fast

China is attempting to prove its command economy is better positioned to handle economic trauma than economies built upon democratic capitalism.

To this end, they implemented a large stimulus package and have expanded state lending. And while improvements are likely, China has deliberately misrepresented data to paint a picture that simply does not exist. There are simply too many disconnects.

Industrial production is increasing slowly, smelting is down, consumer spending is up, electricity production is falling, lending is up, investment in factories is up and exports are falling off a cliff.

The emerging picture is one of two economies, with the China's domestic side coping fairly well, but heavy industry now showing signs of faltering after initial "green shoots."

China's Economic Growth Claims Lack Credibility

In addition to growth inconsistencies noted by the author, there is a mounting fear that China is taking on unmanageable risks in stimulating its economy.

The fiscal stimulus plan is being accompanied by a state directive to increase lending and investment. And in a command economy, its pretty straightforward to expand lending and investment through state controlled enterprises.

The concern has to do with the investments and whether they add capacity where needed...........or whether they duplicate previous efforts and simply create excess capacity. A related, and equally serious, concern has to do with the quality of the loans being made and the prospect of high default rates.

While not the focus of global attention, many believe China has its own banking problems.

China Investor Update

Chinese corporations and the state owned sovereign wealth fund are striking keen deals across the globe and and are securing long-term access to needed resources at bargain prices.

The Chinese have what nobody else has at the moment: cash. This gives them tremendous leverage as does their willingness to strike deals with countries that have strained relationships with the US, e.g. Venezuela.

They appear to be focusing upon oil and minerals, both essential to the Chinese economy. In the literature there is a debate of sorts whether these deals will expand supplies or simply give China secured access at the expense of other buyers such as the US, Europe and India.

However it unfolds, China is doing whats best for China..........and I wish the US would follow its example.