China to U.S. - Thanks for the Jobs, But We’ll Pass on Inflation

Emerging Market Mania:

CHINA, “Thanks for the Jobs Uncle Sam, But We’ll Pass On the Inflation”

The US re-opened formal trade with China in 1971.

This, in turn, kicked off two major trends:

1. The US’s economic shift from manufacturing to services (mainly financial)

2. The dramatic rise in Chinese quality of life

In plain terms, the US began shifting manufacturing jobs offshore. Charting the full impact of this trend on US employment is difficult. However, Robert Scott, an economist at the Economic Policy Institute, estimates that between 2001 and 2008 2.4 million American jobs were lost as a result of increased trade with China alone. Bear in mind, this doesn’t account for the jobs lost in the 30 years from 1971 to 2001.

As for our shift to a financial services economy, consider that from 1970 until 2003, financials market capitalizations as a percentage of the S&P 500 rose from less than 5% to 22%. Over the same period, financials’ earnings as a percentage of the S&P 500’s total earnings rose from less than 10% to 31%.

Put another way, by 2003 nearly one in every three dollars of corporate profits came from the financial sector.

Meanwhile, China was experiencing an unprecedented level of growth thanks to our renewed trade: Chinese per-capita income doubled from 1978 to 1987 and again from 1987 to 1996.

In those 20 years, more than 300 million Chinese ascended out of poverty with accompanying dramatic changes in lifestyle, professions, and diet: between 1985 and 2008, the average Chinese meat consumption more than doubled from 44 pounds to 110 per annum.

So here we are in 2010 and the US and China are now butting heads in a major way. The US (debtor, consumer, declining empire) wants to devalue the Dollar and export inflation to China. China (creditor, producer, rising empire) doesn’t care for this arrangement as its hurts profit margins at Chinese companies, increases food inflation (food is a higher percentage of income for the average China compared to the average American), which in turn means civil unrest.

How this situation plays out will determine the monetary and financial trends for 2011. Already we’ve begun seeing financial warning shots between the two super powers. Have a look at the timeline:

-April-October 17: Geithner vilifies China, calls it a currency manipulator

-October 17: China issues surprise interest rate hike

-October 20: Geithner says world currencies are in “alignment.”

-November 3: Bernanke announced QE 2

-November 8-9: China says QE 2 “imperils” emerging economies and calls US Dollar as reserve currency “absurd”

-November 8: Geithner backtracks from former call for balanced trade

-November 10: Fed announces QE 2 details

-November 10: China hikes bank reserve requirements

This dynamic is the, and I mean THE, key issue for ALL financial markets moving forward. The US Fed wants Dollar devaluation. China doesn’t. How this conflict is resolved will determine the fate of stocks, commodities, bonds, even the US dollar.

Some analysts believe China will opt for the “nuclear option” and dump US Treasuries outright. China HAS proven its more than willing to play hardball in international relations (it cut rare earth exports to Japan after the latter arrested the Chinese fishing crew that crashed into a Japanese coast guard).

However, in the case of Treasuries, China cannot play the “Trump” card without it losing a TON of money in the process: if China dumped Treasuries outright, the whole world would follow suit, resulting in China’s holdings losing hundreds of billions of Dollars and a full-scale financial system collapse.