Wednesday, March 31, 2010

China: Crunch Time

This report is republished with permission of STRATFOR
March 30, 2010 | 0856 GMT
By Peter Zeihan
The global system is undergoing profound change. Three powers — Germany, China and Iran — face challenges forcing them to refashion the way they interact with their regions and the world. We are exploring each of these three states in detail in three geopolitical weeklies, highlighting how STRATFOR’s assessments of these states are evolving. First we examined Germany. We now examine China.

U.S.-Chinese relations have become tenser in recent months, with the United States threatening to impose tariffs unless China agrees to revalue its currency and, ideally, allow it to become convertible like the yen or euro. China now follows Japan and Germany as one of the three major economies after the United States. Unlike the other two, it controls its currency’s value, allowing it to decrease the price of its exports and giving it an advantage not only over other exporters to the United States but also over domestic American manufacturers. The same is true in other regions that receive Chinese exports, such as Europe.

What Washington considered tolerable in a small developing economy is intolerable in one of the top five economies. The demand that Beijing raise the value of the yuan, however, poses dramatic challenges for the Chinese, as the ability to control their currency helps drive their exports. The issue is why China insists on controlling its currency, something embedded in the nature of the Chinese economy. A collision with the United States now seems inevitable. It is therefore important to understand the forces driving China, and it is time for STRATFOR to review its analysis of China.

An Inherently Unstable Economic System

China has had an extraordinary run since 1980. But like Japan and Southeast Asia before it, dramatic growth rates cannot maintain themselves in perpetuity. Japan and non-Chinese East Asia didn’t collapse and disappear, but the crises of the 1990s did change the way the region worked. The driving force behind both the 1990 Japanese Crisis and the 1997 East Asian Crisis was that the countries involved did not maintain free capital markets. Those states managed capital to keep costs artificially low, giving them tremendous advantages over countries where capital was rationally priced. Of course, one cannot maintain irrational capital prices in perpetuity (as the United States is learning after its financial crisis); doing so eventually catches up. And this is what is happening in China now.

STRATFOR thus sees the Chinese economic system as inherently unstable. The primary reason why China’s growth has been so impressive is that throughout the period of economic liberalization that has led to rising incomes, the Chinese government has maintained near-total savings capture of its households and businesses. It funnels these massive deposits via state-run banks to state-linked firms at below-market rates. It’s amazing the growth rate a country can achieve and the number of citizens it can employ with a vast supply of 0 percent, relatively consequence-free loans provided from the savings of nearly a billion workers.

It’s also amazing how unprofitable such a country can be. The Chinese system, like the Japanese system before it, works on bulk, churn, maximum employment and market share. The U.S. system of attempting to maximize return on investment through efficiency and profit stands in contrast. The American result is sufficient economic stability to be able to suffer through recessions and emerge stronger. The Chinese result is social stability that wobbles precipitously when exposed to economic hardship. The Chinese people rebel when work is not available and conditions reach extremes. It must be remembered that of China’s 1.3 billion people, more than 600 million urban citizens live on an average of about $7 a day, while 700 million rural people live on an average of $2 a day, and that is according to Beijing’s own well-scrubbed statistics.

Moreover, the Chinese system breeds a flock of other unintended side effects.
There is, of course, the issue of inefficient capital use: When you have an unlimited number of no-consequence loans, you tend to invest in a lot of no-consequence projects for political reasons or just to speculate. In addition to the overall inefficiency of the Chinese system, another result is a large number of property bubbles. Yes, China is a country with a massive need for housing for its citizens, but even so, local governments and property developers collude to build luxury dwellings instead of anything more affordable in urban areas. This puts China in the odd position of having both a glut and a shortage in housing, as well as an outright glut in commercial real estate, where vacancy rates are notoriously high.

There is also the issue of regional disparity. Most of this lending occurs in a handful of coastal regions, transforming them into global powerhouses, while most of the interior — and thereby most of the population — lives in abject poverty.

There is also the issue of consumption. Chinese statistics have always been dodgy, but according to Beijing’s own figures, China has a tiny consumer base. This base is not much larger than that of France, a country with roughly one twentieth China’s population and just over half its gross domestic product (GDP). China’s economic system is obviously geared toward exports, not expanding consumer credit.

Which brings us to the issue of dependence. Since China cannot absorb its own goods, it must export them to keep afloat. The strategy only works when there is endless demand for the goods it makes. For the most part, this demand comes from the United States. But the recent global recession cut Chinese exports by nearly one fifth, and there were no buyers elsewhere to pick up the slack. Meanwhile, to boost household consumption China provided subsidies to Chinese citizens who had little need for — and in some cases little ability to use — a number of big-ticket products. The Chinese now openly fear that exports will not make a sustainable return to previous levels until 2012. And that is a lot of production — and consumption — to subsidize in the meantime. Most countries have another word for this: waste.

This waste can be broken down into two main categories. First, the government roughly tripled the amount of cash it normally directs the state banks to lend to sustain economic activity during the recession. The new loans added up to roughly a third of GDP in a single year. Remember, with no-consequence loans, profitability or even selling goods is not an issue; one must merely continue employing people. Even if China boasted the best loan-quality programs in history, a dramatic increase in lending of that scale is sure to generate mountains of loans that will go bad. Second, not everyone taking out those loans even intends to invest prudently: Chinese estimates indicate that about one-fourth of this lending surge was used to play China’s stock and property markets.

It is not that the Chinese are foolish; that is hardly the case. Given their history and geographical constraints, we would be hard-pressed to come up with a better plan were we to be selected as Party general secretary for a day. Beijing is well aware of all these problems and more and is attempting to mitigate the damage and repair the system. For example, it is considering legalizing portions of what it calls the shadow-lending sector. Think of this as a sort of community bank or credit union that services small businesses. In the past, China wanted total savings capture and centralization to better direct economic efforts, but Beijing is realizing that these smaller entities are more efficient lenders — and that over time they may actually employ more people without subsidization.

But the bottom line is that this sort of repair work is experimental and at the margins, and it doesn’t address the core damage that the financial model continuously inflicts. The Chinese fear their economic strategy has taken them about as far as they can go. STRATFOR used to think that these sorts of internal weaknesses would eventually doom the Chinese system as it did the Japanese system (upon which it is modeled). Now, we’re not so sure.

Since its economic opening in 1978, China has taken advantage of a remarkably friendly economic and political environment. In the 1980s, Washington didn’t obsess overmuch about China, given its focus on the “Evil Empire.” In the 1990s, it was easy for China to pass inconspicuously in global markets, as China was still a relatively small player. Moreover, with all the commodities from the former Soviet Union hitting the global market, prices for everything from oil to copper neared historic lows. No one seemed to fight against China’s booming demand for commodities or rising exports. The 2000s looked like they would be more turbulent, and early in the administration of George W. Bush the EP-3 incident landed the Chinese in Washington’s crosshairs, but then the Sept. 11 attacks happened and U.S. efforts were redirected toward the Islamic world.

Believe it or not, the above are coincidental developments. In fact, there is a structural factor in the global economy that has protected the Chinese system for the past 30 years that is a core tenet of U.S. foreign policy: Bretton Woods.

Rethinking Bretton Woods

Bretton Woods is one of the most misunderstood landmarks in modern history. Most think of it as the formation of the World Bank and International Monetary Fund, and the beginning of the dominance of the U.S. dollar in the international system. It is that, but it is much, much more.

In the aftermath of World War II, Germany and Japan had been crushed, and nearly all of Western Europe lay destitute. Bretton Woods at its core was an agreement between the United States and the Western allies that the allies would be able to export at near-duty-free rates to the U.S. market in order to boost their economies. In exchange, the Americans would be granted wide latitude in determining the security and foreign policy stances of the rebuilding states. In essence, the Americans took what they saw as a minor economic hit in exchange for being able to rewrite first regional, and in time global, economic and military rules of engagement. For the Europeans, Bretton Woods provided the stability, financing and security backbone Europe used first to recover, and in time to thrive. For the Americans, it provided the ability to preserve much of the World War II alliance network into the next era in order to compete with the Soviet Union.

The strategy proved so successful with the Western allies that it was quickly extended to World War II foes Germany and Japan, and shortly thereafter to Korea, Taiwan, Singapore and others. Militarily and economically, it became the bedrock of the anti-Soviet containment strategy. The United States began with substantial trade surpluses with all of these states, simply because they had no productive capacity due to the devastation of war. After a generation of favorable trade practices, surpluses turned into deficits, but the net benefits were so favorable to the Americans that the policies were continued despite the increasing economic hits. The alliance continued to hold, and one result (of many) was the eventual economic destruction of the Soviet Union.

Applying this little history lesson to the question at hand, Bretton Woods is the ultimate reason why the Chinese have succeeded economically for the last generation. As part of Bretton Woods, the United States opens its markets, eschewing protectionist policies in general and mercantilist policies in particular. Eventually the United States extended this privilege to China to turn the tables on the Soviet Union. All China has to do is produce — it doesn’t matter how — and it will have a market to sell to.

But this may be changing. Under President Barack Obama, the United States is considering fundamental changes to the Bretton Woods arrangements. Ostensibly, this is to update the global financial system and reduce the chances of future financial crises. But out of what we have seen so far, the National Export Initiative (NEI) the White House is promulgating is much more mercantilist. It espouses doubling U.S. exports in five years, specifically by targeting additional sales to large developing states, with China at the top of the list.

STRATFOR finds that goal overoptimistic, and the NEI is maddeningly vague as to how it will achieve this goal. But this sort of rhetoric has not come out of the White House since pre-World War II days. Since then, international economic policy in Washington has served as a tool of political and military policy; it has not been a beast unto itself. In other words, the shift in tone in U.S. trade policy is itself enough to suggest big changes, beginning with the idea that the United States actually will compete with the rest of the world in exports.

If — and we must emphasize if — there will be force behind this policy shift, the Chinese are in serious trouble. As we noted before, the Chinese financial system is largely based on the Japanese model, and Japan is a wonderful case study for how this could go down. In the 1980s, the United States was unhappy with the level of Japanese imports. Washington found it quite easy to force the Japanese both to appreciate their currency and accept more exports. Opening the closed Japanese system to even limited foreign competition gutted Japanese banks’ international positions, starting a chain reaction that culminated in the 1990 collapse. Japan has not really recovered since, and as of 2010, total Japanese GDP is only marginally higher than it was 20 years ago.

China’s Limited Options

China, which unlike Japan is not a U.S. ally, would have an even harder time resisting should Washington pressure Beijing to buy more U.S. goods. Dependence upon a certain foreign market means that market can easily force changes in the exporter’s trade policies. Refusal to cooperate means losing access, shutting the exports down. To be sure, the U.S. export initiative does not explicitly call for creating more trade barriers to Chinese goods. But Washington is already brandishing this tool against China anyway, and it will certainly enter China’s calculations about whether to resist the U.S. export policy. Japan’s economy, in 1990 and now, only depended upon international trade for approximately 15 percent of its GDP. For China, that figure is 36 percent, and that is after suffering the hit to exports from the global recession. China’s only recourse would be to stop purchasing U.S. government debt (Beijing can’t simply dump the debt it already holds without taking a monumental loss, because for every seller there must be a buyer), but even this would be a hollow threat.

First, Chinese currency reserves exist because Beijing does not want to invest its income in China. Underdeveloped capital markets cannot absorb such an investment, and the reserves represent the government’s piggybank. Getting a 2 percent return on a rock-solid asset is good enough in China’s eyes. Second, those bond purchases largely fuel U.S. consumers’ ability to purchase Chinese goods. In the event the United States targets Chinese exports, the last thing China would want is to compound the damage. Third, a cold stop in bond purchases would encourage the U.S. administration — and the American economy overall — to balance its budgets. However painful such a transition may be, it would not be much as far as retaliation measures go: “forcing” a competitor to become economically efficient and financially responsible is not a winning strategy. Granted, interest rates would rise in the United States due to the reduction in available capital — the Chinese internal estimate is by 0.75 percentage points — and that could pinch a great many sectors, but that is nothing compared to the tsunami of pain that the Chinese would be feeling.

For Beijing, few alternatives exist to American consumption should Washington limit export access; the United States has more disposable income than all of China’s other markets combined. To dissuade the Americans, China could dangle the carrot of cooperation on sanctions against Iran before Washington, but the United States may already be moving beyond any use for that. Meanwhile, China would strengthen domestic security to protect against the ramifications of U.S. pressure. Beijing perceives the spat with Google and Obama’s meeting with the Dalai Lama as direct attacks by the United States, and it is already bracing for a rockier relationship. While such measures do not help the Chinese economy, they may be Beijing’s only options for preserving internal stability.

In China, fears of this coming storm are becoming palpable — and by no means limited to concerns over the proposed U.S. export strategy. With the Democratic Party in the United States (historically the more protectionist of the two mainstream U.S. political parties) both in charge and worried about major electoral losses, the Chinese fear that midterm U.S. elections will be all about targeting Chinese trade issues. Specifically, they are waiting for April 15, when the U.S. Treasury Department is expected to rule whether China is a currency manipulator — a ruling Beijing fears could unleash a torrent of protectionist moves by the U.S. Congress. Beijing already is deliberating on the extent to which it should seek to defuse American anger. But the Chinese probably are missing the point. If there has already been a decision in Washington to break with Bretton Woods, no number of token changes will make any difference. Such a shift in the U.S. trade posture will see the Americans going for China’s throat (no matter whether by design or unintentionally).

And the United States can do so with disturbing ease. The Americans don’t need a public works program or a job-training program or an export-boosting program. They don’t even have to make better — much less cheaper — goods. They just need to limit Chinese market access, something that can be done with the flick of a pen and manageable pain on the U.S. side.
STRATFOR sees a race on, but it isn’t a race between the Chinese and the Americans or even China and the world. It’s a race to see what will smash China first, its own internal imbalances or the U.S. decision to take a more mercantilist approach to international trade.

Saturday, March 27, 2010

Korean Torpedo- Honest Mistake or Disinformation Campaign?

"North Korea 'torpedoes and sinks' South Korean navy ship with 104 sailors on board"

Yesterday, the Daily Mail headline read as listed above. Now it reads as listed below.

"Korea tensions over claims that warship was sunk by torpedo"

Now, the Daily Mail reports-
But South Korean officials played down the initial reports of military action, saying they had no evidence of North Korean forces in the area. They said the Cheonan could have fired its warning shots at a distant flock of birds which had produced an image on its radar. Senior government officials later told South Korean media the ship could have struck a rock or been hit by an explosion on board.
Or- They could have fired at a hostile submarine and received a bellyful of torpedo in return.

Daily Mail article linked: HERE  Related Reuters article linked: HERE

So, to recap the official South Korean story- the ship could have fired "at a distand flock of birds" and then "struck a rock" which set off an "explosion on board", which "caused a hole in the ship, which led to its sinking". However, at this time, we are not ready to rule out the possibility of Nessie or climate change as a cause of this apparent natural disaster.

Tuesday, March 23, 2010

Face It- Our President Is A Communist

Someone, anyone, show me where our President's policies differ from those of the Communist Party USA.

Below is an excerpt pulled directly from the CPUSA website FAQ page.  Simply strike out "Communist Party" and add "Democratic Party (under Barack Obama)" - no one can tell the difference.
What does the Communist Party Democratic Party (under Barack Obama) stand for?

The Communist Party Democratic Party (under Barack Obama) stands for the interests of the American working class and the American people. It stands for our interests in both the present and the future. Solidarity with workers of other countries is also part of our work. We work in coalition with the labor movement, the peace movement, the student movement, organizations fighting for equality and social justice, the environmental movement, immigrants rights groups and the health care for all campaign.

But to win a better life for working families, we believe that we must go further. We believe that the American people can replace capitalism with a system that puts people before profit - socialism.

We are rooted in our country's revolutionary history and its struggles for democracy. We call for "Bill of Rights" socialism, guaranteeing full individual freedoms.

Until we win enough support to change the system, communists democrats (under Barack Obama) call for radical reforms under capitalism. We call for nationalization of the banks, railroads, and industries like steel and auto. Everyone who wants to work should be guaranteed a job or get unemployment payments until she/he can find a job. We say put the unemployed to work at union wages on massive public works programs to rebuild our cities, provide affordable housing for the homeless, build mass transit, and clean up the environment!

Our outlook is based on the social science of Marxism-Leninism. We study history, politics and economics in order to change the world.
Only three strikeouts required in 245 words- now that's efficient.  You see, it's much easier to show the similarities than the differences.

Saturday, March 20, 2010

China is stealing America

"The American government is currently letting China make rules excluding American companies from selling in China unless they produce in China and do their research and development in China and move their patents to China. If we consent to this, we will eventually become a third world country."

Read the entire article here: NY Times ignores China's R&D Rules

Wednesday, March 17, 2010

E. Richard Barnes Letter- Nixon Free Trade with China 1971

December 14, 2009

Russia's New Launch of an Old Game

Last week, the Russian newspaper Trud reported that Medvedev planned to create his own political party, to "rival" the United Russia party created by Putin, who now serves as "prime minister" after term limits forced him out.
It looks like Russia is setting up their own game of two card monte.  I wonder if they learned it from watching us?
Source:  AT- Neo-Soviet Russia and America 

Saturday, March 13, 2010

Google now 99.9% certain to shutter China search engine

Source: Financial Times- Google to shut China search engine

Google has drawn up detailed plans for the closure of its Chinese search engine and is now “99.9 per cent” certain to go ahead as talks over censorship with the Chinese authorities have reached an apparent impasse...

So what's next? How about a couple predictions?

First- Expect a 30% to 50% drop in Google stock which is currently @ $580 per share. Get ready to load up on Google between $400 and $300 per share. This will happen within 6 months.

Second- Expect the Chinese government to do to Google exactly what they have done to the rest of world's businesses. They will copy Google's technology, adapt it and use it for themselves. They already have Google's source code. Expect Chinese search engine companies to adopt the Google source code as their own (aided of course by the benevolent Communist government). For years to come, these companies will be successful contributors to the Communist kleptocracy and will remain thinly veiled as capitalistic free enterprises. I suspect that this is happening right now, or has already happened, and has yet to make it into the Western news.  And, when it does make it into our news, the booming Chinese internet market will be heralded as an example of how to do business in the modern age.

Google has served its purpose in China.

UPDATE: Mar 23, 4:21 PM (ET)
MYWAY NEWS- China thwarts Google's detour around censorship
Google's attempted detour around China's Internet censorship rules was met with countermeasures Tuesday by the communist government... The chief concern is whether Google poisoned its business in one of the world's most promising Internet markets. One analyst critical of Google's move predicted the maneuver will cause the company's stock to fall by as much as $50 - or about 10 percent - in the coming weeks. The stock fell $8.50, or 1.5 percent, to $549 Tuesday.

Monday, March 8, 2010

He's Risking His Life to Warn Us

Geert Wilders Fitna (16 minute movie): HERE

Read Geert Wilders address to parliament: HERE

Watch Geert Wilders Warning to America: HERE

Spread the word.  Alert your friends and family to the danger of complacency.

Sunday, March 7, 2010

Modern Globalization- Enabling America’s enemies since 1945.

U.S. Enriches Companies Defying Its Policy on Iran
The federal government has awarded more than $107 billion in contract payments, grants and other benefits over the past decade to foreign and multinational American companies while they were doing business in Iran...

Profiting From Iran, and the U.S.
The New York Times identified 74 corporations that have done business both in Iran and with the United States government over the last decade...

Iran’s Nuclear Program
...Russia, which along with China has consistently resisted sanctions against Iran...

Russia and Iran’s Nuclear Program
Russia’s industrial complex reaps enormous benefits from the sale of nuclear technology to Iran, the supply of nuclear fuel, the training of Iranian nuclear scientists, and the sale of advanced weaponry.

China and Iran's Nuclear Program
China's state-run oil behemoths have committed so much money to Iran -- an estimated $120 billion over the past five years -- that analysts estimate that its engineering firms will not be able to handle all the work.

"The Chinese government has also been stepping in to protect Iranians targeted by U.S. enforcement efforts,"

...According to the Congressional Research Service, the following companies are likely in violation of the Iran Sanctions Act...

Modern Globalization- Enabling America’s enemies since 1945.

Thursday, March 4, 2010

Reported Google Hack Opens Pandora's Box- Unlimited Cyber Surveillance?

Reuters- Google China hackers stole source code
The hackers behind the attacks on Google Inc and dozens of other companies operating in China stole valuable computer source code by breaking into the personal computers of employees with privileged access, a security firm said on Wednesday...

George Kurtz, chief technology officer at anti-virus software maker McAfee Inc... said on Wednesday that he believes that the hackers, who have not been apprehended, broke through the defences of at least 30 companies, and perhaps as many as 100.

Kurtz said the hackers succeeded in stealing source code from several of their victims.

The attackers also had an opportunity to change the source code without the companies' knowledge, perhaps adding functions so the hackers could later secretly spy on computers running that software, Kurtz said.
Now that Google and these other companies (including Adobe, Symantec, Yahoo) are reported to have been hacked, they have a new excuse if ever challenged on the content of their source code-

"We didn't know THAT was in there. The Chinese hackers must have done it."

Related from The Washington Post- Google to enlist NSA to help it ward off cyberattacks

You see- "The NSA isn't spying on you through Google's source code. It must be those Chinese hackers."

Related from CNET- FBI's Net surveillance proposal raises privacy, legal concerns
April 25, 2008- The FBI director and a Republican congressman sketched out a far-reaching plan this week for warrantless surveillance of the Internet...

Because the FBI would run into serious problems doing wide-scale Internet surveillance under existing state and federal law, step 2 may be necessary. That means rewriting U.S. surveillance law.
Think about this. If you were tasked with the creation of "a far-reaching plan for warrantless Internet surveillance", wouldn't it be quicker and easier to simply add the surveillance code and blame it on Chinese hackers- instead of first taking up the task of rewriting U.S. surveillance law?

Don't get me wrong- I am still very concerned about the Chinese communists.  However, the report that the hackers have not been apprehended, coupled with the report that these companies may not be able to notice or track malicious changes in their source code- it raises flags.

Reuters source article found linked on Drudge.

Monday, March 1, 2010

China PLA officer urges challenging U.S. dominance | Reuters

"China's big goal in the 21st century is to become world number one, the top power," - People's Liberation Army (PLA) Senior Colonel, Liu Mingfu in his newly published Chinese-language book, "The China Dream."

"I believe that China cannot escape the calamity of war, and this calamity may come in the not-too-distant future, at most in 10 to 20 years," - PLA officer, Colonel Dai Xu.

Read more- China PLA officer urges challenging U.S. dominance | Reuters

Global Trade and Conflicting National Interests

At least one economist appears to be working for the long term interests of the United States.
Source: Richmans' Trade and Taxes Blog
Among the relatively few economists who view the loss of American industry to foreign countries as a catastrophe in the making is Prof. Ralph Gomory, Research Professor at the Stern School of Business at New York University and President Emeritus of the Alfred P. Sloan Foundation. Prof. Gomory is no ordinary academic. His Ph. D. is in mathematics and he made his mark as Senior Vice President for Science and Technology at IBM...

In an article entitled Manufacturing and Comparative Advantage by Gomory in the July 8, 2009 Huffington Post, he wrote:

Ignored in all these discussions [of free trade] is the obvious fact that when you don't make for yourself the things you need, you will have to trade for them. If you have to import cars and all sorts of manufactured goods, you will be importing on a large scale; to trade for them you will need to create additional goods or services that you can export on an equally large scale....

If you give up large things and specialize in exporting small-scale things for which the demand is limited, you will not be able to buy many of the things that are needed on a large scale. If the things you are going to export don't add up to something big, you will be neither making nor importing what you need. You will simply not have them. You will be a poor nation.
The Richmans' continue-
As we have shown in our book, Trading Away Our Future (Ideal Taxes Assn, 2008), by buying U.S. financial assets, China kept the value of the dollar high and this perpetuated and augmented the trade deficits and contributed to the boom and bust of 1999. And we now add the housing boom which turned into a bust in 2006.

We cannot expect an economic stimulus package to have any success when it will not produce a single exportable good or service to produce a recovery. We have a huge trade deficit in petroleum while we prohibit drilling for oil on public lands and offshore and refuse to permit exploiting our huge petroleum reserves from shale, both estimated to exceed by far the oil reserves of Saudi Arabia. We cannot afford to spend trillions on developing energy from renewable sources while our trading partners are investing in low-cost energy from fossil fuels, e.g., Russia in the Arctic and China in Brazil.

Prof. Gomory agrees with us that we are on a suicidal course. In May, he advocated some version of Warren Buffett's Import Certificates plan to reverse that course. We advocate the same solution in our book and in this blog.