This is a crucial question because Devon Energy, the Oklahoma-based independent oil and natural gas producer has just decided to put billion of dollars in Deep sea Gulf of Mexico assets on the market.

Canada’s National Post reported:

Devon Energy Corp. hopes to raise up to US$7.5-billion from the sale of its Gulf of Mexico and international assets as the company moves to restructure itself as a North American on-shore player.

Devon’s chief executive, Larry Nichols, said the company believes the market is not valuing its Gulf of Mexico and international assets properly. Devon hopes to realize between US$4.5-billion and US$7.5-billion from the sale of assets during 2010.

Reporting on the same issue, the New York Times has indicated that the Chinese may well be interested in these assets.

One company that might be interested in taking the risk would be China National Offshore Oil Corporation, known as Cnooc. It recently agreed to buy a stake in some of Statoil’s Gulf assets, the first time that a Chinese company would take an ownership interest in energy assets in the United States.

Only four years ago, Cnooc’s $18.5 billion bid for American oil company Unocal collapsed under pressure from Congress amid concerns about American oil assets falling under the control of the Chinese government. Since then, the Chinese have been wary of bidding on American energy assets and have concentrated their investments on undeveloped fields at home and in Africa, the Middle East and South America.

The Statoil deal seems to have changed all that. But Devon’s assets could be too much, too soon for Cnooc. It may simply continue to buy small stakes in fields across the region before it is ready to make a major purchase.

The Statoil connection for Cnooc has not made much of a splash up in the mainstream press, but it is significant given the protectionism we witnessed when the Chinese were rebuffed when they outbid Chevron for Unocal, an American company which had largely non-U.S.based energy assets.

Forbes reported on the Cnooc Gulf of Mexico acquisition two weeks ago:

CNOOC Ltd has agreed to buy a minority stake in four prospects in the Gulf of Mexico from Norway’s Statoil, opening crude oil reserves in the U.S. Gulf to China for the first time.

CNOOC will have a 10 percent to 20 percent interest in the four exploration areas, CNOOC spokesman Xiao Zongwei told Reuters.

But, the Devon assets are far more substantial. Moreover, Cnooc comes in after the fact as a minority investor in the Statoil projects. With the Devon sale, Cnooc would be a principal actor and that leaves the door ajar for economic nationalism.

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Max Keiser certainly has a way with words. In one of his latest TV appearances, using the colorful analogy of “Warren Buffett’s toilet paper,” he calls the U.S. dollar worthless.

He goes on to say that China is addicted to this worthless paper because they are using it to stimulate their domestic economy. In another memorable analogy, he labels this an “opium” addiction which will cost the Chinese dearly.

While the Chinese (and the Indians) are increasingly turning to gold as a currency alternative, it is fairly clear that China will have to eventually take an enormous haircut on its holdings of U.S. paper assets. One reason the Chinese are refusing to revalue the renminbi is their desire to forestall this eventuality – and with good reason. Last year, the Chinese central bank needed to go cap in hand to the Finance Ministry because the central banks U.S. dollar paper assets had so depleted the central bank of capital.

Keiser has a lot more to say. Very entertaining. Below is the video. It runs just under 5 minutes.

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On the eve of U.S. President Barack Obama’s visit to China, a major Chinese official has criticized U.S. monetary policy in unusually harsh language. Liu Mingkang, China Banking Regulatory Commission chairman said the zero interest rate policy of the U.S. Federal Reserve posed a “new systemic risk.”

Liu, using language reminiscent of warnings by NYU economist Nouriel Roubini and speaking at a financial forum in China’s capital Beijing, said:

This situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices… It is boosting speculative investment in stock and property markets and will pose new, insurmountable risks to the global recovery and, particularly, to the recovery in emerging markets.

In my view, this is pure political posturing by the Chinese in order to defuse any U.S. criticisms of Beijing’s currency peg. Call it a pre-emptive strike. The U.S. has seen the unemployment rate rise to 10.2% and the trade deficit rise quite dramatically as well. Many are blaming the Chinese and their currency peg to the U.S. dollar.

When Barack Obama visits China this week, the Chinese expect him to focus on the yuan dollar peg. His administration will find it increasingly difficult to hold protectionist pressures at bay given the yuan’s firm peg to the U.S. dollar even while the dollar has plummeted.  To prevent the U.S. from successfully painting the Chinese peg as the sole major risk to the global economic recovery, the Chinese must therefore point to the destabilizing effects from measures taken by the U.S. to reflate its domestic economy.

The Chinese have shown success thus far. Last week, Tim Geithner penned an Op-Ed in the Wall Street Journal along with the Finance Ministers of Indonesia and Singapore which pointed a critical finger at China by asking for “market-oriented exchange rates.” Yet when the APEC (Asian Pacific Economic Cooperation) summit in Singapore ended that same language was cut from the final commiunique.

On the other hand, there has been little change in the prospects of a revaluation of the yuan peg.

Reuters reports:

Chinese Vice Commerce Minister Chen Jian on Sunday played down talk of a shift in the central bank’s currency policy as well as mounting expectations of a rise in the yuan’s exchange rate.

Speculation that China might let the yuan resume its climb after a 16-month pause swirled after a change last Wednesday in the long-standing wording used by the People’s Bank of China to describe its currency stance.

In its third quarter monetary policy report, the central bank failed to refer to keeping the yuan "basically stable at a reasonable and balanced level" when discussing the outlook for the exchange rate.

Asked whether the PBOC was heralding a return to the gradual appreciation of the yuan against the dollar seen from July 2005-July 2008, Chen told Reuters: "I don’t think the central bank meant to say that."

And all indications suggest that we are now returning to the same unbalanced pre-crisis growth model – but with the global economy in a considerably more fragile state. In this climate, the issues of the yuan currency peg and low interest rates in the U.S. will continue to be front and center for some time to come.

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• Chinese to start settling trade in Yuan
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Hat tip Barry Ritholtz

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Hong Kong’s leader Donald Tsang has come out with a scathing criticism of U.S. monetary policy, comparing it to Japan’s which he believes contributed to 1997’s Asian crisis. This is the most direct and strident criticism of the U.S. Federal reserve’s monetary policy from a major international politician yet.

Bloomberg reports:

The Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis, Hong Kong’s leader said.

“I’m scared and leaders should look out,” said Donald Tsang, chief executive of the city, said in Singapore today. “America is doing exactly what Japan did last time,” he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown…

“We have a U.S. dollar carry trade at the moment,” Tsang, 65, said in a speech where leaders of the Asia Pacific Economic Cooperation forum are gathering for a weekend summit. The carry trade is where investors borrow cheaply in one currency and use the funds to invest in other currencies.

“Where is the money going — it’s where the problem’s going to be: Asia,” Tsang said. “You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals.”

Tsang’s criticisms are sure to draw attention as it comes during the APEC summit in Singapore, which is a cross-Pacific economic and political group now being used to show Asian-U.S. cooperation and harmony. Tsang has an especially painful memory of the Asian Crisis as he was Hong Kong’s financial secretary at the time and was forced with the central bank to spend $15 billion to defend Hong Kong’s currency peg as speculative capital fled Asian markets en masse. Depression ensued across wide swathes of Asia, leaving a psychological scar that reverberates today.

As for the comparisons of America to Japan, I find them very well placed.  Yesterday I posted an article in which Marshall Auerback and Fox’s Brian Sullivan discussed parallels between the two. Nouriel Roubini fears that a U.S. dollar carry trade is building which is being used to help inflate assets outside of the U.S. in a global financial bubble.

This is certainly what the Japanese had done in the 1990s. Last August, before the Lehman collapse and panic I wrote that Japan was an enabler of the tech bubble of the late nineties:

the Bank of Japan did not realize the limitations of monetary policy. It could provide easy money, but it could not control where that money ended up. So, ultimately it ended up in the carry trade and helped supply the fuel for the tech bubble.

Was the BOJ responsible for the Tech Bubble? That’s a question that cannot be answered. But, what is true is that the Japanese government and monetary authorities were very instrumental both in the late 1990s and earlier this decade in providing free money to global investors via the carry trade.

Tsang is saying that Japan’s easy money policy also infected Asian markets, helping to inflate an unsustainable bubble which led to collapse and depression. In a macabre repeat of economic history, he sees the same re-occurring now as the U.S. tries desperately to ward off deflation.

Source

Fed May Cause Next Crisis, Hong Kong’s Tsang Suggests – Bloomberg

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Is it just me or did Secretary Geithner just talk out of other side of his mouth? Today he wrote an Op-Ed in the Wall Street Journal with two Asian leaders to mark a big meeting of APEC (Asian Pacific Economic Cooperation) in Singapore.

The WSJ article started out with a bunch of diplomatic niceties about how everyone was working together and must continue to do so, so that all may prosper.

We have just lived through the greatest challenge to the world economy in generations. In acting together, policy makers have shown that they understand the most important lesson of this crisis: Our economies are inexorably linked. We must now work together to ensure strong, stable and balanced growth in the future…

We also must keep our sights on maximizing the potential of global markets. Both exports and imports remain critical stimulate the flow of knowledge and innovation that is enabling emerging economies to catch up with developed-world living standards.

Then it went on to re-affirm the utility of APEC, which people like Andy Xie are calling useless.

APEC will play an indispensable role in establishing strong, sustainable and balanced growth. Our 21 members—which include nine members of the G-20—account for 40% of the world’s population, over half of global GDP and nearly half of world trade. Our ranks include the world’s largest and fastest-growing economies.

But, you kind of got the feeling, this was leading to something else. Wait…wait… hold it… there it is – halfway through paragraph six:

Depending on individual economies’ circumstances, a combination of macroeconomic policy adjustments and structural reforms will be needed. Market-oriented exchange rates in line with economic fundamentals will be essential in assuring the resource and sectoral shifts to match and foster the new patterns of demand.

Everyone knows they are talking about the Renminbi. Remember, Secretary Geithner is the same fellow who accused the Chinese of manipulating their currency during his confirmation hearings. And most people think a freer floating Renminbi would be revalued not devalued.

Yesterday, I posted “Geithner impersonates Nicholson – America, you can’t handle the truth” in which Secretary Geithner was saying he supports a strong U.S. currency, but today he is talking about “market-oriented exchange rates.”

C’mon. We’re not that stupid.

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Tim Geithner has issued a Code Red on the U.S. dollar, but he doesn’t think Americans can handle it.

I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar.

Secretary, I have just one more question. If you gave an order that the dollar wasn’t to be touched and your orders are always followed, then why would the dollar be in danger?

I want the truth!

You can’t handle the truth!

I have a greater responsibility than you can possibly fathom. You weep for the dollar, you curse the U.S. Government. You have that luxury. You have the luxury of not knowing what I know – that the dollar’s death, while tragic, probably saved lives. And, my existence, while grotesque and incomprehensible to you, saves lives.

I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide and then questions the manner in which I provide it.

Did you order the Code Red?

You’re goddamn right I did.

Source

Geithner Says Strong Dollar ‘Very Important’ to U.S. – Bloomberg

Happy Veterans’ Day (especially to my dad, uncles and aunt and all of those no longer with us)

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Andy Xie thinks the Fed is on an inflationary path.  Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

If stagflation is the goal, why might central banks such as the Fed talk tough about inflation now? The purpose is to persuade bondholders to accept low bond yields. The Fed is effectively influencing mortgage interest rates by buying Fannie Mae bonds. This is the most important aspect of the Fed’s stimulus policy. It effectively limits Treasury yields, too. The Fed would be in no position to buy if all Treasury holders decide to sell, and high Treasury yields would push down the property market once again.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret.  There is really no other policy choice because the mountain of debt in the United States is immense.  And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do?  China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate?  Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

The point is that Japan has a strong and genuine case that favors more integration with East Asia. The United States is unlikely to recover soon and with enough strength to feed Japan’s export machine again. There is no more room for fiscal stimulus. Devaluing the yen to gain market share is not an option as long as Washington pursues a weak dollar policy. Without a new source of trade, Japan’s economy is doomed. Closer integration with East Asia is the only way out…

Five years ago, I wrote an op-ed piece for the Financial Times entitled China and Japan: Natural Partners. At the time, a prevailing sentiment was that China and Japan were antithetical: Both were still manufacturing export-led economies and could only gain at the other’s expense. I saw complementary demographics and capital: Japan had a declining labor force and China needed to employ tens of millions of youths migrating to cities from the countryside. China needed capital and Japan had surplus capital. And their trade relations indeed tightened, as Japan had increased the Chinese share of its overall trade to 17.4 percent in 2008 from 10.4 percent in ‘04.

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea.  Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

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China on Friday accused the US of protectionist and biased trade policies less than a week before president Barack Obama’s first visit to Beijing.

In a stinging rebuke to Washington, China’s commerce ministry promised to take measures to protect its domestic industry after the US slapped anti-dumping duties on $2.6bn of Chinese steel pipe imports. The duties are part of a growing roster of trade conflicts between the two countries, despite a high-level meeting last week in China aimed at reducing tensions.

“China resolutely opposes such protectionist practices and will take steps to protect the interests of our domestic industries,” Yao Jian, ministry spokesman, said on its website.

I see this coming to a head.  More here.

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Marshall Auerback here. You saw Ed’s last post on China, quoting from Peter Tasker, one of the top analysts in Japan when I lived there. I take Peter’s insights very seriously. His analysis implies something a lot more in regards to currencies, trade and credit.

China’s bank credit expansion is so great that even if nominal GDP is up five to ten percent, the credit to GDP ratio will rise by about thirty percentage points.  It took Japan ten years to  take it up by fifty or sixty percentage points, and it has already been high in China before this credit boom. How high, no one knows because there is no good data on debt outside the banking system.  But there is such debt.  The debts of households and firms outside the banking system could be thirty percent of GDP.  The total ratio now could be 185%.  This is the same as Japan at the peak and close to the US now. 

This could keep China going for quite some time, but the consequences for Japan could be disastrous.  Indeed, for most of Asia, which could precipitate another crisis for them down the road.

One relatively unexplored aspect of the emerging Asia crisis of 1997 was what pushed these countries heavily into current account deficits.  But between 1992-94, China devalued the RMB by close to 60% (she was already running a current account surplus when she did it the second time), which created huge competitive pressures for the other countries and pushed them rapidly into deficit.  This time, China is devaluing along with the US dollar and reflating a credit bubble — not to encourage domestic demand, but to create a renewed export juggernaut, at a time of weak external demand.  This could really be problematic for the rest of the world.

I wonder how long before the protectionist pressures emerge?

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This article by Peter Tasker, a well-regarded financial analyst in Asia, comes via the Financial Times (hat tip Marshall). He sees an enormous bubble forming in China – and parallels to Japan circa 1987:

Emerging markets, it seems, have had a good crisis. In contrast to the debt-ridden G7 economies, they have quickly resumed their growth trajectory. No surprise, then, that US emerging market mutual funds are experiencing record inflows. The stellar performance of the Brics markets – Brazil, Russia, Indian and China – is due to continue into the distant future.

Such is the narrative now forming among investors. To anyone who has lived through the rise and fall of the Japanese bubble economy, it should set off alarm bells.

Remember that it was in the years following the 1987 "Black Monday" crash that Japanese assets went from being expensive to absurdly overvalued and the Nikkei’s dizzy rise to 39,000 forced the bears to throw in the towel…

But what you saw was decidedly not what you got. The crisis, far from leaving Japan unscathed, exacerbated its structural problems and laid the groundwork for a far greater disaster…

Interest rates have been far too low for far too long. If the natural interest rate is, as the Swedish economist Knut Wicksell posited, around the level of nominal GDP growth, then China’s interest rates should have been close to 10 per cent for most of this decade. Alan Greenspan, former chief of the US Federal Reserve, has been criticised for holding interest rates too low and setting off a housing and credit bubble in the US. But if US monetary policy was wrong for the US, it was even more wrong for the high-growth countries that "imported" it. The result could only be a massive misallocation of capital…

At the 2008 peak, the price-to-book ratio of the Shanghai stock exchange was over seven times, well above the five times achieved by Japanese stocks in 1989. After the turbulence of the past 18 months, the ratio has fallen to 3.3 times, still the world’s second highest after India, and residential real estate trades at multiples of income that make the US housing boom look tame…

What is scary is that the current frothiness of emerging markets, centred on China, may be only a taste of what is to come.

There is a lot more in the original article. Link below.

Source

China rushes towards a Japan-style bubble – Financial Times

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China has sent yet another public signal that it is unhappy with the U.S. and its trade policy by prepping an investigation into alleged illegal auto subsidies by the U.S. government.  The timing of this announcement puts a spotlight on the bailout of GMAC, the auto financial company which effectively has been nationalized the firm. This may be by intention.

The Financial times reports:

China is preparing to launch a trade investigation into whether US carmakers are being unfairly subsidised by the US government, according to people familiar with the matter.

The move comes at a time of heightened trade tensions between the two countries after the US imposed duties on Chinese tyres last month. Many warned this would prompt Beijing to retaliate.

Few vehicles are actually exported from the US to China, but the move would have symbolic power by turning the tables on Washington.

US labour groups have long accused Beijing of unfairly subsidising its exporters. However, through a “countervailing duties” investigation, China would assess whether the US was open to the same charge. The investigation could lead to import duties.

General Motors and Chrysler have received about $60bn in government bail-out funds, though Ford has received nothing.

Yes, General Motors has a large presence in China and its bailout by the government has an impact on its ability to operate competitively in China. But, because the U.S. does not export many cars to China, one might see this as a strange action on China’s part.  In my view, China is telling us with this action that “what is good for the goose is good for the gander.”

I find this story a bit curious because China already said in September that it would investigate autos and chicken in retaliation for U.S. tariffs on tires. But, we should look at this in a wider context. The US is also angling to get Chinese to revalue renminbi. The Chinese are resistant to this and their actions here can also be seen as a warning to the U.S. that any and all protectionist threats will be met with retaliation.

Elliot Feldman, head of international trade at Baker & Hostetler, the law firm, said his firm warned the USTR last January that the approach the US was taking towards China and other countries over subsidies was dangerous in the light of the US’s own support for carmakers, banks and financial institutions.

“We warned that other countries could apply to the United States the same principles the United States was applying to them,” he said. “Apparently we have arrived.”

The problem with protectionism is not that it can protect sectors, but that it leads to retaliation and escalation. This is now what is beginning to occur.

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Former Morgan Stanley economist Andy Xie joins other famed prognosticators like Nouriel Roubini in worrying about an incipient asset bubble. The Rosetta Stone Advisors board member sees the huge increase in money supply created by central banks as fuel to an asset bubble fire. He even goes so far as to call the central banks ‘arsonists.’

The financial crisis exposed gross inefficiencies in the massive amounts of money financial institutions received from central banks. Supplying so much money to the same people who caused the crisis — and with the same incentives — does not feel right. The argument in favor of this policy is that, when the house is on fire, you have to do whatever to extinguish the fire and find the culprit later. The problem is that, in this case, the arsonists have been asked to put out the fire. How can we be sure they won’t start another fire?

Most argue that the answer is not to limit the money supply but to reform the financial system. In this way, future demand for money would be efficient. But so far, no corrective reforms have been implemented in response to the financial crisis. Why? Because the global financial system became so big over the past decade that it has co-opted central banks, legislators and entire governments. Any reforms that do come will not address the main factors leading to the current crisis.

Even the best reforms will never resolve a problem based on the fact that financial professionals generally risk other people’s money: They get big rewards when bets go right and don’t have to pay when bets go wrong. The problem with this incentive system suggests the global financial system is structurally biased toward taking on more risk than what would be taken in an efficient market. The only way to counter this is for central banks to limit money supplies. Asset inflation over the past 10 years and the catastrophe incurred when it burst lend credibility to this argument.

Xie sees stagflation as a threat and a double dip coming, as a result. He warns bond market speculators, “you’ll want to run for your life” when the bond market tanks.

A word of caution for all would-be speculators: You’ll want to run for your life as soon as the bond market takes a big fall. And the case for a double dip in 2010 is already strong. Inventory restocking and fiscal stimuli are behind the current economic recovery, and when these run out of steam next year, the odds are quite low that western consumers will take over. High unemployment rates will keep incomes too weak to support spending. And consumers are unlikely to borrow and spend again.

Many analysts argue that, as long as unemployment rates are high, more stimuli should be applied. As I have argued before, a supply-demand mismatch rather than demand weakness per se is the main reason for high unemployment. More stimuli would only trigger inflation and financial instability.

The post is very entertaining, if scary. (“monetary growth is being used to support leverage, mostly in the financial sector.”) While I am not in the stagflation camp, I agree that money supply growth is fuelling unsustainable increases in asset prices globally. Xie concentrates on China where retail investors dominate the equity markets, operating under the assumption that government will not let assets prices fall. My view is that prices must eventually fall if they are too high relative to the income streams that underpin that price. The resultant crash in prices will be deflationary. Xie believes that this discrepancy between price and value will be closed via inflation.

However, you see it, I recommend reading this article. It asks some very important questions for investors, businesspeople and economists alike, the most important of which is a variation on theme of the Stephen Roach article:

While workers and businesses struggle, asset players are reaping substantial paper profits again. As the central bank’s monetary policy is behind the asset boom, we should ask whether the policy is achieving its goal by helping the real economy, or whether it is just helping speculators and hoping they have something left over for the real economy.

Much, much more here.

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• Is this the way to fight inflation?

This morning, I ran across a post by Prieur du Plessis, which linked out to a Stephen Roach interview on Charlie Rose.

Roach is the head of Morgan Stanley Asia and has been a voice to listen to when trying to discern where China is headed and how its relationship with the United States will develop. That was the topic of conversation between Roach and Rose. Through the links on that post I happened upon a 1996 Roach interview on Charlie Rose of a very different sort where he talked about the hollowing out of America and his concern for the future. I want to link those two below.

In the transcript of the recent China interview on Rose’s website, Roach marvels about the progress made in China:

CHARLIE ROSE: You left Wall Street to go live in China.

STEPHEN ROACH: I did. About three years ago, your friend and mine, John Mack, called me up and said, 25 years as an economist, a long time, good job. How would you like to do something different and be the chairman of Morgan Stanley’s business activities in Asia? And I told John I thought he was nuts. I had the best job. I wasn’t going to leave it. He said, "Think about it."

And, you know, John, when he says, "Think about it," there’s a fair amount of emphasis there. I did think about it. And I’d built fabulous relationships in Asia over the years, Charlie. I was passionate about the region. I thought I knew it well, but I knew in my gut that it would be a lot different from the inside than from the outside, and I said, yeah, I’m going to go for it.

And I’ve been out there now about two and a half years. And I have no regrets. I love it. I have learned an awful lot about Asia, and I thought it was time to put it down in a book and get it out there when the world is very focused on Asia, its own challenges and its role in the global economy.

CHARLIE ROSE: What do you love and what have you learned?

STEPHEN ROACH: What I am most passionate about in terms of Asia is what they’ve done, especially in China, over the last 30 years. You know, big celebration, 60th anniversary of the People’s Republic of China. But the first 30 years were pretty awful and the next 30 years have been spectacular. And the difference is they have really put huge focus on transitioning this economy from one that was owned by the state to one that is more of a market-based economy. They’ve taken huge risks in terms of reforms, layoffs, building market structures, building companies that we’ve never seen before. And to be on the inside and watching, watching that risk taking up close is a pretty fascinating experience for anyone. And I love every bit of it.

They go on to talk about the outlook there as well as how the government is dragging its heels on increasing domestic demand and shoring up a porous social safety net among other things. I definitely suggest you read the full transcript here. It makes for a better understanding of China. A snippet of the video is embedded below.

However, what was equally interesting to me was that Roach and Robert Reich were talking to Rose about concerns over the hollowing out of America’s workforce through downsizing (off-shoring had not yet gathered full steam).

Roach says:

“What has changed for me is my appreciation for what it has taken to get from point A to point B over the last ten years. It would be one thing if these productivity gains were built on the back of a more talented, skilled, educated, dynamic work force, but it’s another thing altogether if these productivity or efficiency changes were built on the basis of strategies that are hollowing out our companies, hollowing out our workforces, stagnating real wages – tactics in the end that can really lead to industrial extinction.

I’m sure you see the connection. If not, watch the video below in the context of the more recent video and your knowledge of what is happening in the global economy. I will say this: Roach was right about the dichotomy between the benefits to the owners of capital and the benefits to labor that these corporate strategies created.

Where I think his view could be tweaked looking back 13 years is in terms of what it has meant for Corporate America.  The hollowing out of America’s workforce and lack of investment domestically has not meant a hollowing out of Corporate America. Those companies that did downsize American workers in a ‘short-term’ play for next quarter’s earnings are many of the ones which have outperformed for the last 13 years because they have gone global. And the impressive leaps forward in China are testament to the gains made in places like China due in part to that move. It’s called ‘global labor arbitrage’ and it is what I see as the defining element of globalization as practiced.

In the end, however, a day of reckoning will come – not for the managers of the companies who have profited over the time span between these two interviews because they are going to keep their bonuses.  The day of reckoning for America will come in terms of the growth and dynamism of its middle class. Whether the U.S. then moves toward a Latin American style economic structure of a few rich at the top, a weaker middle class, and everyone else at the bottom or back to a more equal income and wealth distribution depends on the reaction by the ‘body politic,’ not on Wall Street.

Related posts:

• Stephen Roach: Downturn in Asia less severe, but recovery later
• Stephen Roach and Jim Grant: Video of credit crisis thoughts
• Stephen Roach is still bearish, no recovery until 2010
• Stephen Roach sees a W-shaped recovery for China
• Stephen Roach is talking double dip again

In what looks to be a central line of attack in the quest to re-balance the global economy, the Treasury Department has ratcheted up the rhetoric against China’s currency peg. The Treasury’s semiannual report to Congress slammed the Chinese for their lack of exchange rate ‘flexibility,’ but stopped well short of accusing the Chinese of currency ‘manipulation’ as Tim Geithner had claimed during his confirmation hearings before Congress.

Bloomberg reports:

“Both the rigidity of the renminbi and the reacceleration of reserve accumulation are serious concerns which should be corrected to help ensure a stronger, more balanced global economy consistent with the G-20 framework,” the report said. “The Treasury remains of the view that the renminbi is undervalued.”

China’s foreign-exchange reserves, the world’s biggest, surged in the third quarter as an economic recovery attracted speculative capital and a weak dollar boosted valuations of its yen and euro assets.

Record Reserves

The holdings climbed about $141 billion to a record $2.273 trillion, the People’s Bank of China said this week. That was less than the unprecedented $178 billion gain in the second quarter.

The Obama administration wants China to “pursue policies that permit greater flexibility of the exchange rate and lead to more sustainable and balanced economic growth,” the report said. The U.S. will continue to push China to allow the yuan to appreciate in two-way meetings and through meetings of officials from the Group of 20 nations.

People’s Bank of China officials have called this year for an alternative to the dollar as a global reserve currency. At the same time, the issue hasn’t been a central point of debate at recent international summits like a meeting of Group of 20 leaders in Pittsburgh last month.

If Treasury is looking to burnish its populist credentials, making these statements to Congress where protectionist and populist sentiment is running high is certainly the place to do it.  The question is: what’s your endgame?

Right now the US dollar is looking weak despite Mr. Geithner’s advocacy for a stronger dollar.  If you ask China for more exchange rate flexibility, you clearly are not serious about a strong dollar – and everybody knows it.

Here’s how I see things playing out:

• Congress looks at this report and concurs that the key to ending slower global growth is to correct global imbalances via a Chinese currency revaluation. Fair enough.
• However, individual Congressmen, looking to reassure jobless constituents ahead of the midterm elections, will escalate by presenting bills to ‘punish’ China if no actions are taken.
• China will be aghast at this and, in a further escalation, start making noises about ditching the dollar.

At this point, the question is how does this get resolved.  To date, bilateral U.S.-Chinese economic tensions have escalated and led to protectionism. Further escalation will yield unpredictable results and will be destabilizing. Chinese officials cannot be seen by their domestic constituency caving to American pressure.  This would undermine their authority and create problems domestically. Therefore, a public frontal assault on the renminbi peg is likely to backfire.

Like Stephen Roach, I see protectionism as the largest threat to global recovery. Let’s hope the Administration is aware of the dangers.

Related posts:

• China “serious about the plan to internationalise” Yuan
• Japanese defend dollar’s status while China tears it down
• Mea culpa on the need for a new currency
• China slams U.S. for inflating global asset prices via carry trade
• Is China avoiding using US dollars?

The following post is from Stratfor via John Mauldin, who is a Best-Selling author and recognized financial expert. He is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore.

I think you will find this post reminiscent of Hugh Hendry’s YouTube video which I highlighted in July.

Today I offer you an insightful look at China’s real estate market – a "burgeoning bubble" that deserves a close eye as the possibility for breaking increases. Remember the chaos in Japan after their own housing dreamscape got violently yanked back to earth? As investors, we have to recognize opportunities – and know what to avoid. With a global economic crisis – and now surging housing prices in China – investors in any global market need to keep watch on political and economic developments around the world.

Today’s analysis comes courtesy my friends at STRATFOR, a global intelligence company. They provide unique and on-the-money analysis and forecasts on all things global, essential for any alternative investment strategy. They’ve got a free newsletter as well, for which I encourage you to sign up by clicking here – so you’re not limited to my caprice.

John Mauldin
Editor, Outside the Box

The China Files (Special Project): Real Estate

October 13, 2009 | 1149 GMT

Summary

The real estate market in China, particularly the residential side, is a burgeoning bubble that is growing bigger and more breakable by the day. Land and housing prices were already rising steadily when Beijing’s stimulus package hit the sector in early 2009. Now prices are surging, with developers, bureaucrats and investors cashing in while urban Chinese – once encouraged to invest in home ownership by the central government – become less and less able to buy.

Editor’s Note: This analysis is part of a series that explores China’s industry, finance and statistics.

Related Special Topic Page – The China Files (Special Project)

PDF Version: Click here to download a PDF of this report

On Sept. 10, China Overseas Land and Investment, a Hong Kong-listed company and a subsidiary of state-owned China State Construction Engineering Corp., purchased a prime piece of real estate in the Putuo district in downtown Shanghai. The company paid 7.006 billion yuan ($1.026 billion) for the undeveloped property, which will amount to an average of 22,409.3 yuan ($3,283.9) per square meter of floor space (just in land costs) once the designed residential building is constructed.

The purchase created China’s newest "land king," a term for the real estate developer who pays the highest price for a piece of real estate during a land auction. And 7.006 billion yuan was the highest price ever paid for a piece of Chinese real estate for any purpose – residential or commercial. The milestone is a result of an increasingly intense competition for land in major cities that began early in the year, when Beijing began distributing stimulus money to various industries – including the real estate sector – to sustain the economy. As a result, land prices have soared throughout China. And with increasing speculative investment in residential real estate, the market faces a surging bubble that jeopardizes the country’s long-term economic development.

Since 1998, real estate investment in China has accounted for more than 10 percent of the country’s gross domestic product (GDP), compared to only 3 percent to 5 percent in the United States. Such investment is also closely associated with many other industries, such as construction and finance, and it provides an abundance of jobs. Therefore, it is seen as a critical pillar of China’s economy and enjoys favorable policies from the government and state-owned banks (more than 70 percent of real estate investment in China comes from bank loans). At the same time, real estate developers, local government officials and investors have escalated housing prices across the country by acquiring massive land holdings, limiting the supply and inflating prices, creating a real estate bubble that is not sustainable in the long run.

The bubble has grown mainly on the residential side of the market, where there is more demand and higher profits to be made. However, while fewer developers and investors have been chasing nonresidential projects, Beijing’s 4 trillion yuan ($586 billion) stimulus package in early 2009 has generated more interest and activity in the commercial side. Indeed, there are signs that commercial real estate may also be headed for a bubble, and STRATFOR will be watching the situation closely.

Origins of the Bubble

Since 1978, China’s pace of urbanization has increased dramatically, with the number of middle-size and large cities (those having nonagricultural populations of more than 200,000) growing rapidly. Beginning in 1985, economic reforms implemented in urban areas to make China’s planned economy more market-oriented added even more momentum to the real estate boom, with real estate investment increasing by 71 percent by 1987. The government’s macroeconomic policy of monetary belt-tightening helped cool this overheated market, which was further tempered by the government’s continuing to provide housing for state employees (fu li fen fang, or "welfare housing").

However, when the state significantly cut back on its welfare housing program in 1998, the Chinese perception of personal property changed, and this would have an important impact on the real estate sector. The government began this privatization process by making a private dwelling a "commodity" and granting the purchaser the right to own a newly built house for 70 years. (Likewise, the developer who buys the property on which residential or commercial buildings are to be constructed may own that property for 70 years.) Home ownership in China could now be a sound financial investment.

Thus, the residential real estate market would boom in almost every urban area in China – and particularly in the "first-tier" and "second-tier" cities (only Beijing, Shenzhen, Guangzhou and Shanghai are in the first tier, with more than 20 cities, and mostly provincial capitals or coastal ports are in the second tier). But rising land prices would eventually put housing prices out of reach for the general public. In Dongguan, a coastal second-tier city in Guangdong province, land prices averaged 4,957 yuan ($726.42) per square meter in 2007, a more than 500 percent increase from 2003, while personal disposable income increased 24 percent during the same period (from 20,526 yuan [$3,008] to 27,025 yuan [$3,960] per year).

A 2006 survey conducted by the National Development and Reform Commission showed that the average ratio between housing prices and income was approaching 12:1 in many large and middle-size cities in China (in Beijing it had reached 27:1). Twelve to one is significantly higher than the World Bank’s suggested affordability ratio of 5:1 and the United Nations’ 3:1. The problem was compounded by the fact that, of the more than 80 percent of Chinese who owned their own homes in urban areas (generally considered cities with populations of more than 20,000), 54.1 percent were making monthly mortgage payments that constituted 20 percent to 50 percent of their monthly incomes.

The Recovery Bubble

Following a temporary drop toward the end of 2007, land prices rose steadily, then began surging again with Beijing’s stimulus package and a flood of easy credit in 2009. With much of this money flowing into the real estate sector, major beneficiaries included large state-owned enterprises (SOEs) involved in speculative real estate and housing investment, contributing to the inflating bubble. Among the 10 highest-priced land purchases in major cities in the first half of 2009, 60 percent went to SOEs.

Paradoxically, as the global financial crisis continues, China sees little choice but to loosen its monetary policy even further, fearing the opposite would curtail economic growth and result in massive unemployment, which could lead to social instability. Beijing knows that one of the country’s underlying economic problems continues to be an overheated real estate market, but it also knows that the real long-term solution – limiting the flow of cash and credit – could have dire socio-economic ramifications. Meanwhile, real estate developers, government officials and investors continue to speculate on real estate, raising land and housing prices.

As housing prices continue to rise, a parallel trend is manifesting itself – rising vacancy rates in urban areas. A 2009 report by the Shanghai Yiju Real Estate Research Institute revealed that, by the end of 2008, the average vacancy rate for "commodity housing" (as opposed to welfare housing) in Beijing was 16.64 percent, and vacancies reached as high as 30 percent in some districts. Most of these vacant houses, however, are not unsold ones. They have been purchased by investors as speculative investments. While there are fewer and fewer ordinary people who can afford to buy houses, there is still excessive demand for investment housing – pressure that continues to drive up the prices.

This closed loop in the Chinese real estate market is facilitated by the country’s political and bureaucratic system. In China, all land is initially owned by the state, and local governments have the sole authority to sell it. And income from property taxes and land sales are a primary source of revenue for local jurisdictions. According to estimates by the State Council’s Development and Research Center, tax revenue from the land in some jurisdictions accounts for 40 percent of the local budget. Moreover, net income from land sales accounts for more than 60 percent of the local governments’ extra-budgetary revenue. The soft budget and lack of accountability to the people reinforces the local governments’ incentive to expand their real estate investments without much concern for cost or impact on public services.

Economic performance also is the prime prerequisite for bureaucratic advancement, which gives local officials the incentive to generate as much revenue as possible through land auctions. And this generally involves a level of collusion – and corruption – among government officials, real estate developers and investors.

One typical strategy is for a developer to buy a big chunk of urban land from the local government but leave the land undeveloped, or build on only a small portion of it, thereby keeping the housing supply limited. Despite various state policies to lower land prices in order to make homes more affordable, local government officials and real estate developers control the land auctions. When a lower sale price is dictated from above, it is easy enough for the local sponsors to officially deem the auction a failure. Even when the developer does build houses on the property, a speculative investor, working hand in hand with the developer and government officials, can bribe both parties to ensure that he can buy all the houses at a low volume price and keep them off the market, thereby maintaining a limited supply and high prices.

Another factor that enters the equation is a cultural one. The Chinese people generally prefer to buy new houses, as opposed to renting homes or buying secondary houses in which people have already lived. Indeed, in urban areas, marriage proposals often include a promise to buy a new commodity house. As a result, the secondary housing market remains very small in comparison (due also to fewer available bank loans for lived-in houses and the complicated process involved in transferring ownership).

All of these factors contribute to the burgeoning real estate bubble – and make it difficult to predict when that bubble will burst. With 70 percent of real estate investment in China coming from bank loans, a dramatic drop in land values could send shock waves throughout the economy. There are already signs of decline. In Shenzhen, one of China’s first-tier cities, real estate prices have been dropping for the past two years (30 percent for housing), and many developers and speculators have suffered great losses. The threat looms in other large cities such as Beijing and Shanghai and may be emerging in many second-tier cities as well.

Given the current global economy and the economic balancing act it must maintain domestically, Beijing has few good choices. It must keep enough cash flowing to maintain economic growth and social stability in the short term while tightening credit to avoid a tsunami of bad loans and a market collapse over the long term. Certainly, Beijing does not want to face the kind of collapse in the housing market that Japan experienced in the 1990s, which triggered a financial crisis and more than a decade of economic malaise.

But in China’s real estate, as in most sectors of this vast and complex land, implementing and enforcing prudent regulation has never been an easy task.

Related posts:

• Chinese stock market bubble inflating
• Spain: who is responsible for the property bubble?
• Beijing starts a ‘Buy China’ policy
• China is now on the same bubble path as Japan post-1987 crash
• Manhattan Q2 Apartment Sales down 22%

I just finished reading a Financial Times article about the likely coordinated global policy solutions to emerge from the upcoming G-20 meeting in Pittsburgh.  It does not sound like there is a huge amount of consensus. Indeed, it sounds like there is a lot of finger pointing regarding what the true causes of the financial crisis were.

China expressed scepticism on Thursday about a US and European push to launch an effort to tackle global economic imbalances at next week’s G20 summit in Pittsburgh.

Zhou Wenzhong, China’s ambassador in Washington, said: “People should not focus on only one thing, that is balancing the economy.” The International Monetary Fund should concentrate on doing a better job of monitoring the build-up of financial risks.

Translation: You lot in the West created a house of cards in the financial sector to fund a drunken binge of excess consumption. Your guy Stephen Roach even says so. Clearly, this is where we need to focus future reforms.

Edward here.  Don’t take my word for it that this is what the Chinese are saying.  Later in the same article, we get the following from Ambassador Zhou:

Imbalances were “certainly not the root cause of the problem”, Mr Zhou said. “The root cause of the crisis is the lack of supervision and abuse of the openness of the market, very risky levels of leverage and too much speculation.”

Unfortunately for Zhou, this is not the interpretation of events being drawn in the West.  Western officials are more interested in correcting ‘global imbalances.’

“Global imbalances have to add up to zero, so if the US is going to be less the consumer and importer of last resort then other countries are going to need to be in different positions as well,” a senior administration official told the Financial Times recently.

Britain, France and other European nations are backing a push on global imbalances at the G20 summit. Gordon Brown, the UK prime minister, said this week: “When I attend the G20, I will be putting the case for a global compact for growth and stability for now and for the future.”

Brown and the other Western leaders are not denying responsibility for the global meltdown as directly as Zhou seems to.  Nevertheless, you must realise that this is a coordinated effort to re-focus the policy debate on China, its pegged currency, trade surplus and huge accumulation of foreign currency reserves.  I call this the Blame Asia meme. I would be curious to hear what the Brazilians, Indians and Russians are saying about all of this.

The question is whether this tiff over who caused the crisis in the first place will impede consensus about coordinated global policy going forward.  No one country or set of policy makers covered themselves in glory in the lead up to this panic.  Yet, because the same set of individuals is still at the table, we now see greater interest in putting a positive spin on past events than on moving forward in a constructive way.

Correct me if I am wrong.  It sure looks like we shouldn’t expect anything substantive to result from the G-20 meeting in Pittsburgh.

Source

China scorns focus on imbalances – FT

Related posts:

• Tear gas and rubber bullets at G-20 Protests
• China wants to get rid of the dollar
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Now that President Obama has signalled his willingness to punish the Chinese for dumping on tires, a whole host of other industries are likely to file their own ‘copy-cat’ complaints.

Reuters says:

President Barack Obama’s decision to restrict tire imports from China after union workers complained of a surge could lead to copycat cases in areas such as steel, clothing, paper, machinery and consumer goods, trade experts said on Monday

"It’s a target-rich environment," said Lewis Leibowitz, a lawyer who represents the Consuming Industries Trade Action Coalition, which opposed relief in the tires case.

"There’s almost anything you can hit. And even within import categories that have gone down, there may be smaller product categories that have gone up," Leibowitz said.

However, the question of which industries could qualify for relief is complicated by the fact that overall U.S. imports from China have fallen in 2009 because of the global and U.S. economic downturn, he said.

Obama’s decision late Friday to restrict the tire imports was the first time the United States had used a special import safeguard provision against China known as Section 421.

It triggered an angry response China, which said it planned to challenge the action at the World Trade Organization and begin new anti-dumping investigations against U.S. products.

Beijing agreed to the anti-surge measure when it joined the World Trade Organization in 2001 and former President Bill Clinton’s administration relieved heavily on that commitment to help persuade a reluctant Congress to approve the pact.

Given that the WTO ruled against China on tires, it stands to reason that some grievances in other industries filed in the WTO against the Chinese would also likely be successful.  How can the President not slap tariffs on these products as well, given his actions in this first test case?  Clearly, what works for tires should also work in steel, clothing, paper, and elsewhere. If I were an American exporter in any of these industries, I would be lawyering up right now.

My hope is that we can get a comprehensive and equitable bilateral trade resolution with China to avoid more tariffs on either side.

Related posts:

• Should we expect a protectionist China?
• China: we “will take steps to protect the interests of our domestic industries”
• China launches retaliatory investigation into U.S auto subsidies
• Murder-Suicide in Chimerica
• China cutting overcapacity

In 2002, the global economy was weak and equity markets around the world were at multi-year lows following the greatest equity bubble and bust in world history. Many policy makers including Alan Greenspan, chairman of the U.S. Federal Reserve, feared a deflationary spiral of Great Depression proportions resulting from the stock market collapse.

To prevent such an outcome, the United States embarked on an historic monetary experiment to reflate a post-bubble economy by lowering interest rates to 1%, the lowest in 50 years. The result was a huge global economic boom which benefitted nearly every economy and every asset class on the planet. But the boom has turned to bust. In its wake, the cozy relationship between China and the United States that developed during boom time is unravelling.

Just Friday, Barack Obama slapped Chinese tire imports into the United States with tariffs of up to thirty-five percent. China was outraged and immediately threatened to retaliate. I now see a trade war between China and the United States as the biggest threat to global economic recovery.

With this trade war looming, one must wonder if Chimerica, the marriage of China and America as one economic entity, will end in murder-suicide, taking the global economy down with it.

Chimerica’s origins

Niall Ferguson and Moritz Schularick invented the term “Chimerica” in 2006 to describe the underpinnings of the 2000s boom. In their view, this economic upswing resulted from an America and China joined at the hip in a state of economic interdependence. Americans were the spenders and the Chinese were the savers and producers. The United States spent far in excess of what it saved. Meanwhile China ran a huge current account surplus, accumulating a $2 trillion stash of largely U.S. dollar-denominated international reserves, effectively funnelling America’s borrowed money back into the U.S. economy.

This state of affairs was always unsustainable – more so after the collapse of the associated credit and asset bubble exposed fissures in the global financial system in 2007. However, the flashpoint came in 2008 when the U.S. dollar plummeted to record or multi-decade lows against a host of other major currencies, leaving China’s reserves diminished in value. For the months since, the Chinese have expressed growing concern that they could get the short end of the stick if the marriage which created Chimerica dissolves.

Chimerica’s unravelling disturbs China

If one looks at any one incident involving China and the United States during the global economic crisis in isolation, it is easy to lose sight of the big picture. However, threading the events of 2008 and 2009 together makes a compelling case that the Chinese – U.S. marriage is coming apart.

The first indication of Chinese concern which I detailed came as the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac collapsed last August. The Chinese had put much of their reserve money into GSE debt, believing it as safe as U.S. government debt. It was evident that the GSEs were not a safe investment except through an implicit government guarantee (as I said in May 2008). But when the GSEs collapsed, the Chinese were caught out and warned they could dump dollar-denominated assets unless they were made whole.  Subsequently, Fannie Mae and Freddie Mac were nationalized and creditors were made whole.

The next flashpoint was created by comments by incoming Treasury Secretary Tim Geithner at his confirmation hearings before Congress. Geithner charged China with ‘manipulating’ its currency in an environment in which many western policy makers were openly blaming Asia’s mercantilism for the economic crisis.  The Chinese retaliated, with Chairman Wen slamming the U.S. as a profligate nation in unusually stark terms that raised quite a few eyebrows.

At just about this time, the first hints of real American protectionism came into being in the form of the Buy America provision attached to the stimulus bill. There was quite an uproar from America’s major trading partners like Canada and China – and I saw this as a 21st Smoot-Hawley at the time, a view I still hold. (To make matters worse, the provision has had perverse consequences.)

By this point – early 2009, the Chinese were done. They had suffered the potential for massive losses through the dollar’s weakness and the failure of the GSEs. Now, they were being blamed for a crisis which began in the west.  It was at this time that I noticed a steady drumbeat of ditch-the-dollar talk coming out of China. By the G-20 meeting in April, the Chinese central bank head Zhou outright called for a new international reserve currency.

The drumbeat of anti-Dollar news coming from China got louder and louder during the spring. The Chinese started settling trade in Yuan (Apr. 9) instead of dollars. The Chinese were discovered to be stocking up on gold supplies (Apr. 24). The Chinese central bank attacked the policy of quantitative easing in its quarterly report (May 9). The Chinese positioned themselves as the champion of emerging market nations and assembled support from Russia, Brazil and India for reforms in the international reserve system (Jun. 12).

And then came the retaliation.

Protectionism rises

On June 16, I wrote a post “Beijing starts a ‘Buy China’ policy” which clearly demonstrated that the Chinese were incensed by the Buy America provision in America’s stimulus bill. The trade war was on.

The ‘Buy America” and the “Buy China” provisions were nationalistic and prevented goods from other countries being bought. However, they were merely passive protectionism i.e. legislative exclusion of foreign goods and services. No tariffs were assessed.

But when Barack Obama chose to slap 35% tariffs on Chinese tire imports, this was an unmistakable act of active protectionism. This was the proverbial serving of divorce papers.

Expect prices to rise as a result:

Marguerite Trossevin, who represents a coalition of U.S. tire companies that import Chinese tires, said the tariff decision is “very disappointing.” She predicted price increases for U.S. consumers and losses for U.S. tire importers.

The Chinese have now said they will look to retaliate on U.S. poultry and auto products:

China announced dumping and subsidy probes of chicken and auto products from the U.S., two days after President Barack Obama imposed tariffs on tires from the Asian nation.

Chinese industries complain that they’re being hurt by “unfair trade practices,” the nation’s Ministry of Commerce said on its Web site yesterday. The dumping investigation relates to poultry alone, a spokesman said in Beijing today. The ministry didn’t specify the value of imports of the products.

To be honest, the protectionism should not be a surprise.  Obama is no free-trader. And I certainly foresaw a rise in protectionism and indicated in December 2008 the United States was the likely first mover:

Tariffs, export subsidies and currency devaluations will roil the desire for free trade.  Initially, countries will seek relief at the WTO (World Trade Organization) but later they will begin to act unilaterally.  The U.S. will be the first to unilaterally retaliate.

Even the resistance to unwinding excess capacity and global rebalancing are all very predictable as nations retreat into nationalistic thinking when the chips are down. As far back as March 2008, I warned of a likely multi-cycle W-recession predicated on resistance to unwinding the status quo:

The global economy, now supported in the main only by the overextended U.S. consumer, finds itself at stall speed, susceptible to any number of potential exogenous shocks. Ultimately, the economic malaise created by this confluence of events will take years to unwind. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.

This process will be extremely painful in the short term, but will lead to a healthy economy long-term. Unfortunately, experience shows that these painful steps will only be taken as a last resort. Moreover, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. Protectionism is a natural outgrowth of nationalist economic policy as it transfers wealth from foreign producers to domestic producers by cutting off access to lower cost excess capacity in the goods in service sectors. However, this also serves to transfer wealth from domestic consumers to domestic producers by increasing the price of goods in the protected sectors, ultimately reducing consumption demand.

For these reasons, I am cautious about the long-term outlook for the global economy and the U.S. economy in particular. The likely outcome for the next decade is one of sub-par global growth with short business cycles punctuated by fits of recession.

Yes, trade and dumping are difficult issues. But, protectionism makes most everyone a loser. In June, I wondered should we expect a protectionist China. But I ended saying it was how the Obama administration responded to the green light given by the WTO to impose sanctions which would be most instructive. Obama has gone protectionist.

Chimerica marriage is ending in divorce

All need not be lost. Global re-balancing, where the American partner in this marriage does a little bit more of the saving and a little less of the spending and the Chinese partner does just the opposite, is what most economic counsellors suggest. This could save a strained relationship and put the partners on a sustainable path. This does seem to be happening.

Nevertheless, could this relationship between China and America be coming to an end?

I say emphatically yes. 100%. There is no going back now. Each partner in this marriage, China and the United States, has a bevy of domestic constituencies which are forcing a dissolution of the relationship. Hardliners in China want to move away from the dollar. And populists in America want to punish the Chinese for allegedly manipulating their currency and dumping goods below cost in America.

So, as surely as day turns to night, this arrangement between China and the United States will end.  This marriage is over. The question is whether it will end gradually and peacefully in divorce or violently in murder-suicide. Right now, it’s looking like the latter.

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Below is a little clip allegedly from the Chinese newspaper Southern Metropolis Daily of some precious little schoolchildren. In the clip, a number of them tell us what they want to be when they grow up (I think I wanted to be a baseball player).

Now, I don’t speak Chinese but I understand that all of the kids give pretty standard answers. But, one little girl goes way off script at about 2:00 into the clip.

[Girl]: “I want to be an official”
[Reporter]: “What kind of official?”
[Girl]: “A corrupt official, because corrupt officials have a lot of things.”

Hilarious!  Can someone who speaks Chinese confirm this.  I suspect it’s true because her face is blurred out in the video.

Now, that’s the honesty that only a child can show. Bravo.

(clip embedded below)

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In the latest move toward China’s long-term strategy of internationalising its currency, the Chinese Ministry of Finance announced today it will issue government bonds valued at 6 billion yuan in Hong Kong.

The last article I wrote on this subject was a little over a week ago when the Chinese Vice-Premier Wang opined that the government was looking for ways to make the Yuan a more international currency.  I see this statement by the Finance Ministry as putting paid to those words.

The yuan bond issue, worth about $879 million, will ‘‘promote the RMB in neighboring countries,’’ referring to the renminbi currency, ‘‘and improve the yuan’s international status,’’ the Finance Ministry
said in the statement on its Web site.

‘‘The first step toward internationalization is regionalization,’’ Shi Lei, a foreign currency analyst at Bank of China in Beijing, said in an interview. ‘‘China wants to develop the offshore market in Hong Kong.’’

While domestic banks like Bank of China and the Export-Import Bank of China have already been issuing yuan-denominated bonds in Hong Kong for a couple of years, at the encouragement of Beijing, this is the first time that government bonds, the equivalent of treasuries, are to be issued. The bond sale is set for Sept. 28.

Source

China to Sell Government Yuan Bonds in Hong Kong – Deal Book – NY Times

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According to an account published in the Daily Telegraph by Ambrose Evans-Pritchard, the Chinese government is quite anxious about money printing in the United States and the effect this printing could have on China’s dollar denominated reserve assets.

For months now, the Chinese have signalled growing unease with U.S. monetary policy. And now comes the clearest signal yet that they are moving away from the dollar.  Cheng Siwei, a former vice-chairman of the Standing Committee, said point blank that the Chinese central bank was about to actively diversify new reserve assets away from the U.S. dollar and into currencies like the Yen and the Euro.  He also mentioned Gold as an alternative the Chinese are exploring.

The $2 trillion in U.S. dollar reserves the Chinese already have are a sunk cost.  Going forward, the Chinese are free to do as they wish with incremental additions to reserves. To the degree that they sell dollars and buy gold, Yen or Euros, there can only be downward pressure on the U.S. dollar.

Cheng Siwei, former vice-chairman of the Standing Committee and now head of China’s green energy drive, said Beijing was dismayed by the Fed’s recourse to “credit easing”.

“We hope there will be a change in monetary policy as soon as they have positive growth again,” he said at the Ambrosetti Workshop, a policy gathering on Lake Como.

“If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,” he said.

China’s reserves are more than – $2 trillion, the world’s largest.

“Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets,” he added.

The comments suggest that China has become the driving force in the gold market and can be counted on to buy whenever there is a price dip, putting a floor under any correction.

Mr Cheng said the Fed’s loose monetary policy was stoking an unstable asset boom in China. “If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.

“Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down.”

Mr Cheng said China had learned from the West that it is a mistake for central banks to target retail price inflation and take their eye off assets.

“This is where Greenspan went wrong from 2000 to 2004,” he said. “He thought everything was alright because inflation was low, but assets absorbed the liquidity.”

Notice the statements about an asset bubble in China and the admission that loose U.S. monetary policy is a transmission mechanism.  Cheng is right to worry about asset prices in addition to consumer prices as the Chinese economy has a huge amount of overcapacity right now and any inflation is bound to become apparent in asset prices first.

To be sure, there are other voices in Chinese officialdom that are striking a less alarmist tone. One cannot rely on the words of one Chinese official to represent policy makers in China.  And Cheng never said the Chinese are now actively diversifying away from the U.S. dollar. Nevertheless, Chinese officials have been talking along this dollar bearish line for months now and I tend to believe their words will lead to action.

That is, at a minimum, bullish for Gold and bearish for the U.S. Dollar.

Source

China alarmed by US money printing – Telegraph

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I want to highlight the good work of the BBC again. The last time I featured one of the BBC documentaries, it was about (conspicuous) consumption in China and the push to get Chinese citizens to spend more in order to support the economy.  Today, I want to highlight another BBC documentary, this time on Chinese savings.

The Chinese are world-class savers. So much so that western economists have concocted a theory called the Blame Asia meme which puts the recent financial crisis squarely on the shoulders of Asia.

But, one must ask why the Chinese are saving so much in the first place.  The twenty-three minute clip below demonstrates that it has much more to do with necessity — the one-child policy and a porous social safety net – than anything else.

Audio embedded here

I subscribe to the BBC Documentary Podcast and have featured these clips here before — on reports by Michael Robinson on the U.S. housing bubble and the Latvian collapse in particular. I recommend it highly.  The BBC releases maybe 5 audio podcasts per week of about 22-25 minutes in length. You can access this audio clip, visit the back catalogue, or subscribe to the podcast at the link below.

Source

Assignment – China Saving’s Habit – BBC Website

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Nouriel Roubini is the most prominent economist to warn that a double-dip recession would be a distinct possibility if economic policy-makers return to policy normalization too quickly.  Now, Stephen Roach, head of Morgan Stanley Asia, is making similar arguments. 

Roach was on Bloomberg Radio’s show Bloomberg Surveillance with Tom Keene and Ken Pruitt yesterday, where he had a wide-ranging discussion about the global economy, China, Japan, government stimulus, and a host of other issues.

Some memorable quotes:

• China: “Late last year the Chinese economy came to a full stop and the government embarked on a massive investment and bank lending stimulus that I think is worrisome and not sustainable.”
• Japan: “The key premise I think that needs to occur in Japan as well as the rest of Asia is the need to really put a lot of emphasis on internal private consumption.”
• The Fed: “I am really critical of the idea that we can blame America’s problems on the so-called surplus savings glut primarily from China.”
• The U.S.: It looks like the worst of the downturn is behind us.”
• Banks: “The financial crisis itself is far from over. A lot of financial institutions will continue to find their earnings and their lending capacity impaired.”

The downside risks and double-dip that Roach points to for the U.S. and global economy should not be taken as a ‘base-case’ scenario but rather a possible outcome to avoid through the appropriate economic policy response.  I should note that the same risks were present on a lesser scale after the Technology & Telecom bubble-induced recession in 2001, and Roach warned of these risks at the time. We avoided a double dip in part because of loose monetary policy, which created the housing bubble.

He has a lot more to say. The audio is below and runs about 12 and 1/2 minutes. Enjoy.

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Chinese vice-premier Wang Qishan has been appointed to lead a taskforce to make the renminbi the currency of choice for trade settlements, especially with regional trading partners. HSBC economist Qu Hongbin believes this latest salvo in China’s intensifying efforts to ditch the dollar demonstrates the Chinese are moving sooner than most expect to internationalise their domestic currency.

Hu Xiaolian, vice-governor of the People’s Bank of China, is being enlisted to head the research division of the taskforce. Officials from six other central departments have also been drafted to the taskforce.

"China really wants to give a big push in internationalising the renminbi," notes Qu. "Of course it would be a multi-year, long-term process". Still, he adds, the initial stage of expanding the renminbi’s role in trade settlement could be "faster than many expect".

Since China recently became the world’s largest exporter and is the second-largest trading country, expanding the role of renminbi in cross-border trade settlement is "simply a catch-up game," says Qu. "I won’t be surprised if, in the next three to five years, around half of China’s annual cross-border trade is settled in renminbi rather than US dollars."

Given the high volume of China’s trade, even if half of its trade flows are settled in renminbi, that would make it "one of top three international currencies in the world." This, he adds, "will have a substantial impact, not only on China but also the global economy."

I still believe there is no currency that can replace the dollar as the world’s reserve currency in the next few years.  But, the Chinese certainly are hedging their bets.  Eventually, these efforts will bear fruit.

More here.

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