“China and Japan have almost no strategic choice except to fund the US bond market, permitting the US stock market and economy to continue to behave benignly.”
corporate.bmo.com
What is needed is to formalize the large scale ad hoc-ery that is fueling the global boom.
Here is the process:
1. US consumers splendidly play their parts, continuing to
spend up to and beyond their means, which means
2. The US continues to import a bigger share of global
exports than its share of global GDP would warrant, which
means
3. The world has a growing balance of trade surplus with the
US, which means
4. The factory to the world—China—can sell everything it
produces. It runs a $124 billion trade surplus with the US,
and incurs a trade deficit with the rest of the world, which
means
5. China is importing commodities from the world
(including scrap steel from the US) on such a majestic
scale that it creates shortages and price runups on almost
everything from A for antimony, to N for Nickel, to O for
oil, to S for Soybeans, to Z for zinc, and shortages which
means
6. China's reliance on Foreign Direct Investment (FDI) to
supercharge and diversify its economic growth is working
brilliantly. As great global companies send in their
machinery, technology, management and brands, to take
advantage of low labor rates and to position themselves to
participate in China's booming consumer economy, they
account for 40% of China's GDP, which means
7. China is in the early stages of evolution from being an
export-driven economy to being a consumer-driven
economy, on the model outlined by Jane Jacobs. Japan Inc.
has moved in just three years from being the #3 source of
FDI to being #1, which means
8. Japan now has more trade with China than with the US.
Chinese wage rates are roughly one-tenth of Japanese
rates, and an industrial park site near Shanghai costs onesixtieth of the cost for a similar site in Yokohama. Because of Japan Inc.'s huge investments and presence in the
Chinese economy, one could say we are seeing the early
stages of what looks like a new form of East Asia Co-
Prosperity Sphere, which means
9. As long as China can continue to export to the US, while
importing capital and consumer goods from Japan,
Taiwan, South Korea, the EU and the US, and
commodities from the rest of the world, then the global
economy can accommodate the rapid entry of a gigantic
new player without serious disruption, which means
10. China and Japan have almost no strategic choice except to fund the US bond market, permitting the US stock market
and economy to continue to behave benignly.
“History's greatest-ever Vendor Financing Program keeps US interest rates at bargain levels, keeps the dollar at levels profitable for Asian exporters, and permits overindebted American consumers to finance their borrowing.”
All polls of US institutional bond investors display a strong consensus toward maintaining short bond durations, despite what the Street calls "the pain trade,"—the cost of staying short at a time of a steep yield curve.With the ten-year note trading at 4.01% at a time the Fed is predicting economic growth of more than 4%, a fiscal deficit of 5% of GDP and a trade deficit in the same range, Treasury yields are far below intrinsic value. They are being subsidized by the sustained inflow of dollars from fellow G-3 symbionts, the Bank of China and the Bank of Japan (with a little help from their friends). How long can these transfusions of monetary corpuscles and plasma continue?
The Three-Dimensional Chess Game
A Great Symbiosis has emerged and evolved without any
international agreement, minutes, communiqués, rules or
secretariat. Despite lacking these seemingly necessary
ingredients, it rapidly became the sine qua non for the
continued growth of the entire global economy.
History's greatest-ever Vendor Financing Program keeps US
interest rates at bargain (near-Depression) levels, keeps the dollar at levels profitable for Asian exporters, and permits overindebted American consumers—and state and local
governments—to finance their borrowing. European companies benefit, because, even with the euro at 125, most major European exporters can maintain US market share. (Many major exporters, such as Volkswagen, have hedged part of their US exposure, but those hedges are gradually expiring.)
Japan and China find it logical to keep loading up on dollars, because they not only maintain and grow market share in the US, their manufacturers maintain their global competitiveness because most other currencies have risen sharply against the dollar.
But no one seems to have foreseen the scale or durability of a process that has already meant that Asia has acquired a trillion in depreciating Treasurys that pay interest rates ordinarily associated with a deep recession, not an economic recovery. Why can't this beautiful symbiosis continue forever? Everybody wins. Don't they?
This process of mopping up endlessly growing quantities of
dollars gained by exporters and trading them for Treasurys to suppress the value of the renminbi has to be furrowing brows in Beijing. Here's why.
As China's foreign exchange reserves grow faster than
reported cases of avian flu, the Bank of China is forced to
expand monetary growth beyond levels consistent with
strong, but not overheated, economic growth. Late last year
Chinese money supply growth had soared to 29%. It pulled
back in January but is still far above the rate of GDP growth. Those big numbers could mean big problems.
Until recently, the Bank of China was worried about the
deflation which had been dogging the economy for three
years. It was happy with fast monetary growth, because it
understood Milton Friedman's analysis of the relationship
between money supplies and prices. Friedman long
maintained that deflation was a lesser problem for a central
bank than inflation, because you could always print enough
money to kill deflation, whereas the tightening required to
exorcise inflation can be brutally painful.
With January's industrial production up a towering 19% over
2003, China is on the cusp of worrisome inflation. From deflation of 2%, its price index has moved to a positive 3.5%—a big swing.
Meanwhile, Europe has joined the US in complaining about
the undervalued renminbi. France and Germany gripe that the
euro is absorbing the full pressure of the American dollar
devaluation, because the RMB and yen values are being
suppressed by the Asian Treasury transfusion process.
(Currency traders can't buy RMBs to bet against the dollar, so they buy euros and, to a far lesser extent, Australian and Canadian dollars, and South African Rand. China accounts for one-quarter of the US trade deficit but it isn't being hit by a currency rise; it thereby gains competitiveness in Europe and other markets.)
Nevertheless, no one wants to see the Chinese and Japanese
cease their dollar purchases entirely, let alone even think about suggesting they dump a trillion Treasurys.
China responds to rising pressure to revalue the RMB by China responds to rising pressure to revalue the RMB by
restating its view that it cannot afford to move the RMB
upward for several years, because of the need to absorb
millions of migrants to the cities from the rural areas, and
because of the problems in its banking system.
What's wrong with this picture?
First, from the perspective of the presumed beneficiary of The
Great Symbiosis:
1. As Warren Buffett has noted, the US is watching
Americans' personal net worth melt away at an alarming
rate as jobs are exported to Asia and US corporations'
competitiveness fades. As long as the dollar stays at abovemarket levels, the decay of American wealth will continue.
2. The US was once the world's creditor, a role appropriate
for the issuer of the world's currency store of value. Now
the US is $3 trillion in debt to foreigners, even after
deducting the value of US companies' holdings abroad.
That indebtedness rises by the minute, through new
borrowing and through compound interest on existing
debts.
3. Easy money has encouraged Washington's big spenders to
satiate almost every special interest's demand on the
public purse at a time the nation is at war. Bush has been
supine in the face of Congressional profligacy, but he is
finally threatening to find a pen to veto the Highways Bill.
In an election year, that might require more political
courage than invading Iraq.
4. The propping of the dollar means that US corporations
and consumers are paying higher prices for energy and for
commodities generally than are Europeans, Australians,
South Africans, and Canadians. Europeans have seen
almost no price increases for oil, whereas Americans are
paying heavily. The American chemical industry is reeling
because it pays so much more for natural gas than its
European competitors. (Already, 24,000 chemical jobs
have disappeared in Louisiana alone, and Dow and
DuPont claim that the American plastics industry will be
in crisis within months.)
When China became a big buyer of Treasurys, commodity
prices were weak and China was a significant exporter of
commodities, including oil, copper, soybeans, and aluminum.
Now, China is the world's most important importer of
commodities, effectively setting the world price for most
internationally traded raw materials. For example, China is
now the world's second-largest consumer of oil and will
shortly be the world's second-largest importer of oil—four
years after being a significant oil exporter.
The only way a frozen renminbi can work to China's
advantage is if the Big Three economies falter and fall,
sending commodity prices back to, or below, 1999 levels. And
the only way that is likely to happen is if The Great Symbiosis unravels, triggering a global financial crisis. A frozen renmimbi amounts to an expensive Put option on the global economy. An upwardly revalued renminbi amounts to a cheap Call option on the global economy.
The Moment of Truth for The Great Symbiosis will come
when the markets realize China and Japan are revaluing.With
the help of other Asian central banks, Tokyo and Beijing
should be able to intervene in the markets with enough
potency and savvy to prevent a run on the dollar—which
would be in nobody's interest except for some new George
Soros.
One tried-and-true indicator is still available: the ratio of bank
stocks to the Dow Industrials has been an excellent foul
weather warning. For decades the indicator was the NYSE
Financials, but, of course, they've taken that one from us. So it has to be the big banks. In financial crises, there's usually some big bank that bet badly. If you begin to see a major breakdown on relative strength of the banks as against the Dow, start battening down the hatches. The storm will probably blow over—they all have since October 1987. But the next one could be The Big One. |
