Photo: Obama & Chinese ambassador to America Zhou Wenzhong on the Great Wall of China from Reuters
China is succumbing to hubris. It has mistaken Obama’s soft diplomacy, some say absence of diplomacy for weakness, mistaken the US credit crisis for decline, and mistaken its own mercantilist bubble for true global ascendancy. There are many historical echoes of nations badly misjudging the strategic balance of power and over-playing its hand on both sides of this exchange.
Within a month, the US Treasury must rule whether or not China is a "currency manipulator", triggering sanctions under US law. This has been finessed before, but we are in a new world now with America's U6 unemployment at 16.8pc.
Quoting liberal Keynesian Paul Krugman, this year's Nobel economist. "It's going to be really hard for them yet again to fudge on the obvious fact that China is manipulating. Without a credible threat, we're not going to get anywhere." While I do not often agree with Krugman, it’s hard to disagree with that statement, despite the potential out come.
Conversely, China's premier Wen Jiabao is defiant.
From an interview published by Bloomberg, "I don’t think the Yuan is undervalued. We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency." Once again he demanded that the US takes "concrete steps to reassure investors" over the safety of US assets. "Some say China has got more arrogant and tough. Some put forward the theory of China's so-called 'triumphalism'. My conscience is untainted despite slanders from outside," he said
Days earlier the State Council of China accused America of serial villainy. "In the US, civil and political rights of citizens are severely restricted and violated by the government. Workers' rights are seriously violated," it said. "The US, with its strong military power, has pursued hegemony in the world, trampling upon the sovereignty of other countries and trespassing their human rights," it said. "At a time when the world is suffering a serious human rights disaster caused by the US subprime crisis-induced global financial crisis, the US government revels in accusing other countries." And so forth.
Obviously, the Chinese are in denial about is own part in the global imbalances behind the credit crisis, specifically by running trade surpluses, and driving down long rates through dollar and euro bond purchases. While the US treasury, Bond St. the EU Central bank & Wall St. have all made a shambles of markets, this Chinese view of events is twisted to the point of delusional.
What interests me is Beijing's willingness to up the ante. In addition to a drawback in US Treasury bond purchases, it has vowed sanctions against any US firm that takes part in a $6.4bn weapons contract for Taiwan, a threat to ban Boeing from China, Beijing's hardball stance with google and a new level of escalation in the Taiwan dispute.
At the recent Copenhagen “Hot Air Conference”, Wen Jiabao sent an underling to negotiate with Obama in what was obviously intended to be a humiliation. The Obamanator put his foot down, saying: "I don't want to mess around with this anymore." Does that sums up White House feelings towards China today?
We have talked ourselves into believing that China is already a hyper-power. It is on the path and may become one: perhaps THE ONE, but it is not one yet. China is ringed by states - Japan, S. Korea, Vietnam, and India - that are American allies when push comes to shove. It faces a prickly Russia on its 4,000km border. Emerging Asia, Brazil, Europe and many Arab trading states are all irked by China's Yuan-rigged export dumping. Not that they are to be counted upon in a fight, but they are many voices at the UN and represent great market capacity themselves.
Contrary to common belief here at home, Michael Pettis, ( visiting Professor of Economics, at Beijing University) argues that China's reserves of $2.4 trillion - arguably $3 trillion - are a sign of weakness, not strength. (source, seekingalpha.com ) He points out that only twice before in modern history has a country amassed such a stash equal to 5%-6% of global GDP: the US in the 1920s, and Japan in the 1980s, and each example preceded major depressions.
His argument goes on to make the case that these reserves cannot be used internally to support China's economy and that they are dead weight, well beyond any level needed for macro-credibility. Indeed, they may be the ultimate indictment of China's dysfunctional strategy, which is to buy tens of billions of foreign bonds every month to hold down the Yuan, preventing their economy's adjustment to trade realities.
The result is over-investment in manufacturer in capacity that is flooding the world with goods at wafer-thin export margins. As an example, China's over-capacity in steel is now greater than Europe's entire output!
Another source of concern is the stretch of credit limits of China's local governments, mostly linked to massive infrastructure projects, such as the largest dam in global history across the Yangtze. A whitepaper recently published by Professor Victor Shuh from Northwestern University and published by the Economist, warns that the over 8,000 financing vehicles China has put in place has built up debts and commitments of $3.5 trillion, He says Chinese banks may require a bail-out nearing half a trillion dollars.
Just as in the West, debt is catching up to the Chinese.
As America's single largest creditor; holding of some $1.4 trillion of US Treasuries, agency bonds, and other US instruments - China can certainly exert major leverage upon this administration, but this need not be as dire as it seems. If the Chinese Politburo deploys this illusory power, Washington can pull the plug on China's export economy instantly by shutting down trade markets.
Who holds whom ransom?
Any action by China that sets off a run on US Bonds could rebound against China. While an extreme measure, it could be stopped by capital controls. Barack Obama has never exalted free trade, has no love of free markets and in theory is all about controled markets, regardless the pain, he has shown no stomach for confrontation with the Chinese. While his top economic adviser Larry Summers let drop at the Davos conference that free-trade arguments no longer hold when dealing with "mercantilist" powers, summers is a proven incompetent, who lost billions for his past client, The Harvard Endowment.
In such a trade war, there would be a disruption of supply, which could prove to be inflationary over a short term and reap devastation on American holdings abroad. ( Not that this administration would care about the distruction of American business capital when an ideology is at stake) But, large manufacturing capacity for goods does exist outside China and would be made up over time by others. We can live without flat screen TV’s for a while, and history shows that such things have happened.
China's transformation has been remarkable since Deng Xiaoping unleashed capitalism, but as ex-diplomat George Walden writes in China: a Wolf in the World?; no one can feel at ease with a regime that still covers up Mao's murderous nihilism. China has never forgiven the humiliations inflicted by the West when the two civilizations collided in the 19th Century, and intends to exact revenge. They have no concept of property or human rights. We must handle them with extreme care.
The China-US relationship is no doubt symbiotic, but a clash might not be the "mutual assured destruction", as often claimed. Washington could win IF we had the right players on the field.
Obama is the least experienced man in any room he walks into and is guided by blind, leftist ideology. His economic team has a strong track record of incompetency. Neither have shown the slightest concern for American jobs or capital invenstment. I for one am afraid. Be very, very afraid.
We could easily lose a confrontation that we should easily win.
Omar P Bounds III A.A.R.E., C.E.S., G.P.P.A.
The Bounds Auction Company
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