United States vs. China


"China's buying of U.S. debt might not have the importance it used to."

As a general rule, the most successful man in life is the man who has the best information.

The Chinese government, in an effort to maximize exports and minimize U.S. imports, prints its yuan to buy dollars. This prevents its currency from rising and the dollar from falling. Then China loans those same dollars back to America by buying U.S. debt.

At the same time, China:
  • Puts in place purchasing restrictions;
  • Permits piracy;
  • Delays legitimate items from entering the country;
  • Provides massive direct subsidization of export production in many key industries; and
  • Maintains strict non-tariff barriers to imports.
In 2009, U.S. imports from China were worth $296.4 billion. U.S. exports to China equaled $69.5 billion. In the first half of 2010, the U.S. trade gap with China equaled $119.5 billion.

The American Congress is facing a restless, very concerned and increasingly vocal American public. Lawmakers in both the Senate and House, responding to voters unhappy with high unemployment—25 million people don't have a job or are working part time, 6.2 million people have been out of work for longer than six months—are blaming China for the loss of U.S. jobs and are pushing for legislation that would expand the government's power to impose trade sanctions on China.

With midterm elections in November and the Obama administration vulnerable in the House and Senate, there's the very real possibility that President Obama will pass a law that restricts Chinese exports into the U.S.—he did promise to get tough on China over its currency practices in his election campaign and he is now facing bipartisan pressure.

Many economists, and most U.S. manufacturers, estimate China's currency is undervalued by up to 40%. An undervalued yuan means that Chinese products are cheaper for U.S. consumers but American products cost more for Chinese consumers.

Treasury Secretary Timothy Geithner, while not yet endorsing the new legislation, said China must move faster to allow its currency to rise in value against the dollar. Recently, China's central bank (the yuan's trading range is controlled by the Chinese government) did allow the yuan to rise against the U.S. dollar; but with a rise of 1.6% since June, many lawmakers in the U.S. are frustrated.

The U.S. Treasury is required to submit to Congress twice a year (April and October) a report Congress can use to identify whether any of the U.S.' major trade partners have manipulated their currencies to boost their exports to the U.S. or make U.S. goods more expensive in their markets. Will the U.S. declare China a Currency Manipulator this October?

"We will take China's actions into account as we prepare the next Foreign Exchange Report [due Oct. 15], and we are examining the important questions of what mix of tools. . .might help the Chinese authorities to move more quickly," said U.S. Treasury Secretary Timothy Geithner.

If China is designated a currency manipulator, it could lead to economic sanctions if the U.S. took a case before the World Trade Organization (WTO) and won.

The Obama administration recently filed two new trade cases against China before the Geneva-based WTO.
"We are concerned that China is breaking its trade commitments to the United States and other WTO partners." -U.S. Trade Representative Ron Kirk
China's Problems

Capital controls and trade restrictions have been absolutely necessary for China to reach this stage in its economic development. This economic development is largely driven by fixed asset investments (FAI), such as land and buildings, motor vehicles and plant and machinery. China's fixed assets investment reached 14.1 trillion yuan (US$2.1 trillion) in the first eight months of 2010.

China is able to invest so much into FAI because, in addition to the inflow of foreign direct investment (FDI equaled 488.7 billion yuan in the first eight months of the year, FDI is a measure of foreign ownership of productive assets), its citizens have a very high savings rate as a percentage of income. And because of controls on how and where they can invest that money, Chinese savers have little choice but to invest at home. If China were to lift its capital controls, the resulting outward savings flow seeking higher and safer returns overseas would cause China's economic growth to stall because the largest (by far) of its two major engines of growth—FAI—would simply run out of money.

Before he was forced onto the Bush/Snow party bandwagon former Federal Reserve Chairman Alan Greenspan said a floating exchange rate and/or ending capital controls could trigger an outward flood of capital to more secure foreign banks (Chinese banks to this day carry a massive amount of bad loans). He went on to say this might destabilize the Chinese economy and drag down world growth.
"Export industries employ so many people, and a drop in exports would mean a rise in unemployment which could cause very serious social unrest. Social stability is Chinese leaders' top priority, and the way to achieve it is fast economic growth to keep people working." -Xiang Songzuo, deputy head of the International Monetary Institute at Beijing's Renmin University
The Chinese Communist leaders have to feed, clothe and house untold millions of urban residents and hundreds of millions more rural residents moving to urban areas over the next couple of decades. Their biggest fear is social unrest leading to an overthrow of their communist regime. U.S. lawmakers, on the other hand, are facing midterm elections—and nothing is more important to a politician than getting re-elected. Jobs are the hot button of these midterms, and the Obama administration is vulnerable.

Japan increased its holdings of U.S. Treasury bonds by $16.9 billion in June alone. Demand for Treasuries from U.S. investors is increasing at a tremendous pace. Spending and incomes are stagnating; and the savings rate hit the highest level in almost 18 years reaching 6.4% in June, the Commerce Department said on Aug. 3—the U.S. savings rate has now been higher than 5% for 21 straight months.

The bottom line here is—China's buying of U.S. debt might not have the importance it used to.
"Americans are consuming less and saving more. That causes an increase in savings and deposits, which end up being invested in government securities." - Baker Group Chief Market Analyst Jeffrey Caughron
The U.S. could put in place its own capital controls. Washington could also shut down the U.S. market to Chinese exports100%. A major clash would bloody both nations but, in the end, China would lose the most and the politburo would run an even greater risk of losing its position of power than in a loosening of capital controls.

This dispute over Chinese currency reevaluation is just the harbinger—the tip of the iceberg—of what's to come in the future U.S.-China relationship. Potential areas of conflict include:
  • Trade disputes;
  • Conflicts over resources;
  • Geopolitical disagreements;
  • Intellectual property rights; and
  • Chinese acquisition of U.S. companies
This is an extremely interesting drama being played out on the world stage between two of the world's most powerful nations and economies. It's a powerful story unfolding in real time, and it should be on everyone's radar screen. It certainly is on mine. Is it on yours?

Richard (Rick) Mills
[email protected]

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Richard is host of aheadoftheherd.com and invests in the junior resource sector. His articles have been published on over 200 websites, including: The Wall Street Journal, SafeHaven, Market Oracle, USA Today, National Post, Stockhouse, Lew Rockwell, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor and Financial Sense.

Legal Notice/Disclaimer
his document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified; Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Richard Mills only and are subject to change without notice. Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, I, Richard Mills, assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this Report.

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