The dangerous case of the Chinese stumper

The dollar and euro need to be devalued by 25%-50% which means yuan must appreciate another 20%-35% from it record high (update on 26th August, 2011)

Let us call this the Chinese Stumper! (Hambone by Mike Flanagan; Cartoon courtesy - Business Standard; from issue dated 19th May 2010; Copyright - Graphic Syndication, England).

Siamese’ triplets

The Great Recession is like a case of conjoined triplets.

One is the USA – who has used their Bretton Woods licence to print dollars and flood the world market with excess liquidity. The US has also used their ‘dollar power’ to gain loyalty by favouring their allies, satellites and client states with low exchange rates that boost exports. Europe, Japan, Asian Tigers, (and now) China have all been favored with a ‘beneficial’ exchange rate in the past. At an ‘appropriate’ time, this ‘benefit’ was taken away. The US gained by ‘recruiting’ low-cost labour of these economies.

The US 'out-thunk' the Euro-zone on the Euro-currency strategy!

US imports, were underwritten by an increasing volume of IOUs, denominated in depreciating dollars. By paying for imports with IOU notes, the US could subsidize their high-cost exports, to these ‘semi-captive’ markets.

With dollar IOUs and dollar liquidity, US funded hi-tech R&D, overseas acquisitions (of companies, raw materials, allies), commercialize new technologies and standards (internet, software) space and defense, et al. Last forty-year estimates, show that US obtained funding equal to one full year’s US GDP. At nil cost!

All this due to the US dollar’s reserve currency status!

Can Europe be far behind

The Euro unwinds!

Post-Plaza Accord, Europe decided to get into ‘reserve-currency’ game, with the launch of the Euro currency in Jan 2002. As an incentive to TT-Note holders, the ECB ‘allowed’ the Euro to appreciate – vis-à-vis the dollar. This gave windfall gains to countries holding Euro as a reserve currency.

From dollar parity in 2002, the EU appreciated by more than 60%. After the introduction of Euro, in the first six years, Euro-bond holders hit a gusher. Anyone who held Euro bonds from January 2002 upto Decemeber 2007, would have made some 80% return during this six years. A return of 15% per annum. Close to junk bond returns.

After the ECB took the bait, the US played a waiting game. After running with the overvaluation bait, for 8 years, the Euro- fish is now tired. It is not able to break free of the over-valuation hook. The US is now reeling in the fish.

With a ‘strong’ currency, the option for Euro-zone is massive and painful deflation. Wages, pensions, prices, welfare state benefits will need to come down – and drastically. Do they have the steel or the hunger to do this. Used to a gold-plated Welfare State, Euro-zone does not have the moral resolve to go on a cold turkey diet of frugality.

500 years ago, a poor and marginal Europe could take the risk – and inflict genocide, slaughter, war, crime on a hapless world. Today’s geriatric Europe, effete and crumbling, cannot repeat their run of ‘success’, confronted as it is, by a militarily prepared Asia. Modern Europe’s problem is compounded by the lack of availability of victims.

Which brings us to China.

Change in US Govt securities by China - which has ranged between 30%-60% of total reserves. (Image source and courtesy - http://usa.chinadaily.com.cn). Click for larger image.

Doing business with bankrupt customers

China’s currency reserves of some US$2.5 trillion, (Update – US$ 3.2 trillion August 2011) in rapidly depreciating Euros and dollars with manufacturing overcapacity, exports-growth economic model is building into a complicated pressure head. Waiting to blow up. Already under US pressure for a yuan revaluation, add complications like

1. Empty building blocks combined with inflated real-estate prices
2. Bloated banks loan ledgers with ballooning bad debts
3. Low entrepreneurial levels with foreign ownership of Chinese businesses
4. Aging population with a dominant public sector
5. Increasing foreign exchange reserves of depreciating currencies

and the Chinese Growth story begins to sputter.

As for the Rest of the world

The real challenge for the rest of the world, will be, one, wealth protection. Easily done. Buy gold.

Two, how do we let events unfold – safely. Insulating ourselves from the cycle of calamity, catastrophe, chaos, confrontation, confusion, crises – and then finally a crash.

A cycle that a 86-year young, mentally active, Gujju stock-broker, in Mumbai, shivering with Parkinson’s, explained to me, a few days ago.

Related articles

• ‘Black Death’ of eurozone crisis will hit exports – China (telegraph.co.uk)
• Any euro zone solution requires pain: Stiglitz (theglobeandmail.com)
• German Leaders Reiterate Opposition to Euro Bonds (nytimes.com)

The bubble you know

A Chinese bubble has been deflated. Too bad it’s the wrong one. The main Shanghai stock market index has fallen 23% from its peak at the beginning of August, reversing half of the run-up that started early in 2009. That’s a welcome correction, but it doesn’t mean a return to normality, or address the bigger bubble round the corner.

Shares were driven up by a belief in China’s recovery – and by a rush of liquidity. The fall occurred because both were gently dampened. Politicians have warned that economic recovery isn’t a done deal. Monetary authorities drained some liquidity from the market, curbed certain kinds of lending and asked banks to show restraint. (via The bubble you know).

Look ma, "Green shoots"

The long and short

The US economy is going to take some time to recover – a long time. Green shoots versus Brown Weeds is the kind of empty debate which covers the complete lack of visibility on the probable outcome that economists have.

The Japanese have finally decided to sack the LDP – after more than 50 years. The Japanese do not expect any major recovery or growth to happen for the next few years.

Europe is in the boondocks – and is unlikely to come out out of this soon. Their most feasible European option is a greater role for public sector – which the Europeans seem to have embraced in a bear hug.

The BRICs of global economy

Which leaves the BRIC countries. Russia is too dependent on high raw material prices – which need greater demand from the world economy to make a difference. Russia feeds on high growth rates – but cannot be the reason for growth of the global economy.

Ditto for Brazil. Which leaves the world with India and China. Let us first take the Chinese case first.

How ln can this model work

Biting the bullet

Most economists believe that to kill the Beast of Great Recession, the world is left with one, single  magic bullet – China. This being the only bullet in the chamber, makes everyone very nervous, keeps everyone busy, reading Chinese tea leaves with great care.

There is overall consensus that the Chinese growth figures need to be ‘tempered’ – and significantly. The fears seems to be in two areas: -

1. Overstated growth rates.

“The Chinese government is one of the few governments in the world that knows its GDP numbers three years in advance,” Marc Faber told CNBC. Combine this with the other preoccupation where “China is desperately trying to figure out how to withdraw its funds from the dollar without driving it down — not an easy feat.”

2. Understated bad loans by banks.

an astonishing $300 billion vanishing act … the amount of bad debt the top three banks offloaded in the early 2000s. Back then, the People’s Bank created four asset management companies to scrub away the dirt from two decades of policy-driven lending. There was a big catch. The AMCs bought the loans for up to 100 per cent of face value, while recoveries were in the 20-30 per cent range. That means the top three lenders’ Rmb1.2 trillion of AMC bonds, which start to mature this year, are likely to be almost worthless. In theory, the Ministry of Finance is ultimately on the hook, but it is unlikely to make good for the banks. The amount due to all three is roughly one-sixth of China’s fiscal revenues for 2008. (from If in doubt, rub it out BY John Foley /  August 29, 2009, 0:03 IST).

Housing makes up roughly a quarter of investment spending, which is in turn 40% of gross domestic product. The differences between China’s big cities make a bubble harder to spot. But record bids for land are cause for concern, as is falling affordability in big cities. Meanwhile, stagnant residential rents suggest speculation, not demand for somewhere to live, is pushing up house prices. A burst real estate bubble could be fiendishly tricky to clear up. While stock markets clear in a day, property gluts can take months – if they clear at all. ( from The bubble you know by John Foley, Septemeber 1st, 2009, 01:33 IST).

Everything is made in China

Both these severely strain the economic outlook and the banking sector. This may lead to, what the WSJ.COM says, a situation, where “China in the medium term will face just the overcapacity and bad debt that many observers feared already existed.”

But some of these observations and scare stories are exaggerations – and need to be read with the caveat that the dominant Western media portrays all competitors in a similar manner.

What about the Indian economy

That pretty much leaves India as the sole candidate. India cannot absorb the kind of imports that are required to make a difference to the global economy. Or boost exports to the rest of the world – to create consumer led growth. World Bank estimates are that India will grow faster than China by 2010. So, no go!

A plan for Indian businesses

What this means is that India needs to do: -

1. Not bank on any kind of global recovery soon.

2. And island itself – by ensuring that any kind of global mayhem, counter-party risks do not hit Indian banks, corporates, exporters, et al. This may need some strong alliances on export guarantees and credit enhancement by importers for exports from India.

The Indian Government, may not take any major initiative in this regard, but it is the Indian businessmen, who should and must understand this situation – and take the necessary precautions, actions, insurance, guarantees, due diligence, comfort letters – the entire gamut.

China beats US as biggest auto mart- International Business-News-The Economic Times

China overtook Japan in 2006 to become the world’s second-largest vehicle market, thanks to strong sales to the country’s fast-growing middle class. With 1.3 billion people, China was bound to catch up with the US population 300 million at some point, but the dramatic contraction of the American market could make that happen sooner than expected.

Of course, if US sales recover strongly in coming months, outpacing those in China, the American market would remain the world’s biggest. (via China beats US as biggest auto mart- International Business-News-The Economic Times).

I am not sure if this is good news – for China or the world. This is just copying the Western urban model – and India may also be on the way to become a copy cat too.