The Chinese paradox...

As many people may have heard, the Chinese have vast reserves of foreign currency which they are holding onto and may use to buy the ENTIRE WORLD (or something like that).

At the moment, those reserves are apparently in the order of some $1.4 trillion US. In other words, an awful lot of money.

This article is a great read explaining why the Chinese are doing what they're doing and what the ramifications are.

Basically, the Chinese are getting lots of foreign currency, because they're selling lots of stuff overseas. The vast majority of this currency is being put into safe, long term investments, such as treasury notes and bonds, the majority in US dollars.

By doing this, they are deliberately keeping themselves poor (at least functionally) and ensuring that they stay competitive on a world stage. As an added benefit, the vast amounts of US dollars the Chinese hold are helping to hold up the US economy by keeping the dollar strong and interest rates low. If the Chinese stopped pumping in all this cash the US govt would have to borrow from elsewhere, probably at much higher rates.

By keeping the dollar strong and rates low the Chinese are in effect subsidising the American people (to a significant amount) and thereby enabling them to buy yet more stuff, from the Chinese.

Of course, this isn't much fun for all those poor Chinese people who would quite like some of that money to be spent at home, on things like, say, heaters in schools in areas with blizzards in winter.

However, the Chinese are now in a quandry. If they start pulling their money out, the value of the dollar will fall, thereby lowering the value of the rest of their investments. Not only that, the Chinese currency would rise, making it harder for exporters and the ramifications for govt spending and the economy in the US would be huge. Suddenly the Americans wouldn't be able to buy as much stuff from the Chinese. This ends up in a huge downward spiral.

So rationally, the Chinese can't do anything because they're stuck.

Except, lets face it, people aren't rational, especially crazy, paranoid communist party members convinced that the US is out to get them. Forget the GFC, apocalyptic world economy collapse anyone?

It's a fascinating article, you should definitely read it.

cheers

Dr Harry

Global Financial Crisis + 1

As I´m sure some of you may have heard, there´s a distinct possibility of the current problems in the US being extended even further. This is because of another class of loans that is about to begin causing big problems.

These are the alt-A loans. The barefoot investor says

If sub-prime loans have been referred to as toxic, then the Alt-As are like passing wind in an elevator—not exactly toxic, but still not pleasant.

People with less-than-stellar credit histories got these loans (liars took out sub-prime).

Just like with sub-prime loans, the honeymoon is ending for many people who took out these Alt-A loans in the boom years. They’re just starting to see their loans reset to higher rates—and the default rates are soaring.

The professionals who watch these things closely predict that over the next 12 to 18 months these loans will be the cause of another wave of mortgage defaults.

Basically, the further down the tube the US financial system goes, the more people get laid off and the more people get freaked out, stop ALL discretionary spending and start eating rice for every meal.

Now the success in recent times of China has been fueled to a large extent by the fact that there were lots of Americans spending lots of money (cash and credit) on crap that was made in China. Basically lots and lots of discretionary spending. Now, obviously crap from China is generally cheap, so there will continue to be some demand, but it is an absolute certainty that consumer spending has taken a big hit and will continue to do so as long as people are worried that they won´t have a job next week (a very real fear for many in the US).

So what does this mean for China? They have a developing home market to sell to, will continue to have some demand in the US and they still sell to markets around the world, both in the developed and developing world (definitely Chinese crap for sale in Ecuador). However, realistically they are going to experience a severe drop in demand. There current free-for-all attitude to capitalism will see an accompanying massive rise in unemployment as factories close or shed staff.

So, we have an oppressive, nationalistic and brutal dictatorship, with a young, male dominated population (some estimates suggest there maybe 40 million more young men than young women in China) and great unrest and dissatisfaction caused by unemployment and hardship.

What do dictatorships sometimes do in situations like this? They find a diversion to take the people´s minds off the problem. How?

Traditionally they start a war.

I don´t think it´s at all unrealistic to expect that a newly empowered China, with billions of dollars cash, a gradually modernising military and a range of domestic problems might see this as a good way to get people supporting the Government and forgetting about domestic issues.

So where?

Probably not Taiwan, although it is definitely possible. Obama seems to prefer talking to doing anything realistic (like deploying a carrier battlegroup) and there might be an opportunity to make some noise and score some points, even if nothing else.

China is basically next door to Russia´s possessions in the East, possessions that are both immensely wealthy and also often underutilised due to Russia´s population crisis. Such a target would be attractive but Russia a) supports China in the Security Council on various matters to do with oppressing human rights and has b) lots of tanks (better than the Chinese) and c) nukes.

India is another neighbour of China and the two have clashed in the past, mostly at brutally high altitudes where nobody is around to hear you scream. This would be a likely scenario, as the conflict could be contained, however there´s nothing very exciting about capturing a mountain or two, it doesn´t really mean anything.

Mongolia is right next door, but China already has shit loads of semi desert, do they really want more? Probably not.

So where than?

The three most likely options as I see them are:

A brutal crackdown of the Uighurs and other ethnic minority groups, under the guise of putting down a rebellion or averting a civil war.

Annexing the Spratley Islands would be another possible move. They are claimed by China, the Philipines, Vietnam and (I believe)Thailand. Apparently some Chinese ships sailed through the area many hundreds of years ago, so that seems a good reason for the Chinese to claim them. This would be a small scale conflict, characterised by sinking a few enemy ships and loudly declaiming that what was rightfully Chinese has been reclaimed.

Similarly, Vietnam for many hundreds of years was a Chinese possession and the two countries even clashed in the late 70´s (the Chinese were embarrassed rather dreadfully). While China is unlikely to want all of Vietnam, they might consider ädjusting¨ the border somewhat, getting a conflict, some land and lots of patriotic fervour, all together in one big package.

Another out there option?

China apparently has 1 million ethnic Chinese in Africa in various positions. The Chinese are the reason that Sudan continues to kill black people with impunity and why Robert Mugabe is still the man in Zimbabwe. While it´s extremely unlikely the Chinese would actually try and conquer anything, they might send in the troops to help an ally out and get some fighting happening.

Of course there´s lots of other possibilities, but I think the idea of China using it´s military as a way to divert attention from domestic issues is a very realistic one.

You heard it here first!

Harry