Posts Tagged ‘trade war’

Pay attention to China-US currency tension

Monday, September 27th, 2010

Last week, in What can you do to protect yourself from increasing currency volatility?, we wrote about the rising currency/trade tension between the US and China is flaring up again. While such tensions are hardly common occurrence in the love-hate mutual co-dependency relationship between the two giants, this current one has reached a a new high point.

Last week, US politicians have agreed to vote on a bill to retaliate against perceived Chinese currency ?manipulation? with trade sanctions (see US Congress committee approves China sanctions bill). For this bill to become law, the two Houses of Congress (House of Representatives and Senate) have to approve of the bill. This coming week, the House of Representatives is going to vote for it. But it is unclear whether the Senate will support this bill before the November mid-term elections.

If this bill comes into law, and if the Obama Administration decide to slap China with draconian trade sanctions against China, then outcome will be a trade war between the world?s two largest economies. The Chinese will definitely retaliate, sparking another round of retaliation from the United States. The outcome will be mutually assured economic destruction.

Some prominent American economists (e.g. Paul Krugman) in the United States that a trade war will hurt China more than it will hurt the US. This is because they subscribe to the theory that a trade war will disrupt vast swathes of the Chinese export-oriented economy, which in turn will result in social and political instability that will threaten the legitimacy of the government. Hence, these economists are very keen and aggressive with the idea of imposing trade sanctions on China. But as we wrote in Will China fall under popular revolt?,

? this school of thought do not understand the cultural and political reality of modern China.

However, there is a subtlety that you have to understand- Yes, the immediate impact of a trade war will probably be more painful for China initially. The idea is that, as we wrote in Can China really ?de-couple? from a US recession?,

This will translate into a disproportionate contraction in the higher stages of production, which is China?s job. This in turn will result in yet another disproportionate contraction in yet another higher stage of production.

But we do not subscribe to the theory that this will result in political upheaval in China. Instead, we believe a trade war will fan the flame of nationalism in China and strengthen the position of the Chinese regime.

Regardless of who wins in a US-China trade war, countries like Australia and the rest of Asia will suffer as collateral damage. As the saying goes, when two elephants fight, the grass below will suffer.

What can you do to protect yourself from increasing currency volatility?

Sunday, September 19th, 2010

Six months ago, we wrote about America’s consideration to label China as a “currency manipulator” in Watch April 15 2010: simmering tensions between US and China. Just before the deadline, China appeared to make a little concession about their RMB, thus avoiding the “currency manipulation” label.

Today, currency tension between the US and China is rising again. The little concession that the Chinese government made was simply not enough. American lawmakers are getting impatient and are itching to enact laws to slap China with trade sanctions. Should that happen, it will be the beginning of a damaging trade war between the world’s largest economies. Their charge is that China’s artificially low currency is responsible for (or at least contributed to) America’s economic woes. But as we wrote in Watch April 15 2010: simmering tensions between US and China,

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China?s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America?s unemployment rate. By implication, it is perceived that with China?s official unemployment rate much lower, China is ?prospering? at America?s expense.

Currency tensions between China and the US are nothing new. As we wrote in that article, it’s been around for the past 3 to 4 years. Many times, the rhetoric about America labelling China a “currency manipulator” came and went away without eventuating into reality. However, that does not mean that it will never happen. As America’s economic woes worsen, the pressure to find a scapegoat will increase. As a result, the probability of a trade war will increase.

The Chinese, on the other hand, are not standing idle, waiting for a trade war to happen. For starters, they are establishing trade and investment links with Asia, Middle-East and Africa. Secondly, it is no secret that they have been diversifying their colossal hoard of reserves away from the US dollar. Given the well-known intention of the Federal Reserve to print more money, diversification has become increasingly urgent. But that in itself is not easy because given the colossal size of the money involved, any whispers and hints about any particular Chinese diversification strategy will move the markets quickly in a big way. For example, the recent rumours that China was buying up Japanese government bonds probably helped to contribute to the surging yen. As a result, the Japanese government became very unhappy because a very strong yen will negatively impact on their export-oriented economy. In response, the Japanese government may take concrete actions (beyond just talking about it and taking token measures) to weaken the yen, in which the end result is more Japanese purchase of US government debt.

In such an environment of competitive currency devaluation and price volatility, what should investors and savers do?

To us, it is clear that having all your savings and investments confined to a single country or currency is an increasingly risky proposition. Currency exchange rates will become more volatile, with implications on asset values, price inflation and economic growth (see Real economy suffers while financial markets stuff around with prices). For example, in Japan, real businesses are suffering as a result of the rising yen. The Germans, on the other hand, are secretly gloating whenever the euro weakens. In Australia, should the banking system fall into a crisis as a result of the bursting of the property bubble, the consequence of a resulting collapsing Australian dollar will be price inflation (see Can price inflation occur in the midst of debt deflation?).

If currency volatility goes to the extreme, investors will even have to question the idea of national currency as a store of value. So, what can investors and savers practically do to mitigate against this?

Quite some time ago, we talked to the guys at and learnt of how a lot of their clients (presumably the “rich”) use them. In case you do not know, (a regulated company operating in the financial services industry) enables

… you to hold gold, silver & platinum that is fully insured and stored securely in specialised bullion vaults in London, Zurich and Hong Kong. All metal is owned directly by you with no counterparty risk.

You can “easily buy gold, silver & platinum and take delivery of physical bars of gold.”

What their clients did was to use their account as a conduit to link their bank accounts all over the world. This strategy makes sense as it gives investors and savers the flexibility to shift their savings all over the world, using gold, silver and platinum as an anchor for the store of value. In an environment of currency volatility, this flexibility is a valuable aid in helping to protect your hard-earned savings from hare-brained government interventions.

However, for those who are ultra-pessimistic and distrust any assets that have any hints of paper, the only way to go is to take possession of physical gold and silver (see How to buy and invest in physical gold and silver bullion).

Is the Chinese export surge really good news?

Monday, June 14th, 2010

Last week, the mainstream financial news media was cheering on the news that China’s exports surged on a year-on-year basis. This led to the belief that China’s economic recovery is on track, which implies that the recovery in commodity demand will be sustained, which will then flow on to the Australian economy. As a result, according to media narrative, the stock market rose on that ‘good’ news.

But before we get carried away with this bout of optimism, let us put on our thinking caps and consider the bigger picture. Firstly, is the surge in Chinese exports and imports really a good news for Australian mining companies? To answer this question, consider this news article,

But rising textiles and electronics exports will do little to offset the slump in Chinese demand for Australian commodities that will come with an expected construction slowdown.

Construction starts for government infrastructure projects have slowed sharply and private sector transactions have been bludgeoned by government measures.

Private sector measures show real estate transactions fell by as much as 70 per cent from April to May in Beijing, Shanghai and Shenzhen, where policy restrictions have been most severe.

To put it simply, China’s demand for Australian commodities post-GFC is mainly influenced by China’s construction ‘boom’ in 2009. It is open knowledge that there’s overcapacity in China’s steel and cement industries. As we wrote in Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle),

It had been reported that China?s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined.

A rise in Chinese exports will not be likely to offset the slump in construction.

Next, when you look at the big picture in mind, an export surge is the last thing the world needs. In the this post-GFC world, where growth is anaemic and unemployment is stubbornly high, countries are covertly engaging in competitive currency devaluation in order to prop up their exports in order to prop their economies. The Americans wants to re-balance their? economy with more exports, which implies other countries have to import more from America. Yet, on the other side of the Atlantic ocean, as Niall Ferguson said in this recent interview, the Germans are shedding crocodile tears over the falling Euro because that would boost their exports, which in turn is good boost for their economy. As Marc Faber said in this interview, a falling Euro (i.e. rising US dollar) will give the Americans the excuse to print money to give their economy another adrenaline boost.

Unfortunately, growth-via-exports is a zero-sum game because a for every export, there is an import on the counter-party. If every country wants to increase their exports to boost economic growth, who’s the one doing the importing? Thus, China’s export surge is one step in the wrong direction. The world needs a rebalancing of exports and imports, not more of the same unsustainable imbalance.

Already, the Americans are murmuring about this ‘good’ news. As? China export surge stirs U.S. anger reported,

A surge in Chinese exports and rising anger in the US Congress will put renewed pressure on China to allow its currency to rise against the US dollar.Chinese trade figures showed exports leaping by 48.5 per cent in May over the year before, way ahead of analysts’ forecasts. Data released in the US showed America’s trade deficit widening slightly in April, with some economists arguing that the improvement in net trade and its contribution to US growth appeared to have stalled.

The data gave more ammunition to China’s critics in the US Congress, who have said they will proceed with legislation to restrict Chinese imports to correct the perceived misalignment of the country’s currency. The US Treasury has been pursuing quiet diplomacy with Beijing to allow the renminbi to rise, but lawmakers said they were losing patience.

In the bigger picture, rising trade tensions between the US and China is moving them towards trade war. This can hardly be good news.

Can emerging stock markets underperfom?

Sunday, January 10th, 2010

We have covered China in our previous two articles (Hazard ahead for Australia- interim crash in China and Chinese government cornered by inflation, bubbles & rich-poor gap). Following them, we will look at the implications for the financial markets today. This should not be interpreted as ‘predictions’ of what will happen in the financial markets. Rather, they should be seen as issues for investors to consider. Since we are delving into a complex area, we do not pretend we will get everything right here.

Firstly, as we wrote before in Chinese government cornered by inflation, bubbles & rich-poor gap, China will eventually have to tackle their inflation problem. The longer they delay tackling this issue, the bitterer the medicine will be when they have to do it. We are sure the Chinese government understands it and they are probably debating among themselves in their inner sanctum.

In the meantime, there’s a potential danger that can throw the spanner into the works- trade war with America and Europe. The sticking point is the value of the yuan. By keeping their currency undervalued, the Chinese are exporting their goods to America and Europe while the latter export their inflation back to China. The popular sentiment among many in these Western nations is that China is contributing to higher unemployment in their countries. Already, we are frequently reading news report of initiation (and retaliation) of trade restrictions between the two sides. In a sense, low-level trade wars (“skirmishes” is a better word than “war” in this context) are already happening.

To their credit, the Chinese are doing something about this. They are expanding their trade ad investment relations with the rest of Asia, Africa, Middle-East and South America. This means that with each passing day, trade relations with Europe and America will become less and less relevant, which means that China will become less and less reliant on their currency peg to maintain the status quo in their economy. As we wrote before in Rumours of China diversifying their US dollars,

Not only that, the Chinese are setting up currency swap agreements with their trading partners [mainly with the non-Western nations] so that their yuan could be directly used for trade instead of using the US dollar as an intermediary.

This is another example of what the Chinese are doing to make the US dollar less relevant. If the Chinese can trade more with the emerging nations in their own currency, then the currency peg with the US dollar will become less and less necessary. Not only that, this will give China the prerogative to export inflation to other countries (as the US is currently exporting inflation to China- see Why is China printing so much money?).

The risk is that before the Chinese long-term plan can bear fruit completely, trade war erupts between China and America/Europe. Of course, both sides will suffer in such an eventuality, which is a reason to believe that they would not want that to happen. But our suspicion is that China may suffer a bigger pain initially. The reason is because, as we wrote before in Can China really ?de-couple? from a US recession?, the fall in Western consumption has a leveraged effect on China’s economy.

To compound China’s problem, in such a context, our guess is that the US dollar may devalue, which means China’s US$2 trillion kitty of currency reserve will lose its purchasing power. This is because the US current account deficit will shrink significantly, which means China’s purchase of US government debt will shrink as well. That in turn will be less supportive of the US dollar. Also, the spigot of Chinese imports will dry up, which will translate to price inflation in the US. In a way, with commodity prices in its up-trend once again (e.g. copper prices is back to the pre-GFC level), China’s kitty is losing purchasing power once again.

In such a scenario, stocks in the emerging economies may actually perform worse than American stocks. In the Panic of 2008, as the Chimerica imbalance unwind with a big bang, emerging market stock markets fell much more than their American counterpart. The 2009 ‘recovery’ winds up the imbalance once again. Therefore, should the imbalance unwind again (e.g. due to rising trade tensions, major economic correction in China, Chinese government clamping down on inflation), it is possible that we will see history repeating itself once again.

Chinese government cornered by inflation, bubbles & rich-poor gap

Thursday, January 7th, 2010

Today, we will continue from our previous article, Hazard ahead for Australia- interim crash in China. Before we delve into the implications for financial markets, we will first look at the stark choices available to the Chinese government.

First, we have to understand the dilemma faced by the Chinese government. Their number one priority is to ensure social stability. But we have to distinguish between social and political stability. As we mentioned before in Will China fall under popular revolt?, we doubt the Chinese people will rebel against their government and drag their nation down into the extreme political chaos that is reminiscent of the first half of the 20th century. But social instability can undo much of economic growth made over the decades, including further roll-back of liberalisation that was made over the years.

Factors that can undermine social stability include: corruption, mass unemployment and inflation. We doubt mass unemployment alone will pose a great threat to social stability. Back in the 1990s, under the leadership of tough, clean and anti-corruption Premier Zhu Rongji, China could still cope when many unprofitable state owned enterprises had to close shop, throwing millions into unemployment. Today, when corruption is probably a much more serious and endemic problem, perhaps mass-employment and/or inflation will become much less tolerable?

Every Chinese knows that corruption is a problem in their country. Inflation, along with its symptoms (e.g. growing rich/poor divide),? is a growing problem. Unemployment is not yet at a critical level. As long as the Chinese government can finely balance between unemployment and inflation, corruption will be tolerated up to a certain extent. Our guess is that when this balance breaks down, public anger may erupt.

That is where the dilemma lies. As long as the yuan is pegged to the USD, the Chinese government cannot control inflation (see Why is China printing so much money?). But the yuan has to be pegged to the USD in order to keep the Chinese exports competitive so that American consumers can fill in the wide gulf between Chinese investments and domestic consumption. By not allowing the yuan to appreciate, the Chinese government shows that at least for now, they fear unemployment and excess capacity more than inflation.

But there will be a day when they have to tackle the inflation problem. As long as the inflation problem is not solved, there will be rising prices and bubbles in the asset markets. As this gap widens, it will be harder to grow their domestic consumption demand to soak up their growing excess industrial capacity. As there’s a natural limit on how much a human being can consume, this will imply that the growing number of poorer ones will have to consume less (due to inflation), while the richer ones will have more and more of their wealth that cannot be consumed. This will result in them having to ‘invest’ their excess wealth into asset markets, contributing to an even bigger bubble. In other words, the paradox is that the further the Chinese government delay in tackling inflation, the more reliant they will have to rely on American consumers, which means it is harder for them to let the yuan appreciate.

Will the Chinese government have the guts to let the yuan appreciate? All they have to do is to look across the ocean at Japan and that will be enough for them to hesitate. As Satyajit Das wrote in this article,

In 1985, Japan, the US, Britain, Germany and France signed the Plaza Accord, in which they agreed to depreciate the dollar in relation to the yen and the mark by intervention in currency markets. The accord had limited success in reducing the US trade deficit or helping the American economy out of recession.

The Plaza Accord signalled Japan’s emergence as an important participant in the international monetary system and global economy. But the effects on the Japanese economy were disastrous.

The stronger yen triggered a recession in Japan’s export-dependent economy. In an effort to restart the economy, Japan pursued expansionary monetary policies that led to the Japanese asset price bubble that then collapsed in 1989. Economic growth fell sharply and Japan entered an extended period of lower growth and recession, generally referred to as ”The Lost Decade”.

The bigger the bubble in the Chinese economy, the bigger the consequences when the bubble collapses. But if the yuan appreciate too much too fast, it will be pin that pop the bubble.

This is where the next problem for the Chinese lies- the United States. The Chinese cannot allow their yuan to appreciate too much too fast. But the Americans are simply too impatient to wait. With influential voodoo economists like Paul Krugman writing inflammatory articles like this one, we shudder to think we will happen if the Obama Administration heeds his words and bring a trade war between China and the US a step closer.

If there’s a trade war between the Chinese and the US, we can be sure the Chinese government will stir up nationalistic feelings and put the blame on outsiders. This will definitely result in political tensions between both nations.

First steps towards currency and trade blocs?

Tuesday, November 24th, 2009

By conventional wisdom, government debt is supposed to be the safest form of debt because governments cannot default on debt repayment due to their powers of taxation and monopoly on creation of money (out of thin air). Conventional wisdom also dictates that the US government debt is the safest of all government debts because the US dollar is the world reserve currency. Since most of the debt accrued by the US is denominated in their own currency (a luxury that no other nation can enjoy), there is no way it can default.

Well, in reality, governments do default on their debt. Russia did in 1998. Many banana nations did as well. But a nation as prestigious as the United States? Today, even the mainstream news media is toying with the heretical idea that the United States government may go bust (see Is sovereign debt the new sub-prime?). Will the US government debt become sub-prime?

If the world’s ultra safest debts becomes bad debts (whether via monetary inflation or outright default), what hope will there be for other debts?

As we wrote in Permanently low interest rates for Uncle Sam?, it is very difficult for the Federal Reserve to raise interest rates. Not only that, the current yields on the US government debt are ridiculously low (some of the yields are even negative). As we said before in What will be the next market panic?, this will piss off America’s creditors immensely. Some Chinese officials, whether fairly or not, are already accusing the US monetary policy as the culprit for price inflation and asset price bubbles in China. Some US officials, on the other hand, will point their finger at the Chinese’s ‘manipulation’ of their currency exchange rate as the cause of the bubbles, thus implying that it’s the Chineses’ fault. Also, as we speak, both the US and China are engaging in low-level trade war, with import restrictions on Chinese tyres and American chickens as the first step. We can see that trade restrictions between the two sides will gradually increase as time goes by.

On top of all that, Asian nations are considering capital controls to stem the danger of asset price bubbles in their home countries (see Asia Considers Capital Controls to Stem Bubble Danger). Assuming that US interest rates are going to remain negative in real terms for an extended period time, the considerations will eventually become a reality.

All these are happening in the context of increasing trade ties between Asian nations and reduce trade ties between the East and the West. All these may be a precursor to currency and trade blocs in the long term. As we quoted Murray Rothbard in our book, How to buy and invest in physical gold and silver bullion, between 1931 and 1945,

The international economic order had disintegrated into the chaos of clean and dirty floating exchange rates, competing devaluations, exchange controls, and trade barriers; international economic and monetary warfare raged between currencies and currency blocs. International trade and investment came to a virtual standstill; and trade was conducted through barter agreements conducted by governments competing and conflicting with one another. Secretary of State Cordell Hull repeatedly pointed out that these monetary and economic conflicts of the 1930s were the major cause of World War II.