Archive for March, 2013

China Eclipsed the U.S. as the Biggest Trading Nation. Questions to ask from an Austrian Perspective

Great-Wall-of-ChinaLast month one of the Bloomberg’s headline news was titled “China Eclipses the U.S. as Biggest Trading Nation”. There seems to be of concern China’s 2012 reported trade of $3.87 trillion surpassing the U.S. report of $3.82 trillion.  For the full article click here.

The concern arises with the fact that…

China’s growing influence in global commerce threatens to disrupt regional trading blocs as it becomes the most important commercial partner for some countries. Germany may export twice as much to China by the end of the decade as it does to France, estimated Goldman Sachs Group Inc.’s Jim O’Neill.

Why worry so much about an Olympic athlete that had worked hard for many years to win the gold medal?  The benefits of twenty and some years of manufacturing and producing real capital in the world are evident and well deserved.  As far as Germany increasing its exports to China there should be no big surprise. Germany, one of the few productive economies left in the EU, needs to find a strong trading partner with whom to exchange goods and services.  The key word is “strong”, financially strong.  Who else should Germany trade with?  France, Spain, Italy, Greece, countries which are literally economically insolvent?

O’Neill goes on saying that…

“For so many countries around the world, China is becoming rapidly the most important bilateral trade partner.  At this kind of pace by the end of the decade many European countries will be         doing more individual trade with China than with bilateral partners in Europe.”

So, what’s wrong with that? If I owned a company and found that my best consumers for my product are on another continent, I would not hesitate.  In addition, knowing that my consumers are financially capable of buying my products gives me even more reasons to target that market.  Why settle for local consumers heavily in debt who can’t afford my products and/or would have to acquire more debt to afford it?  Competition and free markets are key components of growth and success. At this point, those European countries should pay serious attention and do whatever it takes to become competitive in the market.

Then, under the chapter U.S. Leadership, we’re finding out that…

When taking into account services, U.S. total trade amounted to $4.93 trillion in 2012, according to the U.S. Bureau of Economic Analysis.  The U.S. recorded a surplus in services of $195.3 billion  last year and a goods deficit of more than $700 billion, according to BEA figures released Feb. 8. China’s 2012 trade surplus, measured in goods, totaled $231.1 billion.

The U.S. economy is also double the size of China’s, according to the World Bank. In 2011, the U.S. gross domestic product reached $15 trillion while China’s totaled $7.3 trillion.  China’s National      Bureau of Statistics reported Jan. 18 that the country’s nominal gross domestic product in 2012 totaled 51.93 trillion yuan ($8.3 trillion).

“It is remarkable that an economy that is only a fraction of the size of the U.S. economy has a larger trading volume,” Nicholas Lardy, a senior fellow at the Peterson Institute for International         Economics in Washington, said in an e-mail.  The increase isn’t all the result of an undervalued yuan fueling an export boom, as Chinese imports have grown more rapidly than exports since 2007,  he said.

As far as services versus goods provided this is a clear sign that the U.S. does not provide enough goods. Goods are of two kinds. Consumer goods (those items we shop for such as cars, furniture, toys, clothing, jewelry, etc) and capital goods (which are the machinery and equipment with which consumer goods are being produced). Maybe the U.S.’s protectionist agenda, taxation, heavy unionism in conjunction with a national trend of favoring a socialist, if not fascist, economic system did not help after all.  Maybe the corporate bailouts and Quantitative Easing did not in the end help the private manufacturing sector.

If I were in a position of power I would wonder – and would want to find out – how come my country with a GDP of $15 trillion has a trade deficit higher than my competition, which has a GDP half of my country’s GDP. Could it be that too much of our GDP is comprised of 1. the growing of the federal government, and 2. military exposure all over the world?  Could it be that such a big economy has little to justify its big number considering its producing capacity is in a less than desirable stage?  Mr. Lardy addresses such a question but he seems surprised.  But the small businessman in America is hardly surprised.  Why?  Because it’s become very hard for the small business owner to compete with the government subsidized corporations when he has to jump government imposed barriers in form of rules and regulations, when he’s coerced with providing health insurance coverage to his employees, and when he’s faced with minimum wage restrictions.  Then Mr. Lardy brings up a good point. China’s imports are now replacing its exports.  The answer is: Think of the U.S. back during the 1980’s, when it was the largest manufacturer in the world and the largest creditor. There seems to be a role reversing going on.

The article goes on…

Biggest Exporter

The U.S. emerged as the preeminent trading power following World War II as it spearheaded the creation of the global trade and financial architecture. Protectionist policies in the 1930s had         exacerbated the global economic depression. At the same time the U.K., the leading trading nation of the 19th century, began to dismantle its colonial empire.

Wait a minute, did I read that right? It says that Protectionist policies in the 1930’s had exacerbated the Depression. Wasn’t Goldman Sachs concerned with Germany not trading locally within the E.U. territory? What Germany is doing is simply trading in a free market exchange. Why use protectionism to stifle it?

If the article referred to the U.K. as a colonial empire what makes today’s U.S.A. different than Great Britain during the beginning of the last century?

China began focusing on trade and foreign investment to boost its economy after decades of isolation under Chairman Mao Zedong, who died in 1976.  Economic growth averaged 9.9 percent a     year from 1978 through 2012.

After a long period of central planning and economic regression under the communist system China recognized that hard work and free markets are the answer to economic prosperity.

China became the world’s biggest exporter in 2009, while the U.S. remains the biggest importer, taking in $2.28 trillion in goods last year compared with China’s $1.82 trillion of imports. HSBC     Holdings Plc forecast last year that China would overtake the U.S. as the top trading nation by 2016.

This begs the question: Is the U.S. consuming too much and producing too little?

The article continues with claims from a few banking institutions that China’s export figures could be manipulated. Maybe or maybe not. What I know is that wherever I shop in the U.S. , whether Walmart or JC Penney, I can’t help noticing the “Made in China” tags.

Eswar Prasad, a former International Monetary Fund official who is now a professor at Cornell University in Ithaca, New York, says…

“The U.S.’s bilateral trade deficit with China, which peaked in 2012, could remain a flashpoint of tension between the two countries.”

Why tension?  Is it mutual from both countries, or unilateral?  The question of who benefits the most out of the trading partnership at this time has not been addressed enough. What would happen to American people if Chinese goods imports would stop over night?  Has the American politician explained how the lifestyle of the average American would be impacted?  Has it been argued that an unemployed American may suffer drastic changes?  The typical comment out there is “let’s build American”. Sure, I am all for it but with what? There is no savings to produce the capital required to produce goods.  Or should we borrow more and increase our debt?  Should we allow unions to force manufacturers to keep wages up?  If we do, it means that we should also expect to pay double, if not triple for a product that otherwise would have cost us less if it were imported from China.

On the other side would China and its people be affected as much?  Do they need the U.S. to consume its products?  Maybe. But what if the Chinese renminbi is allowed to freely float? If that happens, the Chinese people’s purchasing power is increased.  If their currency goes up it means their people would be able to afford more.  With a population of more than 1.3 billion I would think there would be a large enough market to consume the locally manufactured products. Not to forget the rest of the countries in the region, some with affluent residents (such as Singapore) and some emerging countries with growing industries and growing wealth (Indonesia, Malaysia, Vietnam, etc).

Mr. Prasad continues…

“This trade imbalance is not representative of the amount of goods actually produced in China and exported to the U.S., but this perspective tends to get lost amidst the heated political rhetoric in the U.S.”

If it’s not indicative of the productive nature of China then what does it represent? The answer is just that. China: Large production and little consumption. U.S.A.: Little production and large consumption.

Goldman Sachs’, O’Neill, is concerned with…

“the trade figures underscore the need to draw China further into the global financial and trading architecture that the U.S. helped create.  One way or another we have to get China more                 involved in the global organizations of today and the future despite some of their own reluctance.  To not have China more symbolically and more importantly actually central to all these things is just increasingly silly.”

Why bring China to be part of the Wall Street game?  So that it becomes part of the Debt web and contributes further to the global economic instability?  No, it’s not silly to be sovereign.  No, it’s not silly to be self-sufficient.  And it’s not silly to be rewarded for hard work leading to production of real goods.  Better than Goldman Sachs’ paper derivatives.  Common sense, if applied, should lead us to think of this as an advance warning.  Maybe it’s time America starts producing real hard assets instead of Wall Street paper assets.

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Ben’s Balance Sheet Blues

By: Peter Schiff

Fed-stimulus-planDuring his testimony before Congress this week, Federal Reserve Chairman Bernanke made it a priority to dampen the growing concern that the unprecedented growth of the Fed’s balance sheet presents great risks to the economy. There has been a heightened sense even among normally complacent members of Congress that the Fed could spark a precipitous decline in the economy and the financial markets if and when it seeks to “withdraw liquidity” by selling even a minor portion of its bond portfolio (which is projected to swell to $4 trillion by year end). This is a valid concern that I have been discussing for years.

Gentle Ben soothed these fears by his novel assertion that the Fed doesn’t actually need to sell bonds to neutralize previously injected stimulus. Instead, the Fed could simply allow its bonds to mature, thereby achieving a more natural, and potentially less disruptive unwinding of its gargantuan portfolio. Although his explanation seemed to satisfy many of the Congressman (and the vast majority of the journalists who slavishly dote on Bernanke’s assurances), the idea is completely absurd.

As a result of its previous efforts during “Operation Twist” (which was conducted in order to push down long-term interest rates), the Fed has already swapped hundreds of billions of dollars of short-term securities for Treasury bonds with maturities of ten years or longer. Only a small portion of the Fed’s portfolio, then, becomes due at any given time. The average maturity of the entire portfolio is now over 10 years. There may well come a time when inflation or asset bubbles become so pronounced that aggressive withdrawal of stimulus is needed. Forceful action will only be possible through active selling, not simply by passive maturation.

However, either approach will be insufficient to tighten policy without a simultaneous cessation of buying of newly issued Treasury bonds. After all, to shrink the size of its balance sheet the Fed must stop adding to it…or at least add less than it is subtracting. Even if the Fed had the luxury of holding its bonds to maturity, such a stance would not prevent a collapse in the bond market. The Treasury does not have the cash needed to retire maturing bonds if the Fed stops rolling them over. As the government will have to sell the new bonds to other buyers, one way or another additional supply is going to hit the market.

The Federal government is projected to run trillion dollar deficits for years to come. To cover that gap, the Treasury will need to continuously sell new bonds. This need will persist regardless of the Fed’s policy priorities. For the last few years the Fed has been by far the biggest buyer of Treasuries, in recent times sucking up more than 60 percent of the total issuance. According to some reports, the Fed is expected to buy up to 90 percent of Treasuries in 2013. The only other significant buyers are foreign central banks (who buy for political reasons) and nimble hedge funds. Who does Bernanke expect will fill his shoes when he stops shopping?

To answer that question you must consider the economic environment that would compel the Fed to tighten in the first place. Presumably a period of accelerating economic growth, surging inflation, or rising interest rates would trigger asset sales. In such a situation, who in the world would want to buy low-yielding, long-term government paper while inflation is surging, the dollar is falling, and interest rates are rising? With the Fed on the sidelines, such an investment would be a guaranteed loser. Bernanke claims that the financial conditions will be soothed by an aggressive communications campaign that would let market participants know, in advance, precisely how the Fed intended to dispose of its assets. The cardinal rule in investing is that big players never telegraph their intentions. Fed “transparency” will simply mean that the hedge funds now making money by getting in front of the buying will be making even more money by getting in front of the selling!  There will be no cavalry of new buyers riding to the rescue.

This means that any attempt to tighten, no matter how passive, will result in a significant drop in the price of U.S. Treasuries and mortgage-backed securities. Not only would this inflict massive losses to the value of the Fed’s balance sheet but it would exert enormous upward pressure on interest and mortgage rates that the Fed will be unable to control.

In addition to his absurd “let them mature” gambit, Bernanke also announced other novel policy tools that will supposedly help him orchestrate a successful exit strategy, most notably raising the rates paid on funds held at the Federal Reserve. Such a move is expected to deter banks from lending into a surging economy or to invest in risky assets by enticing them to park cash at the Fed. But how high must these rates go, and how much would it cost the Fed (in reality U.S. taxpayers) to do this effectively? Given how high I believe inflation will become, these payments could be truly staggering. The net result will be a substitution of large operating losses for large portfolio losses (which would have come from bond sales).

As I have said many times before, the Fed has no credible exit strategy. Its portfolio is far too large, and the economy, the housing market, the banks, and the government, are far too dependent on ultra-low interest rates to allow Bernanke any real options. In truth, his only exit strategy is to just talk about an exit strategy. Bernanke’s contention that the Fed need not sell any of its bonds is the closest thing yet to an official admission of this fact. Not too long ago Bernanke made the absurd claim that his intention to sell the bonds on the Fed’s balance sheet meant that he was not monetizing debt. How times have changed.

Bernanke is banking on the hope that his policies will jump start the economy which will then be able to motor along on its own.  However, the current era of cheap money and fiscal stimulus will never create an economy that is capable of standing on its own legs. Instead, it is propping up a parasitic economy that is completely dependent on the very supports the Fed believes it can one day remove. But if the Fed does not remove them on its own, the markets eventually will.

Bernanke also defended himself against some members of Congress, particularly economically savvy New Jersey representative Scott Garrett, who pointed out the hypocrisy of Bernanke’s claims that Fed policies are responsible for the recent rise in home prices (while simultaneously absolving the Fed of any responsibility for rising home prices during the real estate bubble). To justify this claim, Bernanke made the self-serving distinction that while the Fed is currently purchasing mortgage-backed securities (in order to lower mortgages rates and boost home prices), no such actions existed prior to the 2008 financial crisis. As a result, he claims the Fed could not have been responsible for the bubble.  On this point he is dead wrong.

Fed policy during the mid-years of the last decade had an enormous effect on mortgage rates and home prices. By holding short-term rates too low for too long, the Fed was responsible for the proliferation of Adjustable Rate Mortgages and the popularity of the ultra-low teaser rates without which the housing bubble never could have been inflated so large in the first place.

In other words, the Fed broke it then, but it sure can’t fix it now.

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