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Cold Currency War

In the Cold War, the foundation of diplomacy was mutual fear and hatred.  With that behind us, interdependence  has introduced a new system which includes much closer relationships – and something more like angst and loathing.  So has our relationship with China evolved.

As China has awakened, the GDP has grown by a factor of ten since 1990.   The population went from 22% urban to 52%.  All of this came at the expense, and mutual support, of hungry US consumers, corporations, and our nearly limitless need to finance our debt.  It was too much, too quickly, and wise investors saw that it was a bubble ready to pop – or at least relax the insane pace.

That day is coming very soon.

renminbiThere have been signs that China is in trouble before, but this one seems like the real thing.  Their manufacturing is in a slowdown which appears to be accelerating.  Exports drove their rapid growth, but competition with Japan and South Korea, among other nations, is becoming fierce.  But China’s economy can’t have a soft landing for many reasons that are all related to the terrific inefficiency of a system that centrally plans nearly everything.

The problem is credit, or the inability to get it through standard, legal methods.  Nevermind that, Chinese people have a history of finding a way to make do.  The “shadow banking system” that has grown up has funded nearly all of the entrepreneurial advances away from the government’s eye.  It’s a loose system made of up everything from pawn shops to loan sharks to manufacturing companies that loan their suppliers a little bit on the side and make the whole system work.

It has to be this way because ordinary Chinese cannot get loans at state run banks – at least not if they don’t know someone.  So they get loans from a very advanced kind of loan shark who often borrows the money from a foreign bank running at much lower interest.  Because of all the hands and risks involved, the rates are often very high – 20% or more is not unheard of.  But it’s not a problem as long as growth remains high because tomorrow will bring in a lot more money than today.

The demand for money in China has been extreme.  Total credit went from 75% of GDP in 2007 to 200% today, and the majority of it is outside their banking system.  It’s all tied to foreign loan rates in some way, about 10% of it pure shadow banking and a solid 30% formed by investment pools.

Interest rates in the US have begun climbing.  The 10 year T-Bill spiked over 2.4% when Bernanke announced the winding down of mortgage purchases, up from 1.6% just two months ago.  When US money is more expensive, the investment pools and loan sharks are squeezed – and will certainly take it out on their clients.  Demands to pay outstanding loans are going to increase right when China can afford them the least, given the slowdown and competition.

chinaworkersWhile not every Chinese entrepreneur can expect a knee-capping in their future, the credit bubble has to burst.  That will slow down the growth in their internal markets simultaneous with the external slowdown.  The problems with income inequality – where the well connected have become rich and the workers not so much – will become very stark.

Why should we care?  The ability to finance our debt is going to become much more difficult.  China hasn’t been buying much US Treasury debt lately, but it may feel compelled to sell some off.  Interest rates rise by having the underlying debt change in value, and a rising rate means that the US bonds will fall.  Plus, higher US rates will translate into more expensive US Dollars and make Chinese exports appear cheaper, something that will have to be tempting.  But in the process, China will be killing its own shadow system, which the control freaks will probably find desirable even as it destroys the internal economy.

In short, they can’t win.  And as they can’t win, it gets more expensive for us to run a deficit and keep on with our own economic stimulus.

It’s something like a Cold War that is playing out, except it’s likely to be a Currency Cold War.  They can threaten us with collapse in our standard of living, and we can threaten them with millions of unemployed people crammed into dirty cities and ripe for serious unrest.  The weapons are all pieces of paper.  The threat is not one of abject destruction, but instead a much slower decline and even hunger.

That’s the beauty of the new world we live in.  The success of our “enemy” is in our best interest, even as we want to beat them.  And boy, is our “enemy” in trouble.

11 thoughts on “Cold Currency War

  1. I don’t begrudge China anything but how can we compete against a country with no standards at all? I think we do have too much regulation but I would not want to go their way with it. Its like they can’t take care of the most basic things like keeping workers from being slaves and air you can breath but boy do they make it impossible to get a loan. WTF?

    • It does seem incredibly backwards, yes. China is simply taking its rightful place in the world after a few really bad centuries. The process has been rapid but very uneven so far, and it has made for a life that is often hellish at best. Normalizing this into something modern is still going to be difficult.

  2. China has never been the enemy, they gave us what we wanted which was cheap labor to make things for us. We totally need each other and that was always the arrangement. If things aren’t going as well as they want they should take a long look at how their government controls people’s lives. Sometimes I think we used them and I feel bad for the people of China but if it works out in the end its OK. Part of the deal has to be that they become a free society and people can speak their minds.

    • To get from here to there will probably take civil unrest – the government won’t give up power unless it has to. I expect there will be civil unrest if they shut down the shadow banking system because people will be plunged into poverty. The social upheaval China has experienced has been amazing – any other nation wold have had intense riots by now. Something is likely to happen, yes, and it may well lead to more freedom. But I think it has to be guided that direction if we’re going to see it happen.

      • Well Erik I’m not that worried about China to tell you the truth. Government won’t give up power for sure and hopefully there will be civil unrest when the shadow banking system is curtailed. But you are incorrect about “. . . any other nation would have had intense riots by now.”

        Maybe if we are lucky the American people will wake up and burn down Wall Street and kill the Banksters but that is wishful thinking on my part. Americans are complacent and as the government take away the Constitutional protections, and Wall Street and the Banksters hoard the free money they “borrow” from the Fed. at the expense of the people ……… Americans sit waiting for the Banks to take their homes.

        Riots ………. bring them on!

        As a nation we have recently gone through Bush’s “reign of error” and Step-An-Fetch-It-Obummer bend over and take it up the wazoo leadership so a full fledge riot would be refreshing.

        Whatever we do I would not want to see the U.S. provide “guided direction” to China for more “freedom” I’d rather see Americans over throw the existing oligarchy and bring it down so we can “groove on the rubble”!

      • I won’t argue with you on most of this – serious change is necessary, and if it doesn’t come through peaceful means there’s a time to start upping the pressure. As I’ve said here, there is a chance for a great golden age if we just get our act together, but congress is split between two parties – one that can’t get anything done and one that refuses to get anything done.
        As for China, however, the changes they have seen in 20 years are gut-wrenching at best. Nearly a third of the population came from farms to live in absolutely filthy cities where they work like animals for really meager pay. That’s what I mean by a need for intense riots. Sure, we have it bad – but they have it worse and have been promised a lot more.
        But yes, we should take care of our own problems first, and there are a lot of them. I am afraid it will come down to a kind of revolution – but if that’s what it takes, count me in. What we have now can’t hold.

  3. Oh my goodness! Amazing article dude! Thank you so
    much, However I am having problems with your RSS. I don’t understand why I can’t subscribe to it.
    Is there anyone else having the same RSS issues? Anyone that knows the solution will you kindly respond?

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