Who's Gonna Say Uncle???
This essay discusses the differences between the United States and China today with respect to market structure, and where things are heading. A combination of market analysis and biological observations are included to give a more accurate perspective of how the future may transpire
Differences between the US and China
The items in this section are broken down numerically for easier referencing later in this article.
i) Currency and Debt
The US allows their currency to float (although intervention has occurred until the decline since 120) and the Chinese Renimbi is pegged to the US dollar at around 8.2:1. Quoting Ernest H Pregg (Manufacturers Alliance/MAPI, October 2, 2002) "In the case of China, the renimbi is fixed to the dollar, but is non-convertible on capital account. What this means in practice is that the export earnings in foreign exchange, plus FDI not utilized for purchases on current account, have to be sold to the central bank for renimbi at the fixed exchange rate. In effect official intervention is carried out through mandatory foreign exchange sales to the central bank rather than central bank purchases in the market, as take place in Japan and elsewhere. The net effect, nevertheless is currency manipulation through protracted large-scale purchases of foreign exchange by the Chinese central bank".
Any attempts by the US government or natural market forces to have a lower dollar will be more beneficial to the Chinese who will have their currency fixed. In effect the Bank of China controls the money transfer to its country, shielding trading fluctuations that may arise on an open market system. There is discussion among G-8 nations to try and force Chinas hand to allow the renimbi to float under natural market conditions +/- 20% of the current set value.
China as a country has a greater amount of domestic debt than foreign debt. The amount of foreign debt to GDP is small. Coupled to the fact that Chinas foreign reserves are higher than total foreign debt outstanding, the ability for repayment on loans is not high risk. 74% of the Chinese government debt is US dollar denominated, so any expansion in US currency will reduce the net value of the outstanding loans. The Chinese government has a high asset value (major Chinese banks, all land (leased by farmers) infrastructure, companies, etc), so debt can easily be repaid. Chinese debt at the level of the Central government is no concern.....it is the lower levels of government (townships) that have the majority of debt. For a more comprehensive reading on the Chinese debt, I would recommend the following link (http://www.worldscinet.com/cij/01/sample/S0219747203000062.pdf)
The United States government currently has a deficit 5% of the GDP. The total US debt is around $6.72 trillion dollars (http://www.publicdebt.treas.gov/opd/opdpenny.htm ). The amount the government is on the hook for $44 trillion in pension funds, medicaid, medicare and other social programs etc. This is nearly four times the US gross domestic product (GDP). The total debt load on the country in the coming years is unmanageable and impossible to pay back. Prior to 1933 when Roosevelt made it illegal for people residing in the US to own gold, and 1971 when Nixon totally went off the Bretton-Woods system, inflation was relatively stable. The currency could only be expanded as the gold reserves of the nation could increase. A worthy read for a better understanding on this subject may be found at the following web address: http://www.plata.com.mx/plata/plata/worldres.htm. In 1948 the US government held twice the value of gold in their vaults as outstanding currency. Countries were exchanging so much gold for the US dollar Nixon had to step in and dishonor the Bretton Woods monetary arrangement that stated the US dollar could be redeemed for gold. The loss of a gold-backed currency paved the way to have a fiat currency, which could be expanded infinitely. The expansion of the US dollar helped to allow economic expansion for the bull market of the 1980's till 2000. Money entering the US creates an increase in the money supply, which is the classic definition of inflation. This causes a rise in prices, which makes the imports to the US less attractive. Foreign countries must then devalue their own currency relative to the US dollar in order to continue the supply of goods at an equivalent rate. The currency wars in Asia are the by-product of the US going off the Bretton-Woods system. The devaluation's of foreign currencies and expansion of the US trade deficit will only cease when there is a collapse in the current system. The cure will be discussed later as this essay proceeds.
The US population is approximately 300 million while China has 1.3 billion. Currently the US has 6% unemployment, while China has approximately 8%. The interior of China though has unemployment upwards of 40%. The percentages do not seem much in China, but given the population, this creates pressure to maintain a growing job stream. The salaries in China are a fraction of what the US commands, so major blue chip companies such as Hewlett Packard and IBM have relocated portions of their businesses in China. Figures 1 and 2 show yearly and weekly % unemployment in the USA. Since the markets topped in 2000, the % unemployment has slowly been increasing with most jobs heading to Asia or lost permanently through bankruptcies.Weekly Percentage US Unemployment (Source: US Department of Labor)
Yearly Percentage US Unemployment Rate (Source: US Department of Labor)
Since China entered the World Trade Organization, job creation has been the central task of the government in combating their relatively high unemployment.. One advantage China has over the US is a lower standard of safety requirements, less stringent human rights and salaries. Lower safety requirements and less stringent human rights allows China to get more work per person at a lower salary thus producing a product that is significantly cheaper than an equivalent manufactured in North America.
The most important basis for an economy to grow is one with manufacturing capacity. Since the 70's and 80's, China has been developing its infrastructure to make it more competitive. Earlier in the 20th century the US was the undisputed manufacturing site of the world. This shift in manufacturing capacity sets the stage for China emerging as a new global super power in this coming century. The removal of manufacturing jobs from the US has created a larger service industry to try and fill the void. The manufacturing sector is 10x more engaged in trade than the services sector. A reduction in the manufacturing capacity of a nation will have a significant reduction in the GDP of a nation. The current reduction in the US government revenues can be attributed to many factors, but a loss in the manufacturing sector is surely a contributing factor.
One of the key factors for China's entry into the WTO was a satisfaction of the human rights code. A great site to visit for a very thorough description describing conditions for China entering the WTO may be found at http://www.uschina.org/public/wto. Since China is a Communist country information and personal freedoms are essentially dictated by the governments position of the day. Human rights are still an issue and the author feels that they will still be an issue for a portion of this decade. Fifty percent of the Chinese population not having an adequate water supply is highly suggestive of the overall high poverty rate existing in that nation. Although voting elects forty percent of the officials at the village level, the electoral processes at the central level of government have yet to occur. The US trade deficit is fed by Chinas lower wages and other factors described above. Whenever a country develops new prosperity, wage increases, benefits, access to higher education and goods become hurdles later in the business cycle. At some point, China will have greater levels of civil unrest due to the desire for a higher standard of living.
The fly in the ointment of Chinas progression to a developed nation lies in its ability to maintain its economic strength. Walmart accounts for 1.3% of the US GDP and they obtain most of their manufactured items from China (nearly 70% of the worlds shoes are manufactured in China). The American quest for purchasing cheap products has fueled the erosion of their manufacturing sector and Chinas boom. Once the American economy heads into dire straits and the consumer stops making purchases, this will have negative feedback to the Chinese economy. Significant portions of the infrastructure in China are loan based, and failure to have constant output of products could reduce plant profitability causing the Chinese government to step in and take over control or plants. As mentioned previously, the Chinese government has more in assets than their annual GDP so China as a whole will stand to have more of a cushion from a severe economic downturn. China does face problems similar to the US with regard to pensions. In 2000, the pension debt was 20-30 times the current pension payment. Calculations suggest the US government face 44 trillion dollars in shortfalls. The American government does not have the asset base the Chinese government has, so absorption of these huge shortfalls most likely will be derived from issuance of more fiat currency or outright. How the issues will be dealt with in both countries is unknown. China has a higher level of poverty than the US, but poverty levels in the US could surge with the coming economic slowdown. The key to the success and survival of either country will be the level of the gold reserves. The US is likely to default on all debt at some point in the future if payment with an expanded currency is null and void. Most likely the US will not allow any transfer of its some 8000 tonne holdings to any country for debt payment. A new gold-backed currency will be issued and things start anew. Failure for debt payments will create strong resentment and global pockets of trading due to projectionist measures.
Oil, Ecology and Health of the Nations
With 1.3 billion people and counting, China has severe stresses on its own environment. The US has 300 million people but put more strain on other countries due to imports. The best method to gauge a countries population impact on a given unit of land is using a term coined "Ecological Footprint". An ecological footprint defines x hectares of land required to support one person in that country. The lower the hectare/person, the lower the smaller the ecological footprint for a given country (refer to http://www.ecouncil.ac.cr/rio/focus/report/english/footprint/ranking.htm for further details). Deficit values are possible if the land use required per person exceeds the available land. China has a deficit of -0.4 hectares/person while the US deficit is -3.6 hectares/person. Increases in the standard of living in China could raise their deficit value to a point of unsustainability due to their shear population size. The ecological constraints of the size of the ecological footprint of China will be the rate-limiting step in the growth and status of a developed nation. The US is likely to have a key reversal in their ecological footprint as they lose their status as a world superpower and their greenback loses reserve currency status. The US utilizes nearly 10x the land space per person compared to China and this will shift dramatically over the next decades.
Oil and gas are the energy for GDP. No oil and gas means no GDP. An increase in Chinas GDP would imply that a heavier use of oil and gas which could pose problems for the US in obtaining relatively cheap energy supplies (refer to http://www.ott.doe.gov/biofuels/energy_security.html for further information). In 2000, the US consumed 19.7 million barrels of oil per day, or one quarter of the total world oil production (the US economy represented 25% of the global economy in 2000 coincidentally). By 2002, China accounted for 68.5% of the increase in global primary energy consumption. China imported 69.4 million tonnes of crude oil in 2002, an increase of 15% year over year. The transfer of energy imports from the US to China over the coming years will represent the changing of the guard. How will the world function in the future if currencies are to be backed by gold? Nixon in 1971 took the US off the Bretton-Woods arrangement due to the feared depletion of the US gold reserves. If the Arabs demanded gold for oil Fort Knox would be empty. The history books will probably view George W.'s attack on Iraq as one of the most important strategic wars in the history of the US. With the US having a foothold in Iraq, they essentially control the oil fields, guaranteeing themselves a stable oil supply. Oil could be exchanged for American dollars rather than a direct exchange of gold. This would give the USA an edge over China as Iraq has 112 billion barrels of oil - the worlds second largest proven reserves (http://www.eia.doe.gov/emeu/cabs/iraq.html). Chinas growth may be regulated by control of the oil supply. Since the Chinese fixed their currency to the US dollar, oil traded with China via Iraq may be restricted to counter the effects of the cheaper Chinese imports.
My education background is in the field of science, so I may go into more detail on the following than is required. It does however have a very significant impact on how the economies of the two nations and others will develop throughout this century. The US has better regulation of health care and disease control than China. Country infrastructure develops prior to bonus features of a developed country like Medicare. Although AIDS has had resurgence due to people becoming ignorant to human immunodeficiency virus (HIV) globally, the levels in the US are fairly stable except the noted increase among homosexual men. China currently has 1 million people infected with HIV, but that number is expected to approach 10 million by 2010 (a conservative estimate). The danger with HIV lies with the fact it is a retrovirus. Retrovirus's nuclear material is RNA rather than DNA. When a virus enters a cell, an enzyme called reverse transcriptase converts the RNA into a DNA template allowing insertion into the host DNA. When a person is infected with HIV, drugs can be given to slow down the eventual death. Persons with multiple partners and unsafe sex practices pose the highest chance of becoming infected. With a large percentage of its population in poverty, China stands to have AIDS reach epidemic proportions in the coming decades. Medication for AIDS only delays the inevitable, and since it is sexually transmitted, the younger population stands to become the heaviest hit. This is does not bode well for a population curve that will have significantly larger proportions of elderly people depending upon the younger generation to fill the void. Some African nations have lost 40-60% of their populations. There are not enough people to tend to crops or fill working positions. This has had a devastating effect on the nations as a whole, but has lead to more sustainable land usage and increases in local animal populations. Although death is a tragedy, ecologically these situations lead to a cleansing and rebirth of the system. In an article by Carla Carlsdottir to the Seattle Times on May 10, 1998, a description of people immune to AIDS is described:
"The mutation occurs in the gene for CCR5, a receptor on the surface of immune system cells called macrophages. The AIDS virus uses the CCR5 receptor as a molecular "docking bay," permitting it to land on, attach to and infect the cells. People devoid of the receptor (a condition that occurs when someone inherits the mutant gene from both parents) are essentially immune to HIV infection. People with one mutant and one normal version have fewer than normal numbers of CCR5 receptors on their macrophages. They can be infected with HIV, but if that happens, they tend to have a longer, more indolent course of the disease than people with two normal CCR5 gene". This mutation was found to have occurred in populations of Europe that were resistant to the Black Plague of Europe during 1347-1350 that killed 1/3 to 50% of the entire European population. The US has a high European population base, so there would be a greater chance of immunity occurring than the Chinese population base that was not exposed to the Black Plague of Europe nearly 700 years ago.
AIDS was mentioned in this essay due to the destruction it has over a 20-year period on a country population if left unchecked. Other diseases are also on the rise but are lifestyle or resistance driven from heavy antibiotic usage (none compare to the potentially tragic economic consequences if AIDS becomes an epidemic). A country that grows must have a strong population base to support the job structure. Pending how well AIDS is contained in China will ultimately determine how successful they are at transitioning to a new global superpower. If the handling of the SARS problem (severe acute respiratory syndrome) in China is any indication of how the Chinese government deals with internal issues (Chinese officials knew of SARS for months prior to global outbreaks, but did not disclose information for fears it may damage tourism to the country) then there is cause for alarm. An ultimate reduction in the population of China would have longer-term benefits to the nation as a whole (reason for the one child per family policy) but if AIDS is the method, there will be decades of misery before prosperity blooms again. The US has recently had AIDS increase amongst poorer persons mainly due to lack of education or desensitization to nearly two decades of AIDS awareness. A significant number of US citizens stand to contract HIV over the next decade, but not in the shear numbers that China is expected to.
How Debt Will Dictate Government Policy and Global Relations
An aging population will be an issue for China, but not nearly in so much as the US will face. The Chinese government has substantial assets relative to their total debts. The US government faces a potential 44 trillion dollars in debt for Medicare and social security programs. This number is astronomically beyond the current float of total US dollar currency. The US government supposedly has 8000 tonnes of gold equating to 92.6 billion dollars. If all of the gold ever mined is 120,000 tonnes, the net value of global gold is currently1.39 trillion assuming $360/ounce gold. The wise Richard Russell suggested the price of gold and the DOW will meet around 3000 for both. If true, the best the US government could hope for value of their bullion holdings would equate to 926 billion dollars.......an incredible shortfall to try and cover expenses. I have read that the US government will reprice gold at a ridiculously high value to pay off their debt. Based on the above, it is not even feasible or possible for the US to honor its debt unless the FED or the government interject and take over the corporations that have debt and monetize it. The absorption of debt into the government could simply be transfer a swap between fictitious departments and the debt is absorbed and canceled. If this is performed, the US government stands to absorb significant amounts of real estate, companies etc. Sit back and compare this prior statement the way the Communist government of China has positioned itself.......The US government inadvertently stands to transform its democratic structure into a Communist-type of regime. A government with the majority of control over a countries assets and companies will have negative psychological implications in the fabric of society. Social uprises and a demand for better living conditions spells a situation similar to the early 1920's when unions were just starting to get a footing in North America. This situation is now unavoidable, since the state will have no other means of looking after the elderly, sick and those reliant on government programs that must be financed somehow. With total control over the system money flows can be directed without a problem if they control the taps. This type of environment could be hyperinflationary due to a rapid increase in local currency, only to have deflation kick in and create a very bad depression. The next question to ask is HOW WILL THE DEBT BE PAID?
The US can a) default on debt (b) expand its currency to create current debt levels easier to pay. No currency around the globe is backed by a gold standard. In fact most countries are expanding their fiat at an alarming rate. If currencies are expanded at an alarming rate, the possibility for hyperinflation exists. The problem with this scenario is people are already at maximum levels of debt. Increases in prices would slow consumer spending drastically. The velocity of money depends upon how fast it is circulated. If consumers do not spend, the velocity of money slows, and the economy slips into a recession.
The US greenback is the reserve currency, which is about to slowly be eroded over the next decade. As other countries repatriate the US dollar to their own or other currency, this will devalue it to levels that cause imports to become significantly expensive. Importing goods with nations not using the same currency could become financially straining which stands to have block economies around the world. The European Union was the first step in the direction of creating block currencies. The US will likely have Mexico, Canada, Iraq, Puerto Rico (maybe Britain) adopt a currency all participants share. This not only achieves currency instability but also keeps import prices relatively constant between different nations. How wills a democratic country with a socialist (deep down Communism) agenda function in a trading block?
Gold backed currencies keep inflation low and prices stable. When the price of gold (POG) was $35 between 1933 and 1970, inflation was present but somewhat subdued. When Nixon nixxed the Bretton Woods agreement, the relentless currency expansion that followed created heavy inflation. A fixed price of gold helped stabilize inflation, while the US currency expansion slowly dissociated the two. Washing the world with fiat paper washed a lot of memories on the importance of gold and silver for providing economic stability. The bull market from the 1980's through 2000 caused a switch from a gold price blow off to a stock blow-off. As the bull market continued in the equities prices rose and stocks were split to keep up with investment demand. Meanwhile, the POG slipped into the abyss to significantly undervalued levels. The $800 POG in today's dollars would equate to $3000 given no more currency expansion occurs.
Fully traded gold in China now makes it unlikely that the US government would try and confiscate gold from its citizens. If Communist China allows people of its nation to buy gold, any attempt by the US government to seize gold would give the impression they were a worse regime than a Communist government.
What Lies Ahead?
The road ahead is one of more negatives than positives. The US is going to be demographically challenged in the coming years. As more people leave the work force, there will be a higher stress put on the medical system. Throw in a 60% obesity problem and AIDS in the future, the downfall lies with the up and coming medical burden. All of the health care requires money, and money will be harder to attain. When the world does finally resolve all debt, most of it will be erased. This will bring out protectionism among nations (we are already witness to this) which will probably put the East against the west. Even if the US has 8500 tonnes of gold in Fort Knox, its dollar will be loathed, and no one will probably trust it (even if they do decide to back it with gold) for a long long time. Local trade blocks will probably form with trade being conducted exclusively within this block until walls of protectionism are slowly knocked down. So.....Whose gonna say uncle, will be it be China or the US? That is a very tough question, and impossible to answer.
1) The US does have a lot of debt at the government level all the way down to the people of the nation. The Chinese governments at lower levels have high levels of debt, but not as much at the national level.
2) The US has a better infrastructure in place to deal with prevention of AIDS and medical ailments than China.
3) The US government holds 8500 tonnes of gold while China holds 500 tonnes. The Chinese government holds hundreds of billions of US dollars in their currency reserves. A switch to holding bullion would drive down the US dollar. A switch to the US having a gold-backed currency would be a tough sell, since a lot of people will not trust the Americans for de-coupling the gold standard in 1971.
4) Both countries have nukes to sway foreign threats.
5) The US occupies Iraq, China does not.
6) The US has a lower population base than China.
7) Both countries are going to have to deal with an aging population.
8) China has developed itself into the manufacturing country of the nation, while the US lost this status from earlier in the past century.
I am assuming that it will take up to 2016 to 2020 before we are going to have a recovery at the social level. We had such a long bull market with rules and earning stretched to the limit. When a rubber band is pulled, it usually moves in the opposite direction just as hard. Things will definitely continue to get uglier before things get worse. Analysis of the above 8 points, I would have to place favor in China for a future economic engine and place of investment. The US peaked in its stock market and business expansion in 2000, and will probably fight the current bear market tooth and nail like Japan has done since 1989. All countries will suffer when the US recession does kick in and things take a turn for the worse. Times will be tough, but Japan and China should be the first nations to recover from the turn down. I think the US will be calling "Uncle" later in the coming decade, lets hope that country relations are maintained in a fair state so no repeats of history occur.
The best thing for individuals to protect themselves is own gold. Its store of value will be realized too late for most. I joined the gold party last year, well after many other astute individuals picked up on gold bottoming. It is still not too late. Elliott wave analysis is my forte, and based upon the Gold BUGS Index, we have a long ways to go before the markets top out, 2010 and beyond.