You may know that 2009 is the Chinese Year of the Ox. But I bet you didn’t know this: Each Chinese New Year is marked on the second new moon following the winter solstice. Trivia? Yes. Trivial? No. There is so much that we in the U.S. don’t know about China, yet we coexist with this country in a most unlikely symbiotic relationship.
There are many who say that the U.S. desperately needs China to finance our current wave of debt through their purchases of our bonds. Who else if not China? On the flip side, if not the U.S., then who will trade with China at the volume sufficient to support their ravenous need for growth?
Unlike Europe, China remains a mystery to us. I am not an expert in European politics, but if I find myself lacking, I can access reliable expert resources. When it comes to China, where do I turn to for insightful, reliable and predictive analysis on their politics and economics? In fact, where is the line between China’s politics and a Communist party controlled and Politburo-directed economy?
“Visibility” is a word conventional economists use when forecasting future trends based on current indicators. In the Western economies, we can rely on the visibility provided by the government and private sector data. But even “opaque,” I believe, is a generous word to use when it comes to data coming from the official Chinese ministries.
China is a country of more than 1.3 billion people led by a small cadre of members of the ruling Communist Party estimated in the thousands. Certain progressive reforms helped create an explosion in manufacturing exports, but a critical factor in sustaining those exports has been an artificially low exchange rate between the yuan and the U.S. dollar. The result has been a trade imbalance, by which China is now sitting on more than $2 trillion in foreign currency reserves. They are holding $750 billion in U.S. Treasuries, $500 billion in agencies, and estimates place their sovereign wealth fund holdings in corporate bonds, equities and money market funds at another $300 billion.
While the U.S. went on an easy-money buying, spending and borrowing spree, the Chinese dove in head first. Now the party is over, deflation is here and the Chinese are unhappy at the losses evident in their U.S. portfolio. Premier Wen says, “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.” What is he really saying? The last thing he wants is a rising yuan, because that would devastate exports.
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I see China as a spinning top: As long as it maintains momentum, it can continue to stand on its needle spindle. Should that momentum slow too much – and the top falls over. Already China is experiencing massive job losses and public unrest as tens of millions of rural migrants are now out of work and socially displaced – and that’s at an estimated 7% GDP growth rate! While some would argue that China needs to reduce this massive reserve balance, their only real option, currently, is to keep buying U.S. Treasuries to support the U.S. dollar and finance our economic recovery – in order to sustain theirs.
China has hitched its future to the dollar, and its interests as both major exporter and creditor to the U.S. are at odds. It wants to keep an annual economic growth rate in the double digits in order to maintain reforms. However, historically, such growth is unsustainable, and progressive reforms – short of more economic and political freedoms – can only carry the economy so far.
The U.S. continues to spend as if debt didn’t mean anything, and China’s spinning top is losing momentum. Something has to give. If they decide to unpeg the yuan from the dollar, stop buying Treasuries – or, at worst, sell their dollar holdings – that would likely mean skyrocketing interest rates and a dollar freefall. None of these would result in pleasant memories for the Year of the Ox.
Bill Fox has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional traders spread around the globe.