Breaking China's Piggy Bank
Back in the late 1920's the Federal Reserve reduced the money supply (for their own reasons that probably sounded good at the time) and the result was a loss of liquidity and the Great Depression. But this time it is not the Federal Reserve that is lowering liquidity, it is the Chinese. By withholding the dollars and not sending them back to America through new ious, they have reduced the liquidity available throughout the economy. In effect, China today is filling the role that the hapless Federal Reserve did in the Great Depression.
Written by Dagny D'Anconia
Sunday, 28 December 2008
Money is really a loan from the value creator to the purchaser. You do work for someone, and they give you a tradable piece of paper that is an iou for the loan of work. When you work for paper money you are acting as a banker loaning your work to someone. You are making a loan, just a surely as a bank does. Later when you need work etc. from others you give them the iou of paper currency. You may put money into stocks hoping that the promise of value they entail will be used to create more value that you can take out or trade later in retirement etc.. but it is all trading ious.
The Chinese have been making things for us and piling up these ious in the form of dollars. They traded them for other ious from the US Treasury (T-bills). They did this for many years, and at an accelerated rate since 2003. They kept their people busy and they felt rich on paper. Keeping the Chinese RMB artificially down, and keeping unbalanced trade agreements in place also helped the Chinese keep their people busy at work, and the dollars rolling in. Busy people with wealth on paper keep out of trouble, and that is a good thing for any repressive corrupt regime.
The ious piled up, and when the oil price spikes happened in 2007, it started to look like the US might really be in trouble. Americans started cutting back on their purchases of Chinese imports. Furthermore, the oil shocks were causing food prices to shoot up with rice shortages in February of 2008. China needed the export money to keep their people contented and well fed. They needed a happy successful face to show the world for the Olympics.
Furthermore, the number of Chinese riots was increasing exponentially. In 1993 there were just 8,700 riots. In 2005 it was up to 87,000. In 2006 it had shot up to 599,392. link An extrapolated number of riots becomes over 100 million in late 2008. The data is limited so it is hard to be accurate in extrapolation, however the numbers it was based on were the numbers before the earthquake and the economic downturn, so imagine how many riots must be occurring now. Police in one area recently had their own protest, which is something unheard of since end of the Cultural Revolution in 1977. link
Money was probably going to be needed to keep order, placate workers, and rebuild after the quake, especially with the Olympics coming up. It is no wonder given all this that the Chinese appeared to sell T-bills and dollars, and reduced or stopped buying new t-bills. There was a short respite for the Olympics to make nice for the world scale party, but then the stock markets resumed their drop. Liquidity had begun to dry up in the West.
On top of it all, the Democrats were doing their best to destroy the economy in the US so they could win the election. Hillary and Pelosi were picking fights with China over Tibet and anything else they could use against the Chinese to spoil the Olympic party. (See Cow in a China Shop). It is no wonder given all this that the Chinese appeared to sell T-bills and dollars, and reduced or stopped buying new t-bills. There was a short respite for the Olympics to make nice for the world scale party, but then the stock markets resumed their drop. Liquidity had begun to dry up in the West.
One cannot just blame the Chinese. They tried to return the dollars to America. The Chinese had tried to cash in their dollars by having its sovereign wealth fund (China Investment Corp., CIC) buy into private equity funds, but the funds dropped sharply in value after their purchase. "It invested $5 billion in Morgan Stanley, the second-biggest U.S. investment bank, and $3 billion in buyout firm Blackstone, manager of the largest leveraged buyout fund. Both New York-based companies have lost more than 70 percent of their market value since the purchases." The Chairman of the CIC fund said recently "If you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit. They are crap. They serve to cheat people." (link) Given the recent collapse of the 50 billion ponzi scheme by the former Chairman of Nasdaq, the CIC head is exactly right.
They don't dare to invest in any more large financial institutions such as American banks because of the risk involved. For all they know the Democrat administration could nationalize the American banks, as Bush and company are already partially doing. The CIC Chairman said "The policies of the developed nations on these financial institutions are not clear. Until they are clear, I don't dare to invest in them. What if they go bust? I will lose everything." (link) "Right now we don't have the courage to invest in financial institutions because we don't know what problems we will put ourselves into." link
They tried to buy Unocal (the gas and oil company) in 2005 but were rebuffed for political and national security reasons. (link)
They didn't want to use dollars buy imports from the US because it would put their own workers out of work. Having workers idle is more than just economics in China - it is a matter of political survival for the ChiComs.
Even "safe" investments were not safe. As much as $5.4 billion of China's money was frozen in a U.S. money-market account. (link) Needing somewhere to put the dollars, the Chinese grudgingly resumed purchasing t-bills that are returning next to nothing. (link)
It is not easy to get value from all those dollar iou's - especially with the bunch of crooks we now have in charge, and about to be in charge of the Federal government. The Chinese don't trust the US government, especially Obama and the Hillary retreads infesting his imminent administration. They especially don't like Hillary who they consider to be a two faced traitor. They have contempt for the huge salaries of CEOs and financial managers who are absolute failures. Thus they have no stomach for bailing out failed American big businesses, banks or governments. Any prudent investor would be leery of parting with his money, and China is no exception. When China bailed on the US, so did investors world wide.
Back in the late 1920's the Federal Reserve reduced the money supply (for their own reasons that probably sounded good at the time) and the result was a loss of liquidity and the Great Depression. But this time it is not the Federal Reserve that is lowering liquidity, it is the Chinese. By withholding the dollars and not sending them back to America through new ious, they have reduced the liquidity available throughout the economy. In effect, China today is filling the role that the hapless Federal Reserve did in the Great Depression.
The Federal Reserve et. al. today have vigorously tried to increase liquidity by increasing the money supply through the bailout etc. Giving out money is what the government does best - especially to cronies and key thug constituencies. So quite sensibly the Fed et. al. have done their best to compensate by increasing the money supply, while the powers that be direct the booty toward fellow leftists and political elites in a manner reminiscent of Russian oligarchs under Yeltsin and Putin.
Meanwhile Americans keep buying things from China and sending China dollars that disappear from circulation because the Chinese are afraid to spend them. If the Chinese suddenly returned the dollars to America the money supply would increase so sharply we would have huge inflation. However, the Chinese are unlikely to do that.
They cannot just let the RMB rise and start equal trade. If they have fair trading conditions they will not have enough work to go around in China and the riots that are endemic will increase. The ChiComs got into office using a mob mentality, and they may be removed by the same. He who lives by the sword dies by the sword. That fear of mobs hangs over them like Damoclese's sword.
Even in China people are speaking out about revolution: "The redistribution of wealth through theft and robbery could dramatically increase and menaces to social stability will grow," Zhou Tianyong, a researcher at the Central Party School in Beijing, wrote in the China Economic Times. "This is extremely likely to create a reactive situation of mass-scale social turmoil," he wrote. link
Meanwhile America's economy and the rest of the world has been going in the tank. Chinese workers are losing their export jobs as companies go out of business. Riots of out of work workers are increasing. Sooner or later the Fed et al under the free spending Democrats may succeed in increasing the money supply so much that they in effect devalue the dollar in spite of the Chinese controls. All those dollar ious will become pretty worthless. The Chinese are in a real pickle.
The first week in December the Chinese actually lowered the RMB (link), causing an abrupt drop in the US stock market. A drop in the RMB would have been a disaster - a game of chicken that would have plunged both China and the US into the abyss. All heck broke out diplomatically and financially.
It was a harsh message just before Paulson came to China: Be nice and kowtow or else. As the head of the Chinese Sovereign Wealth Fund said "Be nice to the people loaning you money". From the Chinese point of view we are the moral degenerates who borrowed and cannot repay. We have lost face and should show appropriate shame and submission. Psychologically from their point of view, they won the economic and social war and we should surrender.
Who is to blame? The bank (China) that does not think of the future, or the borrower (America) that does not think of the future? The Chinese maintained this imbalance through unfair trade practices. Our own traitorous people voluntarily agreed to these trade agreements. It kept America on a fat, dumb, and happy consumerist Democrat path toward socialism, and it kept the Chinese workers too busy to riot. (See article) It served everyone in power's political purposes - until now.
There is a potential solution to the dilemma and Paulson and the Chinese was able to secure a deal for it: The Chinese banks are coming to America. In addition to agreeing to slowly devalue the RMB, China "promised to ease restrictions on foreign banks by allowing their local subsidiaries to trade bonds on the same terms as Chinese institutions. Washington agreed to speed up approval of licenses for Chinese banks to operate in the United States. The two sides promised to cooperate more closely in regulating financial risks." link
Instead of working through the big shots at Blackstone, Goldman Sachs and their revolving door to government, they have gotten permission to do direct banking to American companies and individuals. they have a high opinion of the American people. The CIC head says "I have great admiration for the American people. Creative, hard-working, trusting, and freedom-loving." link Thus going more directly to the American people they can get value for their ious and dollars and not get ripped off by the kleptocracy now running Washington and New York. Furthermore, the Chinese banks are on a talent hunt looking for banking expertise to hire in the US and England that can speak good English and do good banking work. link
The plan also includes allowing American banks in China. Thus American banks can accept deposits and make loans. This constructs a financial pipeline from the excess of funds in China to the deficit of funds in America. It is a pipeline for the liquidity, but one done wisely. Compare that to the plans of the American Left which plans to give money to those least able to manage it.
This is a potential solution, but not a quick one. Loans will be made on a case by case basis which takes time. It will take time to set up their systems and structure. Loans may have political biases and hoops to jump through and that may hold up things. The backlog of money is huge, and there will be caution as the economy falters.
Will it be quick enough to straighten things out before a worldwide great depression develops? Will the Democrats kill the deal out of greed, racism, and spite? Will the frugal Chinese take the risk and help financially bridge the gap between the solution and the meltdown? Will our own government manage to inflate the Chinese debt out of existence? There are many relevant unknowns.
There are several possible potentially overlapping outcomes:
The world economy could continue to deteriorate and China could have uncontrollable urban unrest. Given that more people in China believe in the free market than people in America, China may become more free and a bastion of free market liberalism, with Chinese characteristics. In fact out of 20 countries surveyed, China was more of a believer in the free market than any other country, including America. link Just this week a letter was signed by 303 prominent rebel leaders in China who see this crisis as an opportunity to shift China toward real democracy and reform. link Of course the ruling elite in China will try to blame the disaster on capitalism and revert to more communism.
Money may flow freely into America to increase liquidity through the Chinese banks, causing a recovery as liquidity to businesses and individuals bypass the elite who got us into this mess in the first place. Small manufacturing enterprises could get the funding they need and the fat cats of GM and the unions could go to heck. Small businesses could help support a revival of free markets and individualism in America. International banks with activity in China and the US such as HSBC may become a pipeline to move investment money where it is most needed and profitable.
Obama and Hillary may kick out the Chinese banks or demand unreasonable bribes so that the world economy continues on this path until there is depression and violence in many nations. For example, what if Obama and company regulate that China's banks are required to loan to deadbeats of color in inner cities? They must be drooling over the prospect of Chinese money. A few well placed bribes to Hillary may smooth things over, but the Chinese have already been stung by her fecklessness.
What if China uses its new found financial freedom in America to bribe and manipulate political events in their favor? Could they take Taiwan with our approval? Could they gut our military? Could they extract even more egregious trade agreements? It seems to me that this has already been done to a large extent.
With the new agreements on banking, the kow towing of Paulson, and the Chinese realization that they need to recover in tandem with America, they may already be helping to undo the damage to the economy. They have begun a program of investment in their own domestic needs to placate the "ordinary" people outside of the major cities. link They are in effect trying to bribe the rabble into passivity. This is increasing their liquidity and may thus be indirectly freeing up some liquidity in America as well.
If you were a wealthy Chinese bureaucrat, and you saw massive unrest ahead what would you do? You would take your money and put it outside of China to buy alternative homes and objects of wealth. The dollars locked away would be freed into circulation. Perhaps we are seeing some of this now. The ious accumulated by the Chinese have been hoarded for a long time, and just perhaps we are now seeing the freeing of the dollars, and a financial recovery in the making.
Just a few days ago a dissident published "The 08 Charter" which is a manifesto of political and legal reform.(link) It read "The current system has become backward to the point that change cannot be avoided." ... This situation must change! Political democratic reforms cannot be delayed any longer!" It was signed by 303 academic and other free thinking leaders in China who brazenly braved arrest for this act. The dissident Liu Xiaobo was promptly arrested, as he had been for his role in Tiananmen Square. Things are afoot now that have not happened since the great Revolution that brought the Communists to power.
A very helpful TTP'er in Beijing reports that the riots are widespread in third tier cities and rural areas away from the centers of power. More than 60% of the population is in rural areas. While China reports continuing economic growth of 9% (link), our contact reports 0% growth for recent and upcoming quarters.
Whether the dollars flow out in an orderly way under the current Chinese government, or in a disorderly way in a revolution, or in fleeing wealth, the dollars are going to flow back out. When they do the liquidity will return, banks may get their nerve back, and hopefully the liquidity crisis will be over. The Chinese piggy bank is breaking open, and hopefully some freedom and prosperity will flow out along with their carefully hoarded American dollars
