We have long forecast a move by China to invest some of its vast ($1.2
trillion) in non-U.S. Treasury securities. We have long urged our investors to
imitate Harvard and to boost their overseas equity asset allocations, where they
are better rewarded than at home in domestic markets.
Today, The Wall Street Journal has two front page articles on this subject.
One article describes how, in keeping with their general announcement earlier
this year, "China plans to invest $3 billion in private equity firm Blackstone.
The landmark deal signals the country's determination to earn higher returns on
reserves. …"
The article goes on to say that, "…Blackstone may gain a potential advantage in
deals in China." If that proves to be so, it will likely boost the aftermarket
price of Blackstone's IPO share price (currently $29-$31). To that extent, China
will have pulled off another relatively small coup as its new shares of
Blackstone can be expected to climb further.
Story Continues Below
Our readers will know that a most important Chinese delegation, containing
almost half their cabinet is to attend a two-day meeting, starting tomorrow in
Washington, hosted by U.S. Treasury Secretary Hank Paulson.
This meeting is part of a vitally important series of top level economic
meetings between the two countries. The stakes are so large that we feel these
meetings are the economic/financial equivalent of the presidential "Hot Line"
contact between the U.S. and the U.S.S.R. in the bad old days of the Cold War.
As the late Sir Winston Churchill once said, "Jaw, jaw is better than war, war!"
[Editor's Note:
Forget China.
This Is Asia's Next Tiger.]
These top level meetings between these two economic giants are "jaw, jaw." By
ensuring open and frank discussion of the major issues, they act to lessen
market concerns and over-reaction to any perceived major move by China, for
instance, to diversify out of U.S. dollars into other currencies or even into
gold.
In short, these conversations can enable major economic tensions to be discussed
and managed in a manner that will cause the minimum of damaging over-reaction in
the economic financial markets.
As the Journal also points out, "continued investment in U.S. entities could
help restore some equilibrium to China's accounts with the U.S. and thus
alleviate one of the biggest sore points between Washington and Beijing.
In this respect, we feel China's announcement of a $3 billion investment in
Blackstone was a strategically timed goodwill gesture.
The profoundly sad thing is that the Iraq war has so seriously reduced the
prestige of our White House led government that today, a Democrat dominated
Congress, thinks it knows better than our Treasury about international monetary
and trade matters.
Of course, a cheaper currency helps to boost exports, at the margin. It is also
true that China's government must "deliver" to its people.
But, as Stephen Roach, chief economist at Morgan Stanley research, maintains,
the central issue is not relative currency valuation, but the vast disparity in
relative savings rates.
China has a very high savings rate and spends relatively little on importing
goods from America.
On the other hand, we in America have a chronically low savings rate and suck in
massive amounts of low cost goods from China. Hence, our vast trading imbalance
with China is created.
In addition, by importing cheap goods, we have imported a vast amount of
deflation from China.
Our Democrat dominated Congress appear not to understand the key issue of
relative savings rates. They concentrate instead upon the apparently more easily
visible and popular matter of relative currency rates.
[Editor's Note:
5
Inflation-Proof, Recession-Proof Stocks to Buy Now.]
If our Congress were to enact tariff walls against China, they would unleash a
massive inflationary effect on our economy and strong upward pressure on our
interest rates.
It is also probable that China would retaliate with discriminatory tariffs
against the United States, benefiting our international competitors in entering
the vast Chinese domestic market and capturing early, brand conscious market
share.
We believe that tariff barriers would be very damaging to our country.
History shows clearly that tariff wars have led all too often to hot military
war.
History also shows that tariff walls tend to keep uncompetitive companies alive
long past their "sell dates," and hurt national competitiveness.
Ultra strong currencies in countries such as Germany and Switzerland made them
highly competitive. Indeed, earlier this year, Germany displaced the United
States as the world's largest exporter.
Last month, China pushed us into third place.
We believe the long-term answer is for America to compete — not just in
production but in savings rates and by reducing an "over kill" of costly
regulations, such as Sarbanes-Oxley.
Things have now become so serious that we feel it may even be time for Congress
to remove the second mandate (to encourage economic growth) from the Federal
Reserve to enable it to become more truly competitive with other central banks.
As our readers will know, we believe the CPI is politically "cooked" to the
downside.
As most people believe the published CPI, the reversed Treasury yield curve and
the TIPS spread must be suspect as indicators. In the meantime, they have
allowed our Fed to keep its rate falsely low.
These misleadingly low interest rates, when combined with massive liquidity have
encouraged a "spend, spend, spend" mentality and a gigantic asset boom.
This, in turn, has encouraged not savings but a negative savings rate in our
country and the massive importation of cheap products from China.
Finally, it seems strange that our Democrat Congress, should, in criticizing
China, turn such a blind eye to the massive depreciation of our own dollar.
For a number of years, China pegged her yuan to our dollar. In July 2005, China
pegged her currency to a basket of currencies of which the U.S. dollar is a
major component.
[Editor's Note:
4
Foreign Currency Plays to Beat the Falling Dollar.]
Since then, the yuan has depreciated some 7.23 percent against their basket (see
Bloomberg chart 1).
Chart 1
In the meantime, over the same time period, our U.S. dollar has depreciated
against the international currency index by some 8.83 percent (see chart 2) and
against its main reserve currency competitor, the euro (see chart 3), by a
whopping 12.24 percent!
Chart 2
Chart 3
In light of these statistics, to criticize the Chinese for "predatory"
currency depreciation is, in our opinion, somewhat like "the pot calling the
kettle black."
We should also remember that the Chinese government, like our own, has to keep
its export dependent people happy.
All this being said, the massive trade imbalance between the United States and
China is still a most serious matter. The fact that these two giants are talking
and not fighting is good — very good.
In the meantime, America has to learn to compete with a massive and new
competitor.
Some very tough negotiations lie ahead. The risks of failure are very great.
We believe that, despite a "hot-headed" Democrat Congress, reason will prevail
and that America will compete successfully, over the long-term, just as we did
against Japan.
Editor's Notes:
