The Heat Is On

Published on November 16, 2009, 12:36 pm
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He lied like a finance minister on the eve of devaluation.

He Doesn’t Mean It

US Treasury Secretary Tim Geithner has been going around giving speeches saying that the US wants a strong dollar. He means the opposite. The US wants a major devaluation of the US dollar against the Chinese renminbi and other Asian currencies. In other words, a weaker dollar. And with the sick US economy, he doesn’t want the US to have to raise interest rates.

In my opinion, duplicitous as the US approach is, a devaluation of the dollar is probably the best outcome for both the US and China.

Keep an eye on the APEC meeting in Singapore and Obama’s Asian tour. The heat is on China. And maybe America too. The world desperately needs change in the international monetary system. As I’ve argued repeatedly, the change should not be some grandiose scheme like Special Drawing Rights or some ill fated attempt to reimpose a real gold standard. Rather, the change must be the graduation of the Chinese currency to “important country” status. In other words, the renminbi has to be allowed to float upward against the dollar, and its capital controls have to come off.

The Bubble Rolls On

Hong Kong is the proverbial canary in the coal mine. With its currency pegged to the US dollar and its economy tied to both the US and China, Hong Kong is a special barometer of what is happening in the greater world economy. To protect its peg to the US dollar and with the US federal funds rate almost at zero, Hong Kong has had to buy US dollars by the boatload. A property and stock market boom in Hong Kong has resulted even as the economy has suffered from the global recession. A clear indication that something is rotten in the world financial system.

“I’m scared,” Donald Tsang Yam-kuen, Hong Kong’s Chief Executive, told an audience of business leaders at the APEC CEO conference in Singapore. “Leaders should look out and watch out. What is happening now? America is doing exactly what Japan did last time. We’ve got a US dollar carry trade at the moment. And where is the money going? It’s where the profits can be gained—Asia. And again you can see the asset prices going up. In Korea, Taiwan, Singapore and Hong Kong and going to levels that are incompatible with economic fundamentals.”

Donald Tsang was Hong Kong’s Financial Secretary during the 1997 Asian crisis. He successfully guided Hong Kong through that difficult period. He is not some glib politician who barely squeaked through Economics 101. If Donald Tsang is scared the world should take note.

The only solution in my opinion is for China and other surplus countries to stop buying dollars. The dollar will then decline, US interest rates will have to rise and speculators will stop borrowing US dollars to buy Asian assets. And the bubble creating carry trade will cease. The US economy in the short run will be hurt but in the long run employment and US exports will benefit. And China and the rest of Asia will avoid an inflationary bubble even if they have to take a hit on their dollar reserves. Sometimes you have to take the short run medicine and pain. In 1979 Paul Volker took the medicine and broke the back of inflation. The US and China have to take the medicine again. This time the medicine is a realignment of currencies.

Chinese Growth – Unbalanced, Part of the Bubble?

Chinese GDP growth will likely come in at over 8 percent for 2009. That’s what the government targeted and that’s what will be reported. China’s 2009 performance—which contrasts with the pathetic stumbling of the American economy – is being celebrated in Asia and is considered an indicator of China’s emergence as a major economic power rivaling the United States.

But a consensus is emerging among what might be termed a global underground of China skeptics that the Chinese growth is overly driven by investment and the stimulus program and is unsustainable. Massive overcapacity and excess inventories now exist in China in such basic materials industries as steel, cement and aluminum. Numerous infrastructure projects have been undertaken financed with the explosion in bank financing but with reportedly low expected marginal rates of return. In any case, fixed investment is now running at an extraordinary 44 % of GDP. That’s not a sustainable growth path.

By this reasoning, the Chinese economy is extraordinarily unbalanced and must slow down in 2010. By this reasoning, the recent global rebound in industrial metals prices may soon be coming to an end. The Australian dollar, which has soared of late on the strength of Chinese raw material demand, could be due for a breather. Long term the outlook for Australia has to be bullish but near term there are now caution flags.

The artificially depressed exchange rate provides financial incentives for both substantial exports of the products of China’s surplus capacity and for further overinvestment in industrial capacity. Articles in the financial press are full of admonitions to China to encourage more consumer spending and to reduce savings and investment. But economies respond to real price signals, not homilies. The American U6 unemployment rate – which includes workers who have given up looking for work – is now at an astonishing 17.5% and the US trade deficit soared in September. The cries for protectionism will get ever stronger on the US side.

On the Lighter Side…

One good long run investment theme is that of US exporters who stand to gain from a weaker dollar. One example – although this should not be taken as a specific recommendation – is Disney (DIS).Disney just announced the planned opening of a multibillion dollar Disney theme park in Shanghai. Disney exports pure Americana. America gets Chinese dollars. China gets Mickey Mouse.

The following excerpt is from the latest column written by Chip Tsao, who is one of the most irreverent men in Hong Kong. Chip Tsao’s column is entitled Politically Incorrect and it is written for a Hong Kong weekly called “HK”. Investors, who may be in need of a good laugh, may find the following of financial, cultural and culinary significance:

“Will Shanghai Disneyland make any money? If you are mesmerized by the sheer figure of 1.3 billion (Chinese that is), the answer would be a definite yes. But it’s not just business. By invading Shanghai, the Americans are declaring war on China by building an ideological factory to counter-brainwash Chinese children, who are currently subject to a nationalistic education and a resurrection of Maoist indoctrination. Unlike the American middle class, for whom Mickey Mouse, Snow White and Buzz Lightyear are household names, the Chinese have little sentimental affiliation with Walt Disney’s characters. Chinese parents and children are unlikely to be moved to tears when they see Bambi’s mother being shot—more likely, they’ll think of venison. The image of Donald Duck serves as a good reminder that a Peking duck needs to be force-fed before being roasted. And the nuisance of Plato’s incessant barking can be settled once he’s made into a hot bowl of dog-meat broth brewed with ginger and spring onion, a traditional Cantonese dish served in November once the weather gets cold.

Opening a Disneyland in Shanghai is thus a decision braver than when the peasant girl Mulan saves her emperor-father’s throne from the barbarians, more exotic than the love affairs between Mowgli and Shanti in ‘The Jungle Book,’ and definitely more dangerous than the fornication between Pocahontas and John Smith. It involves hard mould-breaking work…”

One note: They don’t eat dogs in Shanghai. Pluto is safe.


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