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SUB-ROSA TRADE WAR
The winds of war are blowing. What is brewing is dangerous and ominous. Put aside the military warfare waged in Iraq and elsewhere. Adversaries have begun to align in opposition on a financial battlefield. Imagine an old manner of battle to the death from the Old West. A native plains bare-chested warrior and an anglo blue-coat soldier, or a nomadic warrior and an anglo settler/hunter, would be tied arm to arm with a rawhide strip. They would engage in a fierce hand-to-hand battle to the death with knives, unable to gain distance. That is the image in my mind as the upcoming trade war with China forms a foundation with clear directional pulls. The two nations, the USA and China, are inextricably linked through commerce. On the surface, the link appears to be mutually beneficial. Each is put at extreme risk, but for different reasons. Despite the inter-dependence, a titanic battle is soon to begin. The hint of war is unmistakable and unambiguous. It will in its early stages emerge as a “sub-rosa” protectionist exercise (hostility under the table), sure to morph into outright trade war. Residents inside the USA remain asleep and largely unaware. Frustration from lost financial security will soon find a focal point, an object of hatred, upon which to vent extremely hostile emotions. They might not trust USGovt authorities and their shallow reassurance of global trade benefits. At this point in time, they are not adept and aware enough to comprehend that trade with China is bankrupting our nation in the aggregate. They will soon awaken. We saw the same conditions before World War II with Japan, as each fought over growing economies. Two emerging industrial powerhouses waged war over competitive trade. The battle quickly spread to military conflict. Given the huge stakes nowadays, and the countless millions of innocents who risk being collateral damage, but at the same time operate as critical players in the financial war, the trade war will develop “sub rosa” since each is capable of harming the other so mortally. The plains warrior new industrialist and the anglo hunter old capitalist want mutually beneficial commerce. Instead, they have the lethally imbalanced exchange where over-expansion, over-production, and inflation threaten China, while lost income, credit dependence, and bankruptcy threaten the United States. If not for our discarded “dirty” manufacturing for “clean” financial engineering, military conflict would be just over the horizon. Our inflationary machinery has temporarily provided a stay of execution, since the real economy is in a plain depression. Instead, the perilous risk of military conflict lies in the next decade. The US Economy, complete with its army of spenders on credit cards, and the Chinese Economy, complete with its army of workers in factories, provide the world economy with its current engine. Chinese equipment is purchased with cash straight out of the US financial credit system. Instead of carrying debt obligations with Asia as debtor, the buildup amazingly comes with Asia as creditor and owner of the capital equipment base. This is a massive inflation backfire. Anyone who fails to recognize that the financial stimulus from the United States is generating Asian growth is out of touch with economic events, or unwilling to examine facts, or possibly unable to discern and to diagnose clear unmistakable deadly symptoms. Observers are either totally blind or pre-occupied by the next whizbang retail item offered with an attractive zero percent deal. They are either unable to distinguish the main economic structures or distracted by the pressures of their daily lives. They might be falling victims of disinformation. Worse yet, they might just be permanently unaware, ill-trained, unconcerned, or ignorant. SLEEPY TIME, SLEEPY HEADS Our nation of financially and mathematically illiterate citizens fails to comprehend and distinguish economic matters adeptly. Numerous contrasts can be stated which illustrate the perceptual and analytic inadequacies and shortcomings of our citizens as trade war looms. Such extreme misconceptions and misguided policy have led us to ever-widening imbalances which cannot be resolved under the current system and the current leadership. Nothing compares with the failure to comprehend the grand mega-trend reversal at work and still very much in progress. The Strong Dollar momentum in the last decade served as a tail wind which has now shifted into a deadly headwind of rising energy costs, rising production costs, and rising household costs. At the same time, in the past decade an overly valued USDollar enabled an Asian industry build-up to such an extent that prices cannot rise in the USA in either the manufacturing arena or the service arena. Their manufactured exports to our land are too omnipresent. The ease of service outsourcing is too simple.
We are providing as a nation, via our monetary stimulus of artificially low interest rates, a giant assist to China and its economic development. We see a gigantic mercantilist state in full uninterrupted development. The Chinese middle class is growing rapidly. Until it is able to absorb their considerable industrial output, theirs will remain a large and growing mercantilist economy hell bent on expanding their export trade. They are becoming expert at exploiting their lower labor costs, their absent regulatory drag, and their non-existent environmental obstacles. The effect to our homeland is an eradication of the remnants which survived the last two decades in the manufacturing world, e.g. home appliance makers such as Maytag, air conditioner makers, and others. The more current effect is the gradual devastation of widespread service functions. Rather than identifying the long list of vulnerable niches, an easier task is to list the safer areas: health & medical care, restaurant & food business, car maintenance & repair, home repair & remodeling, government service. We already have x-ray reading by Indian doctors. Someday we might make a broadband connection to India for car problem diagnosis. Note the low pay scale structure inherent to each among their respective worker class. Fringe benefits are available to some among this class, but in far smaller numbers than in the professional and union classes which have been supplanted in our evolution. Or is it de-evolution? Methinks it is the latter in the ladder of decline. One must maintain the appearance of cooperation with our Asian trade partners. The United States and China are joined commercially, a tie which deepens and broadens each year. If either feels under attack or siege, they will react in a way that hurts each other. China can hurt the USA badly. Despite our bravado, arrogance, and strut of superiority, we are amazingly vulnerable, not them. They can locate new markets to sell their high quality, low priced finished products far more easily than we can identify new potential bagholder suckers willing to take on our avalanche of indebted paper. The currency risk and eventual stress to the US credit market represent giant risks to any party accumulating more mountains of our corrosive paper financial securities. Eventually, domestic economic weakness will undermine our position as debtor. Protectionism and trade war will loom as the likely outcome, by default, in an obvious appeal to human nature. Those who cannot see its inevitability are asleep or downright naïve. UNSAVORY TACTICS OVERLOOKED Gone are the days with concern over sweat shops, worker conditions, coerced low pay, exploitation of the young, and US masters cracking the invisible whip. Once upon a time, if Nike would sell shoes from a sweat shop in Indonesia, criticism and public humiliation would follow. If Kathy Gifford sold clothes from a Central American sweat shop, public outcry and apology would follow. Those days are gone, a distant memory. We do not care anymore about worker conditions, as long as we see low prices. The 1999 Most Favored Nation status granted to China came with certain clearly stated conditions. China pledged to honor US copyrights, and would pay homage in the form of royalties for software, music, books, and would respect patented trademarks. While pirated Microsoft software is routinely seized, more illegitimate inventory surfaces from fresh new production plants. Unlikely as rumor, almost certainly fact, those plants are owned by the Chinese Army. Do the research yourself, and their Army is behind most piracy, a veritable wide highway to provide an income stream. The pirating of other copyrighted material is rampant in Asia, mostly without law enforcement. Global trade has shown itself often to be a one-way street, with Asian property theft far more prevalent than our national leaders are willing to admit or negotiate away. To cry foul too often by our leaders would jeopardize bond sales to Asia. Not only sweat shops are overlooked by US investors and shoppers, but also dubious social and medical practices. The Chinese are notorious for extracting livers and kidneys from condemned prisoners facing execution, which feed the medical organ transplant trade in a vastly understated volume. The Chinese adoption agencies have made a brisk trade of providing baby girls to the US market of hopeful parents. At least the Chinese offer up healthy little girls, unlike the Russians and Romanians, who offer up critically sick children from orphanages with incomplete documentation. My personal experience includes two Russian babies adopted by a family friend, and their associated $25 thousand medical bills. Chinese households are urged to put their baby girls up for adoption, in a national spirit to assist population control. My personal experience includes a woman who adopted such a baby, a co-worker who named her baby Cecelia. She was so cute that my friend adopted a second at a price of $20 thousand, the same cost as little Cece. We as a nation pay little heed to internal worker and social conditions. It is not our problem if tens of millions of baby girls suffer the fate of rejection. If a liver is made available to a sick patient here, then many thanks to the prisoner with no voice. If Wal-Mart and a host of other “big box” superstores benefit from cheaply built products to stock their shelves, as do our buyers with low prices, then we believe a perceived benefit. A well-informed, very bright, and generous cyberfriend from Hong Kong has provided me a lifeline of reliable information from his country for more than four years. My friend Jay tells me that baby girls are under-reported in census systematically. Families answer by telephone and door-to-door query by their government. Those same families lie about newborn babies born and living under their roofs. My friend tells me that in the last ten years, the pitter patter of the feet belonging to as many as an extra 100 million little girls must be factored in. So the argument that tens of millions of young Chinese men will not be able to find wives might be exaggerated, an argument for increased Chinese militarism. A vast under-count has taken place, as the nation has come clean on its growing population. That revision of +100 million constitutes more people than reside in Germany. Jay’s favorite story is that the total number of Chinese people named Chen or Cheng or Chang or Chuang or Tsang is roughly 350 million, far in excess of the entire US population. This common name is like our Smith or Jones, or the Russian Ivanov (Johnson). Entire small rural villages bear such names. My travels have crossed several with such names, in graduate school, as co-workers, and a current friend. EXAMPLE: MACHINE TOOLS INDUSTRY A case in point is the machine tools industry. We Americans are without a doubt asleep at the wheel regarding industrial changes, big changes. With the aid of gargantuan (and growing) trade surpluses, China has moved from virtually a zero participation in the machine tools business to the position of a strong rival now of the United States. How did that happen so quickly? A story was recounted to me one year ago by the same friend Jay. The impact of the story was chilling. Its memory is equally chilling. In my conversations, the story has been told a few times. Why not one more for the record? In the summer of the year 2003, Jay was made aware of a US Congressional delegation which made a month-long tour across several major machine tool plants in China. Their tour is highly enlightening on several critical parts of the business. Each was addressed by the 30 members of the delegation over the month, whose trip seemed to take on a life of its own. At the onset, the common tone among the Representatives from the US Congress was excitement and enthusiasm, fueled by a warm glow from the prospect of mutually beneficial cooperative trade. The tour group noticed right away that automated equipment was newer, quieter, sleek, and operated smoothly. When they asked the local managers, they were told of the degree of sophistication and its advanced nature. Purchased from Japan, equipment was in most cases one generation ahead of what US competitors use in their plants. Both countries use computer aided design, computer aided manufacturing, commonly called CAD/CAM. What might differ is the degree and complexity of command and control exerted upon the equipment which cuts and molds with extreme precision tolerance, and one level more advanced design capability. By the third or fourth planted visited, the delegation noticed that the Chinese plants had almost half the number or workers as US machine tool plants. They were told of the advanced nature of the Japanese state-of-the-art equipment. It enables far fewer workers, more automation, and greater efficiency, and lower variable cost. Inquiries were made as to the pay scales. The managers were quick to boast that the Chinese engineers were very well paid by their own standards. A follow-up revealed that their highest paid workers earn roughly one third of what US technicians earn. By this time, as more details had been revealed, enthusiasm had become totally neutralized. Members touring the sites had clung to the glow of cooperative trade, and its certain mutual benefit. In all, seven sites were on the schedule to be toured. They proceeded, and the topic of debt was raised. Then came the shock. The businesses producing machine tools in China have almost zero debt. They pay as they go with cash for their equipment in a step by step fashion, earned as profit from ongoing operations and considerable profits. A few concluding dinners were assembled for the delegation, which had taken a more subdued tone, best described by outright dejection, defeat, and despair. A few members actually said “China is going to bury us. The USA cannot compete with this” to each other, as well as to their hosts. Lost was the confidence and excitement, if not the good will. These are chilling words which bring a tingle down my spine as they stream onto the page. Our Chinese competitors are building their plant with export surplus, largely funded by our growing federal debt and consumer debt. This is an enormously dangerous pattern. These machine tool firms in China accumulate no debt. They have much lower labor costs. They have equipment more advanced than ours. Comparative advantage? Are you daft, blind? Is your brain plugged into a video game? Where have you been in the last few years? No way. The Chinese advantage is universal. The biggest recent threat is the migration of the penultimate design function, highest on the food chain. We give away our only advantage (technology), as they slowly wrestle away the design function. See the Dell Computer summertime announcement of their design teams now working in Taiwan. A tragedy unfolds of epic proportions. Political leaders and their economic advisors encourage the ongoing gutting of our nation’s manufacturing and information based service economy. Our national economic policy is utterly incompetent, absent, void, vacant, empty, and emanates from numb skulls actively executing backward thought process and policies totally in conflict with established economic theory and precedent. LABOR & CREDIT MARKETS, SUPPLY CHAINS The upcoming conflict with China will be played out in three primary areas. Labor markets will respond to the ongoing hemorrhage of job loss, with gradually more violent actions. Credit markets will gradually be used by China to retaliate, thus rendering the USA more alone in intervention initiatives. Supply chains of a wide range of commodities will be secured by China, thus bypassing the marketplace, and rendering us more isolated. Implications to all three are dangerous and huge, but mostly under-estimated by our crack team of economists. The US manufacturing base has been systematically dismantled. We as a nation have fostered the growth of the Pacific Rim for three decades. The fruit of this policy inside the USA is increased poverty, a shrinking middle class, and a frightening rise in debt in offset to the wealth lost. We most definitely cling to the belief that service is higher in the evolutionary chain, superior to the dirty industries. However, they are both important. The basis of wealth creation is added value, certainly more key to the manufacturing process. Services usually support the process of making products, farming foodstuffs, or mining materials/metals. Whether from the offshore dispatch of our manufacturing plants, or from the outsourcing of service functions, jobs are lost inside the United States. Years ago, the US Economy would retain some comparative advantage even as the mfg sector suffered erosion and abandonment. We retained the design function, steeped in intellectual property. We held firm with much of the management functions, with distribution, with marketing, even some assembly. We have never had any trouble owning the retail function, THE BOTTOM OF THE ECONOMIC FOOD CHAIN. In the financial markets, stock valuations are helped by effective exploitation of cheaper foreign labor, without the added burden of worker benefits. On a higher plane, governments have interfered on a grand scale with any correction in the currency and credit markets. The USDollar has been blocked from reaching a much lower level, a natural course in any corrective process. The US Treasurys have been blocked from reaching a much higher interest level, a natural course in any corrective process. Intervention obstructs the natural correction. When financial solutions are interfered with, political solutions emerge, and with them the potential for a mushroom of conflict. They will come in many forms pertaining to tax changes and other measures based in conflict, like tariffs and strikes. Many will be the response under the table, beneath the rose garden if you will. The upcoming trade war will arrive in stages, urged on desperately by labor. Many of our workers suffer the indignity of having to train their Asian replacements. Such practices amplify the strain which will demand a political response. Many detailed responses, such as tax changes, are outlined in my private newsletter. The USA mistakenly believes that we dominate since we possess and control the open market. Not so, not even close. Structural imbalance carries with it strange consequences. The US mfg output has practically vanished, as in totally disappeared. We cannot export electricity and refined gasoline, the mainstay of our national mfg base. If conflict erupts, how can the USA turn to our domestic alternative when we have none? The principal vulnerability exposed by our China trade lies in the credit market. The USA has become hopelessly dependent upon massive capital import. What used to be only $1.5 billion in required capital per day has risen to a needed $1.8 billion per day. Credit supply in no way offsets the dependence upon Asians for manufactured finished products. IT MAGNIFIES THE RISK. This can be argued in much greater detail. Asians are in every respect engaged in active subsidy of our bond market. They cannot find large markets to “park” such large sums of money. They have no other destination but our bonds, as Richard Duncan described in an article last year. Therefore, they put it in Treasurys, mortgages, and corporates, the major types of bonds. They may be sanctioning the subsidy of housing mortgage rates, which keep housing prices high. Rising home values enable equity extraction, which finances purchase of consumer goods. If (more like when) angered, China will retreat from supporting our bond markets. That day might have already arrived. At one point in late summer, China had pulled back by 90% in their bond purchases, compared to last year. That has left the US Federal Reserve isolated, alone in the battle to cap interest rates. This summer marked an historical development in the commodity arena. China has tendered offers to secure copper and silver supplies, along with energy field development. China has begun its bold attempt to execute an end run around the commodity market, to secure their future supply, and in effect to lock out American customers. This spring we suffered interruption to large Florida construction projects, due to unavailable cement supply. Such disruption will become commonplace. Karl Marx warned that a capitalist will sell you the rope to hang that same capitalist. In this case, the USA will supply the shipping vessels to send commodity supply to China, as our nation suffers from lack of supply. A new battleground will become more apparent soon, supply chain guarantee, much like past shelf space battles in convenience stores. We have begun to sense our vulnerability, but to date, we have not executed on a single action in response. By making acquisitions, China benefits in other ways which are discussed in depth in my private newsletter. China will broaden the field of battle, to exploit their advantages and trump the USA. They have a better hand of playing cards in this grand poker game, and have only begun to use them. We are not prepared for quid pro quo agreements between China and Middle East oil producers, who are very angry at the USA. The battle will put at severe risk and strain the longstanding relationship between the USA and Canada. Expect the USA to become locked out, except where we are willing to deploy our military might to pry open markets for such supply delivery. Expect the USA to demand that Canada put the USA first, even before their own citizens !!! Do not expect our USGovt to sit idly by. The unfolding of events is not only covered in my private newsletter, SUCH EVENTS WERE FORECASTED almost exactly as have occurred. See past writings on trade conflict, growing trade gaps with Asia, conversion of Asian surplus into commodity supply line, scapegoating of China, service outsourcing to Asia, and oil priced in euros. Tipping points and trigger events have been already identified and are closely watched. Consequences of pending disturbances have been outlined in my analysis. Trade war and implications to Chinese supply chain guarantee are central topics in the November issue of the Hat Trick Letter. NEWS TIDBITS "This is lack of interest at the moment -- as the day has worn on, there's been almost a withdrawal to the sidelines by buyers and sellers, and I think it will be that way through today and tomorrow," said John O'Donoghue, CSFB managing director of listed trading. The US Presidential elections take place tomorrow, accompanied by much higher enthusiasm and anxiety than at any time in a great many years. Voters must weigh personal motives with national trends, security needs with economic stress. The Institute for Supply Management said its index of national manufacturing activity fell to 56.8 in October from 58.5 in September. US consumer spending climbed 0.6% in September, in line with expectations, as shoppers splashed out after showing restraint the month before, government data showed. Personal income climbed 0.2% after a 0.3% gain in August. Toyota Motor, the world's most profitable car maker, posted a surprise drop in quarterly profits despite robust overseas sales growth as a strong yen and rising materials and sales costs took their toll. The Japanese car producer booked a 2.2% fall in the third quarter operating profit to Ұ417.6 billion ($3.95 billion), below an average estimate of Ұ445.5 billion from 10 brokerages. That follows a 3.5% fall in operating profit at Nissan Motor, offset by a 9.2% increase by Honda Motor. US Treasury bond prices initially picked up on the manufacturing data, sending yields lower, while the dollar and stocks slipped. But a sharp sell-off in crude oil futures, with New York prices moving below $50 a barrel, helped reverse those moves. Oil prices fell sharply, taking crude oil below $50 on speculation that a US election win for Senator John Kerry could ease the geopolitical friction that helped fuel this year's record-breaking rally. US light crude dipped as low as $49.3 a barrel before bouncing back to close above $50. US crude has spent nearly a month above $50 and peaked a week ago in the mid-$55 range. Reports indicate that Iraqi oil production has now surpassed pre-war levels. The Commerce Department said construction spending in September ran at a $1.014 trillion annual rate, $136 million lower than in August. Oracle raised its hostile takeover offer for rival software company PeopleSoft by 14% to $8.8 billion, and for the first time set a deadline for acceptance of the bid. Citigroup, the world's largest financial services company, denied claims it helped defraud the insolvent Italian dairy group Parmalat. In a filing with the Court of Parma's bankruptcy division in Italy, Citigroup said that the administrator's claims of complicity in Parmalat's accounting scandal are "factually baseless," and "unfounded and completely false." An agreement to provide $500 million of financing to Delta Air Lines came from General Electric's Commercial Finance unit, another positive step in the airline's fight to avoid bankruptcy. Dutch financial services group ING will pay $370 million for the Canadian non-life insurance business of German insurer Allianz, to be funded by floating part of its ING Canada unit. The Boston RedSox won the baseball World Series, in case anyone missed the historical event which reversed the “Curse of the Bambino” inspired by the ghost of Babe Ruth. The RedSox swept the StLouis Cardinals in four games. The Pittsburgh Steelers ended the 21-game win streak by a defeat in convincing fashion of the New England Patriots, who had two key injuries to defender Ty Law and running back Corrie Dillon. In movie box office receipts, “The Grudge” starring Sarah Michelle Gellar led with $22.4 million, followed by “Ray” starring Jamie Foxx with $20.1M and “Saw” starring Cary Elwes with $17.4M. TODAY’S MARKET Today the Dow Jones Industrials wrapped up at 10054 (+27), S&P at 1130.5 (+0.3), Nasdaq at 1980 (+5). TENS yield 4.09% (+6.1 bpt). Currencies closed with Euro at 127.43 (-0.45), JYen at 94.16 (-0.50), Can$ at 81.81 (-0.14). Metals finished with gold at 428.2 (-1.6), silver at 733.0 (+2.0), copper at 130.75 (-2.95). Energy ended with crude oil at 50.18 (-1.58), natural gas at 872.5 (unch), unleaded gasoline at 129.70 (-3.15). Prices are at major futures contracts. Jim Willie CB
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