Editor’s Note:

The series continues.

The Chinese revalued the Yuan on July 21, 2005. The financial markets began to factor in a new reality, and the consensus was one of surprise.

In fact, there was little surprise about it, other than it actually happened. As Dr. Joe Duarte’s series of articles in the month of April, chronicled below shows, the Yuan revaluation was in the works for several months, and was even predicted with a certain degree of certainty by Federal Reserve Chairman Alan Greenspan.

In this, the sixth part of an ongoing series, Dr. Duarte explores the Yuan revaluation in retrospect, as well as other key developments that made it something that had to be done by the Chinese Government, due to mounting political pressures.

Part 1 of The China Syndrome concluded that China is not just a power to be reckoned with in the future, but rather that China is a major player in the world now.
Part 2 of The China Syndrome set forth evidence for irregularities in the way China does business, and how the world is looking the other way.
Part 3 of The China Syndrome explores the implications of China's activities on the Asian region.
Part 4 of The China Syndrome described the key aspects of the relationship between China and the world’s other emerging potential Super Power, India.
Part 5 of the China Syndrome explored the bid by Chinese oil company CNOOC for the U.S.’s Unocal.

April 22, 2005

Oil, China, And Greenspan: Conflicts And Consequences

High oil prices and China’s economic policies are the talk of the town. But this time, it is indeed different, as Mr. Greenspan is clearly on a path to address certain “imbalances,” some of which were of his own making.

The House of Representatives passed an aggressive and controversial energy bill on 4-21. According to Reuters, three things stand out: 1) “The Republican-written bill, which passed 249-183, would encourage future production of domestic oil, natural gas, coal, nuclear and other energy sources. It would also boost output of ethanol, a corn-based gasoline additive, and allow oil drilling in Alaska's Arctic National Wildlife Refuge.” 2) “The bill has incentives for renewable energy, but its $8.1 billion in tax breaks are mostly aimed at the traditional energy industry. 3) Democrats said a major weakness was the legislation's failure to set stricter fuel efficiency standards for new vehicles to curb the U.S. appetite for oil.”

The Angry Consumer

According to Investor’s Business Daily: “Consumers are feeling the pinch. Though average gas prices fell 4.3 cents last week to $2.237 a gallon, that followed an eight-week, 38.2-cent surge to a record $2.28, said the Energy Department. Many observers say energy prices are also a big reason why Bush’s approval ratings have slipped.”

Reuters noted that politicians have gotten an earful from their constituents: ["It's about gas prices, gas prices, gas prices," House Speaker Dennis Hastert said. "Consumers are getting squeezed at the pumps. House Republicans want to do something now." However, President Bush, who supports the House bill, acknowledged that it would not lower prices any time soon. "An energy bill wouldn't change the price at the pump today. I know that and you know that," Bush said in a speech Wednesday.}

But, the message is clear. According to IBD “A Gallup poll earlier this month found 44% said it was [“extremely important”] for Congress and the president to address gas prices. “

Even the conservative IBD noted that “The legislation is mainly tax breaks intended to spur U.S. production. The major sections include $1.6 billion for natural gas pipelines, $1.5 billion to expand electricity transmission capacity, and $1.3 billion for nuclear power. That’s considerably less than the $23.5 billion bill the House tried to pass in 2003. That bill contained billions in conservation provisions. Most were dropped from the new bill, as were higher fuel efficiency standards. Some, such as a $391 million credit for energy efficient homes, remain. Way and Means Committee chairman Bill Thomas, R-Calif., indicated the bill was stripped down to make the upcoming House/Senate conference go easier. He said the dropped provisions might be put back in later on. “

Greenspan Digs In On The Yuan

Meanwhile, Fed Chairman Greenspan chimed in on the increasingly popular Chinese economic situation. According to the Wall Street Journal “Greenspan said China will unpeg its currency from the dollar "sooner rather than later" because the policy poses a growing threat to China's own economy. Mr. Greenspan told the Senate Budget Committee that China's peg ["is beginning to significantly work to the detriment of the Chinese economy."]”

The heat is certainly rising inside the beltway. The Journal added “President Bush and Treasury Secretary John Snow also have recently pressed China to loosen the peg, and some lawmakers have gone so far as to ask for trade retaliation for what they consider the unfair advantage the low currency gives Chinese exports in the U.S. market. Mr. Bush's nominee for trade representative, Rep. Robert Portman, told another Senate committee yesterday that he plans to take an aggressive stance toward China. During his confirmation hearing before the Senate Finance Committee, the Ohio Republican promised ["an immediate top-to-bottom review"] of the various trade complaints against China and said he would make an early trip to Asia ["to deliver a strong message in person to the appropriate Chinese official."]”

What makes the Greenspan remarks interesting is the fact that the Fed Chief, in a rather public forum actually described much of what we and other non mainstream sources have been discussing for some time. According to the Journal’s story, Greenspan told Congress that “To keep the yuan from rising against the dollar, China's monetary authorities sell newly printed yuan in foreign-exchange markets. It then attempts to drain those excess yuan from the economy by issuing yuan-denominated IOUs. But ["they are finding some difficulty in selling an adequate amount"] to soak up the expanded money supply, generating ["imbalances,"] a reference to inflation pressure, Mr. Greenspan said. He also said the low yuan is subsidizing labor-intensive industries that use less advanced technology. ["That keeps employment at a maximum, but it also prevents standards of living from rising,"] he said.

According to Reuters Greenspan noted that “the vast currency intervention required to keep the yuan cheap -- with China buying billions of dollars' worth of U.S. government bonds -- risks bloating its money supply. ["That is creating imbalances that suggests that sooner rather than later they are going to have to, for stability purposes, move their currency,"] he said. ["Fixing the renminbi to the dollar is beginning to significantly work to the detriment of Chinese economy."]”

Greenspan added that “Currency intervention was also distorting the proper functioning of the Chinese economy, favoring labor-intensive industry at the expense of more technology-rich enterprises that would do a better job of ensuring future prosperity. ["If the exchange rate began to rise, they would start to move capital into more efficient types of uses which essentially would mean that output per hour would rise,"] Greenspan said. ["Holding their exchange rate where they are is preventing the growth in the terms that would be most valuable for China in the decades ahead. So as far as I'm concerned, it is very much in their interest to move."]”

Conclusion

High oil prices and the Chinese dynamic remain the central tenets of the current global economy.

The word imbalance, used by Mr. Greenspan is clearly applicable to both concepts, as is his central involvement in what is clearly a potentially explosive situation.

On the one hand there is the continued dependence of the United States on foreign oil, while on the other is China’s subsidization of its government run “busy work” economy by the manipulation of its currency.

What Greenspan didn’t note is that both imbalances are intertwined, and that the relationship between them is a dangerous web to untangle, because he had a hand in the acceleration of both dynamics.

If China unpegs the Yuan, its domestic economy, especially that portion subsidized by the peg will unravel. Social unrest, and an economic crisis of some magnitude is likely to follow. And there will be global repercussions.

Among the repercussions will be a decline in oil prices as Chinese demand for oil will be significantly reduced.

This is not new, certainly to those who read this space frequently.

What is new is that Greenspan is out there now, promoting what is an increasingly popular Bush administration policy, the removal of the Yuan’s dollar peg.

More interesting is the fact that Greenspan knows that by raising interest rates he is causing money to leave China and to come to the U.S. in search of higher yields.

In a sense, some of the imbalance is already being addressed, as money from China is steadily coming to the U.S., as is clearly evident from the steady increase in the U.S. Dollar Index.

Greenspan never says anything off the cuff. Every mumble, hrumph, and chuckle is clearly intended to have a desired effect. And in this case, Mr. Greenspan seems to be trying to energize a process of painful adjustment on the Chinese economy.

Greenspan is not trying to cause a global crash. Indeed, he is trying to let the system slowly adjust its way out of the imbalance. But having been involved in multiple crashes before, the Fed Chief knows that things could get out of hand in a hurry. His speech and comments to Congress suggest that he is willing to take that chance.

Above all things, it would seem as if Mr. Greenspan is trying to address the “imbalance” of money flows that went into China when the Fed loosened monetary policy aggressively after 9/11. If and when the market, or the Chinese government listen to Greenspan, many interesting developments are likely to happen.

These continue to be dangerous times. Perhaps the most dangerous of all aspects is that Greenspan’s time as Fed Chief is running out. If the global economy crashes and burns, in the next six months, as the “imbalances” adjust, he’s not going to be there to try to fix things.

April 18, 2005

China: Has The Meltdown Begun?

Anti Japan demonstrations spread to as many as ten Chinese cities over the weekend. Violence erupted in Shanghai.

The Japanese embassy in Shanghai was vandalized by egg throwing Chinese demonstrators over the weekend. Chinese restaurants along the path of an anti-Japan march to the embassy were also vandalized. There were reports of Japanese manufactured cars, with occupants inside, some Chinese, that were turned over or attacked. Japan’s Foreign Minister Nobutaka Machimura, flew to China over the weekend, and demanded an apology for the damage and the ongoing demonstrations and show of popular hostility by the Chinese public against Japan. China’s Foreign minister Li Zhaoxing, answered by saying that there was nothing that the Chinese people had to apologize over.

According to Reuters: “Two Japanese were slightly injured in Shanghai, where thousands of Japanese firms and about 34,000 Japanese expatriates are located, the Japanese Consulate in Shanghai said in a statement.”

In Japan, there are fears of retaliation against China. Reuters reported: “A man hurled a bottle at the Chinese consulate in Osaka, western Japan, Sunday and set himself on fire when officers tried to subdue him, police said. Right-wing groups were driving around Tokyo in trucks fitted with loudspeakers, but riot police prevented them from approaching the Chinese embassy.”

The Village Issue

On April 11, we reported, based on a Reuters story, that two elderly women, involved in a Chinese village riot had been run over by a police car. The situation escalated the level of violence in the village, and according to a Stratfor.com report, as of Saturday April 16, the village was no longer under the control of the Chinese government.

Stratfor, citing its own sources reported some interesting developments at the village.

First, it seems as if the report of the elderly ladies being run over by the police cars was not true, or at least “appears to be false.” But the reports were good enough to spur the population to basically overthrow the local government.

Second, and perhaps more important, according to Stratfor, “the town is now apparently bragging about its vanquishing of the security forces -- displaying ["trophies"] from the clashes, including smashed helmets and burned-out police vehicles, and offering tours of the site of the conflict to people from neighboring villages and towns.”

Report: Trade Deficit With China Is Fiction

Is China a victim of bad data? According to the Los Angeles Time, the trade deficit with China is a “fiction,” and a “misleading statistic.”

The Times, in an article titled “Trade Deficit With China Is Misleading” suggests that the dispute between the U.S. and China on the rising trade deficit, which favors China, is more of a problem with the way the deficit figures are calculated.

The article describes an interesting situation. For example, in the garment industry, U.S. companies in Southern California “do the designs, the patterns and colors and sizing and specs for all the garments made elsewhere. The patterns and instructions are sent over the Internet to factories in China, where the garments are made. They are then shipped back through the ports of Los Angeles and Long Beach and on to stores. Although the patterns that go out over the Internet don't count as ["exports,"] the garments that come back in through the ports count as "imports."

The Times gave an interesting example from the toy industry. “Jordan Kort's Northridge-based What Kids Want Inc. designs toys under license from Walt Disney Co. and the Nickelodeon division of Viacom Inc. Princess dolls and other toys are manufactured in China, but the lion's share of the proceeds from making and selling the toys go to Kort's firm, the retailers and Disney and Viacom. Indeed economists estimate that the Chinese manufacturers earn only 20% of the value of the goods they make for export.” Meanwhile, major U.S. companies are thriving in China. The Times offers some startling figures: 1) “Most world-class products in China are made by affiliates of U.S. and other foreign companies. Motorola Inc. makes a lot of the country's cellphones, General Motors Corp. makes cars, Caterpillar Inc. makes bulldozers.” And 2) “The numbers add up. Affiliates of U.S. companies enjoyed more than $75 billion in sales in China last year and recorded $3.5 billion in profits. None of those sales and earnings by affiliates figure in the export-import statistics.

What makes the situation most interesting, and potentially dangerous for the U.S. economy, in the case of a Chinese financial meltdown is this: official statistics do not “capture the growing inter-relationships of U.S. and Chinese institutions. USC's Marshall School of Business, for example, runs an executive program in Shanghai in partnership with Jiao Tang University in that city. In its first year, the program has attracted 45 MBA candidates from many countries. At UCLA, John Long, head of the real estate investment firm Highridge Partners is backing a new center for the study of China-U.S. business.”

The Times concludes that the problem is the slowing growth of the Chinese economy, not the trade deficit itself.

The article offers even more information that we have never seen published anywhere else, and that when taken with the political problems that we are already aware of, paints a more dire picture of the situation in China.

According to the Times, China‘s economy is slowly and steadily fraying, as it is not equipped to maintain the demands that are being placed upon it. “Infrastructure is failing in China. Factories are operating three to four days a week because they lack electricity to stay open full time. Electrical power is insufficient because railroads can't carry the coal to the power plants fast enough and there aren't enough power plants to begin with. “

The Times concludes that the situation is “ominous,” and describes what amounts to unrealistic expectations leading to major negative complications. “The Chinese government wants to keep annual growth at 8% of the $1.3-trillion gross domestic product so 20 million jobs a year can be created. The government fears unemployment because it can add to political unrest, already evident in frequent public demonstrations in the poorer, western regions of China.”

Where we differ with the Times is in this. The report, citing quotes from several experts, predicts that China will have to increase the value of the Yuan in order to address some of the current imbalances, and to allow Chinese companies to invest in American technology, as well as to form joint ventures.

The Times, in our opinion, is assuming that the Chinese government’s intent is to create a harmonious relationship between the United States and its own economy. When the article concludes “The bottom line: In calling for currency revaluation, Washington is wishing really for a stronger trading partner,” it is itself wishing that something good comes from all of this.

What we are seeing is totally different. What is going on is that a corrupt, old line Communist regime, is on the verge of having to pay for all the bad decisions it has made in the last 50 years of totalitarian rule.

The currency and capital markets are ruthless in their decision making, and have no patience, which is why in the last few days, the financial markets have been roiled.

Wall Street is in the business of risk taking and risk management, not in the business of managing ideology, or the nuances of policy.

So while the argument about the trade deficit being a statistical anomaly is interesting, and at first glance, seems to hold some water, a hedge fund or two that find themselves under water after having invested in the wrong factory, or quasi government company in China, isn’t going to wait around for policy wonks to sort things out.

What The L.A. Times Didn’t Mention

More interesting is this take. Millions of dollars continue to pour into China. The Chinese government is now flush in foreign currency reserves, by its own admission, as reported in recent official reports.

If the Chinese infrastructure is so dilapidated, then why isn’t the Chinese government spending some of those foreign reserves in order to upgrade their factories?

Or is that money already lining the pockets of well placed government and banking system officials along the ladder?

When very large institutions and foreign governments start asking those questions, it is likely to already be too late.

Conclusion

China’s government continues to walk along a dangerous road. By continuing to encourage and organize demonstrations against Japan, the government is hoping to take its people’s eyes off of the increasing instability in certain parts of China, where according to some reports, local governments have lost control of at least one village.

This instability is a result of bad policy, and bad decision making, compounded, year after year, by a corrupt systems. And the end result is that China’s industrial economy is now on the verge of failure due to China’s inability to deliver raw materials, technology, and capital to its industrial base in a responsible fashion. Years of corruption, bank scandals, international companies such as China Aviation Oil Singapore in the middle of questionable transaction investigations, are about to take their toll.

Indeed, it seems as if the emperor’s nakedness is on the verge of being revealed.

Japan is a convenient way for China to keep the public occupied and organized on a common cause. But if the demonstrations go much further, we would not rule out the possibility of worse situations and perhaps, although not likely, even armed conflict, as the government becomes more intent of refocusing the public’s attention on anything else than the steady economic collapse.

The government cannot continue to subsidize the non coastal internal economy while the coastal areas such as Shanghai are prospering based on international trade and access to still cheap money. The result of that system has been the creation of an untenable problem, the severe maldistribution of wealth, the one issue which has been the universal reason for social unrest and the overthrow of governments.

More reports are starting to appear, which are laying bare what is really going on in China, a disaster in the making.

China’s government can’t win. If it negotiates with the villagers, soon enough the word will get out and other villages with problems will also start riots. If the government cracks down, news will eventually get out, and international investors could be spooked, causing money to start flowing out of China, and starting a cascade culminating in a financial and political crisis.

And if it does nothing, the government will be looked upon as being increasingly ineffective and more trouble is likely to start.

The government can’t fix all the factories that need it. It can’t deliver all the coal and oil that its rapidly growing economy needs. And if it can’t do any of these things, it won’t likely meet the obligations to its creditors, and business partners.

If the L.A. Times report is correct, and China’s factories are only running three to four days a week, then one of two things is happening. There aren’t enough orders to keep the factories working. Or there isn’t enough resource availability to meet the demand.

Either way, China won’t be able to meet its obligations at some point in the future.

Based on this latest set of data, and the logical conclusion reached through its analysis, it is becoming increasingly evident that the Chinese miracle has already begun to crumble. One or two more interest rate hikes from the Federal Reserve and one or two more unforeseen events anywhere in the world, or a large enough financial scandal in China, could be the spark that sets off a significant set of problems. The repercussions will be felt everywhere.

We could be wrong of course. But, despite the number of articles and analyses produced by us, and other credible sources, we have yet to find any information out there that refutes the negative case. The L.A. Times article above, is the closest thing to a positive so far. And even that article includes negative reports.

April 14, 2005

China And Japan: More Angry Words

China and Japan are just not happy with each other these days. Since our March 5 story in which we predicted that a potential crisis was looming, things have gotten worse.

According to Reuters: “China reacted angrily on Thursday to Japan's plan to allow gas exploration in disputed waters, calling the move a ["serious provocation"] at a time when ties are at rock-bottom in a dispute over Tokyo's wartime past. ["This move by Japan is a serious provocation of China's rights and international norms,"] Foreign Ministry spokesman Qin Gang said in remarks on the ministry's Web site.”

More serious language was added: ["China has already made a protest to Japan, and reserves the right to take further reaction," Qin said, without elaborating.]

Tensions continue to rise. “In Tokyo on Wednesday, members of a right-wing group shouted slogans at the Chinese embassy, where security has been tightened, and dragged Chinese flags behind two vans, a witness said.”

Much of the dispute has to do with natural gas reserves, which the two countries claim as exclusive territory. See our April 5 archived story by clicking on the archived IQ reports link on the left navigation bar.

European Constitution Vote Panics French President

French President Jacques Chirac may be in the midst of a fight for his political life. The wily and dapper Monsieur Chirac, according to the Financial Times is having to resort to a televised meeting with 80 young voters in order to make a case for a yes vote on the EU constitution. Chirac “will on Thursday night publicly throw his weight behind the campaign to secure a Yes vote on the European Union constitution amid fears of an EU crisis within weeks if voters in France or the Netherlands reject the treaty in national referendums.”

Indeed, the until now little covered story is interesting, and could have a pivotal role in the decisions that many countries make over the next several months. According to the report: “Chirac's decision to stake his personal authority on the outcome of the vote on May 29 after months in which he has let his ministers lead the debate comes amid mounting anxiety in Brussels that the EU would be thrown into disarray by a No vote on the constitution. With doubts also overshadowing a referendum vote days later in the Netherlands, another founding member, EU officials have begun discussing contingency plans for containing any crisis, with a scheduled June summit seen as the focus for attempts to chart a fresh way forward.”

Chirac, seems to have a difficult road ahead “with opinion polls suggesting disenchantment is growing, his appearance is far from certain to win over skeptical voters. The most disaffected are those from the left, who fear the constitution, seen as vital for the smooth working of an enlarged EU, threatens employment and France's protective social regime.”

Of course, this being France, the situation is far more complex, and is full of nuance and subtlety. “Mr Chirac also faces widespread dissatisfaction with his government, led by the deeply unpopular Jean-Pierre Raffarin as prime minister. Jean-Claude Juncker, the veteran prime minister of Luxembourg and holder of the rotating EU presidency, is said by officials to be on standby to co-ordinate the EU's response if France or the Netherlands votes No.”

Some reports have noted that the Dutch press has barely covered the story, making it a non issue in the Netherlands. The other side of the story is that since there seems to be so little interest, the chances of a No vote are fairly high.

According to the Financial Times “The sense of apprehension has been heightened by the fact that the medium-term handling of the crisis would fall to Britain, which takes over the EU presidency on July 1. Tony Blair, prime minister, hopes to be re-elected for a third term by then. He has fractious personal relations with Mr Chirac.”

Conclusion: Dangerous Times Around The Corner

Europe and Asia are in danger of falling into major crises. On one end of the spectrum, Japan and China’s dispute over undersea natural gas fields, could lead to a military confrontation. On the opposite side, Europe’s problems are mostly political for now, but are not exempted from deteriorating into regional or wider conflicts.

But both situations are just different expressions of the most basic aspect of politics, deciding who gets how much of what resources are available.

The European Union, in our opinion, may have come as far as it’s going to come for the foreseeable future. The advent of the Euro as a common currency may be the major accomplishment of the arrangement. There are too many old issues that simply have not been resolved that are still festering under the surface.

A perfect example of Europe’s future is the fact that Germany is making deals with Russia, France is making deals with China, and the emerging republics such as Poland and Latvia are doing all that they can to make deals with the United States.

In Asia, it’s a similar situation. Unresolved war issues from the 20th century are being used by China as a trigger in its land dispute with Japan.

Our conclusion form April 5 is still applicable. “In essence we have two countries where bad economic policy is being magnified by their own internal politics, and the consequences of bad, long term, economic policy. As history shows, countries that find themselves in that sort of position, look for something to unify the population. A tried and true unifier is usually a war, or at least a situation that takes the country to the brink of war. In other words, there is no better cure for a rebellion, and or a recession than a good fight with a traditional enemy. China and Japan, on many levels fit the bill quite well.”

If you change a few words, and shift a bit of the emphasis, by putting France in here, or Europe in there, the above statement becomes a pretty useful template to explain a great deal about what’s happening around the world.

More important is what history shows can happen if these kinds of situations don’t get resolved.

April 13, 2005

China And India: How An American Built Road Could Shape The New World Order

India and China are touting their recent agreement as one that could create a New World Order. But, as it is usually the case, when it comes to new paradigms, the devil is in the details.

Billed as a “strategic partnership,” the agreement focuses on the resolution of a 40 year border dispute, and is built on trade, projected to reach $20 billion by 2008. According to AP: the two governments “signed a raft of agreements for cooperation in such diverse areas as civil aviation, finance, education, science and technology, tourism and cultural exchanges.”

While there has been much speculation about what might come from this interesting set of developments, our inside the beltway source, The Beltway Bandit, forwarded us an interesting piece from UPI, that casts a geographically focused light on how this deal may or may not flourish.

There is a 60 year old road, built by America after World War II, called the Stilwell Road, which may hold a significant part of the key to how things work out. According to the UPI story “The Stilwell Road, also known as the Ledo Road and informally as "Pick's Pike" stretches almost 1,100 miles from Ledo, the easternmost rail depot in India's northeastern Assam state, to Kunming, capital of China's southwestern Yunnan province.”

What makes this road important is how it is part of the border dispute between India and China, and how it involves some of the less orderly countries along the way, including Myanmar. The road was built, through the malaria infested jungle in order to transport supplies to troops that were fighting the Japanese in the area, in 1942, and was built largely by American troops using picks.

According to UPI, “Some segments of the route -- including incomplete spurs -- all but vanished, returning to jungle footpaths due to a lack of maintenance since 1945 and the Sino-Indian War in 1962.”

The terrain can be challenging: “The Indian leg of the Stilwell Road starting at the Ledo rail spur is 38 miles of challenging vertical ascent into the Patkai Range south of the upper Brahmaputra River valley close to the Arunachal Pradesh, a keenly disputed border region with China.”

Here is where it gets interesting. “In the lexicon of political geographers, there is an imaginary ["Line of Actual Control"] between China and India dividing the sparsely inhabited eastern Himalayas. There are overlapping territorial claims as to what belongs to Tibet and Arunachal Pradesh. Analysts privately say the line fluctuates frequently in the hostile high altitude environment, and encounters involving military patrols occur more often than public statements made on the matter by either side.”

To be sure, both countries are trying to put the best possible light on the agreement. According to AP: “The two countries outlined a set of broad parameters to demarcate their disputed boundary through a [“fair, reasonable and mutually acceptable solution, through equal and friendly consultations.”

Yet, the specifics are still very fuzzy. According to AP: “Chinese state controlled media on Monday did not provide any official interpretation or acceptance of border delimitation in this contentious area. Xinhua reported the two governments signed an agreement on ["political guiding principles for solving the border issue."]

There are some more sticky points. According to UPI: “The next 646 miles of the Stilwell Road runs through Myanmar's Kachin holdings, long regarded as a no man's land with a violent history in rough remote terrain. Northern Burma (now Myanmar) hosted units of Chinese Kuomintang resistance to the Chinese Communist mainland victory in 1949 until the 1970s. Besides spillover from China's modern Civil War, there were also Cold War intelligence operations based in the region. Firefights between government forces and drug lords in the 1970s-1980s evolved into ones pitting the numerically dominant southern Burmese against smaller fragmented northern hill tribe cultures during the 1980s-1990s.”

And there are of course the usual, but troublesome U.S. issues. “Myanmar has been run by a corrupt authoritarian military junta suppressing a predominantly docile devout Buddhist population for almost 30 years. Long excoriated by the U.S. State Department as a human rights nightmare, Myanmar is a weak underdeveloped country sandwiched between competing colossi it can ill-afford to offend.”

But due to the geographical importance of the area, “India and China compete in providing their neighbor with political and economic support. China has long been poised and willing to up the infrastructure ante through Myanmar to consolidate economic ties with India.”

Conclusion

India and China are on an interesting and important path, that of rising economic cooperation. The recent set of agreements between the two countries is a serious attempt to further the relationship between the two countries, as well as to increase their global influences, politically, as well as economically.

Both countries have a great deal in common. They are the world’s most populous nations, and together, they have significant amounts of intellectual capital, in the form of capable engineer and science personnel, much of it being U.S., U.K., and European trained.

The raw power of their work force, and the fact that it is willing to work cheap, is even more important.

But both countries share a great deal of differences, and although they are trying to cooperate, they remain rivals, economically, politically, and if necessary, militarily, with both having nuclear weapons.

The Stillwell Road, is indeed, a centerpiece to this agreement, and may hold the key to how easily things develop between the two countries.

The current land trade routes between the two countries are difficult at best. According to UPI: “At present, southwestern China's trade with India follows a convoluted shipping route from Kunming to the port of Zhanjiang in Guangdong province, where goods are loaded onto ships bound for the Malacca Straits, a distance of more than 3,700 miles.”

If and when the Stillwell Road is improved, and becomes fully operational, many problems of transport could be solved.

As with anything else, though, there will be difficulties. Pirates, smugglers, dissidents, and terrorists, not to mention covert operators and other operatives are likely to figure prominently and at least sporadically in how things go.

The fuzzy language about how the two countries will resolve disputes, and the lawlessness of portions of the Stillwell Road are likely to create occasional disagreements.

The main question is how much are China and India willing to overlook these inevitable disruptions, in order to keep an eye on the big picture, the proposed new paradigm, and New World Order.

History is full of instances of how small tracts of land spawned major conflicts.

April 11, 2005

Today’s Analysis: China: Social Unrest. A Sign Of Worse Things To Come?

China is focusing its population’s frustrations with an increasingly difficult set of economic choices for the country, on Japan. But, rising instances of social unrest beyond Beijing suggest that the population is just as angered with its own government. The situation, while not out of hand, could easily worsen if just a few things go wrong, setting in motion a cycle of social unrest, and raising the risk of a major internal crisis for Beijing.

Several demonstrations and a riot were reported in China over the weekend. According to Cybercast News Service: “Relations between East Asia's two rising powers took a new dip at the weekend with the spread of anti-Japanese protests in Chinese cities. The protests stemmed from accusations that Japan is glossing over wartime abuses, but they also focused on Tokyo's bid for a permanent seat on the U.N. Security Council.”

And while the focus seems to be on Japan, Reuters reported a riot in a small village that was protesting against Chinese water pollution from a factory. Two elderly women died during that demonstration, prior to its dispersal, as the protest turned violent when police tried to disperse it. According to Reuters, citing witnesses: "They were run over by police cars. " The news service added: “A source with knowledge of the incident who requested anonymity said the two had died during arrest. He did not elaborate. Thousands of villagers clashed with police in riot gear, overturned about 10 police cars and hurled rocks at officers holed up in a local high school, residents and officials said.”

The rise in unhappiness in China focuses on both external and internal pressures, setting up a potentially dangerous situation for the Chinese government.

According to Reuters: “The rioting on Sunday in Huankantou village in the wealthy coastal province of Zhejiang coincided with violent anti-Japanese protests in China's capital Beijing and the southern cities of Guangzhou and Shenzhen over the weekend. It was the latest in a string of outbreaks of rural violence as the world's most populous nation faces disgruntlement over a widening wealth gap and widespread corruption.”

Cybercast News Service added: “More than 20,000 Chinese took part in demonstrations in Beijing on Saturday and in the southern cities of Shenzhen and Guangzhou on Sunday, in which projectiles were thrown at Japanese missions and other buildings, and Japanese flags were burned. The protests were described as the largest in China since 1999, when demonstrations targeted the U.S. after NATO forces accidentally bombed the Chinese Embassy in Belgrade, Yugoslavia.”

On April 5, in this space, we were among a handful of services that devoted any significant space to covering this increasingly important story.

In that story, which can be fully accessed in our archives (click archive link on left navigation bar), we wrote: [“An underreported, but persistent dynamic in China is the presence of social unrest in several areas of the country, where the wealth effect has not been delivered by the government. This is one of the main reasons that China continues to expand its influence globally, in order to deliver something to as many people as possible, and prevent a major rebellion. At the same time, Japan’s economy continues to wallow in the after effects of the 1990’s Depression, and the lackluster recovery thereafter. In essence we have two countries where bad economic policy is being magnified by their own internal politics, and the consequences of bad, long term, economic policy. As history shows, countries that find themselves in that sort of position, look for something to unify the population. A tried and true unifier is usually a war, or at least a situation that takes the country to the brink of war. In other words, there is no better cure for a rebellion, and or a recession than a good fight with a traditional enemy.”

What is not being reported, is how often protests in China are occurring, and the severity and extent of the situations. According to Reuters: “More than three million people staged about 58,000 protests nationwide in 2003, according to the latest available official figures. The number of demonstrations jumped 15 percent from the previous year.”

Of course, since they are official numbers, they should be taken with a grain of salt, and we should assume that they are only partially accurate, meaning that many more people actually took part in demonstrations. Nevertheless, Reuters reported: “analysts said protests were becoming more common and word leaks out more regularly as technology makes it increasingly difficult to block news.”

Yet, the government continues to suppress news. According to CNN.com: “authorities have controlled media reporting of the protests. ["Chinese media is not reporting the protests in any major way ... CNN's reporting of the protests on Sunday was blocked out,"] CNN correspondent Tara Duffy reported.”

Conclusion

Our position on this developing situation is clear. We expect a major set of problems in China, sooner, rather than later, and we expect major economic repercussions, to the Asian region, and global markets.

And the reports over the weekend suggest that our time table for worse things to come in Beijing, seems to be rather on schedule.

As we concluded in our recent op/ed piece for Marketwatch.com: “Assuming that the Chinese economy hits what is an inevitable bump in the road, that would mean that somewhere later this year, perhaps in July or August, the traditional time for financial markets to start stumbling and churning, we could be in for another Asian meltdown, as in 1997's Thai Bhat debacle. That could mean that by October, the usual bad month in the markets, things could be fully underway. If U.S. households find themselves in a cash flow crunch, as a result of rising mortgage rates, and the Chinese economy is suddenly drained of foreign cash, being repatriated to the United States due to the lure of rising interest rates, a significant change of scenario in the markets is not just likely, but inevitable. The shift could start suddenly, and progress quickly, fueled by fiberoptic communications and the flow of information at the speed of light. A sudden slowing of the global economy would also nearly guarantee lower oil prices, a situation that in and of itself, given the geography of OPEC and Russia, the world's number 1 and 2 oil producers, could lead to geopolitical instability.”

In other words, some of the reliable signs that China’s miracle is getting wobbly are no longer sporadic, but frequent.

Social unrest is never a sign of a happy population. It is not always a sign that the government is going to collapse, as it didn’t do in the U.S. in the 1960s, or during the Watts riots during the Bush I administration.

But, it is usually a sign that change is coming, and that change is usually brought about by the maldistribution of wealth. History clearly documents that with prominent examples ranging from the French Revolution to the collapse of Communism.

The problem in China, is that change is both unpredictable and unwelcome. The former is dangerous to the financial markets. The latter is more a reference to how the Chinese government views its hold on power.

April 7, 2005

Today’s Analysis: China And The U.S. : Congress, The World Bank, And Middle America All Agree.

Introduction

The situation between China and the United States is about to become very tense. And the chances of a major confrontation, and perhaps worse may be starting to rise.

Frequent readers are aware of our views on the Chinese economic boom, and its potential as a cause of a global financial crisis. The situation was well summarized in our recent op-ed piece for Marketwatch.com, titled “How oil, housing, and China could all crash.” The article can be found at http://www.financialsense.com/editorials/duarte/2005/0405.html.

The article’s main idea was summarized in the following two sentences: 1) “Uneven growth rates in the United, Europe, and Japan especially compared to China are setting up a dangerous situation in a competitive world dependent on oil.” And 2) “A sudden slowing of the global economy would also nearly guarantee lower oil prices, a situation that in and of itself, given the geography of OPEC and Russia, the world's number 1 and 2 oil producers, could lead to geopolitical instability.”

Enter two of the most dysfunctional institutions in the world, Congress, and The World Bank, and the situation in China, and the world economy looks to be entering a rather interesting, and in our opinion, dangerous phase.

Congress Stirs The Pot

Congress is threatening China with high tariffs. According to Marketwatch.com “Sens. Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., introduced an amendment Wednesday to a State Department appropriations bill that would slap a 27.5% tariff on Chinese imports if China doesn't revalue its currency within 180 days.”

The report is alarming, and comes at a time when the U.S. and the rest of the world are starting to show alarm at China’s continued growth as an economic force as well as a political and military power around the world. “Lawmakers have expressed growing frustration over China's refusal to weaken the yuan's peg to the dollar. They contend that the tie has left the yuan significantly undervalued, putting U.S. manufacturers and workers at a disadvantage and contributing to the sharp rise in China's trade surplus with the United States.”

According to Marketwatch, Schumer, in a statement noted: "We think there is no more broad-based and serious violation of the spirit and rules of international trade than a purposefully undervalued currency. When those conditions are violated, the system must respond or else the actions of one nation will upset the whole global balance."

In the Wall Street Journal Schumer was quoted as follows: "This is a red-hot issue. What it shows is the overwhelming bipartisan sentiment -- from every part of the country -- that the Chinese must once and for all play fair."

The Wall Street Journal added: “Supporters of the proposal claim the amount was calibrated simply to offset that advantage, and no more. But currency markets don't intersect in such a simple way with goods markets and, in reality, such a large duty likely would boost prices of Chinese-made goods significantly higher than any currency adjustment.”

Although the Schumer-Graham proposal is not likely to become law, it is a sign that “on a broader, symbolic level,” there is a rising tide of “ public concern over China's rising economic power and the growing frustration in the Congress with the inability of the Bush administration to force changes. In 2004, the U.S. recorded a $162 billion trade deficit with China -- the biggest with any trading partner.”

The situation for China is not particularly promising, as public opinion is turning rather negative. Senator Schumer bluntly noted: "The Chinese give lip service, and don't change," referring to China’s frequent pledges of loosening the yuan’s peg to the dollar.

According to the Wall Street Journal “Senate leaders were caught off guard by the depth of support for the measure, and final action was postponed on the amendment, which was offered to a bill on international-affairs programs. Sen. Schumer said one possible outcome would be to bring up the currency initiative as freestanding legislation.”

In a recent Zogby poll, “the general public, business leaders and Congressional staff -- viewed trade between the U.S. and China trade in a positive light,“ but “36% of Congressional staff members said China posed a serious military threat to the U.S., compared with 15% of the general public and 16% of business leaders. When asked if China were a dependable ally in the war on terror, 27% of the general public, 25% of business leaders and 16% of Congressional staff said yes.”

World Bank Issues Dark Outlook Just In Time For Wolfowitz To Work His Magic

Paul Wolfowitz is not completely established as the head of the World Bank. But he has now gathered enough support to take over the institution. But, the tone of the bank’s latest report suggests that Mr. Wolfowitz will have his hands full.

According to the Wall Street Journal: “The World Bank warned that the global economic recovery has peaked, and said that the severity of the coming slowdown will depend on how skittish foreign investors are about buying U.S.-dollar-denominated assets.”

In sharp contrast, “ the Asian Development Bank said that Asia's developing economies will sustain robust growth into 2007 as strong domestic demand, regional trade and a steady inflow of investment offset soaring oil prices and moderating growth in the U.S. and China.”

The World Bank is actually painting a realistic picture. “In an annual report on the risks confronting developing economies, the World Bank said the global recovery of the past three years has masked cracks that can't be left unattended much longer. The fragility, it said, was highlighted by ["brisk selloffs"] of the dollar last month after some Asian central banks said they might diversify their currency portfolios.”

According to the Wall Street Journal, Francois Bourguignon, the bank's chief economist, in a foreword to the report, offered the following and sobering summary: "The global economy is at a turning point. Growth has peaked, and pressures to address global imbalances are growing, exposing important risks facing both developed and developing countries as the needed adjustments occur."

The report offered a potential solution, and suggested a ["coordinated response" to minimize the risk of a crisis: The U.S. government should shrink its record budget deficits, Europeans should ensure that their monetary policy doesn't get tighter than that of the U.S., and major Asian nations should permit their currencies to rise against the dollar in a "managed appreciation."]

The bank said its best-case scenario calls for a mild slowdown during the next few years. The annual growth rate of gross domestic product, 3.8% in 2004, is likely to drop to 3.1% this year and hover at about that level through 2007. Among developing countries, the rate should slip to 5.7% this year and 5.2% in 2006, from 6.6% last year.

The Asian Development Bank (ADB) report predicted a slowing of the U.S. economy, and rising Asian economies, except in Japan. “The ADB expects developing Asia's exports to rise by 13.8% this year and 11% in 2006 and 2007, after growing an average 25.5% in 2004. Imports, meantime, are expected to rise 16.1% this year, 13.7% in 2006 and 12.2% in 2007. For 2006 and 2007, ADB forecast GDP growth in developing Asia of 6.6% and 6.9%, respectively.”

And here is where it gets sobering: “Tempering the upbeat message, the ADB warned that Asian economies -- and particularly those in Southeast Asia -- are at risk from surging oil prices, epidemics and terror attacks, as well as still-large U.S. external imbalances and the impact of further increases in interest rates by the Federal Reserve.

Conclusion

Another set of bricks has been cemented into the wall of worry.

The situation can best be boiled down to this. The Chinese economy, albeit full of warts and based at least partially on government support, is still growing, and shows no sign, as of yet, of slowing down significantly. The U.S. is starting to feel the squeeze.

Familiar readers know that there is more to it than that. Indeed, the fact is that China’s growth is mostly being financed on cheap credit, and that the domestic Chinese economy is a potential tinderbox for anarchy, if the government subsidized, “busywork” enterprises that support it start to die off, as they likely will, if and when, the Chinese government starts to implement its WTO agreements over the next couple of years.

What today’s report clearly shows, though, is that public sentiment, or at least lobbyist sentiment, has grown to the point where the U.S. Senate is starting to yell very loudly about the China phenomenon, while the World Bank is offering as sobering a forecast and appraisal of the current situation as we have seen.

In our opinion, this is just the beginning of what’s to come, and it is not likely to end well.

The Chinese government is not likely to take outside criticism on how it runs its economy kindly. With rising interest rates and pressure from Japan in the China Sea over a disputed set of natural gas fields, the last thing the Chinese want or need, is a rising tide of U.S. public opinion against them. Which of course means that they are likely to do respond in a less than nice manner.

The Bush administration is not known for its diplomacy.

As far as we can tell, we’re right on schedule for a bad situation emerging from Asia, perhaps as early as this summer.

Middle America is definitely starting to notice. Here is a letter we recently received from a fellow in Oklahoma.

“ Dr. Duarte: Just read your great article, Rate Hikes May Create 'Perfect Storm' How oil, housing, and China could all crash. Here in Oklahoma City, the General Motors plant has just announced shutting down its second shift. This will cause a loss of over 800 jobs. The loss of the second shift is attributed to decreased demand for SUVs that are manufactured at the plant. Squarely, this is resulting from gasoline over $2/gallon. There is no doubt in my mind that the plant will completely close within 2 years. This is only one of the big dominoes to fall and soon.”

When Senator Schumer, and the common man from Oklahoma are on the same page, it’s just a little bit scary, in our opinion.

April 5, 2005

Today’s Analysis: China And Japan On The Brink.

The tense peace between China and Japan is likely to be tested within the next few days, if a deadline set by Japan in a dispute over natural gas reserves in the China Sea is not modified.

According to Kyodo News: “Japan will begin preparations for experimental drilling for natural gas and oil in disputed waters in the East China Sea unless Beijing provides a ["sincere"] response in about a week to Tokyo's demand that it stop explorations in the area, Economy, Trade and Industry Minister Shoichi Nakagawa said Friday.”

The dispute came after the release of survey data that suggests that Chinese exploration activity may have encroached on Japanese territory. Kyodo News reported “a government geophysical survey released Friday confirmed that underground structures in two Chinese-developed natural gas fields extend into Japanese waters. The survey stopped short of confirming the existence of resources on the Japanese side, but concluded that exploration on the Chinese side ["may affect natural resources on the Japanese side." ]”

The language used by Japan was fairly stern. ["We have repeatedly asked Beijing to stop natural resources development and provide data on its gas projects to Japan. Unless China gives us a sincere response, we have to proceed to the next step," Nakagawa said at a press conference. Japan will seek China's response through diplomatic channels, Nakagawa said. The Foreign Ministry will notify the Chinese Embassy in Tokyo of the government's policy, he added.]

Talk is cheap, and deeds lead to consequences. But Japan’s talk is heading in an interesting direction, even if somewhat hedged. “A top Foreign Ministry official also said Friday if China refuses to provide data on the projects, Japan should take countermeasures. Nakagawa said if China offers a response in about a week, Japan will consider what steps it should take at that point,” although the report suggested that Japan may start to grant exploration licenses for the disputed area to Japanese companies if the Chinese fail to deliver what Japan is requesting.

China is responding just as tersely “ ["We ask that the Japanese side not undertake any activities to complicate this situation,"] Chinese Foreign Ministry spokesman Liu Jianchao said Thursday.”

At the center of the dispute is what Japan calls a “median line,” (see Image 1) an area “in the Japanese exclusive economic zone in the East China Sea.” China does not recognize the “median line,” and claims “that its economic waters stretch further than designated by Japan.” Indeed, according to the report, “A Chinese consortium is currently conducting natural gas projects on the Chinese side in an area close to the EEZ median line set by Japan in the East China Sea.”

An Escalation of An Existing Trend

This situation is not new. On December 13, 2004, in this space we noted: “Japan is steadily returning to the ranks of nations with a military whose function is beyond defense of their homeland. And one of the major reasons, as cited by the country’s official policy is the increased global presence of China. This creates a whole new layer of potential friction in Asia, where North Korea, China, and Russian influences are still significant, and where much remains unresolved on multiple levels.”

In that report we noted, based on multiple reports, that Japan’s about turn on its re-arming was likely to lead to a renewed arms race in the region.

We also wrote, at that time: “This is a complex situation with the potential for large amounts of trouble if the right spark appears.”

Scenario For Trouble Continues To Unfold

In multiple articles, we have put forth what we believe is overwhelming evidence that although China’s economic growth is credible, it is simultaneously dangerous.

An underreported, but persistent dynamic in China is the presence of social unrest in several areas of the country, where the wealth effect has not been delivered by the government. This is one of the main reasons that China continues to expand its influence globally, in order to deliver something to as many people as possible, and prevent a major rebellion.

At the same time, Japan’s economy continues to wallow in the after effects of the 1990’s Depression, and the lackluster recovery thereafter.

In essence we have two countries where bad economic policy is being magnified by their own internal politics, and the consequences of bad, long term, economic policy.

As history shows, countries that find themselves in that sort of position, look for something to unify the population.

A tried and true unifier is usually a war, or at least a situation that takes the country to the brink of war.

In other words, there is no better cure for a rebellion, and or a recession than a good fight with a traditional enemy.

China and Japan, on many levels fit the bill quite well.