GLOBAL
TRADE WAR UPDATE
by Jim Willie CB
April 12, 2006
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Jim Willie CB is the editor of the “HAT TRICK LETTER” For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market. Trade war in my opinion coincides with erosion of sovereignty from decades of chronic inflation. Trade protection, even protection from foreign ownership of prized assets, are the manifestation of failed policies. The United States is one of the worst offenders in trade tariffs and policy in opposition to free markets. Year after year of large scale monetary inflation erodes the body economic. It tilts the economy’s wealth generation apparatus toward the financial sector, where inflation most vividly appears and where work is minimized. It renders the worker and wages to be uncompetitive, resulting in destroyed entire industries. In the face of frustration, like folded arms, a nation protects itself after years of highly destructive economic policies have wrecked havoc. The consequence is a final chapter marked by wide destruction of commercial relationships. Trade war usually precedes (if history teaches anything) armed conflict, as in war. Voters (often more aware of economic conditions) tend to push Congress toward that war, in both forms. In the 1930 decade, Japan stood in the path for American trade dominance. Now China stands in the path, both as a real and imagined powerful rival and threat. A certain future rival, potentially an enemy, in some ways China is painted as a scapegoat. USGovt leaders are being outfoxed by China on currency management and tactical maneuvers with its vast capital reserves. We are seeing an increasingly toothless America, damaged by both inflation and reckless policy, whose influence and prestige are on the wane. An all-out trade war with China would rocket up US long-term interest rates, causing significant damage quickly. See “The High Cost of Inflation” for a rant on the subject of consequent economic hardship, and lately lost control, diminished security, and threats to national security. The US public has seen globalization ride as a trend, after a few decades of rampant monetary inflation (govt and credit). Global trade has advanced the industrial growth and power of China. Energy cost distress has advanced the efficient industrial revival in Japan. The US distinguishes itself by making the most powerful (and expensive) weapons. In the United States however, wage gains are non-existent, as three consecutive years of inflation adjusted declines have taken place. The suffered declines are worse than stated, since the adjustment for inflation is very inadequate from gross under-statement. We have created a monster with inflation, and another monster with war. A quote passed my desk last week, relevant to today. “For the man who sets out to fight a monster, look to it that he
himself does not become a monster.” The Schumer-Graham trade tariff bill against China epitomizes our occasional economic stupidity on the global stage. It is on again, off again, like a threat put on the shelf, then picked up, then put back. Cool heads prevail in recent weeks fortunately, the bill now twice suspended. An argument can be defended that the risk of trade war rises when communication lines are cut, clashes develop in commerce, and hostility is in the air. Nowhere do we see such extremely poor judgment, as we pressure an exporter whom we encouraged five years ago, and put at risk a large slice of capital and credit they supply. The United States has embarked on trade protection legislation on more than one front. We seem to have embarked on a path of economic suicide, with exploding federal deficits, reliance upon foreigners which won a gigantic trade deficit. Now we want to erect one-way street signs certain to anger our trade partners, whose low-cost output is critical to our way of life. We have marched into a corner of our own making. We exchanged low-cost supply for lost industries and colossal debts. Now we resent them for our decisions, when the actual demons were our bad policy and chronic inflation. Our leaders strain to understand China and its economic state. Boomtowns like Shanghai are not typical. Failure to properly comprehend comes with great risk. Ignorance back in the ‘hood and back on the farm, where many emotional poorly read voters reside, carries the same risk when Congressional members must satisfy their occasionally deep hostility and frustration. They will be sorely tempted to play the “anti-China” card. On one hand politicians permit inept and ineffective economic advisors to ransack the nation, to lose jobs, to cater to Wall Street. On the other hand voters loaded for bear with angst urge their Congressional representatives to deliver hostile messages and to enact hostile measures directed against what they perceive to be the villain. In most cases it is not Japan, but rather China. Japan quietly has eaten our lunch. China more visibly eats the entire lunch table, but at our invitation. While much about China deserves criticism, namely intellectual property royalty payments, like human rights violations, like environmental abuse, like lack of transparent corporate accounting, their yuan currency is just one of several managed Asian currencys. The Japanese yen receives little harsh criticism, yet they abuse the intervention card more than China ever did. Since 1997 and the Asian Meltdown, Asia has embarked on a path whereby they favorably trade economic development and calm financial volatility in exchange for a pile of USTBond IOU paper credits underpinning huge domestic debt. Few realize that without a formal active bond market, China operates at a huge disadvantage in managing its yuan currency. The challenge is like steering a boat without a rudder. It must order a storm so as to shift the boat in location. MANEUVERS & EMOTIONS By permitting a measly 2.1% official yuan upgrade, China abided by our demands last summer, and thus put the ball in the US court. In addition to the Schumer bill, which would slap a 27.5% tariff on all Chinese imports if they fail to make progress on yuan currency upgrades, other legislation is underway. A House of Representatives bill would block foreigners from buying a wide spectrum of US companies, from energy firms to utilities. The US Congress actually cites the need to protect “American sovereignty” without noting the double standard. Few remember, but Wal-Mart used to have a sales slogan “Made in America” which has been discarded in an about face. We want foreign finished products, but not foreign ownership from purchases using the IOU scrap paper given to them, mere paper with ink on it. Soon they will lose interest in owning USTBonds. The Committee on Foreign Investment might soon be granted veto power over foreign bids. Without its topline label, the USGovt is slowly laying the foundation for the equivalent essence of the Smoot Hawley Act, a disastrous trade protection measure, which advanced and worsened the Great Depression. The shocking process impresses the psyche, whereby some movements seem unstoppable, even though our eyes are open to risk. Simply stated, a diverse nasty trade war with China would send long-term US interest rates up 2% to the 7% level. It would knock down the housing market by 20%, knock down the major stock market indexes by 20%, generate several million new bankruptcies, and lift the jobless rate by 4%. These are rough guesses, but not far off the mark. By diverse and nasty, one should imagine dockworker strikes, boycotts of Wal-Mart chains, certain to spark angry demonstrations in the cities, if not riots. On the China side of the ledger, similar damage would be unleashed. It is in neither national interest to kick off such a trade war. Watch for the uncontrollable path of human nature to take over soon, whose road signs include negative emotions. An adjustment is in progress. Per capita annual incomes are almost $37k in the USA versus under $1200 in China, while wages for professional workers differ by 10-to-1 in ratio. INSANITY OF PRESSURING CHINA ON THE YUAN US Congress keeps insane pressure on China for a yuan valuation upgrade. A yuan upgrade of 500% is required to bring into near balance the wage differentials. US leaders press for a lose-lose outcome, wherein we deeply anger Chinese leaders. Rebalance of this bilateral trade deficit is totally out of the question with a lost US manufacturing base. Rather, the outcome is most likely higher imported finished product prices, a consequent reflection in higher price inflation (even with the corrupted CPI index), and higher long-term interest rates. Conversely, their resentment overseas is most likely to motivate a complete halt by China in USTBond support, probably outright selling under the euphemistic phrase “diversification” of their nearly $1000 billion in foreign reserves. Thus the “lose-lose outcome” to be seen. Meanwhile, trade tension escalates between the USA and China, alongside the financial conflicts. Leaders in Beijing face pressures at home, just like our leaders. Objection was recently raised regarding the Chinese purchase of US railroad optimization software, which highlights the recognition that their military can benefit from private sector efficiency tools. China is rumored to desire the software for rapid deployment of missile systems moved on railways. Before the resentment from the failed Unocal acquisition deal wore off, fresh wounds are opened. One must wonder if USGovt officials will urge Canadian govt leaders to block Chinese investment in Alberta oil sand projects. Methinks yes, already underway secretly in my humble conjecture and considered estimation.
In late March, both the US and European Union filed a complaint against China before the World Trade Org, in an effort to stop an imposed import tariff on foreign-made car parts. Other deals are drawing fire and scrutiny. Citigroup has been bogged down after an attempt to gain 85% stake in Guangdong Devmt Bank. The Carlyle Group has drawn attention from its $375 million deal to grab an 85% stake in state-run Xugong Group Construction Machinery. The German ZF Group has been in talks for three years over its bid for a 70% stake in Hangzhou Advance Gearbox Group, a builder of marine jet propulsion systems. Another deal with Caterpillar has been criticized more publicly, involving Shanghai Diesel. Not only Caterpillar, but John Deere have knocked out rival domestic firms in the capital equipment sector. The state-run Xibei Bearings used to supply train bearings, but no longer, not after the German INA Schaeffler bought into the business in 2003. Reaction is widespread, aided by domestic Chinese lobby groups, an American exported concept. Recently proposed legislation calls for a limit of 40% for foreign equipment suppliers on key projects funded by their central and local govts, in an effort to satisfy the “national will” according to Xinhua News. Objections are laid that Coca Cola dominates their soft drink market, and Eastman Kodak holds a 50% market share in the film business. US presence has grown tremendously. In 1980, only 23 US firms were invested in China, with $120 billion in total investment. In 2005, a whopping 49 thousand firms were invested with total investment of $51 billion. President Hu faces resistance from broken farmers, and business leaders trying to maintain a grip on their power, along with ministry officials. Lobbyists actually dot their political landscape, as they plead cases and exert influence. Wal-Mart and French Carrefour dominate large supermarkets. They are grateful for putting to use formerly idle state assets and bringing efficiency to their industrial structure, even promoting progress in technology. Problems stem from concentration in certain sectors, now dominated by foreign firms. President Hu and Premier Wen Jiabao see no benefits in reactionary movements, but rather urge continued reform. Much in Chin is similar to the US from yesteryear. Progress has its peril. NATIONALISM COLLIDES WITH GLOBALIZATION A highly dangerous new trend is underway, wherein nationalism and security have motivated trade protection on three continents. France, the United States, and China expose the trend which extends even to South Korea, Spain, and Poland. On the European continent France began their protection blockade last year with a raft of actions. Closer to home is the mandated call to nationalize Bolivian industries. The US is on the path of protectionist policy directed toward certain key financial assets. Europe and Asia might walk the same path. Nationalism has collided with globalization, with no valid solution, as the global economy has shrunk in size, labor differentials abound, and commanded wealth disparities linger. A certain backfire from a sense of national insecurity, the protectionist movement is furthered along by heightened border security concerns, whether valid or not. The latest casualty is the nixed Dubai Ports World deal, or rather its apparent alteration. Watch the Alcatel deal with Lucent in the telecommunications sector, a clear merger of weaklings in the 3G wireless arena. The United States must attract $10 billion in foreign capital per week, a fact of life which should render security issues and national spirit as secondary, unfortunately. The degree of our national vulnerability is overshadowed by how much our strong military backs the USDollar currency and USTBond (in)securities. Get prepared for a new round of self-destructive stupider economics to follow three decades of stupid economics. If we preach peace through war, and wealth through debt, then why not also put blame for our errors on our trade partners, and urge them to fix their house when ours has faulty construction??? According to Thompson Financial, almost $900 billion in cross-border mergers and acquisitions were finalized in 2005, up more than 50% from 2004. Only the insanity of 1999 and 2000 eclipsed such levels. The following quote from a US Congressman summarizes the growing sentiment. “We are dealing now with a brand new international animal called state owned enterprises that are looking to spend a lot of money abroad. They are not capitalistic. They are not free market. They are not bound by the rules of profit and loss, and they are going to gobble up international businesses as we know them.” So said Illinois Rep Manzullo. We approve when state owned agencys intervene and rescue the USDollar and USTBond, but they are not permitted to use such money as legal tender in acquisitions. Such is a dilemma founded in a shade of hypocrisy. The benefits from cheap foreign products might seem more costly when our own employer is acquired by a foreign entity, especially a state owned one. Such is what can be called “the rub” or friction in the one-way street. Some experts on the subject of trade point to fear based upon the terrorism threat, but also fear of cheap foreign labor taking good jobs in richer countries. Clearly, the marquee names are attracting attention on what is being bid for in such acquisitions. We are not talking about Rockefeller Center and Pebbles Beach Golf Club anymore. We are rather talking about major US icon corporations, the heart & soul of America. If and when empty carmaker plants owned by General Motors and Ford are snapped up by Toyota, Nissan, Honda, Mitsubishi, or worse, by the Chinese Chery, look out !!! Violent demonstrations might ensue. The IBM PC business was acquired by Chinese Lenovo in 2005 for $1.25 billion, a deal which might not slip through passage today. In fact, reports indicate that a great many PC’s used in USGovt and Pentagon facilities are of IBM PC type, posing a potential security risk. Nationalism and security concerns have collided with global trade. The harsh reality is our enormous staggering foreign dependence on their money, their savings. The earned benefit is the high price of chronic corrosive catastrophic inflation. Such is the center piece of our horrendous economic policy since the Vietnam War and the Great Society. We as a nation permit foreign portfolio investment, such as stocks and bonds. We see no alarms when foreigners accept our IOU debt paper. When it comes to its usage in foreign direct investment at home, we properly see the stark reality of lost control. Decisions on workers and suppliers directly then affect US citizens. France is a focal point to trade protection, better labeled as inhibited asset acquisition. The French govt blocked a deal where US Pepsico would acquire French Groupe Danone (yogurt producer) as they actually blurted “economic patriotism” in the process. When the French Suez (water, waste, energy) became the target for acquisition, their govt rushed a merger by state owned Gaz de France. A schizophrenia persists, since other French companies have been successfully acquired by foreign entities. See aluminum maker Pechiney, insurer Assurances Generale de France, and bank Credit Commercial de France, each successfully acquired. The latest scrap involves French Alcatel and US Lucent, a telecomm merger of weaklings. Lucent lacks bay stations, radio frequency amplifiers, and wCDMA tower equipment. Each company has a firm grip on 2G (second generation) wireless technology, so they are motivated to merge and share their disadvantage, if not misery. The Lucent CEO Russo is slated to head the merger conglomerate, yet she speaks no French. What a laugh, aint gonna play in Gay Paris. Each firm must wrestle with the reality of their obsolescence in the telephone industry, as old business models yield to newer ones. Russo has stated a newly created independent board of Americans will make decisions on contracts bearing on security matters. The importance of the joint corporation is minimal, yet the negotiation for USGovt and French govt approval could be distorted in importance. Americans openly tout their dislike of anything French, except of course some clothing and lingerie, and yes, wine & cheese. Some latent disgust over NATO refusal to back the poorly sold Iraqi War is sure to surface. Anti-European sentiment might come to the fore. Lucent’s importance and prestige might also be grossly exaggerated in the process. It contains the once prestigious Bell Labs, the home to my ex-wife’s father. Expect a snafu to anger France and deepen resentment on the protection front. We grip to a bizarre contempt for the French as cowards and diplomatic Napoleons, despite the fact that 95% of US citizens do not speak the language and have never traveled to that fine nation. In seven days in Aug2003, mine eyes did not spot one native obese person, nor was any rudeness displayed to me in countless encounters. Well, there was that one snotty restaurant fellow in Paris, but nothing like what certain clueless friends warned about. When directions were asked of this unkind little man a second time, he said “assez” with a rude gesture which means “enough.” An expletive was uttered under my breath following a dirty jackass glance over the shoulder. Tu vers, moi je parle un peu de français. (you see, I speak a little French myself) Even the smaller nations are participating in protective actions. France, Spain, and Poland have blocked bids to purchase various domestic companies. The Korean govt has resisted Carl Icahn on a move to bid on a tobacco company. The true madcap laboratory observation can be seen with Bolivia, where foreign investment has virtually dried up overnight. President Morales won election on a platform to renationalize their natural gas industry, along with more sweeping change. He plans to take back from private hands and regain control of privatized companies in energy, oil, telecomm, airways, and railroads. They might not know about the Smoot Hawley Act in 1932 down there, but they have learned to march to its tune. We do know, but we proceed anyway despite some citation of the disastrous trade war act seven decades ago. The Bolivian govt has promised fair compensation (much like South Africans for gold mining companies), but their state treasury cannot finance development. It lacks sufficient resources for exploration and development, especially after payment in compensation. Bolivia risks losing access to the US market at the end of 2006. More importantly, the energy market is likely to see less natural gas supply come the market, even as its price will rise. That is the tragedy of protectionism. CHINA PLAYS HARDBALL The Ukraine incident last winter with the natural gas pipeline used as a weapon is Russia’s contribution to the vicious game of protectionism. They cut offUkraine in midwinter to prove a point, that energy supply is a powerful weapon when interrupted. The world now is well aware of Russian willingness to use the weapon. Behind the scenes on the geopolitical stage, leaders of nations fear Russia as a result. Putin (or is the KGB?) wishes to control supply and price in pursuit of power. With a shrinking pond comes more nasty politics. (See academic department battles for a vivid display. My youth came with a ringside seat to watch academic battles over tenure, promotions, chairman selections, hiring, and distinguished professor invitations. Nasty indeed. My doctoral pursuit required a sidestep from an unprincipled and impersonal chairman who did not object to attempts to skewer me three years after a battle over a woman.) Check out the stall in Gazprom production, a well-kept dirty little secret. Few realize to what extent most of Russia’s vast energy complex is in decline. Putin’s response is treachery. RUSSIA IS NOT OUR ALLY, DESPITE CHILDLIKE PRONOUNCEMENTS BY USGOVT LEADERS.
The network displayed in the graph illustrates to what extent China will go avoid Russia and the US Naval Fleet. This intermediate land is not easily put under control, and includes vast stretches of desolation. It would make more sense for China to opt for a pipeline connection to the ample Siberian gas fields. China wants more control and less vulnerability to Russia. They have a history together. Few seem to comprehend the full nature of the Energy War. It is certainly not totally clear to me. Iran has significance beyond anything mentioned in the press. IRAN HAS WON THE PIPELINE BATTLE. No significant pipelines lead to Turkey, after the dust has cleared. A sizeable amount of energy output from Central Asia, otherwise known as the former Soviet Republics, will pass through Iran for sale at their ports, and not Turkey’s ports. The majority will be transported via pipelines overland to China and Russia. In the Ukraine conflict resolution, it was clear that Russia desired pipeline control not only to Ukraine but to Eastern Europe and parts of Western Europe. China watched and learned, then reacted. They remember well several broken agreements where Russia failed to honor the terms of their past deals. Such is Russian treachery. For more examples, see Yukos, see Pan Am Silver, see British Petroleum, and so on. Turkmenistan does not like dealing with Russia. The ex-republics are each treated like serfs from the disbanded Soviet Empire. The Turkmen deal with China would be at market prices using hard currency, something Russia never provided.
Some amusement might be due. The Turkmen nation has its own challenges apparently. Their self-styled leader is eccentric as best, a lunatic at worst, named Niyazov. He exerts stifling influence over the nation, from required study of his nutcase philosophy, his personal brand of household goods, his own brand of vodka. His nation of vassals have no choice. He even has changed the names of the calendar months and days of the week to suit those from people in his life, no lie. First of all though, Niyazov is a business man. He needs to continually purchase the loyalty of his henchmen and Praetorian Guard for security. It seems each nation designs its own custom Praetorians, like the National Security Agency in the United States. COORDINATED CHAOS ??? A coordination of intentional chaos ignition seems evident among some nations. The US Congress proposes a law to criminalize illegal immigrant hiring, to limit immigrant access to benefits, and to force citizenship or deportation of Mexican aliens. Laws in France have made easier job layoff for younger citizens (25 yrs & younger) in their nation. Protests abound and have erupted in some violence. Violent uprisings in China have neither stopped nor been reported, in response to progress in industrial expansion, in residential construction, in environment compromise, and from worker inactivity. A network of US internment camps is under construction, past inception, for the stated purpose of housing illegal immigrants. A concerted effort seems afoot to instigate chaos, what seems to be a “bunker mentality” having emerged. Hundreds of thousands of immigrant Americans have marched onto the streets in dozens of major cities, angered by the perceived betrayal. The United States is a nation of immigrants. My mother was raised on an Irish farm, my father a native corn fedder from Iowa.To me it seems some national leaders are inciting nationalism much like what was instigated in Europe seven decades ago. Following a bad bad bad Treaty of Versailles, an aggressive talented but misled nation struck back. They reacted to extreme stress and perceived external threat. The United States, following bad bad bad economic policy for four decades, is also aggressive, talented, and misled. It is striking back. Where will it all end??? ©
2006 Jim Willie, CB
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Chinese
leaders must deal with a growing gap between rich and poor, corruption
charges, and to environmental issues. They must find an efficient quick
path for wealth to pass down to rural areas, to the lower class whose
numbers are legion. Foreign capital has infused their economy, and
knocked dead some domestic firms. An estimated 60% of the bilateral
Chinese trade surplus with the US comes from US multi-national firms
building products in China, which we so vigorously encouraged after the
granted Most Favored Nation status in 1999. We wanted lower cost
finished products, but ignored warnings for lost US wages and the threat
from foreign accumulation of our debt securities. The bilateral trade
deficit was $201.6 billion in 2005, up over 20% from 2004. The Chinese
trade surplus zoomed from a mild $2.43 billion in February to an
outsized $11.2 billion in March. Their crude oil imports rose over 25%
in the first quarter, versus one year ago.
A
recent Stratfor Intelligence Brief provided a glimpse of the game going
on between Russia and China. A deal in principal was struck on April 3rd
between China and Turkmenistan. The two nations agreed to build a
natural gas pipeline through their countries. They are intent on
avoiding Russian soil in its connection, since Putin cannot be trusted
with such a potential converted weapon. China relies almost exclusively
on domestic natgas production. Chinese President Hu wishes to complete
the pipeline network. China already plans to construct similar pipelines
to the Turkmen neighbor Kazakhstan.
Jim
Willie CB is a statistical analyst in marketing research and retail
forecasting.