China vs the USA: Better the Devil You Know, or the Devil You Don’t?

We can’t write to you about Australia today. It’s just too embarrassing. Our glorious cricket team isn’t just struggling to play cricket these days. They’re struggling to pull off high fives. Wicketkeeper Brad Haddin was poked in the eye by bowler James Faulkner during a wicket celebration.

There’s plenty of embarrassing things happening to other countries too though. The two most important ones for Australia’s welfare had a rough couple of days recently.

Had enough of the US government shutdown yet? Well things are getting rather nasty over there. The budget impasse is no longer just an economic issue. Gone are the days when young whipper snappers on university campuses protested against political misadventures. Today, it’s the old whipper snappers on the move.

US army veterans invaded their own Vietnam memorial after it was shut down because of the budget debacle. They tore down barricades and carried them off. One double leg amputee carried off a piece of the fence on his two wheeled Segway.

The veterans helpfully decided to return the barricades to the White House just down the road, piling them up in front of President Obama’s front lawn. Snipers on the roof of the Whitehouse and riot police kept watch.

If you haven’t seen the film V for Vendetta, now’s the time to watch it. The end features a standoff between the military that supports a totalitarian government and its people. Unfortunately, we don’t expect the same happy ending in reality.

An optimist might point to the patriotism and hope displayed by the ‘veteran’ protestors . But we’re not sure whether they’re protesting about the state of politics or the risk to their government handouts from the shutdown.

The last time a bunch of veterans took on the White House in person was in 1932, during the Great Depression. The ‘Bonus Army’ numbered 43,000 and demanded cash payment of their entitlements for serving in the First World War. What happened next is a long story, but it ends with a cavalry charge, six tanks and tear gas. Second World War-starring generals Patton and MacArthur were in charge of the attack on their own country’s soldiers (and their families). No bad deed goes unrewarded.

The point being that America is starting to show serious signs of internal strife. Greg Canavan discussed whether this means the end of an empire last week. As interesting as that question may be, none of the possible answers sound very appealing to our subscribers at The Money for Life Letter. That’s why this month’s issue will be about the world’s most boring investment strategy, using the world’s safest investment. The aim is to create a financially predictable retirement without any ‘price risk’. That means part of your retirement wealth isn’t affected by the price of investments.

Vern Gowdie has another strategy for the coming turmoil…you can find it here. And he’s actually stuck his neck out with a prediction for the Australian stock market that surprised even the veteran newsletter writers amongst us, let alone our readers. If he wasn’t an award winning financial advisor, you’d have trouble taking his remarkable warnings seriously.

What about the other side of the world economic equation? China is experiencing its own trouble, and it has nothing to do with cricket or grumpy veterans.

The global economic situation is still complicated,’ said Zheng Yuesheng, a spokesman for the Chinese customs office. Well done Zheng.

Here’s the figure he was trying to gloss over: Chinese exports fell slightly in September compared to last year, instead of rising by around 6% as expected. Whoops. Meanwhile, imports rose 7.4% -more than forecast. Put the two together and the trade surplus fell to just US$ 15.2 billion. That’s about as much as the US government borrowed every three days in 2011, if our back of the envelope calculations are correct.

Chinese exports to Australia fell to their lowest in three months and the Aussie dollar took a hit on the weak export data. But not as hard as Brad Haddin’s eyeball.

The danger of soft economic data out of China is twofold. First of all, the numbers are manipulated to make them look better. So reality is far weaker. Wikileaks revealed that China’s current Premier doesn’t bother looking at the government data to get a real picture of the economy. He looks at things like electricity consumption and rail freights. Electricity consumption data was recently goosed by warm weather causing an unusual amount of air conditioning to be turned on. That’s according to the Wall Street Journal‘s China blog anyway. But rail freight was up a bit too. So the weak export data was quite a surprise.

The second risk is that the Chinese have borrowed money to bet on future growth. Again, the figures are dodgy, but the point is that debt without the corresponding economic growth is dangerous. Debt cannot be paid off with fudged economic data. As we explained in our last Markets and Money, crises are assured in any economy. Debt is what turns crises into a serious problem because it raises the stakes.

Rather than fixing up their own problems, the Chinese are gloating over the Americans’ current issues (a sure sign of big trouble in big China). An op-ed in China’s official press agency Xinhua argued that the world should ‘de-Americanize‘, especially given the ruckus in Washington at the moment. The end of Pax Americana could be a worry for Australia. Who knows what surging Chinese influence will bring?

To be honest, we’d like to declare a ‘pax on both your houses’. But at least the Americans are a devil you know. And we’re not fully convinced of the Chinese miracle just yet.

If they’re hoping to become the next superpower, the Chinese are doing it all wrong. They’re talking the talk before walking the walk. If you remember, the Americans did the opposite. They were a sleeping giant until the world wars woke them up. They’ve been in a terrible temper ever since, taking it out on all sorts of random countries.

Back to China, it looks like they’re throwing their weight around much too early. Despite loading up on 2000 tons of gold from Hong Kong in the last two years, the Chinese still hold a heck of a lot of US government debt. And their economy is still reliant on American consumers.

Becoming the next economic superpower is difficult when you’re tied to the welfare of the last one. Greg Canavan linked to an article on Friday which mentioned that there is growing anger inside China over the excessive investment in US government debt. It is being called ‘irresponsible’.

We’re not sure about that argument. The Chinese loaded up on US government debt as a side effect of keeping their currency artificially low. They created yuan with the excess US dollars they earned  to keep their currency competitive at the pegged exchange rate. They sent the excess US dollars back to the States by buying Treasury bonds. Now they own nearly US$1.3 trillion of them.

But for some reason, nobody seems to care that it cost China nothing to buy the treasuries. Of course, the economic effects of losing the US as a consumer of Chinese exports would be devastating. But it has to happen eventually. A country can’t go on consuming beyond its production forever.

Remember that video set in the future with the Chinese lecturer telling his students about America’s bygone empire? He laughs because China owned so much of America’s debt that it was able to control the country indirectly. But that might not be the way things play out in the ‘real’ future. Especially if China gives away its hand before playing it.

You see, there’s nothing like a bogeyman to unite Americans and ignite that famous American exceptionalism. If China becomes that bogeyman before it is dominant, things could get dangerous. Hopefully Australia will have the wisdom to avoid taking sides, and we’ll keep poking ourselves in the eye instead of the world superpowers.


Nick Hubble+
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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