China’s Endgame

In the last month I have — with great relish — detailed what I perceive to be the developing geopolitical collapse. On the 15th of August I wrote:

Will we ever get to see hyperinflation in America? It depends on China’s response to America’s slouch. If — as mainstream economists hope — China can be patient enough to allow America to resolve its debt problems, eradicate its trade deficit, and manufacture more at home then hyperinflation is very unlikely. America may stumble through a lost decade, before new technologies, and new business models finally pull America out of the slump. American policy makers might even have the foresight to let failed business models fail and liquidate failed businesses, allowing for new growth to take root, and avoiding Japanese zombification.

If China, on the other hand, decides that it is sick of being America’s foot stool, then America has a massive problem. Entering into a trade war with a nation that holds so much of America’s debt, and produces so much of the goods that sit on American shelves is an extremely risky proposition. A drastic fall in goods circulating in America — as the result of Chinese export tariffs, yuan flotation, or an outright export ban — could be a hyperinflation trigger. Excess reserves accumulated during QE would quickly be lent out as more and more people desperately chase fewer and fewer goods.

What I have only hinted at is the endgame that the central planners in the Communist Party — and holders of Treasuries around the globe — are seeking. Explicitly, I believe that the current world order suits China very much — their manufacturing exporters (and resource importers) get the stability of the mega-importing Americans spending mega-dollars on a military budget that maintains global stability. Global instability means everyone pays more for imports, due to heightened insurance costs and other overheads. They recognise that while America falters and struggles under the weight of its military burden, its lack of growth, and its deep debt concerns, their military strength can grow at a much faster pace thanks to Chinese domestic growth, and a high domestic savings rate. They are happy that their dollar pile — China has over $3 trillion in foreign exchange reserves — can still buy plenty — and they want its value to remain as stable as possible. But above all they want to gradually diversify out of those dollars. From TIME:

Sitting on all of these dollars is putting China in an uncomfortable position. As the dollar weakens in value, their dollar holdings do as well. (The Chinese yuan is at its strongest point against the dollar since Beijing lifted a peg in 2005, while the yen is near its record high against the greenback.) Meanwhile, Chinese and Japanese investors get a tiny return on their holdings of Treasuries (since interest rates are so low), even though the outlook for U.S. debt is uncertain following a Standard & Poor’s downgrade of America’s credit rating. Yet China and Japan are, to a degree, forced to hold dollar assets anyway. It is difficult to switch all of those dollars into other currencies without undermining their value even further. (Nor is it clear which currencies would make sense to buy instead. Euros? With a debt crisis raging in Europe?) So China and Japan are stuck watching their dollars evaporate in value, unable to do very much about it.

But there is another option. One way to potentially protect the value of these mountains of dollars is to use them to buy real assets, like property or shares in companies in the United States. At the very least, such acquisitions could make their dollar holdings less vulnerable to the volatile gyrations of financial markets. And there is possible upside. Purchasing real assets like homes could allow Chinese and Japanese investors to benefit from a recovery of the U.S. housing market and overall economy (whenever than happens). Chinese and Japanese firms could capitalize on acquisitions to expand their market presence or acquire new technology or brands. Chinese banking giant ICBC did just that when purchasing control of a retail banking operation in the U.S. earlier this year.

The beautiful thing about this eventuality is that a peaceful world order can be maintained, and the two superpowers would share a greater common interest in peace and a shared future. The biggest fallacy in international politics today is that China is somehow “dependent” on America. It is not: it is the greatest industrial behemoth in history, with a great deal of natural resources, a huge population, huge food production infrastructure, and relatively friendly relations with regional energy titans like Iran and Russia, as well as a strategic partnership with Venezuela, the nation with the greatest national oil reserves. If America stopped buying Chinese goods there are plenty of other markets: Europe, South America, Russia, India, and China herself. Or — more to the point — China could very easily convert her industrial capacity to the manufacture of weapons. No — the real dependency is America, increasingly dependent on foreign oil, and foreign oil infrastructure.

And whatever happens, China will diversify: economic recession(s), high debt, massive unemployment, and the potential for social unrest  leave the dollar as an increasingly perilous currency. What is absolutely in America’s interest today, and tomorrow is Chinese investment in infrastructure, business and commerce in the United States. A trade war — starting with a yuan flotation and progressing up to exports tariffs and quotas — would become increasingly pointless if significant amounts of Chinese money were invested American business. It would give both nations an interest in a non-zero sum future.

Will both nations come to this conclusion? China has little reason not to — with the current shape of the world, she is getting stronger and stronger. But what about America? Can America accept that the era of hegemony is over? Can she accept that in the future her “free lunch” of Arab oil and Chinese productivity will come to an end, and that she will have to manufacture more, and produce much, much more of her own energy? That is the real question — and nobody knows the answer.

30 thoughts on “China’s Endgame

  1. I wonder…. While I agree with most everything you say, I find it hard to see China buying big chunks of the rest of the world, though I admit I could be very wrong. (I once read an analysis that claimed China has enough “money” to theoretically buy Australia.) The U.S. has big problems, so does China. Despite all the U.S. has done to ruin its farmland, and make food production totally dependent on oil, it still has the greatest amount of good farmland in the world. China will never feed itself, is drying up, and polluting itself horribly.

    But rather than some sort of destructive rivalry, both the U.S. and China need to cooperate in building a post-oil, sustainable world. Otherwise everyone loses.

  2. “I find it hard to see China buying big chunks of the rest of the world”

    What else are they going to do with $3.2 trillion of foreign exchange reserves? Give it to Goldman Sachs to invest in ETFs? (Don’t answer that — Qaddafi already found out how “well” Goldman & J.P. Morgan treat sovereign wealth)

    China is already buying up vast swathes of Africa. The Guardian did an interesting article trying to quantify it:

    http://www.guardian.co.uk/world/2011/feb/06/chinas-economic-invasion-of-africa

    Maybe today or this week I’ll do an article explaining my take on China’s current effort to buy up Africa and just how specifically, beyond even the United States, this will change the world.

    “But rather than some sort of destructive rivalry, both the U.S. and China need to cooperate in building a post-oil, sustainable world. Otherwise everyone loses.”

    That’s exactly what I want — I’m just worried that President Rick Perry or Mitt Romney or Sarah Palin might go a bit bonkers at the suggestion that American exceptionalism is over…

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  4. I don’t know about USA laws, but in Australia, if you have enough money, you can buy a business investment visa and migrate to Australia. Then you can buy up Australian farmland, houses and businesses. And you can keep “Duel Citizenship” too!

    I wish I was a Chinese Communist party member, migrated to Australia, had a great life, while I was bank rolled by the Communist party. I even get to Vote! Talk about a scam. I am sure the Communist party is laughing.

    Are we stupid? I believe so. I support refugees coming to Australia to start a new life. But not bank rolled individuals. We in Australia should be supporting industry and innovation from our own populace, not dumbing them down while we pay for our lifestyle with “Imported money”. Bloggers warn of the danger, but corrupt politicians wine and dine the rich, so they can be re-elected with “Campaign money” (Read corruption money)

  5. I look forward to reading more about China buying Africa. It will certainly be interesting to see just how much real stuff they will be able to get in exchange for their depreciating U.S. paper and how long they’ll be able to hold on to it.

    The big problem in buying Africa would seem to be the Africans. The West, as we all know, tried to take ownership of the place without paying for it, but the Africans eventually drove them mostly out. I seem to recollect reading that the Chinese became closely involved with Zambia and maybe some other countries as well in the 1960’s, ostensibly to assist fellow socialists rather than to make profits, but things turned sour and they left with considerable distaste and loss of life on both sides.

    So the question is, what will the Chinese really be able to get for all those paper IOUs? My guess would be, not all that much and not for all that long, but I do not pretend to know any answers. I think it is a very interesting question. Historical examples seem to indicate that countries have a hard time buying other countries. And Africa doesn’t have the greatest track record on sanctity of contracts and rule of law. I guess we’ll see just how far paying off the “big men” there will get them over the long term, and to what degree they will resort to force.

    BTW, really enjoying the blog. You’re certainly putting out a lot of material. Don’t burn out!

    • Thanks Spruce,

      Before I started this blog I already spent a lot of hours a day arguing about politics/economy on the internet. So 2-3 articles a day, even fully-fleshed out ones, is pretty easy. The best way to fight writers’ block is to keep a long list of potential articles. I do worry I am getting repetitive, though. I can see why a lot of bloggers fall into posting more and more news cycle, and less and less opinion. What I would love to know is how the bigger economics blogs manage it. I am starting to strongly doubt that Zero Hedge is just one guy.

      You make some interesting points about China in Africa. The BBC recently did a fascinating documentary on it, if you can find it. I certainly think that the new Chinese model will be more successful than the old one. Paper money is a much worse tool for buying countries than force in the short term, but in the long term — so long as they can create lasting and meaningful relationships with African people and African nations — I think that could be a real winner.

      I do wonder if the Chinese (both their government and their population) have the foresight and the self-discipline to base their foreign policy on relationship-building. I suppose we will get to see…

      • Aziz- From the small amount of research I’ve done, “Tyler Durden” is possibly upwards of 40 contributors all writing under the same pseudonym. However, most of the posting is done by two people: a former hedge fund analyst banned by FINRA for insider trading, and another hedge fund trader in the Chicagoland area, who used to post under the name “Marla Singer”

  6. Thought I’d get a quick word in here,

    If you ever feel like you’re being repetitive azizonomics…
    I ripped through Zerohedge trying to find the link to this website not more than one week ago (as I had forgotten your blog domain name). This may appear as a tangent post, but I am very enthused by your writing and presentation on these world topics I’m interested in. Very stimulating. Keep up the good work my man – I’ll be reading.

    – Ryan

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  17. Your hypothesis that China and US could benefit from each other if they decided to “play” together is idealistic (for you and those that believe the hype). While I do agree that such a relationship would be beneficial is it a relationship that could be formed with trust and reliance on a set of ground rules? You seem to believe that the U.S.A., Inc is acting on its sovereignty and for the health and welfare of its people, when actually our government is merely “the ship” of imperialistic goals which is captained by those holding much power and wealth according to their bloodlines.

    Are you unaware of the strategic placing of troops, bases, missile launchers and puppet governments throughout Eurasia and the Mideast? Does it appear that anyone from the West has even considered a foreign policy of the nature you described?

    No one steps down from a powerful reign without defeat and humiliation. There are no humble public servants in the US and its allies. They have their own agenda for a new strategic order that gives them more control and leaves us with far less liberties and shackled freedom. They are ruthless and evil. The best example is the state of affairs in Libya. The decimation of Libya by NATO is a reason that China and Russia (and a few other smaller countries) will never reach agreement. The butchering of Libyan people and the destruction of their infrastructure and cultural artifacts is just another cleansing just like Iraq, and to a smaller degree, Afghanistan and Pakistan. But I’m sure further devastation will continue.

    The largest ever harvested crop of opium from Afghanistan has been insured by the US military and secretive contractors. This crop is refined and smuggled into countries like Russia and China to further destroy their cultural and the young minds. Its no different than what has been done to the American youth.

    No…I don’t see the path that you suggest. Not in this world until a few things are rectified and major players have been exposed and punished.

    Some of us want to see a reset because the current system of phony democracy only serves a few at worst and a majority at the best. When you speak of a peace between China and US I wonder where you have been in the last decade.

    • I want peace in Eurasia, and between America and China. I believe that is the most economically feasible path. However for the reasons you note, and for a few others, America/ Pentagon/ NATO/ Think-tanks will probably not accept the end of Anglo-American hegemony, nor the end of the great American free lunch. As I have noted a few times in the past few days, America and Israel might well throw the dice and try and destabilise the region by launching wars/ proxy wars in Syria/ Iran/ Pakistan.

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  23. I like your articles Aziz and view of a strategic partnership with China… However do you ever consider the impact that new technologies like 3D Printing will have for American Productivity? One can now buy a 3D printer for less than a couple months salary for most people and start innovating.

    The other aspect I am not sure you have seen in the last couple years developing is the absolute explosion in Bakken resources. It is estimated by Continental Resources, the first player to actually successfully tap into the Bakken’s reserves that have been known since the 1950s, that there are over 20 Billion barrels of recoverable oil. It is also estimated that we will become almost energy independent by 2030 by the IEA and we will surpass Saudi Arabia sometime in the next few years in production.

    I understand our whole debt and future liabilities and interest rates reverting to the mean of 5-6% headache, but I believe a systemic shock to the American economy will allow overseas investors like China to snap up real assets like real estate or companies if the stock market were to take a 50% correction. This coupled with our very real and possible energy independence over the next 2 decades is a key reason why we should get out of any major hyper-inflation depressionary scenario.

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