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Monday January 5, 2009 - 15:53:38 GMT
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The Chinese New Year

The Chinese New Year does not begin until January 26th but her economic future was foretold back in September and October when American consumer and credit spending collapsed leading the world into its deepest recession in a generation

China’s exports shrank 2.2% in November; the first decline is seven years.  The Shanghai Stock Exchange lost almost 70% of its value in 2008. Chinese factories, particularly those feeding export industries are closing, unemployment is rising and wages and property are shedding value. The planners of the economic politburo in Beijing are facing the most difficult economic conditions since Deng Xiao Ping stepped off the Communist road in 1979. And to add dangerous politics to the uncertain economic mix this year is the 20th anniversary of the brutal repression of the student protests at Tiananmen Square.

Predictions for Chinese Gross Domestic Product (GDP) growth in 2009 are between 5.0% and 6.0%.  Such economic expansion would have central bankers in any other country frantically raising rates to head off inflationary excesses.  But in China, where GDP expanded 11.9% in 2007 and 9% in 2008, such a growth rate spreads fear in the ruling political and economic classes.  A 5.0% annual GDP increase is far from the classical definition of recession but in China the practical effect may be little different.

According to the Ministry of Human Resources China needs to create 24 million jobs annually to maintain social stability. Granted ‘social stability ’is a nebulous term.  What a Chinese government official might consider acceptably stable is probably quite different than what a US or British civil servant would tolerate.  But there is no doubt that unemployment is hitting the Chinese workforce hard. 100 million or more rural immigrants have moved to the cities.   Many of these migrants are or will soon be out of work. More than 10 million migrant workers have lost their jobs in China in the first 11 months of 2008.

The Beijing government has promised four trillion Yuan ($586 billion) in additional spending over the next two years.  The immediate need is to stem the job losses and return those already unemployed to work. The potential for domestic unrest from restive crowds of unemployed and unattached men in the cities is feared in Beijing and this fear is underlined by the complete lack of official acknowledgement of the Tiananmen anniversary.  The bulk of the government spending will go to infrastructure projects, roads, bridges, railways and the like.   These projects will provide immediate employment, much of it low skilled laboring work - exactly the kind of job that can be filled by unemployed rural immigrants.  

Will China’s planners also return to the type of export led economic growth that caused so much trade friction with the United States and other countries? Despite the myriad successes of the long Chinese industrialization one failure has been the inability to develop a domestic market capable of absorbing a greater measure of China’s manufacturing output. The current five year plan--they still have that relic of the Communist command economy in China—sought to move economic growth from exports to domestic consumer consumption.  It has not worked. Household consumption was actually lower in 2007 at 35% of GDP than it had been in 1993 when it was 45%.  The absolute dollar amounts of domestic consumption in 2007 are naturally much larger since the Chinese economy is so much bigger than it was 15 years ago but the volume of exports is too.

The government has also halted Yuan appreciation. The Yuan stopped rising in value against the dollar in July, after gaining 7.05% in 2008, 6.86% in 2006 and 3.4% in 2006.  

A static or depreciating Yuan and a revived export sector could lead to renewed trade conflicts with the United States and the rest of the world.

The incoming Obama administration promised to protect American manufacturing jobs against ‘unfair competition’.  Candidate Obama called the failure of the Bush administration to name China as a ‘currency manipulator’ unacceptable. He also supported legislation to permit US companies to seek import duties to compensate for unfair competition from an undervalued Chinese currency, and to permit US companies to ask for higher tariffs on specific Chinese products.   In addition, the unions which contributed many millions to the Obama candidacy are guaranteed to pressure his administration and the Democratic majorities in Congress for protection against Chinese competitors.

There is however, one huge obstacle.  President elect Obama plans to spend $675 million or more on an economic stimulus program focused on creating jobs.  The government has already promised or spent between five and eight trillion dollars on various guarantees, loans, equity purchases and such. And there will be much more as industries and state and local governments line up for their share of federal largesse. 

Every penny of this stimulus will have to be borrowed. This cannot be overstated. All new Federal spending will be a loan.  The funds will be borrowed from foreign governments with their own political and economic agendas. For China the logic is clear.  China is the world’s largest holder of US Treasury securities with $653 billion in their vaults.  If Obama wants to spend on the economy he will have to borrow from the Chinese, among others.  The Chinese have a good reason to lend, since it is American consumption that helps to keep their workers in the factories and off the streets.  But with a huge cache of ready money the Chinese government can afford to spend its own cash to keep its workers off the barricades.  It does not have to lend to the US government. And it can be very particular about its terms.

The Chinese have said they will not depreciate the Yuan to gain export advantage. World consumers have been perfectly willing to buy Chinese products as the currency has appreciated since 2005.   But the actions of the Chinese monetary authorities have made it plain they will not continue to appreciate their currency to appease their trading partners either. The Chinese effect on the world’s currency markets and the dollar will be noticed mostly in its absence—that is if and when the Chinese become reluctant to fund the US federal deficit.

At the moment the cost of funding the US deficit is close to zero.  The safety of US securities has trumped all ideas of maximum return on investment.  But that may not hold. The Chinese and other foreign governments know their influence. When the Obama administration has to choose between increased Chinese purchase of US Treasuries and the job security of US workers, the conclusion will be foregone, no matter the rhetoric from the US side.  It will only take a hint from overseas for trade pressure against China to be dropped by the Obama administration.

The dollar has become, in effect, hostage to the foreign funding of the US deficit. As long as overseas dollars flow into the US, demand and the prospective American economic recovery will keep the dollar strong. Even the knowledge that inflation lurks over the two year horizon will not damage the current dollar.   But if the foreign funding of the US deficit falters the dollar’s status could swiftly slide from safe haven to just one more devalued currency in a world full of shifting values. 

Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst

[email protected]

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