Monday, October 25, 2010

China and the West: The Transition

I posted at The Daily Bell regarding their article entitled "What's Behind the US Currency Promotion?" The original article can be found here:

I felt it necessary to expand on the comments I made at The Daily Bell. Following are my exact comments (in quotation marks), with further explanation and clarification added. Additionally, while this is inherently a political analysis, I feel I should state clearly that my desired preference for social order is quite anarcho-libertarian. However, the reality is that a power and political transition is ahead of us. Following is my speculation on this transition:

"The US wants to maintain control, while trying to pretend that the emperor has clothes. The Chinese want a seat at the table, while pretending (as best they can, because it is so obviously laughable) that the emperor's clothes are still stylish (let alone...exist) in order that the transitions occur as smoothly as possible."

It is obvious on its face that the world order is undergoing a major transition, driven by the drastic economic dislocations which inherently will drive politics, alliances, and control. For much of the last century the US has established and maintained the dominant position on the world stage. For even longer, this can be said about the West in general.

However, while it is obvious to all, both the US and China are trying to go through the transition without admitting the emperor (the US) has no clothes. The US, of course, wants to maintain the appearance of power. China wants a more enhanced seat at the table, with a clear path that corresponds to China's likely continued growth. China, of course, wants the dollar to remain reasonably strong - however recognizes that the US has no political will to make it so (and in fact it may be too late, anyway). Dollar weakness comes sooner if the US is sooner exposed as naked.

"The Chinese will go along with the act as long as they feel power is appropriately being allocated toward them. I believe the Chinese can accept a power-sharing arrangement with the West, as long as they view it is "fair" in their eyes."

It doesn't strike me that China wants to dominate the globe the way the West has attempted to do so. They just want the respect of their position on the world stage.

"The US will move as slowly as China allows. In the long run, this can only be a delaying tactic ‒ absent the US taking China on directly, militarily, which is...NFW."

Certainly, the US doesn't want to race off the stage, they will move as slowly as possible. China, understanding respect - and that an orderly transition is better than a violent one - can go along with this pace, as long as progress is evident.

However, it is only a delaying tactic; the transition will happen...unless the US wants to make military hash of the world to avoid the de-throning. I view this as highly unlikely. The costs and risks are too high, and the US and USSR showed that some sort of sanity can prevail when the alternative is global Armageddon.

"China, and a few others will play their parts in G20 and other global organizations, while at the same time having other conferences without the Western powers in order to focus on alternatives."

To think China and other countries are not working independently to try and find the best path forward is naive. Yes, they will work in established structures, but these structures are dominated by the West - G20, UN, BIS, IMF, World Bank, etc. There is likely some lack of trust by China and others of these institutions, wouldn't you think? For China, pursuing parallel paths is prudent, and I think that it is happening is virtually certain.

"Nothing says China only has the gold they say they have, just as nothing says the West has all the gold they say they have. Both have reasons to share the common lie."

It would cost the dollar if China said they had far more gold than they admit already, and if the US says they have far less. Yet both are possible, and plausible. First, the actual gold reserves are not audited anywhere. Second, it benefits both parties to share the same false information. Third, how much gold has the FED lent to bullion banks which have sold the gold to third parties? We don't know, other than it happens. And to my understanding, this gold is still shown on the FED's books. But if the banks sold the gold to a third party, is it not also on the third party's books as well? Yes, I think.

"China's reserves aren't worth much to the extent they are denominated in USD & EUR (among others). China knows this."

There may be reasons for the Yuan to be a strengthening currency. To the extent the reserves are in USD and EUR, the quality of reserves is not one of the reasons. It is well publicized that China is trying to diversify its reserves. Do we really know how much?

"It is in China's interest (and in the interest of the USG and EU) to lie - in the same direction - regarding China's holdings of these currencies."

Both parties have reasons to say that China's holdings of USD (and separately EUR) are higher than they actually might be. The US wants some semblance of credibility to the dollar, and China doesn't want to lose value in reserves...during its race against diversification.

"China is buying real assets, spending their fiat currency reserves - others still take dollars & Euros in exchange for real stuff."

This is the race - trade pictures of dead Presidents for real stuff. Is China already out in front of the crack up boom? Very likely.

"China, in combination with Russia could easily institute a gold backed currency. Both countries have a complimentary use for each other. While transitioning to a gold backed currency will cause short-term internal havoc in China, such havoc is coming anyway and the CCP needs some way out for the long term. The Chinese are nothing if not long-term thinkers."

Now, I am going way out there (in case you felt I wasn't out there already).

China has a problem. They have a problem no matter what they do. They must transition their economy because they know the US can no longer buy what they used to buy. And even if the US could, does China still want the paper in trade?

China is buying assets, locking up future supply, etc. These can easily be priced in dollars. A strong Yuan (relative to the dollar) would work wonders for controlling future price inflation in China (which is quite well baked in from the monetary side). What better way to strengthen the Yuan than tie it to gold? Maybe backed 20% or so. Then pay for the assets for pennies on the Yuan, so to speak.

Going to a gold backed currency will cause a large disruption to China's economy. But this disruption is here and now, and is only going to get worse no matter what. In this case, why wouldn't China try to gain some real long term benefit for this pain?

With Russia, there are plenty of gold reserves. With Russia, China secures long term access to commodities. With Russia, military equivalence with the West (if not superiority) is assured.

"This move will be the final dagger to the West's dominance ' a death blow to the self-inflicted wounds (both economically and militarily) begun in the early 1900s."

Inflation in the West skyrockets. With a destroyed currency (relative to the Yuan), what can the West buy?

Everyone looks at currency from the seller's perspective - product can be sold cheaper, therefore I can sell more (a false equation, but one parroted exclusively). However, in order to sell, one must buy. With a weakened currency, the West buys less, so it sells less. Let alone, the drastic impact to the standard of living brought on by mass inflation.

The West has been committing suicide since at least 1914 - so much happened then, but it is enough to say the FED, and WWI. WWII put the nail in the coffin, and having false gold-standards (and after 1971, no gold standard), removed all discipline from the system, allowing clear sailing for complete self-destruction. This end was certain, only a question of when.

"Germany (without EU baggage) and Japan would be natural fits for this China / Russia combination, they just need to figure out how to un-encumber themselves from a no-longer-welcomed tenant."

Germany and Japan bring technology that both China and Russia desire. Russia offers resources desired by both Germany and Japan. In fact, could Australia also be brought in to this new alliance? It makes more sense for Australia economically to be tied in here than with the West.

How does Germany, Japan, and maybe Australia break the current strings? I don't know, but it won't be the first time alliances change. Especially alliances brought on only because of conquest in war, as in the case of Germany and Japan.

"Unlike the West, China does not have a history of desiring global dominance - they just don't want to be dictated to about what they view as their own internal affairs. It is not likely that a new global elite will emerge from China."

If I understand correctly, China voluntarily stood down 500 years ago - destroying the fleet and all records, etc. They haven't explored far since. They just don't want to be told what to do. Given the way the world is turning, that isn't likely to be a problem for China in the coming years, especially under the scenario painted in this speculative piece.

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