BEING STREET SMART

by Sy Harding

China's Relentless Advance Continues! December 10, 2010.  

Wars between major countries are no longer fought on the high seas, or on land with vast armies, but in board rooms and markets. It’s now economic warfare that threatens to alter the global landscape, enriching the winners and creating hardship for losers.

It’s no longer about which country has the largest navy or nuclear arsenal. It’s about which country can win the economic battles.

Someone needs to inform Congress and the Federal Reserve, since they rarely mention China’s oncoming juggernaut.  Congress is currently in a contentious debate over the U.S. defense budget, making sure the country can handle the types of war that threatened in the 1980s. To cut spending on military hardware or increase it, to build more F-22 fighter planes and aircraft carriers, or spend more on unmanned drones and beefed-up ground forces.

While remaining by far the most powerful military presence in the world, the U.S. has not won many battles in the economic war of the last decade. The economic powerhouse has been China.

Over the last ten years China’s economy has surged past those of Canada, Spain, Brazil, Italy, France, Germany, and this year passed Japan, to become the second largest economy in the world.

China’s economy still trails the U.S. economy, but is closing fast. The International Monetary Fund and the CIA’s World Factbook, seem to agree that of the world’s total annual Gross Domestic Product of $70.1 trillion, the U.S. accounts for $14.2 trillion, and China about $9 trillion.

However, China’s annual GDP has grown 800% from just $1.1 trillion in the year 2000, while the U.S. economy has grown 60% from its level of $8.7 trillion in 2000. So current estimates that China cannot overtake the U.S. to become the world’s largest economic power until at least 2020 may be wishful thinking, particularly given the diverging paths of late between the two economies.

The U.S. economy came close to total collapse in 2008, and is still on life support provided by the most massive government rescue effort in history. Still worried more than a year after its Great Recession ended in June of last year, the U.S. government has just commenced another round of quantitative easing to try to lower interest rates even further, in an effort to make sure its economy doesn’t double-dip back into recession.

Meanwhile, China’s economy is so strong that its government has been raising interest rates and taking other aggressive steps to cool it off.

While the U.S. real estate industry is in a Depression with a capital D, China is concerned that its real estate industry is growing too fast and is also trying to slow it to a more sustainable pace.

While the U.S., already the world’s largest debtor nation, is forced to take on increasing debt by issuing large amounts of new treasury bonds to finance its stimulus efforts, China, which overtook Japan this year to become the world’s largest creditor nation, is the owner of much of that U.S. debt, holding an estimated $1.7 trillion of U.S. bonds and dollars.

Now it’s being estimated that 40% of the additional liquidity the Fed has begun pouring into the U.S. financial system will also wind up in China.

For example, as the Wall Street Journal reports, large U.S. chemical company Huntsman Corp. leapt at the chance to refinance $530 million of its long-term debt, which lowered its interest costs and pushed out repayment dates. The company said that will allow it to invest more in its business. But the Journal reports that the company’s biggest investment plans are for operations in the fast-growing economies of Asia.

Every day we read of major U.S. companies borrowing cheaply in the U.S., as intended by the stimulus efforts, but then free to invest that capital in China and other Asian nations. That may be good for their investors, but will produce jobs in China and other Asian nations, not in the U.S. Major U.S. banks and brokerage houses, are similarly using their rescued capital for impressive expansions into China.

There’s something wrong in that activity.  

Meanwhile, China’s economic battle tactics are becoming more ominous. This year it began to attack the long-time position of the U.S. dollar as the standard currency in international trade, encouraging the use of its currency, the yuan, in trade settlements. While still a small portion of trade settlements, it has had some success, the use of the Chinese yuan in global settlements tripling in the third quarter of this year. China and Russia have also issued joint announcements that they will begin using their own currencies in bilateral trade between the two countries.

The U.S. doesn’t seem to even be aware it’s in a war, since guns are not firing. But it’s a war the U.S. will be the worse for if it loses.

Providing more liquidity for the U.S. economy only to allow corporations, banks, and investors to send 40% of it to China is the latest strange way to wage the economic war.

Sy Harding is president of Asset Management Research Corp, and editor of www.StreetSmartReport.com, and the free market blog, www.streetsmartpost.com.

These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance.

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