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July 16, 2004

Chinese Checkers

It's past midday in the dead of summer here in the nation's capital and with the NASDAQ hovering right around 1900 and interest rates falling on 10 YR TRES, we can't help extending our mind half way around the globe. After all, way back in the year 1900, there must have been contrarian thinkers out there ready to predict the meteoric rise of the US economy to a position of world dominance. Nobody (but their relatives) had to tell the streams of immigrants coming from Poland, Russia, Italy, Ireland, the Ukraine --you name it-- that factory jobs were opening up in hard to pronounce places called Waterbury, Bridgeport, the Bowery, Trenton, Buffalo, Toledo, Chicago, Seattle etc. Nobody had to tell Tesla or Marconi where to bring their ideas.

In a world dominated by the global colonial powers the equation was quite simple: the poor countries provided foodstuffs and raw materials to the rich countries which turned them into usable items that were then exported at a premium back to the same suppliers. Of course, like everything else in life, it wasn't quite that simple but in taking a look at a fading photo of a meeting of the world's leading physicists, Conseil de Physique Solvay, held in Brussels (see brownish pic) at the Hotel Metropole in 1911 not only is there no attendee from Asia, there isn't one American although names like Plank, Curie, Einstein, Rutherford would later take on international significance.

Most Americans, we'd wager, couldn't give a damn about any of this in July or any other month but even among those who do, it's unlikely many have grasped just how much of the US trade picture is third worldly. To a large degree we export agricultural and capital goods and import manufactured goods. Last year, for instance, the only sector in which the US had a trade surplus, was agricultural products, according to the US Census Bureau. In the single month of May of 2004, in a recent but wholly typical example we exported, to China alone, a little less than $3 billion and imported a little more than $15 billion for a gap of more than $12 billion. The capital goods segment is important because it actually underlines the trend. Capital goods, is the term economist's use for machinery that is used to make manufactured goods. In simple terms, capital goods means machines that American factories might be using to provide manufacturing jobs that are instead being sent to Asia, Mexico and other cheap labor cost areas.

China, like Japan and the US and Europe before it, has become a massive siphon of raw materials like iron ore, copper, petroleum and other agricultural goods and manufacturing know-how that has primarily benefited neighboring countries like Australia, New Zealand and Japan.

Lately, the Chinese government, sensing an impending bubble, has started to cause a slowing mainly by restricting lending activity.

On October 30, 2003 Greg Mankiw, the Bush Administration's Chairman of the Council of Economic Advisers testified to Congress on the subject "China's Trade and US Manufacturing Jobs" The speech is famous because in it Mankiw argues that despite the enormous imbalance, trade with China is a positive with little impact on US manufacturing jobs.

In a concluding paragraph Mankiw states:

"Imports from China are one of many factors that influence manufacturing employment. The five industries that have contributed most significantly to manufacturing job losses since July 2000 are: computer and electronic equipment (16% of all manufacturing job losses), machinery (10.8%) transportation equipment (10.7%), fabricated metal products (10.7%), and semiconductor and electronic components (7.5%). These are export-intensive industries for the United States where imports from China are small. This suggests that US job losses are more closely related to declines in domestic investment and weak exports than to import competition."

What are we supposed to make of these comments?..... Perhaps, that the real losses in jobs to China are okay because we are also losing jobs to other parts of the world, (Europe, airplanes, Singapore, chips) in more vital areas?

So what's going to happen now that it's clear to anybody who knows how to read (and isn't a member of the band) that the much anticipated present US recovery is nearly stillborn despite --or perhaps, because of-- the massive dose of steroids it's been given by the Fed for the last three years? One thing is for sure --and the bond market knows it-- it's going to be very, very hard for the Fed to raise rates any more than the measly 25 basis points it got back last month. Like Japan, after its big bust, the Fed finds itself with absolutely no room down on interest rates. Given, the upcoming election sensitivities, they will probably stand pat.

But after the election, there's going to be noise all over the place no matter who wins. The dollar is already nearly back to its lows against the Euro and Pound and gold has crept back up over $400. Suddenly, we can expect to see a lot of attention given to the Chinese RMB by the Americans. A devaluation against the RMB would slow Chinese imports and raise Chinese buying power vis a vis the dollar, they will exclaim, even as the noise alone drives the dollar further down against the Euro, Pound and Yen. That will, if history is any example, rekindle interest in gold.

But even under intense pressure from its major trading partner, will the Chinese government accede to a revaluation? This is a tricky question. The Chinese do not want to give up their competitive advantage, which is working out just fine for them. They face enormous pressures from the massive populations in their own hinterlands to create their own Waterbury's and Akron's and San Jose's.

One thing we do think: Alan Greeenspan will not stay out the full six years of this present term he just got appointed to. The kitchen is going to get a lot hotter.

Posted by dymaxion at 05:34 PM

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