According to the Shaolin Warrior-Monks, the Dragon is a mythical animal able to fight on land, in the air, and in the sea. By turning its long body, it is able to move smoothly and fight multiple enemies approaching from several directions. This long body, however, is a large target.
Likewise, according to the Shaolin Warrior-Monks, the Tiger is an all-too-real animal known for its strength and ferocity. However, a Tiger has limited stamina, and must count on overcoming enemies quickly.
Today’s financial news is dominated by the new record high set by the Dow, and the 6 year high set by the S&P 500. Apparently Wall Street is in deep denial about what is happening half a world away. In China, American Secretary of the Treasury Henry Paulson and Chinese Vice Premier Wu Yi began a “strategic economic dialog. They were joined on the American side by 4 other members of the President’s Cabinet, the Chairman of the Fed, and our trade representative to China. On the Chinese side were ten senior ministers and their Ambassador to the United States.
If the size of the delegations alone indicate the importance of this meeting.
And to be honest, things are not going well. Mr. Paulson apparenty began the dialog by telling the Chinese their currency would have to float freely, and they needed to maintain economic growth without a trade surplus, and furthermore they’d better open their markets and crack down on piracy. The L.A. Times is under the delusion that these last two points are the important ones. Oh, and Paulson added “[T]hey have just got to move quicker.” Do everything I want and make it snappy? If this is how he thinks, I wonder how long until he is divorced.
Not too surprisingly, China [is] unwilling to budge. More specifically, Ms. Wu says “We have had the genuine feeling that some American friends are not only having limited knowledge of, but harboring much misunderstanding about, the reality in China.” In other words, respectfully, you don’t know what you’re talking about. She went on: “Wu said Beijing would ‘actively push forward trade and investment liberalization.’ But she stressed that changing China’s economy is a ‘long-term and arduous’ task.” Or, we will do it our way and we will do it in our timing.
Meanwhile, the Yuan is at record highs and Chinese banking IPOs are hot, hot, hot.
So Mr. Paulson has rushed in, hoping to get everything he wanted before anybody noticed he was attacking. Meanwhile, Ms. Wu has deftly turned and left the Tiger’s claws empty, knowing she will have time to turn and attack at will.
Why does this matter? Because China has the ability to bankrupt the United States at least 3 different ways.
First, they can continue to be our largest trade partner, draining off American money each month as the trade deficit increases and we buy more and more Chinese manufactured goods. Remember, that’s the reason the Bush Administration wants the Yuan to float freely. Currently it is pegged to the dollar, which keeps the cost of Chinese imports low in the United States. This would be the slow way to do the job. But Asian philosophy allows for the idea that a good plan well implemented might take generations to come to fruition. Look at Hong Kong: the Chinese managed to get the British to build the place and create its economy before taking it back over a century later.
The second way China could send the American economy into a terrible place is they could sell their dollar reserves. A source no less authoritative than the Wall Street Journal warns us “If the Chinese government reduces the amount of dollars it holds in reserve — or slows the pace at which it buys dollars — the revaluation could put upward pressure on U.S. interest rates.” Higher American interest rates means disaster in the housing sector and severe contraction of businesses financing new equipment. Just selling the dollars would severely devalue it, meaning deflation. Higher interest rates would probably exacerbate the effect.
The nice folks at the WSJ are kind enough to bring us way three that China could destroy our economy and send us into a great depression in the very next paragraph. They could sell the very large piece of the United States National Debt that they own. “China’s position in U.S. bonds is huge. China is the second-largest holder of Treasury securities (after Japan), with $243.5 billion of U.S. government securities as of May 2005.” Now granted, the National Debt currently stands over $8 Trillion, or $8 Million Million. Even so, over $200 Thousand Million of bonds hitting the market is going to make a big, big mess. And the thing that many people don’t realize is that “When interest rates go up, bond prices go down and when interest rates go down, bond prices go up.” So if China were to sell a bunch of bonds, interest rates would inevitably rise. Furthermore, this would be seen as a no-confidence vote on the ability of the United States Government to pay back its debts. Just like when Joe Average has lousy credit he has to pay higher rates, the same thing would apply to his Uncle Sam. This would in all likelihood drive up general interest rates, with the same effects listed in the previous paragraph.
Maybe Mr. Paulson should stop treating China like a small child and start treating them like a sovereign nation.