July 2009 Archives

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As China absorbs the decline in exports created by the global financial crisis, the government is emphasizing the need to increase domestic demand and expedite the development of a local consumer culture. To put it simply - the Chinese government wants local consumers to spend more money in order to reduce the country's dependence on consumers from other countries. China's ability to shift from a production to a consumption-based economy depends on a variety of social and economic factors.  

In 1949, China had a population of 450 million; by 1980, it was close to 1 billion; today, it is over 1.35 billion. The UN's World Population Prospects, updated last year, estimate that China's population will continue to grow slowly during the next two decades and then begin to decline. The number of young people joining the workforce each year is expected to decline from 2010 (see Michael Pettis' blog for more on this). China's population is getting older and might soon begin to get smaller as well. Plenty of commentary is published about the implications this has for China's social security network and economic growth. In addition, it is worthwhile to consider the impact such demographic changes might have on local consumption patterns. 

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Looks like the world is going crazy. Yesterday, the Chairman of the Federal Reserve, Ben Bernanke, gave a testimony to the US Senate panel on Fed policy. 

As you may remember, the Fed has a monopoly on printing money and fixing interest rates. Mr. Bernanke tried to explain to the Senators how the Fed would eventually 'let go' of its current policy of 'near-zero' interest rates and flooding the market with newly-printed cash. He noted that things are getting better and that already "many markets are functioning more normally".

Bernanke openly talks about his policy of (i) manipulating interest rates in order to increase borrowing, (ii) printing more and more cash in order to create inflation and 'growth',  and (iii) using public money to bail out banks and other companies that made the wrong choices, instead of letting them pay for their mistakes and go bankrupt. At the same time, he mentions that "markets are functioning more normally". What "market" is there when so many parts of the economy are centrally controlled and manipulated by the Fed?

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I often write about the importance of free markets and the dangers of big government. There seems to be a lot of confusion these days about the meaning of those two concepts, especially when seen through the prism of traditional political left/right divisions.

Yesterday, a friend of mine pointed out that the current crisis was created under George W. Bush. If free markets and small government are really the solution, how come a "right-wing" president who "reduced taxes" brought us into this mess?

That's a great question, and president Bush is a perfect example of all the misconceptions people have about economic policy and the right-left division in US politics. How so? Let's look at the numbers.

Bush may have reduced (some) taxes, but federal spending during his two terms went up 19.7% and 25.3% respectively, not including defense spending. If you include spending on security and other adventures, the growth is almost 50%.

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"Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion....To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end.... It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression."
Karl Marx once wrote that every historical occurnce happens twice: first as a tragedy, second as a farce. Above is an excerpt from an essay published by F.A. Hayek in 1933, at the height of the Great Depression. It is based on an essay he published in German in 1928. Not much has changed.
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Passing.
While the rest of the world is suffering from the most severe financial crisis since the 1930s, it's business as usual for the people who got us into this mess. Two articles from today's Financial Times tell the whole story.

The first one talks about a new plan to give the US Federal Reserve 'extensive powers over all large US financial groups' and create an 'independent body to police risks across the financial sector'. 

The second announces that China's 'foreign exchange reserves reached $2,132bn after rising by $177.9bn in April to June, including a record monthly build-up of $80.6bn in May'.

And so, Chinese currency manipulation is going on at full speed to ensure Chinese exports remain artificially cheap, and the Fed now has even more power to make sure US interest rates remain artificially low. Will that get us out of the current crisis? No. It will only allow China and the US to pretend things are getting better, until the next crash. 

They just can't help it. If China floats the Yuan, more Chinese people will lose their jobs in the short term. If the US lets interest rates rise, more Americans will default on their payments and lose their pants. And since both economies are regulated by politicians and not by a free market, short term is the only thing that counts. 
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"But certainly for the present age, which prefers the sign to the thing signified, the copy to the original, fancy to reality, the appearance to the essence, this change, inasmuch as it does away with illusion, is an absolute annihilation, or at least a reckless profanation; for in these days illusion only is sacred, truth profane. Nay, sacredness is held to be enhanced in proportion as truth decreases and illusion increases, so that the highest degree of illusion comes to be the highest degree of sacredness. "
Ludwig Andreas Feuerbach, The Essence of Christianity, 1841.
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PDD Bank.
Below is an excerpt from a wonderful article by James Fallows from The Atlantic. Fallows traces the route of a USD in and out of China as it makes it's way through the country's enforced saving and currency manipulation mechanism. This is a must read for anyone wishing to understand how un-free China's market really is, especially when it comes to trading with other nations. The article was written more than a year ago, and Fallows did not fully grasp how unsustainable the process is. Since then, the imbalance created by China's actions, American's wrong response to it, and a variety of other minor factors brought the global economy to its knees:

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The Fall.
The global financial crisis rekindled the debate about the advantages of central planning as opposed to free markets. Various "experts", including leading American economists, are using the crisis to promote their political agendas and call for increased regulation on, and government intervention in the market , both nationally, and globally through institutions such as the UN and the IMF. I am now working on a longer post regarding the dangers these ideas pose to individual freedom and global stability. In the mean time, it's important to note that such ideas are not new, and have been found wanting by the test of time. 

China is considered by many to be the ultimate example of successful central planning. It is run by a ruthless and totalitarian government and exhibited strong economic growth for three consecutive decades. Previously, I wrote about the assumptions outsiders make when looking at Chinese economic indicators, and the way in which such assumptions affect decision making. However, even those who visit China in order to get a "real idea" of what's going on are often misguided by what they see. Visitors to Beijing, Shanghai, and other cities are impressed with the beautiful airports, highways, and central business districts and deduce that the country is developing well. 

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Note: The views and observations expressed on this web site are published for the sake of public discussion and do not represent my personal opinion or the opinion of my companies, clients, and/or employers. If you would like to get my opinion on anything, ask me.

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