At Arm's Length - Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 08.22.05

Or Else - except without Clout

Secretary of State Condoleezza Rice issued a stern warning to the Chinese last week that went all but unnoticed. Her charge, an echo of the President's claim that he and the US are a "fair traders" suggested in rather harsh tones that Chinese were not. The playing field is not level, the State Department feels and the Chinese should rectify the situation and do so soon.

The Chinese president Hu Jintao is scheduled to make a state visit next month and perhaps the strong words were meant as a way to open dialogue between the two nations. But c'mon Connie, the Chinese neither need to open dialogue or are apt to at your criticism of their practices.

The Chinese are rather new at this whole world politics sort of thing. They are bound to make mistakes and for the last several years, their investment in the good faith and credit of the United States government was not considered one of them. Long time investors in foreign lands, the Chinese interest in our thirst for debt has left them an opportunity to gain an economic foothold here. In reality, they actually have more than a foothold here. Think of the debt we owe the Chinese as more of a hand around the upper arm.

They have with great success created customers in far off lands almost as a matter of state policy. Africa has long been a customer, one that was developed while we were freezing the planet with Soviet anxiety. Asia and South America was built with a good deal of Chinese investment as well and their influence with many of these nations has been open and profitable.

Does the Bush administration really understand how the Chinese conduct business in a country that has become as large an economic force as the United States once was? His actions do not point towards this appreciation of their position on the global stage. He should.

According to a 1999 study conducted by Interhemispheric Resource Center and the Institute for Policy Studies to determine the effect of China's invitation to the WTO, the Chinese economy was seen as poised to grow rapidly while, at the same time, it was being regulated from within by its own size, antiquated policies and cumbersome populace. The report reads as follows when discussing how the WTO should perceive this enormous country:

Internationalists

Nationalists are the second major economic force in China. They control businesses (including farms) that are not efficient enough to compete successfully in international trade but that dominate the domestic market. These nationalists are prominent in many heavy industries and in some farm sectors in which China is not a competitive producer, and they include wheat farmers and most of China's leading chemical, petroleum, high-tech electrical machinery, aircraft, and automobile producers. Occasionally, some of these large firms woo a foreign partner to inject capital and upgrade their technology to make them more competitive, but the political complexities of such investments often discourage foreigners. Thus most nationalists will not benefit from Chinese WTO membership. Instead, they will suffer in two ways: directly from increased foreign competition and indirectly as increased competition in the financial sector attracts capital away from their losing ventures toward more competitive internationalist firms.

Localists are China's third major economic force. These are producers who are not only less competitive than the world market standard, but also less competitive than the leading national producers within China. They are mostly small-scale producers for local markets. Despite their relative inefficiency, they have helped provide political and economic stability through employment and subsidies. In the past two decades, they have flourished because China's economic liberalization has been accompanied by substantial political decentralization. Local officials at every level of government have many means to subsidize and protect local industries. China's agricultural reforms have provided many farmers with increasing income with which to purchase products. The underdevelopment of China's transportation network has insured that, in most parts of China, people buy mostly from local businesses funded by local branches of government banks. This has resulted in hundreds of small-scale producers of items such as fertilizers, steel, cement, motorcycles, and farm machinery. However, the recent rapid construction of highways provides an alternative to state-run railroads, bringing in new competition. Some localists might find ways to redeploy their capital to more efficient pursuits, but many will eventually succumb as outside competition increases. Because China's tariff cuts will increase the competition they face, they will view WTO membership more as a threat than as an opportunity.

On November 10, 2001, it was admitted to the group. But the stigma that surrounded this super power has lingered here in the US. China was once a nation whose trade status was reviewed yearly by Congress. Of late, the Bush administration has done little to sway this anti-Chinese sentiment among the Congressional hard-liners. Instead, they have fanned the flames with their open concern and criticism of the Cnooc offer to buy Unocal. Using threats to national security, the rabble raised enough commotion to force the Chinese to withdraw their offer. This has been erroneously been seen as a victory for American interests.

Our protectionism is ringing somewhat hollow as pieces of Americana are being sold everyday. If not from major international players like IBM, but from the federal government themselves. The selling of the national debt, a product who's appeal is unique to certain buyers has been dominated by the Chinese. Recent auctions have not attracted the same interest in our debt and this has Wall Street and the Treasury wondering why.

The State Department would like the Chinese to embrace our point of view when trying to create a trade relationship. Trouble is, our point of view tends to be skewed somewhat because we have no rational restraints. One the other hand, the Chinese are entering a global market with territorial restraints and attitudes. As long as these differences exist, expect a stalemate of sorts at least in the near term. The reasons are simple as the definitions are different.

Our rational restraint embraces a seemingly irrational notion about our debt driven growth. To the Chinese, this must seem an odd and funny position to be in. While we continue to suggest that they play fair and by the rules, we spend money we don't have, given to us by the Chinese and then we have the gaul to cry foul at their currency valuations. They buy our debt, in essence giving us a cash advance that we promptly spend it on goods created by them and yet we are not satisfied.

Their territorial restraint should be just as confusing to us. We were once just such an economy ourselves until technology dragged us from the dark ages into globalization. Forced to operate within our borders, we once held the same suspicions about outsiders and their motives. We were once xenophobic traders who once produced the goods the world bought. But those days are over.

The evidence lies in the unemployment statistics which point to a continued decline in manufacturing jobs and an increase in construction and service sector employment - the kind that can be paid for with creative financing or by the swipe of a credit card. The Chinese territorial restraint is understandable. Our (ir)rational restraint is not.

So Condi's chastisement of the Chinese, citing everything from human rights violations to trademark infringement to threatening American workers and farmers was quite a bold stroke. Considering that not much of China's economy or their current approach to capitalism has change since that 1999 WTO report cited earlier.

Question is should our approach be less fearful and more open? Not necessarily. Our wariness is well-founded and should be used to keep our wits about us in any negotiations with the Chinese. With the exception of their surplus, their largely shape-as-they-go economy, and the enormous base of customers American business is hungrily eyeballing, China is anxious to keep its biggest customer on the hook at least until it finishes whatever reforms it needs to enact.

Meanwhile, we operate from a position that seems to be the polar opposite. We run an enormous deficit, actually two, and have no real plan in place to stop the spending spree both in Washington and across the countryside. To look at our recent growth the way the Chinese might is to see an economy based on borrowed money. That is not normally a bad scenario except when all facets of the economy are relying on inexpensive capital to continue current growth.

Ms. Rice and all of the administration talking heads on down to average folk like Senator Charles E. Schummer (D-NY) should understand that the seeming interest in sustained and amicable relations with the US is a game of time. Given enough time, the Chinese will find the strongest ground in which to dig their heels and any hedges the US to protect ourselves with other countries such as Japan and India will be for naught.

In another place and time, probably not too far into the future, those harsh condemnations might be perceived as fighting words and not just strong trade talk designed to strengthen our position. In the mean time, the Chinese smile at the hollowness of the threat.

The previous week's articles.

COLUMN REQUEST | AT ARM'S LENGTH ARCHIVE | WHO WE ARE | CONTACT US | LEARNING CENTER