China's Dollar Dilemma

Just ran across this article, China's dollar dilemma. Articles like this always make me nervous.

China's near $2,000bn (£1,380bn, €1,560bn) in reserves, the world's largest, are often viewed outside the country as a great strength – an insurance policy against economic turbulence. But within China, they are increasingly seen by the public and even some policymakers as something of an albatross – a huge pool of resources not being used at home that will plunge in value if the US dollar collapses. Why, people ask, should such a relatively poor country bankroll such a rich one?

An excellent question. The answer is they shouldn't. Nobody should, unless that money is going towards investment in businesses that will use the money to buy capital and create goods (some services can be included in this). But the majority of the debt we've been accumulating for the last 30 years has been going toward consumption. If you refinance your house and use that money to go on vacation or remodel your kitchen, that money is simply gone. It's not going to make more money for the investor. The only hope is to get some interest off the debt, which right now isn't looking very profitable.

If China would ever decide to start spending their reserve of US dollars, or undergoes a major diversification into other currencies, we will be in for some serious inflation as that $2 trillion starts to come home.

Evidence of Deflation

Here is an article about companies cutting pay checks instead of jobs - More companies, such as Acco Brands, turning to pay cuts to avoid more layoffs. It has to be extremely painful for the employees, and a 47% pay cut for six weeks seems really bad, but it is allowing these companies to keep people employed. Again, anyone with debt will be hurt the worst. It is keeping people employed though, and hopefully allowing these companies to be prepared when the recession ends. And it will end eventually.

Here is the reason why - Economy Strains Under Weight of Unsold Items. A lot of overcapacity and inventory. We've been on a lending and buying spree for so long, everything is out of wack. Now that people are trying to pay off their debt, they are spending far less. Spending probably won't pick up until people feel comfortable with their financed, which means paying off their debt and increasing their savings. It's going to take a while.

I've been reading a book by Murray N. Rothbard called America's Great Depression. I'm just getting into the details about what caused the depression, but the main premise seems to be rapid monetary expansion and inflation in the form of banks loaning too much money to too many people. Back then though, it was the stock market everyone thought would go up forever, not housing. The result was pretty much what we're seeing now. I have yet to get into why the Depression lasted so long, but I have a feeling the main focus will be government intervention. Sounds familiar. It's all making me a little depressed actually.

China Monthly Auto Sales Overtake US

Wealth and money are two different things. We have had a lot of money over the last 30 years because we have been borrowing it from foreign countries. We have been giving away our wealth by sending our capital (manufacturing equipment, factories, etc) overseas and by spending our savings and going into debt.

After WWII, the reason why the United States became so affluent in the world was because we had a massive reserve of manufacturing capacity. Americans sacrificed their standard of living during the war to build factories that could produce the necessary goods to win the war. There were shortages of metal, rubber, nylon, food, you name it. People planted victory gardens for the war effort and women painted lines on the back of their legs so it looked like they had nylons on. After the war we had an amazing capacity for manufacturing. But instead of building tanks and planes, the factories switched to building cars and appliances. We became a net exporter of the goods we produced and became wealthy because of it.

For the last 30 years, we have been shipping that manufacturing capacity overseas, mostly to China. We have become a "service" economy which essentially means we consume more then we produce. Seventy percent of our economy is based on services. Meanwhile, China has been sacrificing their standard of living in order to lend us money and make us goods. There has been a massive transfer of wealth. Some believe that China is now poised to take over as the manufacturer of the world and will become wealthy because of it. Their standard of living will rise while ours falls. You can read more about all this in Peter Schiff's book, "Crash Proof".

Today, the following article caught my attention. China monthly auto sales overtake US for 1st time. It says, "China's vehicle market has grown dramatically in recent years, overtaking Japan in 2006 to become the world's second-largest by annual sales. With 1.3 billion people, China will inevitably leapfrog the U.S., with a population of 300 million, into the No. 1 spot, industry experts say." I think this is evidence that this theory of wealth transfer is correct.

China is also suffering from the world recession, but they are in a far greater position to weather the storm then we are. Their savings rates are near 50% for individuals, and there government has very little debt. Once they realize that they can stop lending us money and start using that money to increase their own standard of living, look out. They'll move into the No. 1 spot for pretty much everything.

Spending Down, Savings Up

More "bad" economic news.

"U.S. consumers cut spending for a sixth straight month in December and their incomes shrank, according to a government report on Monday that underscored the rapid deterioration in the economy."

- Consumer spending falls, savings jump

I think they should have said a "rapid correction" instead of a "rapid deterioration." Also, notice how it talks about incomes shrinking? That goes hand in hand with my previous post. Still, spending only decreased by 1 percent. When you think about it, people are still spending money. There will always be consumption, just a little less of it.

My favorite part of that article, "Personal savings surged in December to 3.6 percent of disposable income from 2.8 percent in November, the largest rate since May 2008." Sounds like we've learned something. Only a few years ago, personal savings was less then 0%.