If you have any interest in global affairs, you've probably noticed that CNN International's menu these days is invariably a main course of Arab unrest with a side of EU sovereign debt served atop, you guessed it, a plate made from (and probably in) China. I'll be the first to admit that this slanty-eyed new kid on the economic block doesn't seem like the most approachable bloke, and there's two reasons for my wariness.
The first goes back to a Dutch academic by the name of Geert Hofstede who dedicated his professional career to exploring "cultural dimensions" used to quantify the extent of social dissimilarities between residents of various countries. Of all nations examined, the US and China have some of the most disparate scores. Even a cursory, qualitative glance paints a pretty clear picture: pillars of the American Dream are founded in entrepreneurship, individualism, and the resultant accumulation of wealth and ownership. That's how I've been raised all of my 24 years-- those silken values are emblazoned on my breast pocket and worn on my sleeve. In China, an entrepreneur is someone unfit to work within a respectable organization, the greatest strength is found in numbers, and your picket-fenced suburban homestead is licensed under revocable government contract. I've experienced mainland Chinese culture, and I've tried my best to embrace and understand the people beneath the values. At times, it's quite difficult.
The second reason is that they tend to smell of cabbage. I don't like cabbage.
So what's the point of this post? What's going on here? Well, ready or not, here they come. All 1.3 billion of them. And that's come as quite a surprise to even the foremost of experts on foreign policy. Henry Kissinger, US Secretary of State during the Nixon administration, was interviewed by CNN yesterday. He was asked if there was any indication that China would become an emerging global superpower during his tenure in the 1960s. "It would have been inconceivable," he replied. "Nobody had any such perception or expectation."
If the rising red moon comes to eclipse the western world, it would be the most important trend of the 21st century, beyond a shadow of a doubt. And it certainly has the tools to do so. I think that's why the media features China so prominently and acts as though its embryonic economy is being propelled skyward with unflappable inertia. What I want to do here is cash in on my investment in business school and explain, in as non-businessy way as possible, why the red moon very well may wane before the watchful eyes of concerned Americans, speculative investors, and the media.
It all starts with the Renminbi, China's currency (also known as Yuan, which is to Renminbi as bucks is to dollars). Every concerned reference about "made in China," the "trade imbalance," and outsourcing stems from China's currency or, more specifically, the way the Communist Party of China and the People's Bank of China treat the currency. But before I delve further into specific policies, it's important to first understand exactly what currency is, and how the world's currencies are related. Really, they're meaningless. They just symbolize how far each person can dip into the same pool of global resources. No skinny dipping please, that's gross. We all share.
Normally, currencies fluctuate depending on their relative supply and demand. Why is the British pound the world's strongest currency? It's consistently in demand, and there aren't that many in circulation. Why are there 20,408 Vietnamese Dong to the US dollar? I'm going to steer clear of the potty humor here and say that it's because the Vietnamese government at some point printed a ton of them to kick-start the economy, but nobody wanted them. There are a couple of things that impact the supply/demand relationship.
The first is the interest rate offered by the country's central bank. If the US is offering 4% interest per year and the UK is offering 6%, Americans will rightly convert their dollars to pounds to fetch a higher interest rate. We're not as dumb as everyone thinks we are. It's here that currency speculation comes into play. If I've traded for Pounds to get the 6%, and the pound strengthens against the dollar by 10% over the course of that year, well I've actually made 16% when I convert it back. Lucky me!
But that brings us to the second factor impacting the relative demand for currency, and that's imports and exports. If I want a Lotus Exige S (which I do, trust me), I'd have to import it from the UK. That means I have to swap my dollars for pounds to go buy it. The more people that want that car (along with millions of other British goods), the more dollars will wait in line to be exchanged, and that mismatch between supply and demand enables people with pounds to ask for more dollars in return. Basically, the pound goes up in value. That's supply and demand, baby.
Here's where China comes into play. Some enterprising, cabbage-scented fellow realized that Chinese workers would put in a full days' work just to dip their toe in the refreshing pool known as consumption. In fact, that mindset was consistent across the entire country, from food to houses to services. Americans, however, expected to at least paddle around. Everyone recognized the discrepancy, but there was nothing they could do about it: the Chinese government wouldn't allow international trade. True to communism, the government pretended to pay the people and the people pretended like they were working. In the late 1970s and early 1980s, however, the enticing aroma of money wafting through the window was too sweet to ignore. When the government relented (slightly), manufacturing proved the easiest way to take advantage of wage discrepancies. Even the cost of shipping goods across the world didn't make up for the difference. In the service sector, outsourcing was established as a way to exploit the same difference.
The government saw the money coming in, and decided that it liked that. It wanted to perpetuate the discrepancy for as long as possible, and up until recently was succeeding magnificently. How do we know? Even now, after recent declines, exports account for 28% of China's total economic output, which is now second in the world only to the United States. The fact is, that shouldn't happen. At least not naturally, and you can figure that out by logic. If the United States is always buying more from China than China is buying from the US (what economists aptly call a "US trade deficit"), more Yuan are requested than dollars. Eventually, unless the US is offering a much higher interest rate than China to counteract that trend, more Yuan will be demanded relative to dollars, which should push up the price.
The United States has indeed been running a huge trade deficit for quite some time (to the tune of over $13 billion for the month of May alone), and our interest rates, thanks to the crummy economy, are practically zero as our bank tries to incentivize spending rather than saving.
The problem, the entire crux of this matter, is that China will not let the Renminbi rise as it should. They artificially "peg" their currency to ours and maintain their favorable discrepancy, much to our chagrin. Liberalized, capitalist countries abide by a set of gentlemen's trade rules that include free-floating currencies. China plays by its own rules. But how exactly are they manipulating the currency? It all goes back to supply and demand. The Central Bank of China goes into the exchange market, where this supply/demand relationship exists, and buys enough US dollars with Yuan to perfectly counteract the opposite flow. "Now wait," you say, "that's not fair." The US, and actually most of the western world, would agree with you. China does not, nor are they particularly bothered by your objection.
But this practice becomes more nefarious. All those dollars they bought have to go somewhere right? Indeed they do, right into the hands of the CIC, short for the Chinese Investment Corp. This is the world's largest investing entity (other than perhaps the Abu Dhabi sovereign wealth fund, which doesn't disclose its capital). They take that money and go buy stuff...anything really. They bought some of Harvard's real estate portfolio, 10% of Morgan Stanley, and even made some strategic purchases like Canada's West Penn oil sands exploration company. Technically, there's nothing wrong with sovereign wealth funds along as they simply invest to earn financial returns. The divisive issue is whether or not China's into it for more than that, trying to snatch up and control resources or advanced technology. I'm of the opinion that they absolutely are, but I'll disclaim that my opinion is just as the definition implies.
So what's to stop it then? Have they got us by the balls? Not exactly. Or should I say, not anymore. You learn pretty quick in an economics class that when you artificially manipulate natural market movements, there are always repercussions. There's no exception here. Aside from basically keeping its citizens poor, which a depressed exchange rate does, China is causing inflation. Just as all the dollars they buy go somewhere, all the Yuan used to purchase them go somewhere too, and that somewhere is the growing mound of made-in-China cash getting bigger and bigger despite representing the same amount of access to the global consumption pool. The more of their stuff we buy, the more severe their inflation. They know this, and they've "re-fixed" the pegged number of Yuan per Dollar recently (by temporarily failing to correct the trade surplus) to 6.48:1, 5.4% higher than it was before. This move should have eased inflation, but it didn't. The average item in China required 5.6% more Yuan in 2011 than in 2010. At this point, they've thrown the policy bible (probably written in symbols) at the problem, but domestic inflation is persistent even as the currency appreciates. That's really rare, and speaks to the gross mismatch between what the Yuan is worth, and what it should be worth.
The economists among us will be quick to point out that it matters little- Goldman Sachs still expects China's total economic output (GDP) this year to be 9.4%, even with inflation factored in. That's torrid growth, but I'd counter by pointing out that food prices specifically are up far more. If a Big Mac in Beijing was 10 Yuan in May 2010, it's 11.70 a year later. Of course, this 11.7% rate of inflation, doing the fancy calculations, still means the average Chinese person can afford 3.3% more food this year than last.
Still, 3.3%. That's nothing to scoff at right? It is when you live by the arbitrary rules of an opaque, oppressive regime that denies personal liberties and abuses its citizens. And I've conversed with enough Chinese to know that that is not an opinion. The Party knows this too, and they're scared poopless by the "Arab Spring" revolutions to the point of overt paranoia. They've tweaked the "Great Firewall of China" to censor searches for every possible keyword relating to the uprisings. If you're connected through mainland servers, you won't read about revolutions on Facebook or Twitter either. Both are blocked. In fact, when CNN got wind of a potential impromptu demonstration in a public square, reporters arrived to find all entrances blocked by unmarked cars. They were approached, frisked, and by some accounts beaten by plainclothes officials patrolling the area. The Party's reaction to every jab at liberalization has been nothing but an uppercut of repression. If history tells us anything, it's that the proletariat, when repeatedly repressed, will eventually usurp its oppressor. Even if they're as passive as the Chinese.
I'm not saying that a revolution is happening tomorrow. Nothing but isolated protests have occurred and no other indications suggest a movement. Without going into too much more depth, however, China has the demographic makeup and, God knows, a reason to be discontent with their limited lifestyle.
China's always prominently featured in the news because it's a controversial and, for many people, threatening topic that garners page views. I'd contend, though, that the government is hiding from its people atop an economic structure built ever higher by masking tape and moist toothpicks. Let's just say I wouldn't want to be standing near it when it comes crashing down, and sooner or later, it will.
