China Buys the World

I missed the news.

And, I presume a lot of others also missed the news.

“In the weeks ahead, a 104-year-old unit of General Motors will be sold to new owners from China. The unit made steering equipment for decades under the name Saginaw Steering Gear. Now known as Nexteer, it employs 8,300 people around the world. It new Beijing owners call themselves Pacific Century Motors.” (http://professional.wsj.com/article/SB10001424052748703957804575602943255219552.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)

China is, and has been, buying companies throughout the world.

“But,” the above article goes on, “it is one of the landmark deals of the era, the first time Chinese investors have bought a U. S. industrial operation of such scale and history: Twenty-two factories around the globe, six engineering centers, 14 customer-support centers.”

The only direct way to stop this activity is through capital controls and other forms of protectionism.

The United States Congress did balk at some earlier attempts by China to purchase U. S. companies that were considered to be threatening to American security interests. Still, China continues to seek out and acquire United States companies.

I have mentioned this behavior on the part of the Chinese before. But, the Chinese are not alone…other emerging countries are engaging in the purchase of American companies as well.

And, the United States government continues to feed China and these other countries with the means to buy American countries.

“Ironically, at the G-20 conference in Seoul this week, U. S. leaders are trying to cajole China to buy more from the U. S., to help right a trade deficit that hit $28 billion in August alone. Such imbalances, they say, helped feed the credit craze that culminated in the 2008 financial crisis.”

In my mind, the “U. S. leaders” don’t get it!

The United States government continues to inflate the world with dollars and dollar-denominated U. S. Treasury securities and then encourages these foreign governments to buy American companies to combat the trade deficits that they have been instrumental in creating.

What am I missing here?

The United States government is inflating the world with dollars because the unemployment rate is too high and then encouraging foreign governments to buy American companies to put these people back to work again.

Again, what am I missing here?

And, why should the Chinese government want the situation to change. The Chinese government is in the driver’s seat and the United States is just feeding it with the means to buy companies both in the United States and in the rest of the world.

The Chinese have no reason to change the existing situation.

And, as long as the leaders in the United States government keep pointing their fingers at the Chinese and saying that the problem is out there…the problem will be that of the United States continuing to feed the rest of the world the means to acquire America.

But, this will not continue forever. The United States Congress will not allow it.

The threat, then, is as described by the German chancellor Angela Merkel stated in an interview with the Financial Times, is the imposition of controls and protectionism. (http://www.ft.com/cms/s/0/3cb912ca-eb6f-11df-b482-00144feab49a.html#axzz14tWucN4h)

This will not be good for either world trade or for international cooperation and peace.

But, the United States government shows no inclination to change its behavior. The leaders in the government are still working off of an outdated and inappropriate economic model. They are also working with an outdated ego that claims that America can still “go-it-alone” in the world.

Unfortunately, these outdated ideas are working entirely against what the United States would like to achieve. It is hard when you are your own worst enemy!

And, the United States continues to shoot itself in the foot. There is an excellent op-ed piece in the Wall Street Journal this morning by Alan Reynolds. (See Ben Bernanke’s Impossible Dream”: http://professional.wsj.com/article/SB10001424052702303467004575574610003111250.html?mod=ITP_opinion_0&mg=reno-wsj)

Although though Reynolds concentrates the focus of the article on the Bubble Ben’s quantitative easing plan, I could not help but think about who would benefit from the consequences of the “easing” that is presented. All the consequences described by Reynolds will benefit the wealthy because they are the only ones that are in a position to take advantage of the incentives that will be created by the quantitative easing.

This policy, then, will have three ultimate effects. First, income (wealth) inequality will continue to increase in the United States. The economic policies followed by the United States over the past fifty years which are just variations on the quantitative easing policy, have created a massive shift toward a more unequal distribution of income (wealth) in America. But, in an attempt to help the less-well-off, the government will continue to follow its existing policy-prescriptions.

Second, the United States will continue to become less and less productive. This is one of the criticisms leveled by Wolfgang Schäuble, the German Finance Minister. Schäuble stated that the reason for the strength of German exports was the fact that German industry was so effectively productive. He implied that other countries, like the United States, were not as competitive. The United States will be even less so if the results Reynolds foresees are achieved.

Third, given the current economic philosophy of the United States government, the leaders of the government will continue to combat this loss of competitiveness by “more-of-the-same” in terms of economic policies. This will just continue to hand the Chinese, and others, the means to acquire American companies.

Following such a path will result in the Obama administration achieving exactly what it does not want to happen. But, this is precisely what the Obama administration has achieved in the less than two years it has been in charge of the United States government.

And, why should China want anything different?

International Capital Mobility: the United States Dilemma

In this globalized world, international capital mobility must be taken as a given.

According to modern international economic theory, if international capital mobility is a given, then there are only two other policy choices left a nation, but that nation can only choose one of the two. The first is a fixed exchange rate and the second is the ability to run an independent government economic policy. By independent is meant that a nation’s economic policy can be run according to the internal goals and objectives of that nation without regard to the economic policy of any other nation in the world.

The assumption has been that a nation can follow an independent path internally so as to achieve high levels of employment as well as other social goals like attempting to put every family in the country in its own home.

The United States began following a fully independent economic path in the 1960s and with the growing mobility of capital globally following World War II, the Nixon administration found it could not continue keeping the value of the dollar tied to a gold standard. In August 1971, President Nixon released the dollar and allowed its value to float.

The basic assumption of this move was that the value of the dollar would adjust in international markets so that the United States government could inflate the economy so as to achieve full employment of its labor force. As credit inflation took place within the country, the value of the dollar would decline causing exports to increase which would keep the labor market fully engaged.

One problem: this assumed that the United States economy would stay competitive with other nations. Unfortunately, this assumption did not hold as the credit inflation within the United States resulted in a deterioration of the competitive base of American industry.

A consequence of this deterioration is that American exports could not keep up with the competition in world markets. As the value of the dollar declined, exports did not expand as the economic model predicted. Charles Kadlec reported in the Wall Street Journal that as the value of the dollar declined dramatically over the 42 years following 1967 “net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today.” (http://professional.wsj.com/article/SB10001424052748703440004575548451304697496.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)

Hello?

Is the market trying to tell us something?

In my post yesterday, I presented information cited by Tom Freidman in the New York Times who focused on a report from the National Academies listing how the United States has declined from being a leader in innovation and technology. The conclusion from this report is that the United States just is not as competitive in the world as it was fifty years ago.

Bloomberg adds further evidence that the world is shifting in terms of competitive action. How do you like this headline? “IPOs in Asia Grab Record Share of Funds as U. S. Offers Dry Up.” (http://www.bloomberg.com/news/2010-10-27/ipos-in-asia-grab-record-share-of-global-funds-as-u-s-offerings-dry-up.html)

“‘What the market needs and wants is a lot more IPOs coming out of China,’ said Jeff Urbina, who oversees emerging-market strategy at Chicago-based William Blair, which manages more than $41 billion. ‘That’s where the growth is.’”

The article states that “Record demand for initial public offerings in Asia is reducing the share of U. S. IPOs to an all-time low as companies from China to Malaysia and India flood the market with more equity than ever.”

Who says the world is not shifting?

And, then, in another blow to American pride, we learn that the Chinese have built a supercomputer that has 1.4 times the horsepower of the fastest computer that exists in the United States. (http://www.nytimes.com/2010/10/28/technology/28compute.html?hp)

Maybe, just maybe, the United States needs to take a hard look at the economic philosophy it has based economic policy on over the past fifty years. Maybe an economic policy based upon credit inflation is not productive in the longer run after all.

There is substantial information being produced by the market place to indicate that maybe the predominant economic model in the United States, the “Keynesian” model, does not produce the results that we want. In fact, the information is pointing to the fact that, in the long run, the results that are produced by this model are exactly the opposite of what people were trying to achieve.

However, the real Keynes argued that when the facts seemed to point away from the models currently in use, one should change the models that are being used.

Maybe, just maybe, we should listen to this Keynes and not to the “Keynesian” true-believers that preach the fundamentalist gospel that has dominated economic policy making over the past fifty years.

The "New" Economic World Order

Experts tell us that one way to solve trade problems is to let the value of your currency fall. When the value of your currency declines relative to other currencies, your exports will rise and your imports will fall. This seems to be the accepted theory.

This seems to be what the Federal Reserve is trying to do. “U. S. officials are determined to push the dollar lower” we read in the Wall Street Journal Wednesday commenting on the minutes from the September meeting of the Fed’s Open Market Committee. (See “Fed Viewed as Trying to Devalue Dollar”: http://professional.wsj.com/article/SB10001424052748703440004575547553908304106.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)

Maybe, however, there is another part of this theory that is not being considered. Remember, in economic theory there is a “ceteris paribus” assumption attached to all models: thus we assume “all other things the same.”

One of the other assumptions made when discussing the value of a country’s currency is that the relative productive power of all the countries considered remains the same.

My question is, can we assume that the United States, over the past fifty years, has maintained its relative position in the world with respect to its productive power?

I ask this question because it appears as if the continued decline in the value of the dollar has not improved the trade balance of the United States, especially against many of the emerging nations.

The value of the dollar goes down…the trade balance…if anything…worsens.

This is not the way it is supposed to be. Thus, something else must be at work.

The United States has been on the top of the world since the late 1940s. It continues to act as if nothing has changed.

I will respond with just two broad comments on this situation.

First, the economies of the emerging nations are developing: they are developing rapidly; and they are developing in a very competitive way.

Second, the United States has followed an economic philosophy in terms of policy over the past fifty years that has weakened it in many ways. I have presented this case on many occasions in recent weeks.

“Other things” have not remained the same, yet leadership in the United States continues to assume that they have.

As a consequence, to the leaders of the United States, the problem is “out there.” The problem is China!

One of my favorite Stephen Covey quotes is this: “If you believe the problem is ‘out there’; that’s the problem.”

My belief is that as long as the leadership of the United States believes that the problem is ‘out there’, that will be the problem.