US Politicians Playing with Matches as they Threaten a Mutually Destructive Trade War with China

By: Ty_Andros

This week US Treasury Secretary, Hank Paulson, held a summit meeting with Chinese Vice-premier Wu Yi in Washington DC . It was mostly overlooked in the press and media as the fight over funding the war in Iraq consumed the headlines. The impact of this summit sets the table for the future of the United States in a far more meaningful manner as it outlines the coming miscalculations of the Mandarins in Washington DC . And like an exploding cigar, these issues have the potential to blow up in our faces, the unintended consequences of which can create investment opportunities that can be anticipated.

In the last several months the protectionist bombast (soon to be bomb blast) has been spewing forth from the most ignorant of our federal public servants who inhabit the Di strict of Columbia . These elected representatives from both sides of the aisle have decided to try to pin the tail on the Chinese for the failure of US public policy to set the table for wealth creation, and an expanding US economy, in the emerging global economy.

What do you do when someone throws a huge and extravagant party and you are not invited? We are about to see, as this is what is unfolding on a global scale, with America on the outside looking in. The G7 in general is embracing socialism and it shows in the economic growth numbers; they are barely growing and after the true inflation numbers are included, they are not growing at all (see “Misery spread widely”, www.TraderView.com ). The global economy is growing like mad as the recipes of Austrian Economics and Capitalism are combining to work their timeless magic. Huge piles of savings, combined with the pipes of International Global Money flows, modern communications, the internet, instantly available top quality education resources, entrepreneurs in the emerging world, emerging middle classes, modern transportation, and the loosening grip of socialism substituted with capitalism are creating a global economic boom that is astounding in its size and breadth. Economic growth and wealth creation which used to be made in America , are now being made in many other places. They are now sliding into old age in the US and are on life support.

During the Carter Administration the US economy was in serious distress: inflation was in the teens, individual tax rates were as high as 70%, regulations were smothering the economy, inflation was eating everyone alive and in general, the future was so bleak in the public's mind that change was in the air.

Wham! The arrival of Ronald Reagan and Paul Volker, policy makers with BACKBONE, a firm knowledge of history, capitalism, the sources of wealth creation and economics. Regulations were reduced as the bureaucracy got a haircut, the federal register was reduced for the only time in history. Voters were so desperate that the electorate wiped out the Democratic president and handed Congress to President Reagan. Pain created the impetus for change. Paper money was trash at the time; inflation swallowed alive anything that was printed. When people were paid, they quickly put the money into something that could hold value; real estate and gold were front and center in this period. Bonds were known as certificates of confiscation, stocks were dead, and Wall Street's name was mud. Inflation was killing the stock market, as dividends could NEVER keep up with the corrosion of the currency they were denominated in. Newsweek was reporting the death of equities in 1982.

In the United States we are heading back into many of these environments, but it will take us many years to get there as many things have changed in the global economy. Stocks could soar now due to the same elements, “too many dollars chasing too few goods” that was present then, but will play out differently in this timeframe. In 1980 the United States was the greatest creditor in the world; now it's the greatest debtor, and that is the keystone of the different endgame.

People that have big fat bank accounts don't have to worry about a rainy day, and even with all those domestic problems at that time, the US was still the manufacturer and banker to the world. Most of the world's capital resided in the United States . Now it sits in foreign financial hubs, and that pile of capital is growing by the day, as public servants in Washington DC busily tear up the roots of previous wealth generation, and foreign competitors plant the seeds necessary to generate the growth that at one time resided in the United States.

China is one of the new primary emerging economic super powers , with an immense population, huge pools of savings, an emerging entrepreneurial class and increasingly good educational system, as well as developing modern communications and transportation. The stage is set for growth. And grow it must as it transforms itself from an agricultural society to an industrial and knowledge-based one. Billions of people are leaving the fields and heading for the cities, seeking to improve their lives and prosper.

These things are transpiring in a far broader context in the world as the rest of Asia , the new EU 15, India , Russia and Brazil , join the chorus of emerging capitalism and industrialization. Poverty is receding and wealth creation is mushrooming across the world as vast new middle classes are born, newly created middle classes that will dwarf those now living in the G8 club of industrialized countries.

Everywhere, that is, except several countries and regions in the world that are not at the banquet table, and thus they are not going to be part of the big party that is unfolding. What are those places? Principally, they are places such as the United States , the old EU: France , Italy , and Germany ( Germany is an interesting subject - some is good, some is very bad), Belgium and Greece , to name a few. The Public Servants and citizens in these countries are caught in the “something for nothing” mentality (see Ted bits archives www.TraderView.com ).

They wish to fight the inevitable oncoming globalization and think they can do so by writing something on a little piece of paper, aka “legislation”, which they believe can stop the future from coming to their little piece of the world. Like waves striking a beach, these efforts will be eroded in the same manner. These countries either change their ways or become Banana Republics. Some are farther along the process then others, e.g. Italy and France are arguably solidly in this camp. The US is rushing headlong to catch up to the “bananafication” of these leaders.

The United States is now the greatest debtor in the world , and if the real extent of their indebtedness was ever compiled and reported, it would cause an immediate collapse of its currency and inevitably its economy, as the capital required to create future business and wealth creation would quickly be withdrawn by our creditors. This has not happened yet but our leaders are quickly trying to bring this day forward with confrontations like this one with the Chinese Vice-premier. Take a look at this table from the CIA's website (this website is fascinating), and realize that these numbers have been growing on a compounded basis for years upon years.

Rank Order – Current Account Balance

Countries for which no information is available are not included in this list.

Source: www.cia.gov Data last updated on May 10, 2007 .

Carefully look at the table above. The countries listed all they way to the Cook Islands at number 63 have healthy trade surpluses. Then there is a long, long list of countries living far beyond their means; the names aren't pretty when you look closely at them. Notice who brings up the rear? With fully nine times greater deficit than any other country in the world. And this indebtedness is accumulating and compounding at a yearly rate. Every year oceans of new obligations are sent overseas and are being saddled on the American public. This is what Warren buffet means when he says we are creating a sharecroppers society, as when these dollars aka “repatriated” are spent they will buy the United States lock, stock and barrel.

Witness this week's event.

(Authors note; looking for assistance in creating portfolio diversification that can survive and thrive in what I am outlining? In fingers of instability? If so contact me through www.TraderView.com . Subscriptions to this newsletter are also free at this address; send it to a friend, Thank you)

Our biggest creditor came to town to have a calm and reasonable conversation and our leaders drew a line in the sand. The Chinese arrived to speak with Hank and keep reasonable concessions flowing in both directions, and he is trying mighty hard to keep the situation from exploding in our faces like the aforementioned cigar. He fully realizes what's on the table, even if Washington doesn't, and now he is saddled with the additional roles of ambassador/diplomat and bomb “defuser”, along with his role as Treasury Secretary. During last week's meeting Hank stated the obvious:

There is a growing skepticism in each country about the other's intentions. Unfortunately, in America this is manifesting itself as anti-China sentiment as China becomes a symbol of the real and imagined downside of global competition." -- Henry Paulson, Treasury Secretary

Notice his reference to “ China becomes a symbol of the real and imagined downside of global competition." Make no mistake; he is fully aware of the misinformation being distributed for public consumption and manipulative purposes. The rhetoric is fierce as Washington and the main stream media demagogues mislead the American public about what is the source of their current economic problems. Take a look at this chart from last weekend's Wall Street Journal:

As you can plainly see, the US trade deficit is a much broader problem for the US economy. China may be our largest trade deficit, but as a part of the total it is a little more than 25%; the other 70 plus percent of outstanding deficits is held by other foreign trading partners. Public servants and policy makers are misdirecting the public's anger by trying to pin the problems on the Chinese for the policy failures they themselves have embraced and implemented. These policy failures are the result of campaign paybacks and special interest funding of career politicians; political solutions to tough problems rather than practical ones, written cumulatively since Reagan left office. China is only a small part and a symptom of the problem, but they are the chosen poster boy and newest foreign devil used to manipulate public anger and frustration.

The rhetoric has succeeded and failed. It has achieved its desired effect in that the US public is ready to rumble, and pick a fight without understanding the consequences to them that will unfold. The demagogues are fully in control of the dialogue in the US . It is poisonous to our futures.

It has failed in that the Chinese said “STUFF IT UP YOUR A??” Wu Yi had one comment which summed it up really quite nicely:

"We should not easily blame the other side for our own domestic problems."-- Wu Yi, Chinese Vice Premier

So the stage is set for the economic destruction of both parties. The Chinese rightfully have the duty to steward their economy as they see fit. They have the enormous task of steering their immense population into the global economy while dealing with the other task of turning an agrarian economy into an industrialized one. It is a daunting task and must be carefully done in a manner which does not explode along the way. Their banking, financial, regulatory, environmental, tax, and social systems all must be completely reformed to meet the challenges of a modern society.

The Chinese may be formidable manufacturers to the world and gather a lot of business from the US and Europe , but they have also given back, no matter what is splashed on the headlines. They have reduced the cost of living and inflation enormously for citizens in the developed world. A trade war with these people would be a giant tax on the very same people they are claiming to protect (the public), it is as they used to say in the cold war era “MAD” aka mutually assured destruction, the double entendre is correct it is madness.

They have accepted dollars and euros which they are fully aware are being printed like toilet paper. They have taken those dollars earned and invested them back into the developed world when western politicians have allowed them to! Which increasingly they aren't! Of the 1.3 trillion dollars of reserves they possess, they have plowed almost 2/3 back into US fixed income instruments of one kind or another. In addition to the 400 billion plus in Federal treasuries shown above, municipal bonds, mortgage bonds, corporate, and myriad other fixed income instruments have been absorbed by them as well. They, in concert with our other foreign lenders, have allowed the United States to live beyond its means for years as they financed an enormous amount of US capital requirements, both public and private.

These foreign lenders are partially financing the capital investment, consumer consumption and government deficit, which the US public refuses to, or cannot finance through savings, as their ability to save has been structurally removed (see “Misery spread widely” in Ted bits archives at www.TraderView.com ). They do so knowing fully that when they finally do get paid back from these FIXED INCOME instruments, they will do so with dollars which will be worth considerably less than the ones they lent. These fixed income instruments they have purchased generally pay up to 6 % interest. Factor in the loss of purchasing power as measured in gold (-18% a year since 2002) and they are already doing us a mighty big favor as it equates to a purchasing power loss of up to 12% per year, compounded annually. For the Chinese these are certificates of confiscation by printing press. But it is a price they are willing to pay as it is the grease that allows them to build an industrialized and more modern China .

It is a good deal for both parties. China escapes poverty, builds an industrial society and avoids social unrest during the transition. The US gathers a reliable trading partner that allows US corporations to preserve global competitiveness which has been destroyed by years of structural attacks (increased taxes, regulations, mandates, etc.) from previous public servants.

Now American politicians want to change the terms of the implicit agreements, with disastrous consequences that these ill-conceived “avoid the blame” games will produce. The Chinese will never let the Mandarins from Washington impose their will from across the Pacific, and they shouldn't as they are the “sovereigns” of their own country. Their task is to serve their citizens while they also strive to serve their trading p

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