The China Challenge

Congressmen in Washington DC have considered 'punishing' China for having such a large trade deficit with the United States - either through trade tariffs, or forcing them to revalue their currency. Politicians say this because they don't know any better, and/or they're trying to score political brownie points with their consituents.

It sounds good at first glance, but it's a terrible idea for these reasons:

1) China is the 2nd largest holder of US Treasury notes (debt) at around $600 billion. Japan is #1, holding approximately $1 Trillion. If the Chinese get tired of lending us money, all they have to do is not make future purchases - or worse yet, sell even a small portion of their Treasury holdings. Interest rates on these 10-year Treasuries would spike very quickly, and so would most mortgage rates. It has the potential to hammer the residential real estate market - literally overnight. Cheap mortgage money and speculation are the big reasons for the real estate mania/bubble/craze. It's darn sure not fundamentals.

2) The big reason for the trade deficit is structural - China has a large and growing manufacturing base, America's manufacturing base is in decline. I agree that China's currency is very undervalued compared to the US Dollar, and that's helped fuel the large trade deficit. Over the past two decades or so, its been a gradual process. Economists actually believed that the US didn't need the manufacturing base for a healthy economy; we'd just make it up in services.

The problem with this theory is that more of our service base is going overseas - mainly to India, where a large number of well-educated, English-speaking workers are ready, willing and able to do the same work at 10-20% of what Americans will do it for. It will take many years - if not decades - to regain our manufacturing base.

China is making and selling Americans more goods than America is selling the Chinese. It's as simple as that. Until US companies re-commit to rebuilding a solid manufacturing base in America, this will continue to be a problem.

3) The Smoot-Hawley Act helped plunge the US into the Great Depression in the 30s. Legislating a 2006 version of Smoot-Hawley is economic and fiscal insanity. Especially when you're trying to strong-arm your 2nd biggest lender to do things your way - and you don't have any leverage. A verse in Proverbs says, "The borrower is servant to the lender."

China will eventually revalue their currency to a more 'fair ' rate. Some Americans should be careful what they wish for. When the Chinese do this, it will increase prices on imported Chinese goods. The doo-dads and geegaws that were cheap at Wal-Mart will be more expensive. Since consumer spending makes up about 70% of GDP, that will slow down the economy. The economic correction and strong financial medicine will have to be taken - it's just a matter of being sooner or later.

No country can borrow and spend their way to prosperity. Lord knows Americans are trying their darndest to make this work. A household, business or government can only prosper when there is real savings, investment and profits. When you borrow and spend too much, you eventually will pay the piper. Or in this case, VISA, Washington Mutual and GMAC.

There won't be a quick fix for the trade or budget deficits. Americans will be forced to go back to these old-fashioned economic ideas (instead of a borrowing and spending blingfest) if they want to see things improve.

2006 - The Year Debt Finally Matters?

Most economists have been gushing about how 'resilient' the American consumer has been, and how great this has been for the US economy. That's true, since consumer spending makes up 67-70% of America's GDP.

The only problem with this is debt has to be repaid, or defaulted on. Manic borrowing and spending by consumers, corporations and government has led to an economy 'juiced up' with financial steroids. Like an athlete who's performance slips after he (or she) goes off the juice, I see the American economy being less buff in 2006.

The debt and real estate bubble has gone on much longer than I thought it would. It proves the old saying correct: "The market can remain illogical longer than you can remain liquid." Luckily, I didn't lose any money shorting stocks during the last few years.

How will this house of credit cards, mortgages and car loans come tumbling down? It's hard to say, but I think we're starting to see the decline in certain areas. Foreclosures have been increasing in the seven county Denver-metro area, and hit their highest level since the oil bust days of 1988. General Motors recently announced they're lowering prices on new cars and trucks.

GM realizes that consumers aren't buying cars the way they used to, and GMAC probably wants to minimize its risk exposure to high balance loans. On top of this, Fortune 500 companies are outsourcing more white-collar service jobs to India. With American workers' incomes stagnating, and expenses going higher because of inflation, we're seeing that rare economic creature that hasn't been seen in the US since the 1970s.

It's name? Stagflation. These conditions fueled the last big commodities bull market during this decade of disco. Gold hit a peak around $850/ounce in 1980, and silver topped at around $50/ounce until the feds put the kibosh on the Hunt brothers.

A wise man once said, "History doesn't repeat itself, but it usually rhymes."

These economic tunes from the disco and today's techno times sound very, very similar. That's why I'm very bullish about gold and silver, along with well-managed energy and metals stocks and funds. That's all for now, until next time...

Welcome and Happy New Year!

Thanks for coming to my blogsite! The goal of this site is to give you the best economic and financial information that's based on fundamentals from an Austrian economic point of view.

What is Austrian economic theory compared to Keynesian theory? Keynesians believe that if a government can simply borrow and spend enough money, that's enough to keep a country's economy out of any recession. The problem with this view is that eventually you have to pay this incurred debt back, and it wreaks havoc on your country's budget.

The Austrian view is based on 'hard money' (i.e., currency backed by gold and/or silver), and sound fiscal policy. Namely keeping borrowing and spending to an absolute minimum. Most modern economists don't see anything wrong with running huge federal budget and current account deficits. Heck, we've run them in the past and nothing bad happened - right?

True, but eventually you have to pay interest on these deficits and debt. These conditions also contribute to inflation of your currency, lowering the purchasing power of each dollar you hold. As a country, we're in very interesting economic times. There will be challenges in the future, but also great investing and business opportunities.

I'll go over these scenarios as I see them in future posts. In the meantime, I highly recommend you check out several websites:

www.DailyReckoning.com
www.FinancialSense.com
www.investmentrarities.com
www.321gold.com

All have excellent analysis and commentary on economic and financial issues. Best Wishes for a Happy, Healthy, and Prosperous 2006! Until next time...