Wednesday, October 7, 2009

The Great 'Shift' - China and the West

We are living through one of the times in history when a major and irrevocable shift is taking place. It will be a time that will be the subject of controversy amongst historians and, no doubt, there will be arguments about causation, about what set off a chain reaction of change. They will perhaps ponder and wonder that so many people were so blind to what was actually taking place before their eyes.

The shift that we are witnessing is the move of economic power from the West to the East. It is a well worn theme on Cynicus Economicus, that we are seeing the rise of China, and the fall of the US, and the process is now accelerating. Alongside the fall of the US, we are also seeing further declines in countries like the UK.

When I first arrived to work in China in 1997, I could see the emergence of an economic juggernaut. Sure, there were huge problems, and I encountered the legacy of communism in a generation of senior managers who were next to hopeless. Despite that, when I finally left China, I could see that the future was going to be Chinese. I could see a generation of hard nosed business people emerging.

The experience in China shaped my thinking on economics. On the ground in China I could see the massive investment from the West shaping a new and dynamic China. The Chinese welcomed us with open arms and, when I first arrived, were still somewhat in awe of the success of Western business. However, as time progressed, I also saw that Westerners were seen as a soft touch, who would overpay on everything.

The establishment of joint ventures was just one example of the many ways in which the Chinese would extract great deals. When I first arrived in China, all of the consultants were urging investments in joint ventures, and would prattle about notions such as 'guanxi', without any real knowledge of what they were talking about. The Western companies would send out a senior executive with orders to arrange a joint venture. When they arrived in China, they would be presented with four or five prospective joint venture partners, all of whom would have opaque business operations.

In the end, with all of the partners similarly opaque, the Western executive would settle on the least ugly partner. The documentation would then be drawn up, and the business would commence. It was at that point that the Western company would find out that they were supporting a whole raft of pensioners and other commitments in the joint venture. As part of the deal, the Western company would introduce new technology and process, train the management and the workforce. The trouble is that they were training the people ready for a new company to be established by their joint venture partner, and the new company would take all the technology, process and training, and open a competitor company. The competitor would be free of all of the social commitments and other costs.

Then there were the deals where, in order to win a contract, China would insist on technology transfers. I remember a GE power station turbine deal with technology strings attached, or the opening of an assembly plant by Airbus in order to secure deals in China. In so many cases, the price of doing business in China was risking the very thing that made the Western companies such a success; transfer of technology and process.

Then there is 'outsourcing', the rush to China to cut costs at the price of de-skilling the Western work force. It is not just the factory workers, but the designers and engineers who end up de-skilling. A good designer or engineer will understand the process of manufacture. Whilst there may be a legacy of good designers, as time goes by, the great design will emerge in the location of the manufacturer, and that will mean China. It will take time, but it will happen. The other trouble with outsourcing is that, as the manufacturers undertake the work, they will gain scale and experience, and will one day seek to move up the value chain. They will be in a position where all they need know is how to market and distribute their products. Outsourcing may make profit in the short term, but often at the cost of the future of the company doing the outsourcing.

Alongside this, there has been the artificial manipulation of currency by China, and no respect for intellectual property rights. The countries of the West have allowed this to take place, and now appear powerless to stop such practices.

There is a reason why I have returned to the subject of China. I have long argued that the ascent of China will progress far faster than most analysts and commentators suggest. I have long argued that China will emerge as the winner from this crisis, and have argued that their currency will be the new reserve currency in the future. Over many, many posts, I have tracked their steady process of internationalisation of the RMB, and consistently argued that the $US is so weak that it must collapse. I have returned to the subject as the mainstream media are finally really starting to understand what is taking place. Amongst the many articles, it is this article from Ambrose Evans-Pritchard that inspired me to return to the subject:

Beijing does not need to raise money abroad since it has $2 trillion (£1.26 trillion) in reserves. The sole purpose is to prepare the way for the emergence of the yuan as a full-fledged global currency.

"It's the tolling of the bell," said Michael Power from Investec Asset Management. "We are only beginning to grasp the enormity and historical significance of what has happened."


"Everybody in the world is massively overweight the US dollar," said David Bloom, currency chief at HSBC. "As they invest a little here and little there in other currencies, or gold, it slowly erodes the dollar. It is like sterling after World War One. Everybody can see it's happening."

"In the US they have near zero rates, external deficits, and public debt sky-rocketing to 100pc of GDP, and on top of that they are printing money. It is the perfect storm for the dollar," he said.

"The dollar rallied last year because we had a global liquidity crisis, but we think the rules have changed and that it will be very different this time [if there is another market sell-off]" he said.

The self-correcting mechanism in the global currency system has been jammed until now because China and other Asian powers have been holding down their currencies to promote exports. The Gulf oil states are mostly pegged to the dollar, for different reasons.

This strategy has become untenable. It is causing them to import a US monetary policy that is too loose for their economies and likely to fuel unstable bubbles as the global economy recovers.

The article was a response to news (since denied) that China, France, Japan, Russia, and the Gulf states were planning to abandon the $US for pricing of commodities. Ambrose Evans-Pritchard argues that the currency of pricing commodities is of no importance, but this is something with which I disagree. This is what I had to say on the subject of the emergence of the RMB as a reserve currency in April:
However, the real key to reserve status is when trade is more broadly conducted in the RMB, such as move to trading oil in RMB. Perhaps Venezuela will offer such an opportunity? An article here suggests that Venezuela may need to turn to China for financial support, and this may well present an opportunity for China to start this process:
In Latin America, the external funding situation remains relatively stable but in the case of further deterioration of capital flows, the solid economies would be able to tap the IMF or the Inter-American Development Bank (IADB) for non-conditional lines of credit, while the economies with less sound macroeconomic frameworks such as Ecuador, Argentina and Venezuela would most likely only be able to obtain funds through more formal conditionality or by turning to lenders like China.
Returning to the question of whether it is possible, I see no reason to prevent the RMB from taking on this role. There has been talk about the RMB not being 'liquid' enough, the lack of depth of their financial markets. However, I take a fairly simplistic view, which is to ask whether a currency has the underlying strength of being able to be used to purchase goods and services. The answer to this question is, of course, 'yes'.
It appears that ambitions for pricing of oil in RMB are far more ambitious than I first thought. Whilst the story has been denied, there is an underlying logic to the story that belies the later denials. It is only a matter of time before we see commodities priced in RMB.

In order for the RMB to succeed the $US as the reserve currency, it was always going to be necessary for the $US to collapse. The US has undertaken policy that will ensure such a collapse, and it is simply for the reason that the US is fiscally incontinent, printing money, and pouring the wealth of the future into zombie banks. When the $US falls, the US will finally see the forces of inflation unleashed, as the massive imports of commodities, goods and services surge in price. It is at this point that the underlying reality of where real economic power lies will finally become clearly visible. It is at this point that the real wealth generating capacity of the world will emerge into the light.

When the US is no longer able to borrow, when it is reliant upon what it actually produces, rather than borrows, it will be apparent how bad the situation has become. The same will be true of several other economies, such as the UK. For many years, these economies have been subsidised by the economies to the East and, without any further subsidy, they will find life is far harsher than they have ever imagined.

The rise of China is no mystery but, no doubt, the historians will manage to find controversy, manage to bury all of this under complexity. The economists will meanwhile suggest that the transfer of economic power emerged out of the banking crisis. The reality is far simpler.

The Western world was complacent, arrogant, and bloated. Collectively, the West allowed the emergence of a new competitor who used mercantilist policies to accumulate the modern equivalent of bullion, they allowed the export of all that had made their economies such a success and, when confronted with reality buried their heads in the collective sand of borrowing and money printing. Whatever happened, once China opened to the world, a new economic challenge was inevitable. However, the way that the West met the challenge has ensured that China will emerge as the great economic power.

As we move towards the end of 2009, we are entering into a new world, a new economic structure. We are witnessing a change in the world that will be viewed in hindsight as one of the defining moments of the 21st century.

Note 1: I have not referenced as many points as usual. However, many of the points made are consolidating the points made in previous posts, and these provide support for the case that I am making. I have listed some previous articles on China and the $US, if you are interested in seeing my case in greater detail, and the evolution of my thoughts on China's rise:
  1. July 2008, China - What Future?
  2. August 2008, China Propping up the $US
  3. January 2009, Free Trade 'Yes' - Mercantilism 'No' - Why China Should be Shut Out
  4. January 2009, The Myth of the Eternal Status of the $US as 'the' Reserve Currency
  5. February 2009, China's Pivotal Role in the Next Step for the World Economy
  6. Fenruary 2009, China and the US - Fighting on the Edge of a Cliff
  7. March 2009, Economics and Power, the Loss of US Power
  8. March 2009, China, Gold and the $US
  9. April 2009, China as the World Economic Power?
  10. April 2009, The RMB as the Reserve Currency
  11. May 2009, China, the RMB and the $US
  12. July 2009, The RMB as the Reserve Currency - an Update
  13. September 2009, The Rise and Rise of China
Note 2: Am I repeating myself here, or does this post add to past posts? Comments welcomed. If readers feel I should move off this subject for a while, I will do so.


  1. Your thoughts on the UK's Conservative Government of 2010 would be interesting.

  2. You could see what was going to happen in China if you looked at Taiwan. Hitech industry is the perfect case study, in particular Semiconductors. In the mid eighties Philips set up a joint venture semiconductor foundry in Taiwan. Now that company, TSMC, is the biggest foundry co in the world, even rivaling Intel in terms of manufacturing muscle. Philips is out of Semis and is now a 'lifestyle' products company. Most US and European companies needing to source their own chip designs go to Taiwan for manufacturing. Why did this happen? In Taiwan it was easier, less rules, people prepared to work v hard but also investors were prepared to take more risk and the government had an agenda. In the UK it seems there is no industrial agenda. Sure Britain has second best research in G8, but very little results in any manufacturing output. If it does, it is done in Germany or China ('we need to be close to our customers'). The recent crisis seems to have just made this movement more apparent, since those people not involved in making stuff now see the horrible truth. As for myself, after 25 years in the semi industry, I will have to find something else to do until I retire at the age of 66, err no 67, err 68 etc etc.

  3. Mish points out that China has been printing even more irresponsibly than the Fed:

    His suggestion is that if China allowed the Yuan to float, it might crash rather than rise.

    (Don Keyes)

  4. The article was a response to news (since denied) that China, France, Japan, Russia, and the Gulf states were planning to abandon the $US for pricing of commodities.

    The article by Robert Fisk in the Independent only talks about moving away from the use of the US dollar in oil trading:

    In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

    Robert Fisk, "The demise of the dollar"

    Moreover, there is an important Middle East factor here:

    Of the $7.2 trillion in international reserves, $2.1trn is held by Arab countries – China holds about $2.3trn – and the nations interested in moving away from dollar-trading in oil are believed to hold over 80 per cent of international dollar reserves ... Such massive financial movements, encouraged by the de-dollarisation of oil, will have enormous political effects in the Middle East, especially if economic superpower rivalry between America and China comes to dominate the Arab world. Will American economic support for Israel remain as loyal in nine years' time if China and the Arabs are setting the pace in global financial markets? .... Nor can it be denied that the very project to take oil trading away from the dollar market has deep political roots. The collapse of the Soviet Union has allowed the US to dominate the Middle East more than any other world region, and the Arabs – who can no longer contemplate an oil boycott of the kind they imposed on the West after the 1973 Middle East war – are still anxious to prove that they can flex their economic power to bring about change.

    Robert Fisk: A financial revolution with profound political implications

    If anything, the move by Middle East oil exporters has been in response to utterly incompetent US political and foreign policy blunders in the Middle East.

  5. Question for Ingenieur

    You made a fascinating comment. Taiwan, like Japan, had a highly successful and flexible industrial policy from the 1960s, which you can read about here.

    Don't you think the UK and the US need industrial policies like this as well?

  6. Cynicus,

    Hope you are well.

    Your insights on China are, as always, fascinating.

    I would be very interested to hear your take on recent UK developments - your thoughts on Osbourne's proposals at the Tory conference for example. It appears to be a foregone conclusion that they will win the next general election, but do you think the Conservatives are showcasing the correct strategies to pull this country back from the brink?


  7. Just as a quick note, I have had two comments asking for my thoughts on the Conservative economic policy. I will aim to cover this in the next post.

    Tiberius: I note that you are still not posting on your blog??

  8. Please carry on with the Chinese focus. It gives me some optimism, something positive to think about. And hope that there are places in the world where people can earn a living through real jobs making real stuff.

    The important relation between China and Japan are discused here.

    "Tokyo and Beijing are discussing plans to create an "East Asian Community," similar to the European Union, that would improve economic and political relationships in the region"

    It seems obvious that in a world where almost everything I possess has been manufactured in Asia, the West has completely gone off the rails. The UK is now doomed to twelve months of policy hiatus, we can look forward to the Tory/Labour playing a ridiculous game of ping-pong rhetoric over fiscal solutions to the financial mess, all of which will be inadequate watered down compromises to keep the "action groups" happy. And in the meantime the population will be rivetted on any signs the miracuous producer of wealth and growth, the Amazing UK Average House Price, is heading upwards again. We're saved, yippee!!!

    The finance "bonus boys" club will continue to invent ways of avoiding regulation and produce massive amounts of "mystical wealth", wealth which was created out of nothing and can just as quickly vanish into nothing. It is cyber-wealth, existing only as huge numbers in computer systems, not an asset but a terrible public liability, as any attempt to convert a substantial part of it into "real goods" would result in massive and overwhelming inflation in the price of real goods and massive deflation in the cyber-assets of stocks and bonds.

    But I digress, surely the fact that the Yuan is not freely tradable is a huge advantage? Wouldn't Goldman Sachs just love to be able to corner this market? Another "instrument" to be traded, skimmed, hedged and a plethora of derivatives as well? They have managed to pump up the derivative market to several quadrillion USDs, well over 25 times the world's GDP. This market should now be relegated to the wrealm of computer games, as the numbers are clearly out of touch with the reality of producing real wealth through labour.

    They could run around in their own "cyber-economy" producing even more zeros on the ends of their cyber-bonus-cheques, and the world would be a better place.

    Sorry about that little rant, but I believe you are correct about the transition from the West to the East. And that this process is now heading up the steep part of the curve and will accererate very quickly. The Asians can see this and, taking a long term view, are pushing through the pain of this development and making themselves and their populations richer. The West is totally blinkered on squandering trillions on bailing out failed financial systems, which should be allowed to fail, resulting in the West becoming poorer and going through the pain of economic decline.

  9. The Shift from the US dollar in Oil Trading is more likely to benefit the Euro

    Another point:

    In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

    The countries in question are planning to move to a basket of currencies including the Japanese and the euro.

    Given that the Euro is already the second most commonly used reserve currency, has a liberal and developed financial sector and the Euro zone tends to trade balance (with the economic powerhouse Germany at its centre), the Euro may well be a more credible international reserve currency than the RMB.

    The fact that France is supposed to be involved is suggestive.

  10. In answer to Lord Keynes- I absolutely agree that Britain and the US need Industrial policy. Britain is tragic when you think about it. There is the well known decrease in manufacturing between 1979 and 1982 under Thatcher and since then a total incompetence and/or neglect around industrial support in the UK. But, the UK has extremely good research - I was surprised to read this last week on BBC, many papers from UK researchers published and cited. So this shows scientific/technical things are possible in Britain. UK manufacturing is still a big part of the economy, but it has so few people working in it - they are amongst the most productive in Europe. The pressure of high sterling has meant no jobs growth in manufacturing, or decline in fact, while maintaining output. It seems obvious to me, that a fall in Sterling, combined with advent of an industrial policy that tried to combine UK'S high class research with high productivity manufacturing could lead to a renaissance and provide income for the country and in particular 'ordinary' people. Unfortunately, the Tories and Labour do not have the imagination to see this.

  11. "As we move towards the end of 2009, we are entering into a new world, a new economic structure. We are witnessing a change in the world that will be viewed in hindsight as one of the defining moments of the 21st century."

    Welcome to the NWO.

  12. Given that China is almost absent from the thoughts and minds of much of the London Mediocracy, and has limited coverage, the more intelligent comment on the web the better. At the moment it is about the only way of getting a perspective.

  13. I can see your eye-sight was elonged in the past years, from 3 inches to 3 feet. But you need to have 3 meters eye-sight to win out the fair play.

  14. Keep up the good work. I rank this website in my top ten, and I collate reports from every part of the world.
    You probably have found your articles appearing on our website.
    We try to emphasise the multipolar nature of the power shift with a view to how the power shift from West to East will help the non aligned nations, among other issues, or themes.
    The complexity of the rise of China has been made simpler to me by you. With much applause.

  15. The whole world is in this economic mess together, and I whilst Cynicus is correct on the weakness of the USA and UK, he overstates the strength of China and the RMB.

    When soon the US $ and UK £ halve in value (as the gilt strike begins) such that hyper-inflation of all imported goods double in price overnight, it will also result in a halving of demand exports from China causing a deflationary depression in China due to insufficient domestic demand to take over. It is as much China's fault for artificially suppressing the value of its RMB currency by buying US $ treasuries to stimulate exports as it is the fault of the US to borrow for consumption, and China will also suffer not just the loss of their $ reserves value but also high unemployment as their factories and office blocks become even more empty.

    As for the EU and the Euro, they have as great a net debt to GDP ratio as the USA, and their exports will suffer if the Euro temporarily strengthens. eg imagine what the EU will do when similar US Boeing planes cost half of EU Airbus ones.

    The only world currency that will gain or become a reserve currency is Gold-grams that cannot be printed into existence.

    As for the UK Conservative policy, £7 billion cost savings is too little too late versus a £200 billion budget deficit plus rolling over current short term debts, though obviously this is better than Labour Marxists who can only benefit from a majority debtors revolution when the government borrowing economic mess of their making collapses our financial system.

    No painless solutions exist now that the world economic damage has been done, though the longer that people remain ignorant of our coming financial and civilisation collapse, the longer it can be deferred by 'confidence' to continue borrowing whilst they still can.

  16. Wow, economics as a morality play.
    Chinese monetary policy is the result of a decision taken sometime ago to copy the Japanese policy of exporting your way to success. This policy developed its own momentum. As the Chinese start to get diminishing returns they will change there policy. This is a good thing and will put the global economy on a sounder footing. The dollar will remain the most important currancy, because the US will be the largest economy on the planet. There no Chinese plan to destroy the dollar, (or US). The current trends are beneficial to the US economy.

    More confirmation perhaps of the overall shift.

  18. I could not agree more. China is the future for the world economy in terms of manufacture, design and power.All future wars will be between India and China for resources as they will be the two dominant world powers.

    Therein lies the rub though. As 2.5 Bn people become part of the global economy they will demand and purchase more. Nothing wrong with that, they want part of the good life that we have enjoyed for so long. However the world is a finite resource and we will accelerate its decline due to this incessant demand for goods and resources.

    "Get out quick and don't have any kids yourself" ;-)

  19. Which is why it was so frustrating in the 90's and early 00's in highschool/college when I would try to tell people that outsourcing would only work until it reached a point where we imported so much, that we had to borrow so much, that our currency would devalue, and thus all of the gains of outsourcing would vanish, and we'd end up paying more for a cheap chinese good than a cheap or good american product.

    They said it wouldn't happen. They said if our dollar fell, exports would increase.

    Well what the hell do we export anymore? As a caveat, in significant quantity, as a percentage of the world's production in that product? Nothing.

    The only people that gained by outsourcing was the CEO and upper management, in terms of higher salaries, bonuses, etc.

    Soon those jobs will be outsourced too, via our companies disintegration, and the emergence of the management class in china.

    Some say it won't be a problem, because we'll just start to produce more. True. But a whole lot harder than it sounds. You need to use your now 'worthless dollar', to buy the raw materials and equipment needed to manufacturer things. You need a competent machine tool industry that has actually been cut around in half since the crisis started, and had already cut in 1/2 during the Bush years, and had been cut in 1/2 the preceding 20 years.

    Not to mention it will take years for this to happen.

    Hell we don't even KNOW if we can't MAKE the same quality products in some areas that chinese or other exporters currently export to us.

    On top of that, during those few years where we realize our folly, we'll be hard pressed to buy anything that is imported. Look around, that's just about everything. Computers, food, cars, oil, raw materials, anything you buy at Walmart, 2/3 of what you buy just about anywhere.

    So what are we going to do when those of us who are still working, for less, and even less than that in terms of purchasing power around the globe, has to pay double, triple, quadruple, for 75 percent of the products they normally buy?

    Well that's why outsourcing was a bad idea. Because we are currently bent over, and the world, including china, is standing behind us. What they do, determines how bad being bent over, hurts.

    End the fed, Lyndon LaRouche HPBA of 2007 needs to be passed, return to hill/burton, return of glass/stegall, and a commitment to infrastructure, manufacturing, and education. Credit system, not a monetary system. Nothing else matters. Because if these things in this paragraph aren't done, all the other stuff above this paragraph WILL happen. That's if we are LUCKY.

    Also, one would have to also realize that China won't do much better. Without us as an export, they go down. No if's, and's, or but's. So what would happen is we collapse, and in very short order, they collapse. Sorry, maybe if this game kept up 30 more years, and they had built up internal consumption to take over for us as purchasers, them and asia would survive, but that isn't now, thus they won't survive much longer than us.

    Good luck everyone, the crap I truly believe is already flying through the air at the fan.

  20. Buzzowrds:

    ~Undeveloping Nation (UK)
    ~Event Horizon (Public Finances)
    ~Up s*** creek

  21. I am new to your blog and have enjoyed reading all the back posts. Two significant questions arise as I review your worldview (and I agree with you 95% of the time thus far). What is your view of the economic future of the Euro? And of most interest to me, how do you see Australia's economic future given its geopolitical position between Asia and the West?

  22. Very interesting and intelligently written, the writer is knowledgeable of his subject matter, moreover there is also a whiff of Nihilism peppered with the hint of philosophical defeatism. Arguably the current recession, which forms the head of a nexuses of cycles, has again increased the number of urban economists, they are for all tents and purposes inversely proportional to growth. When the recession ends, which indeed it will, dooms day armchair economists shall have to find something else to scare themselves with, as there will be a new breed of popular apocalyptic scribes to replace them; perhaps writers of alien invasion? Asylum seekers? Clash of civilisations? 2KY time bombs? The second coming of Jesus?

    What I believe we are experiencing this the death of the nation state, and a push towards federalism, the judgement day economist followers of this website remind me of Aristotle who while eloquently singing the praises of the city state, failed to notice that Alexander was setting the ground for the nation state/empire. It is only because the western rich and powerful are seeing a possible demise in their own wealth are we witnessing an exponential growth in middle class pessimistic economist; I read someone had even mentioned “socialist Marxism” as the course of this recession, yes I agree, China and Russia have done pretty well recently, although calling them autocratic capitalists would be a better description. But please remember, China has for the past 5000 years held 2/3 of the world’s economic output, except of course for the short resent 100 years, China is simply taking up its natural place in the power house of wealth.

    Nevertheless, federalism is an inevitable state of affairs, no matter how much western upper middle classes write hysterical economic articles. We are not staring into the abyss. As a manufacturer I personally see this recession as a good thing, killing off the dead wood so to speak, it is only those who parasite off society—not the unemployed or our elderly citizens—who are wobbling with fear; the pseudo bankers, middle managers and all those who play with monopoly money, they have blinked while betting long, and that is just a short story. So I say paint me blue, bring on the economic challenge, and lets ignore these shivering trouser wetting cowards who are too scared to leave the trench, playground sissies who had their dinner money taken from them as a child, and had to resort to reading 19th century history books to try and understand the world they live in.

    European civilisation will endure, its engineering and chemical pedigree coupled with her pragmatic and intellectual prowess will overcome any aversion to her heritage.


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