Recent mutterings at the highest level in the Chinese Government about the monetary policy of the United States should send cold shivers down the spine of world leaders.
It signals the arrival of the new economic order. The inevitable Chinese sale of its US denominated assets. The Chinese simply cannot afford to allow the value of its reserve holdings to be stripped away by loose monetary policy in the United States.
If the European or British economies weren’t in the doldrums we could have seen the Chinese diversify into the Euro or pound sterling but these are not realistic options.
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China only has to look across the sea to view its future. In the 1970s and 1980s Japan underwrote the spending splurge of the US consumers. The United States repaid that favour by letting the market devalue the $US against the yen, triggering a decade of deflation in Japan.
China thought they’d sidestep that outcome by pegging their currency against their trading partners, however, the US strategy of quantative easing leading to the monetising of their foreign debt will lead to the same outcome of a deflation spiral for China unless they take bold action.
Thus the decision of China, India and Brazil to buy IMF bonds is of great significance. It is the first step in moving away from the US$ as a reserve currency.
The question is will they go the full way of creating the Bancor as advocated by Maynard Keynes? Or will they substitute another currency as the world’s reserve?
Conventional wisdom in the West is that a Chinese move away from the $US as the reserve currency would hurt China and thus they will keep on propping up the $US and hence the US economy.
The thinking is that the Chinese economy depends on the US consumer purchasing Chinese exports and the symbiotic relationship is so interlinked that the separation will be fatal to both. This view is short sighted and ignores the economic realities of the unfolding 21st century.
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According to The Economist $US170 billion in hot money entered China in the first five months of 2008 this could reach $US504 billion a year.
Chinese policymakers would be very nervous about the implication of asset bubbles emerging in either the immature Chinese stockmarkets or in the commercial property sector.
The bursting of such an asset bubble could undermine the political structure of China and threaten to destabilise the internal power relationships. It is this very reason that the Chinese authorities will act rather than wait to be engulfed by the fate of the Japanese.
So if they have to move away from US assets to avoid the hot money/deflation trap how will they achieve this without destroying their export markets?
Simple, they will create alternative export markets prior to pulling the plug on the United States.
To do this they need to create consumer markets equivalent to the United States. This will be achieved via the economic empowerment of the growing middle classes in India and Brazil. To achieve this we will see significant increases in joint ventures in both Brazil and India. We will see significant increases in foreign aid to Brazil to accelerate the poverty to middle class evolution, over the next decade this will be more like a revolution than evolution.
We will also see a staged wealth redistribution within China to enable a portion of export activity to be switched to meeting domestic demand.
The pace will be limited by concerns that domestic wealth redistribution will place pressure on the Chinese institutions to democratise themselves, nevertheless the policy changes will result in significant internal economic demand by increasing consumer spending rather than run the risk of hot money creating asset bubbles.
The major effort will be in accelerating the growth of the middle class in Brazil. For geopolitical reasons China will be loath to build economic power in India and Russia other than what is immediately necessary.
Brazil also offers the advantage of not being as affected by fluctuating surges in oil prices, which threatens consumer spending in the western economies. Its ability to utilise ethanol and hydro-electricity schemes to maintain its energy independence will make it a very attractive destination for China to funnel its hot money to create a consumer society. This will enable China to make a staged withdrawal from propping up the United States.
With the BRIC nations buying IMF bonds and the US capacity to prop up the IMF being diminished we will see the decision making power of the IMF shift from the United States and Western powers to the BRIC nations.
Australia needs to embark on a process of engagement with South America. First we need to look at developing a free trade zone encompassing the Pacific such as New Zealand, Papua New Guinea and the Pacific Island nations and South America.
Second, we need to look at developing an integrated ethanol industry, not just growing the source product, but changing the car manufacturing specifications so our car industry can move towards capturing export markets in the expanding middle classes created by China’s capital outflows.
Our education system needs to have a co-ordinated approach in developing Spanish and Portuguese in our schools. We need to establish South American Studies schools in our universities so our future graduates are familiar with the nations that will be shaping our future. Importantly we need to fund exchange programs for students to study in these South American nations and for their graduates to study in Australia.
Dynamic shifts in the word geopolitic landscape provide threats and challenges, but it also provides opportunities and as a nation we must plan to benefit from the opportunities and minimise the risks.