Saturday, September 8, 2012

Steeling Rubber Chickens

 There appears to be a typographical error in the title of this post but the error, alas, is fully intentional.  We are, once again, playing macabre roulette with the global economy and China's National Development and Reform Commission (NDRC) ended the week with a domestic economic stimulus announcement that rang the Pavlovian bells for a pack of hungry dogs who bet up equities when that bet is empty.  By announcing nearly 1 trillion yuan ($157 billion) in approximately 60 large scale infrastructure projects, President Hu Jintao and NDRC Chairman Zhang Ping's announcement was not merely a shot of adrenaline for the sagging GDP statistics (still multiples greater than the U.S. and Europe).  It was a warning shot across the bow demonstrating the cost of our "Winners Shall be Losers" topic of a few weeks back.  But to understand this, we need to understand steel, chicken, and tires.

On June 15, 2012, the World Trade Organization determined that Chinese import duties on U.S. specialty steel were "inconsistent" with global trade guidelines.  These tariffs were China's response to what it saw as anti-competitive "buy American" subsidies which were a cornerstone of Washington's foundering economic stimulus package.  And to be clear, high-tech steel has not been the only wishbone of contention between the two trading partners.  China prevailed in its complaints against the U.S. on tires, steel, and other U.S. tariff and trade restraint issues recently and is currently in a heated dispute over its solar panel exports.  A year ago, U.S. chicken producers cried fowl (another intentional typo that's just too irresistible) on Chinese tariffs on U.S. chickens - a tariff China levied under the premise that U.S. chickens were fattened on subsidized corn feed - an allegation that doesn't take any conspiratorial insight to readily confirm.

So this week's infrastructure announcement (which, just to keep our heads straight represents about the same investment as China's official Hollywood-esque "culture budget") was supposed to be a windfall for the global economy and pull us back from the edge of the precipice of fiscal despair.  This "news" came on the heels of European Central Bank President Mario Draghi's "new plan" (which seems to be terribly reminiscent of all his "older" plans) to lower interest rates for euro zone economies and provide short term (1 to 3 year) "sterilized" debt.  While most of you have no idea what sterilization of debt is (and, lest you think that it means that it cannot procreate and make other bad baby debts, would we be so lucky!!), what you need to know is that the last time the eurozone tried to deploy this strategy, it came up about 9 billion euros short on the heels of a 23 billion shortfall the time before.  In other words - it didn't work!  And, the U.S. Department of Labor released crappy jobs data that included downward revisions on previously less crappy data estimates from earlier in the year.  By the way, for those who have a mathematics proclivity, the following represents the economics equation of the week:

China Roads and Sewers + EU Money laundering - 365,000 U.S. Workers out of the Workforce = Stock Market Euphoria


Δ¥1tC + i2 = -1 - 44% U.S. Labor = Irrational Exuberance

And all of this craziness is because "the market" is pretty sure that the events of the past few days will force U.S. Federal Reserve Chairman Ben Bernanke to lower interest rates making money cheaper still.  When one has compressed yields to zero, the utility of this anticipated Fed intervention is fascinating as the next step will be having investors actually pay for the privilege of owning dollars (and you thought servicing fees on your checking account was bad).

So back to our steely rubber chicken where we embarked on this journey a few paragraphs ago.  The much ballyhooed stimuli aren't.  And worse than that, the masters of propaganda alleging that these are positive steps are overlooking several vital long term threats which cannot be avoided and whose pain will be felt quite broadly.

First, the winners on the China announcement will be those countries who play ball with construction commodities - steel, concrete and the like.  And, to be clear, while a few mining and refining technology suppliers in the U.S. may pick up a few extra orders, it's far more likely that we'll see the October surprise coming out of the Communist Party's government transition which will award business to those countries who have been most accommodating to the Chinese.  For those of you who weren't watching, the U.S. is not on the top of that list and Secretary of State Hillary Clinton's recent visit set us back further down the most-favored-nations hierarchy.

Second, by pricing our debt at excruciatingly low levels, we're relegating our debt purchasers to fiduciaries alone - in other words, the only buyers are those who are compelled to do so by statute or mandate.  However, these buyers of debt use debt as a means to fulfill long-term obligations (like insurance, retirement accounts, pension benefits, etc.).  By 'solving' the short term stimulus rancorous challenges, we're undermining the future earnings of these institutions and that means that we'll all pay in multiples later.  And with Social Security holding the vast majority of our national debt, we'll 'reform' Social Security regardless of what happens in November as the 'promise' of a retirement benefit is both unfunded and now insufficiently yield-generating.  No matter how you vote in November, the end of FDR's New Deal is all but certain.

Third, while many U.S. companies are waiting to get their fingers on China's infrastructure spend, this announced domestic expenditure may very well be the tipping point where China's mandatory technology transfer strategy of the past two 5 Year Plans (executed by the NDRC) rears its ugly head.  Few corporations in the U.S. or Europe have wanted to talk about this phenomenon.  For the uninitiated, China has, for a decade, demanded that when it buys technology from international corporations, those corporations must frequently transfer technology, patents and know-how along with the purchase.  What this means is that large companies like GE, Siemens, and others have assigned to or developed co-owned rights to their intellectual property with  the Chinese government.  Now, rather than dictating the price for goods and services, these same companies will be invited to grovel for whatever crumbs their customer is willing to share.

We've got about 6 weeks before a new China emerges.  The ascension of the "Fifth Generation" leadership will take place in October and the rising leaders of China will, for the first time, be represented by a number of senior officials who were trained in the U.S. and Europe.  Many of the rising stars have real executive experience in companies like SINOPEC, China Telecom, several of the banks and industrial behemoths.  With their business training and corporate acumen, the China that is rising is one that is more likely to be far more savvy than their predecessors.  With an eye towards economic conquest for domestic "harmony" and pacification, the post-October China will be far less collaborative with those who seek to rely on historical hegemonic clout.  

What this means to the rest of the world is that the markets at week's end bet wrong.  Sure, there's the irrational exuberance that is merely our modern incarnation of the Dutch Tulip craze or John Law's giant swindle in the Mississippi Company.  Astute investors should know that the Chinese infrastructure spend is a jobs and commodities play.  Astute investors should know that the ECB concessions are neither new nor announcements - they're a cheap magic act that accomplishes no structural benefit.  And We the People should see through the pressure on the Fed to realize that greater intervention today will merely accelerate the harm to our social fabric tomorrow.  Social Security's creator famously said that, "In politics, nothing happens by accident.  If it happens, you can bet that it was planned that way."  Little did he know that his "sacred obligation" would fall prey to the hyenas who seek to pick the last sinews off the bones of system upon which they've fattened.  Get used to rubber chickens because that's what comes next!

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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave