Last week, when President Obama signed off on the new tariffs on imported tires from China, an immediate response from China followed.  In short, the action take was protectionist, without merit, and they had the data to support it.  It was a reaction that indicated to me that, they had their ducks in a row.  And spreadsheets in tow.

In recent comments, Thomas Donohue, head of the US Chamber of Commerce added some color to the picture that is now hanging on the wall of the Oval Office.

“This is an agreement we made when the Chinese went into the WTO,” Donohue said. “At the time we were making low-end tires. We don’t make low-end tires in this country any more; it’s not a competitive business for us.”

Although Obama isn’t applying all the penalties he could, Donahue said, “Most people didn’t want to pull that trigger for the simple reason of getting into a trade war, because we don’t make the tires any more. What’s going to happen is the price of tires is going to go up and people may lose their jobs because of this.”

.. and why is he saying this?  why is he worried?

Chinese retaliation could hurt U.S. auto companies, which last year agreed to export more than $2 billion in vehicles and auto parts to China, including thousands of Michigan-made vehicles and transmissions.

.. which aren’t the only only trade relationship(s) that may be at risk

Donohue urged the Obama administration to complete pending trade deals with Columbia, Korea and Panama, as well as finishing the stalled Doha Round agreement with the WTO.

He noted that a Chamber study found more than 380,000 U.S. jobs and $40 billion in potential export sales are at risk if the trade agreements aren’t completed

[...]

The U.S. chamber study also forecast another 120,000 potential lost jobs from ongoing problems over cross-border trucking with Mexico and possible foreign retaliation against “Buy American”

Now, without getting into the politics of this particular issue, my concern here is that we are still facing what is a systematic gap in reasonable knowledge, understanding, and decision making when it comes to the global economy.  It is an issue I wrote on when questions how trade statistics were being measured and used in policy in today’s environment, and how arbitrary the application of different policies could become.

In short, the system isn’t a system, or at the very least the system is not functioning as one, and as a result the credibility of the system is diminished.

It is an issue (tires) that in the short term leads to a situation where two leaders question each other in the open, support the case for the opposition, and show a clear need for changes to be made in how issues will be addressed going forward.

With all the doom and gloom that has become the current economic cycle, and the fact that the current cycle largely comes as a result of poor debt management, I have always worried a bit about the long term attractiveness of US Debt as an investment vehicle.

Yes, I will agree that US treasuries have historically been seen as risk free, or as offering the least amount of risk, but it has been clear to me for a long time that China was not all that comfortable taking up as much as they have been.

That they would have preferred other instruments to bring a bit of balance to their portfolio

In fact, it wasn’t more than a few weeks ago that Luo Ping was quoted as saying that they hated their position.

“We hate you guys. Once you start issuing $1 trillion-$2 trillion…we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.

today, that was taken to a higher level when premier Wen Jia Bao offered a bit of color to what otherwise was a standard NPCC:

“Of course we are concerned about the security of our assets and, to speak truthfully, I do have some worries,” Wen said.

“I would like, through you, to once again request America to maintain their trustworthiness, keep their promise and guarantee the safety of Chinese assets.”

A big statement. HUGE in fact

Seeing this coming early on, I once quipped that the US should just offer Alaska as collateral to keep the Chinese investing.  It has oil, it has clean water in the form of icebergs, it has fish, and it can “almost be seen” from China’s northern border anyway. (I WAS KIDDING… DON’T SEND ME HATE MAIL)

It is clear that the US needs the money (Obama’s plan requires funding), and that the only alternatives were either printing money (Carter era inflation) or keep their Chinese buyer’s happy… or at least reduce the risk of default (Mexican Style).

So, the question now. the real question. Is what does the US need to do at a policy and fiscal level to maintain their credit trust worthiness, and what will be the cost of capital going forward? What should happen were China to finally act in a much larger measure to diversify their risk?

Obviously China cannot do anything drastic as that would cause the dollar to the wrong way, but like any boxer in the corner taking body blows, China is going to look for a way to get out and may need to throw a punch or two to do so.

It only takes a day like today to put force analysts to retrace their footsteps, see where they went wrong when calling for a recovery, and then set off on the path to recovery again.

Today’s numbers that China’s February trade figures have PLUMMETED 25.7 % from February 2008 were stunning.  Especially as orders to the US (China’s largest trade partner) fell off more than 45%…

45 percent

What were the analysts expecting?

5 percent

Imports fell at nearly the same pace, but in anther sign that people have yet to understand the fundamentals of the economy, CNN is saying that this 24.1% represents China’s consumers failing to keep up their end of the bargain.

Interesting considering anyone who is operating or monitoring the manufacturing economy would know that the majority of imports from the world are for goods that are reprocessed for export/ manufacturing.  not for consumption.

LCD screens from Korea, recycled Pulp/ paper from the US, Hard wood logs from Indonesia, and so on.  It is all destined for the manufacturing economy

Why I think this needs to be clarified is that while the 25.7% drop in export number is a measure of past performance, the 24.1% drop in imports is a measure of future performance.  That, and let’s assume exports were going to rebound, imports of materials would need to happen (on a broad base) at least 2-3 months in advance or export.

Thus, I predict two things:
(1) Exports will continue to be at least 20% off for the next two months against their 2008 figures
(2) when the manufacturing economy starts turning around, it will be shown thorugh the imports first and then through the exports (2-3 months later).

From September 6-8 the World Economic Forum held its meeting of New Champions in Dalian, which is one of China’s newest champions… for investment.

A testament to the power of Web 2.0, and the power of the internet, the entire summit has been put on Youtube, at the World Economic Forum Youtube Channel.

With 22 videos, roughly 20 hours of showing, one would need a weekend of non-stop broadband and Starbucks to watch the entire summit worth of videos…. However, I do suggest spending some time watching those that you feel are most pertinent to your organization or your own interest.

Overall, the discussions themselves are very interesting, and if there is one theme that I see throughout is that the level of Chinese panelists was much higher than the foreign side (on average). As Rebecca McKinnon pointed out in her analysis of the Soft Power debate, Thomas Friedman was out of his element.. and his comfort zone…. and he was not the only one. As I have spoken on a few panels in my day, and as I organize various panels in Shanghai, I am always interested to see how many foreign panelists end up on a panel (WEF, AMCHAM, or other) that have little China experience or knowledge….

With that in mind, some of the most interesting I have seen so far are:

1) Global Trade: Avoiding the Backlash: Avoiding the Backlash against the New Investors. Recent government interventions to protect national champions and domestic industries from international investment highlight increasing popular resistance to economic liberalization. Economic nationalism and financial protectionism risk hindering the new champions from achieving their maximum potential and fully contributing to economic growth.

Questions asked:

1. Where is the balance between adequate regulation for environmental, food safety and national security concerns, and ensuring an open and competitive business environment?
2. What is the role of governments in creating a positive investment climate for the new champions?
3. How can governments, investors and companies work together to address the underlying concerns of the public?

Moderated by Michael J. Elliott, Editor, Time International

Panelists:

• Neelie Kroes, Commissioner, Competition, European Commission, Brussels
• Jean-Pierre Lehmann, Professor of International Political Economy, IMD (International Institute for Management Development), Switzerland
• Kevan V. Watts, Vice-Chairman, Merrill Lynch & Co., Hong Kong SAR

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It has just been announced that China’s trade surplus hit an all time high at $26.9 billion
USD for June. That is double the amount for June of last year.

The only “good” news from a political standpoint is that imports rose by 14.2%, a “sign” that more and more imports are making their way into China from other countries.

Before getting into the real analysis though, there are still a couple things I would like to note:

1) July 1 was the deadline that was the cut off for higher VAT rebates, and as such the volumes being exported were much higher volume wise as people were trying to beat the deadline.

2) These statistics are USD based and as the RMB has moved considerably in the last month, and even more so since last June, nearly 5~6% can be explained by currency adjustments alone.

3) These statistics are not broken down at all at this point, and as such little is known about overall volume increase/ decrease, whether it is Chinese manufacturers or Foreign manufacturers who account for the growth, if the goods are changing from low value goods to high value, etc.

Short term, I would expect to see a blow back in the States and increased pressure on product safety and RMB, which could begin to have a significant impact American business

Medium term, this subject (unless the RMB goes 1 to 1 with the USD) will continue to carry significant ppolitical tone as the U.S. enters the 2008 elections. During this time, I am expecting a slowdown in new entrants to China as well as the restructuring of entities whereby products currently being sold to U.S. will either be sold to other countries or domestically consumed.

Long term it is anyone’s guess. China is taking a real beating in the U.S. press, and most Americans I speak to fail to understand the macro fundamentals that would take place should an all out boycott take place.

for Western businesses in China, it is time to plan ahead, and plan more than ever.

• If are exporting products from China and were once basing your export costs on 7.61, use 7.5 now rather then 7.5t to see how your margins hold up, then run at 7.2 to see how your margins hold up, and then throw in a 5% reduction in VAT… what do you get?

• If you are a manufacturing firm looking to enter China, now is the time to sell high value technology (cleantech is HOT right now) into China. You will have the full blessings of both governments (assuming the product is not dual role), and there is currently a critical gap

• If you are a manufacturer exporting products made in China to U.S. or E.U. markets, I have two words for you. QUALITY CONTROL. The next 18 months will prove that those who are able to sell quality will not be affected by the recent scandals, but those who have failures of any kind or on any scale will experience brand depreciation on a big scale.

• If you are an investor continue to buy assets, but plan for exiting underneath the most horrendous taxes and regs you can imagine. There are still many many opportunities to make significant returns in China, however the government will continue to introduce ways to punish those who flip or exit in the 1-5 year time frame. Plan ahead

• If are a consumer in America, get ready to pay more for the goods you love. You have had it good for 10 years, and you will begin seeing price level increases along with every RMB And VAT change. retailer’s have pushed pricing so low, that there is nowhere for anyone in the system to absorb a 5-8% cost increase without it trickling back to the market.

• If you are an investor in the U.S. stock market.. well, I guess you already have you mark picked out.. .but I would expect to see some stocks fall back as their exposure to China gets highlighted and used as the political lightening rod for the next 18 months.

• Finally, if you are a fresh mint MBA looking to cut your teeth in China, start planning for tough times. Only come if you are in for the long haul, there are already signs that the pool of fresh minted MBAs with no China based skills or language are too many. If I were you, I would find the next bubble and set up camp… not going to give anything away here, but I hear Costa Rica and Panama are BOOMING.

What possibilities do you see? share your ideas here