China has been building a rapidly
growing economy albeit with a very delicate financial structure,
and now the bull is loose threatening to destroy the innards
of this shop. Rewind to the 1980s when Japan was in a similar
situation. Basically, their growth was being subsidized by
the government. Profits were not important – market
share was. Now multiply that by 100, and you have a bubble
expanding in China that if exploded will have much more severe
repercussions around the world. The problem in China is debt
vs. cash flow – too much debt and not enough cash flow
to cover principal and interest payments. Put very simply,
most companies in China are built with debt and no equity.
These companies then manufacture goods and sell them below
cost to garner market share. This results in the company going
to the bank for more money adding to their debt and increasing
their need for even more cash flow to make those principal
and interest payments. As a result, the Chinese government
has put a moratorium on new loans. They tried to keep this
quiet to avoid any kind of panic, but information technology
being what it is, word leaked out.
Morgan Stanley estimates that the total national debt of
China including foreign loans stands at 176% of GDP (Gross
Domestic Product). No wonder they put a moratorium on new
debt. And there is no shortage of money. The growth rate in
China’s money supply is estimated to be escalating at
over 20% a year. Inflation anyone? China could be the Latin
America of the 1980s and don’t count on the International
Monetary Fund (read USA) bailing them out. We went through
a similar mess in 1998 with the currency problems in the other
Asian countries. As bad as it could possibly become, we would
expect any dislocations in China to have only a temporary
negative effect here.
China is still a developing country, accounting for just 3%
of the world’s GDP. As a result, they are still burdened
by social instability in that urban unemployment is estimated
to be in excess of 15%. In addition, they have a very weak
retirement system and working conditions as well as pay are
substandard. China also exhibits a lack of economic understanding
(loans are still made for political reasons, most often to
uneconomic businesses).
“Measured.” That’s the new buzz word at
least until the Fed meets again. “Patient” is
now passé. The exact phrase from the Fed after they
decided to leave rates unchanged was interest rates can be
tightened “at a pace that is likely to be measured.”
At their prior meeting you will recall they assured us that
they “can be patient.” Can anyone straddle the
fence better than Mr. Greenspan? He still indicates that the
risks of an economic slowdown and acceleration are roughly
equal. Well, bring it on. A quarter or half point rise in
interest rates will not cause an economic collapse. In fact,
it may be positive. It would definitely cool down a housing
boom and it would strengthen the dollar without drastically
hurting the sales of our multi-national corporations. It would
also make our Treasury debt more attractive to investors.
If we may beat a dead horse one more time, inflation is caused
by too much money chasing too few goods. With all the attention
on interest rates, few economists have mentioned the dramatic
increase in the money supply over the last year. Mr. Greenspan
is obviously not going to make the same mistake the Fed made
in 1929-30 when they tightened money and created the big one.
This just in: Employment numbers were released this morning
and showed a gain in non-farm jobs of 288,000 for April. This
much watched monthly number is further evidence of a strong
economic recovery and should push the Fed to increase interest
rates.
Random thought for May 2004:
Two congressmen, from you can guess what state, want to introduce
legislation allowing 14-17 year olds to vote. The 14-15 year
olds’ vote would count as ¼ vote and the 16-17
year olds’ vote would count as ½ vote. And you
thought hanging chads were a mess. Barry lives.
“Someone feed the monkey while I dig in search of China.”
M.J.K.
Retraction: We try to research all the information
that crosses our desk, but occasionally something slips through
the cracks. Congress people do pay into Social Security and
they are not paid their salary for the rest of their retirement
life.
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