Opium Wars

When Richard Nixon visited Communist China in 1972 there was a great frisson of hope in the hearts of American corporate managers and shareholders: ... just imagine all those hundreds of millions each buying just one of our products... oh, the sales...oh, the profits. Thirty-five years later, the promise of immense Chinese trade has been realized, but in a way that no one could foresee back then. Instead of America exporting to China, it is China's torrent of cheap manufactures that flood US markets and, adding insult to injury, it is Chinese savings that provide the vendor financing necessary to sustain the hand-to-mouth existence of American consumers.

This situation is eerily reminiscent of Anglo-Chinese trade during the 18th and 19th centuries: China exported valuable silk, porcelain and tea, but had no need or desire to import much from England in return. Large trade deficits ensued and had to be paid for by British gold and silver - a situation not at all to the liking of the City's capitalists and bankers. So, Perfidious Albion came up with a novel, if entirely unscrupulous, trade-balancing product: opium from the Empire's poppy fields in India. Dope for the masses quickly caught on in China, the trade deficit evaporated and then even shifted to England's favor. The rest, as they say, is history (the Opium Wars and Boxer Rebellion).

In today's fiat currency world there is no need to make payments in gold and silver specie, but there is an implied promise that the dollar IOU's will be readily exchangeable at reasonable rates for essential commodities like oil, iron ore, copper and food, procured from around the globe. Today's Chinese trust, expect, or ultimately hallucinate that their massive holdings of book-entry blips are equivalent to gold. In oh, so many ways they are smoking dope once again, aren't they?

One look at market prices reveals that waking up from the stupor induced by dollar-debt dope is becoming very painful. American consumers are already curtailing their spending and thus growth in Chinese imports and vendor financing is coming to an end. The Chinese are finding out that their accumulated dollars now buy much less wheat or oil: fifty to seventy percent less, depending on the commodity.

The Chinese are certainly not naive. They saw this coming some time ago and tried to directly purchase long-term hard goods and assets with their dollars, e.g. oil and gas reserves in Africa and Iran, US and EU companies, etc. Their success was limited, so they piled into private equity funds, along with their petro-dollar brethren from the Gulf and Russia, as a way to circumvent direct-purchase obstacles. Naturally, they got thoroughly skinned in the "standard 2/20" way, with some funds even charging more. But the alternative - holding rapidly depreciating cash dollars - was even less appealing. Shaking a dope addiction has always been a terrible and costly experience, after all.

But these back-door investments have been drops in the bucket - large drops to be sure, but drops nevertheless. The Chinese Treasury still holds the majority of its reserves as "dollar debt dope" and its officials must be getting increasingly frustrated as they watch purchasing power eroding daily. The foreign "dope" dealers are not dumb, either: their ability to service US debt gets easier with every tick up in international commodity and transportation costs, priced as they are in dollars.

Inflation rose once again in China during October (6.5%), mostly due to sharp rises in food and fuel prices which hit the poor particularly hard. Three days ago in Chongqing three people died in a stampede as they rushed to buy cooking oil on sale at a supermarket. Attempts by the central bank to stem inflation center on raising mandatory reserves (up to 13.5% now, the highest ever) and interest rates (one year depo at 7.29%), but they are hobbled by the dollar-yuan peg which devalues the Chinese currency in international markets as the dollar drops.

Can China free itself from its present day opium addiction and America from the easy vendor financing terms? No one really knows; the situation has been allowed to get out of hand and the blame is shared equally by US and Chinese policy makers. They act like junkies who earnestly promise ...this will be the last hit, really man... as they feverishly light up another pipe, supposedly their last.