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Every day the new world emerges, yet we see it not. Like today, as Europe begs China for loans

15 September 2011

Summary:  A crisis strips away our pretences, the no longer true beliefs to which we clutch out of fear — from our unwillingness to face the future.   Today we have a fine example as Europe begs for loans from China and the other emerging nations.  The new world order emerges before our eyes.

America loves our status as a superpower.  Europe and Japan relish their status as great powers.  We are all broke.  America has borrowed trillions from the emerging nations, but retains the delusion of hegemony.  Now Europe faces its test, and turns to the new great powers for aid.  Not Japan.  Not America.

BRICS in Talks to Buy Euro Bonds to Help Ease Crisis “, CNBC, 13 September 2011 — Opening:

The BRICS major emerging markets are in initial talks about increasing their holdings of euro-denominated bonds in an effort to help ease the euro zone debt crisis, a Brazil government official told Reuters on Tuesday. The talks are still in a “preliminary stage,” said the source, who asked not to be identified because the negotiations were ongoing. The BRICS countries are Brazil, Russia, India, China and South Africa.

With almost 3 trillion euros in reserves, the BRICs have the ability to rescue the European Monetary Union (i.e., BRICs means China plus the others; China’s reserves are almost 3x the other’s combined total).  Doing so would rebuild the global financial system, creating at last a system to replace the long-dead Bretton Woods framework.  But what would the BRIC nations get from this deal?

What do they want?  Probably leadership, or at least a voice commensurate with their growing power.  The BRICs have 14% of the votes in the IMF.  Increasing that would be a logical step, one that’s inevitable eventually.  That’s probably the least they will ask for.  As Europe’s crisis seems almost certain to deepen in the next few months, we (or at least western governments) will soon see their demands.

My guess:  the price might be hidden (much like the deal settling the Cuban Missile Crisis), but it will be high.  Perhaps very high.  The BRICs have no need to hurry, as Europe’s need for loans will only grow — unless (until) its leaders abandon for now the unification project.

Putting the above in perspective

The BRICs are a disparate group.  Very different internal conditions, few common interests, no signs of acting together.

China remains a poor nation, despite its rapid growth.  For example, despite China’s high levels of investment (too high say critics) it’s per capita capital stock is aprox 1/8 that of the US (at PPP, per GaveKal), aprox 1/5 that of Japan (where Japan was circa 1970).

The growing in the BRICs –esp China — lies in the future.  The shift of power has just started.  America’s political dysfunctionality accelerates that process (as our rich increasingly work to further concentrate power and wealth rather build America).

For more information

For all posts about this, see the FM Reference Page End of the post-WWII geopolitical regime.

About China:

  1. Power shifts from West to East: the end of the post-WWII regime in the news, 20 December 2007
  2. China becomes a super-power (geopolitical analysis need not be war-mongering), 9 July 2008
  3. China – the mysterious other pole of the world economy, 22 July 2009
  4. Another big step for China on its road to becoming a great power, 27 July 2009
  5. Update about China: a new center of the world, 13 December 2009
  6. How China builds its commercial empire, 12 July 2010
  7. A look at the future (it’s already here, but it’s not in the USA), 29 September 2010
  8. Why China will again rise to the top, and their most important advantage over America, 11 November 2010
  9. Will China become a superpower?, 9 September 2011

About Europe:

  1. The periphery of Europe – a flashpoint to the global economy, 8 February 2010
  2. A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
  3. About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
  4. Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
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23 Comments leave one →
  1. 15 September 2011 12:26 am

    Good post, but, as you point out, tough to get people to change their POV here in the States. We have a lot of fantasy thinking going on right now based on the thought, “If we could only do this one thing, everything will be like it was.”

    Let’s say we opt for the BRICS bailout and cut a deal for the mula. To what extent do these countries have the international political and economic experience to impose a new set of rules that will actually work in the long run? Can they ask that the yuan replace the dollar? Or that NATO disband? Or that we leave the Philippines? Or that they set the banking rules in NYC, London and Geneva?

    Like

    • 15 September 2011 1:56 am

      All good questions.

      (1) “Can they ask that the yuan replace the dollar?”

      Why would they do such a foolish thing? The US dollar remains the reserve currency largely because by now everybody understands that it is a “poisoned chalice” — leading to an overvalued currency and trade deficits. The successful nations tend to have undervalued currencies and trade surpluses. Only Americans retain their childish pride in the strength of the currency.

      (2) “Or that NATO disband? Or that we leave the Philippines? Or that they set the banking rules in NYC, London and Geneva?”

      This is “mirroring”, assuming China will do the dumb things we would do in their place. My guess is, as I said in this post, that they will negotiate for changes that reflect their increased power in the world and generate long-term advantages. Such as more votes in the WB, IMF, and more broadly a greater voice in global (i.e., multinational) trade and financial negotiations (e.g., WTO, BIS).

      (3) “Or that they set the banking rules in NYC, London and Geneva?”

      That is exactly the sort of thing China will increasingly do, using mechanisms such as the BASIL banking regulations. They well understand the power politics of finance, as described in one of great texts of modern warfare: Unrestricted Warfare by Qiao Liang and Wang Xiangsui (1999). For details see:

      1. Two essential texts in the theory and practice of financial warfare
      2. Words to fear in the 21st century: Lǎo hǔ, lǎo hǔ, Lǎo hǔ

      (4) “have the international political and economic experience”

      Most of this is quite basic. Just because we no longer have the smarts to do these things does not everybody else has also taken the dumbo pills.

      Like

  2. 15 September 2011 12:32 am

    America has intangible assets, creative capital, that China has less of. The hard power_soft power arguments in America don’t seem to appreciate innovation the way they used to. That is where American leadership has its strength.

    Like

  3. asdf permalink
    15 September 2011 12:51 am

    You can always revert to ‘intangibles’ which reinforce American exceptionalism by shifting the goal posts. Most of the world doesn’t care. It’s not like they believe America when it said Iraq had WMDs, why would they care how Americans view themselves as hegemons of the world? It’s no longer true.

    Like

  4. Pluto permalink
    15 September 2011 1:04 am

    “With almost 3 trillion euros in reserves”

    I’ve heard that line already today and have some questions about it. Most of those 3 trillion euros are likely to already be invested in other areas. China, for example, has roughly $1.2 trillion dollars in US government debt. If China were to ride to Europe’s rescue it would likely need to sell some of those US government bonds in order to free up money to invest in EU bonds.

    Depending on how big the European needs are, it is likely that the Chinese would have to sell some of the US government debt at a loss. Are they going to be willing to do so? Especially because doing so would allow their currency to float even higher against the US dollar and make their goods less competitive. Is this the direction the Chinese government wants to go?

    It seems to me like the European hopes for a Chinese bailout are either going to be fantasy or carry a very high price tag for the Europeans because investing in Europe in a large way will be expensive for the Chinese and the Chinese government is not historically altruistic.

    On a different tack, I understand Carl’s point and agree with it up to a point but innovation needs:

    1. Time = innovation does not happen on a schedule
    2. Opportunity = education, infrastructure, and social mobility are key to making the most of innovation when it occurs. All of these are in increasingly short supply in the US. The Chinese are adding opportunity all the time, their innovation is likely to increase as well.

    Like

    • 15 September 2011 1:42 am

      “sell some of the US government debt at a loss.”

      That’s not accurate on several levels.

      1. Interest rates have been dropping since 1982; it takes exceptional skill to have losses on US treasury securities.
      2. China owns short and very short maturities (composition of their foreign exchange reserves are a State secret), so if US rates rose they still would lose little.
      3. China maintains forex reserves largely as a means of keeping the RMB cheap (i.e., rising more slowly that it would if floated) to promot their exports; the resulting forex losses are a cost of that strategy.
      4. Market movements generate gains and losses; selling merely recognizes what’s already happened.

      Like

    • Pluto permalink
      15 September 2011 1:59 pm

      What you’ve said so far makes sense so I’ll highlight the rest of my questions.

      1. How much money does Europe need and how soon?

      2. The Chinese have historically embraced a US/Emerging nations trading strategy. Dumping a couple hundred million dollars of US bonds to invest in Europe would seem to me to be a change in that strategy. Do you think the Chinese are interested in changing it now?

      3. The Chinese have publicly indicated that they’d like European cooperation in advancing their case with the WTO as part of the price for Chinese intervention. Do you know of any other strings that are likely to be attached?

      4. Do you think the Europeans are going to be willing to pay the price (monetary and political) for Chinese funds? It allows them to kick the can further down the road but could substantially increase the pain of finally dealing with the mess.

      Like

    • 15 September 2011 2:40 pm

      All good questions.

      (1) How much money does Europe need and how soon?
      Too complex. There are a wide range of solutions, which in turn depend on economic and social events. Does austerity help or hurt (they bet help; history says hurt)? Will people react with bank runs or capital flight? Will savings rise (slowing gdp)?

      (2) “a couple hundred million dollars of US bonds” would be a minor shift. China has aprox $3. trillion in reserves. World gdp is aprox $65 trillion.

      (3) Most western experts discussing the views of China’s leaders are guessing. But as I said in this post, increasing their voice in the major multi-national organizations seems a logical step for China — reflecting both their increased power and past actions.

      (4) Nobody knows what the peoples (not people, not Europeans) will accept or do. They do not know yet; current events are the process by which they make up their collective minds.

      Like

    • Pluto permalink
      15 September 2011 3:23 pm

      “a couple hundred million dollars of US bonds”

      Very true. That was a typo, I meant to say “billion, ” not “million.” But, as you point out, that still wouldn’t be that big a number in the grand scheme of things.

      Like

    • 15 September 2011 3:29 pm

      It seems VERY unlikely that China would make such a large loan (hundreds of billions of US dollars) to the PIIGS governments. Perhaps they might do so through the IMF, although even that would be an incredibly large step, unless done over years — perhaps a decade. In which case the effects also would be spread out, and perhaps only a minor factor in this on-going crisis.

      Like

  5. 15 September 2011 2:19 am

    A Chinese rescue of Europe will come at a cost to the US economy through higher interest rates on Treasuries since China will either sell some of it’s existing holding or buy less in the future. The full cost might not be apparent because we are in a liquidity trap but over the medium term interest rates will trend higher.

    Like

    • 15 September 2011 2:45 am

      The certain and immediate response to a significant change in the currency composition of China’s foreign exchange holdings will be in levels of the currencies affected — a rise in the RMB/USD, to the benefit of the US. A one-time shift in their composition (from a bailout) is unlikely to affect US rates, and certainly not over any long horizon.

      Like

  6. Tim permalink
    15 September 2011 10:29 pm

    Europe has no real net external funding need, this is really a crisis between Germans and others. Like the Global cris the savers are just as at risk as the borrowers and it is becoming increasingly clear that the longer Germany pretends it can just walk away the more it is one the hook for the Target2 balances at the ECB. German people don’t understand the issue so far and if their Government acts stupidly (as currently) the they could be in a real mess while.

    Like

    • 15 September 2011 11:07 pm

      These are half-truths, as such clear statements are difficult to accurately find in such a complex situation.

      (1) “Europe has no real net external funding need”

      Yes. And no. The creditors have the ability to fund the debtors. But those would be large bets for them to risk. It”s reasonable to ask the rest of the world to help out, both spreading the risk and making default more painful.

      (2) “the savers are just as at risk as the borrowers”

      Yes, both are at rismaxi But not EQUALLY at risk. Both the pig and chicken are involved in my breakfast, but not in the same way.

      (3) German people don’t understand the issue”

      I would like to see some evidence of that. Perhaps the ones who oppose more aid to Greece have different forecasts for the economic risks/gains/losses of unification vs. breakup. Perhaps they have a different view about the non-economic benefits of unification. Perhaps they have little confidence in the ability of Europe’s leaders to manage unification, no mater how well-funded. It’s not a subject where such broad statements are appropriate, IMO.

      Like

  7. Young J. Kim permalink
    16 September 2011 1:17 am

    We need to look into history to realize that the world has been in this position before.

    Let not forget that from since the 13th Century on and as late as the 17th Century, Europe was in a perpetual trade deficit with China. Goods such silk, spices, porcelain, tea, etc were goods of high demand in Europe that only China could produce. The only way for Europe to pay for these goods was essentially paid mainly in silver. There really wasn’t anything that the Chinese wanted from Europe or the West. What this would do to Europe was create a problem with a draining away of silver from their general economy. If your economy is being drained away of currency, it means that there is less and less monetary circulation to which your economy will slow down and grind to a halt of an over valued currency. The Post World War II era we saw something similar to this in the US where being essentially 50% of the world economy we saw the US dollar slowly being siphoned off to the rest of the world as the world rebuilt itself. The impact of the US economy at home was similar to what the Europeans had to go through hence the Richard Nixon solution of Bretton Woods where in 1971 the dollar was taken off the gold standard, leaving our dollar to float making it very elastic.

    However for Europe and China no such thing could be done, the currency was the metal copper, silver, or gold. It wouldn’t be until the 1750s that the British from India hit upon opium as the commodity that Chinese consumers would buy. As you know no society wants their population to be addicted to drugs especially one such as a narcotic as opium that essentially makes your population less productive. The Opium Wars came as a result and against modernized weapons the Qing dynasty in China had no real chance resulting in a loss of territories, sovereignty and especially pride. However it wasn’t so bad as the Chinese would think as British traders paid their taxes to the Qing to which circulated back into the imperial coffers. If history is any indication the rise of the Chinese economy especially where they are so preeminent on the world economy, one should not be surprised as to why the Chinese will increase their defense spending. Especially after what they have seen with what NATO has done to Libya.

    Now let us hit on Europe. Why did Europe come to this? I believe the answer is the creation of the European Union where productive economies are now expected to subsidize non productive ones. Having a unitary currency also affects the ability for non productive countries to trade where weakening their currencies had in the past allowed them the ability to compete in trade. Not anymore. Add to the fact that many European governments also deficit spending, it is no wonder that Europe is in such as mess. Other factors contribute too but I think these are the primary ones. Europe’s economic malaise is largely self inflicted to which for Europe to survive would require the break up of the EU and sooner the better.

    The BRICs have no reason to bail out Europe especially if they can use their reserves to fund their the development of their own domestic economies and that is where China and the BRICs should best use their foreign reserves. Buying up new capital whether real or human and what I mean by that is buying high end equipment and technologies or sending their people to study in Europe. That way the BRICs will get something real in return for their money. Bailing out European financial institutions and governments that have proven to be dysfunctional and nonproductive would be a waste of money, literally. Greece has made no movement to get their economy in order and agree to austerity measures especially if they provide too many free public services that shouldn’t be. Why should the Germans spend more.

    If I was Chinese why should I pay to bail out the EU unless I get something in return? Why did Europe allow the Chinese to keep their currency pegged. Should have called them out on that? China has not been exactly fair in their free trade commitments but then again Europe has much to be faulted as well.

    So where do we need to go from here? Well I mentioned the Chinese economy in the past and their relationship with the West regarding trade. We also seen how China’s economy is not yet self sustainable with a robust domestic market like we see in Japan. Japan’s economy by the way is only 20% dependent of exports, with the remaining 80% is generated with a robust domestic economy. For the Japanese to get there they had to export to buy capital to which they built their domestic economy and infrastructure. Post 3/11 the Japanese will have to rely on exports again to rebuild. This is the model for China. China’s economic development is nothing new it is simply following the pattern that Korea, Taiwan, and Japan had taken. So this is what the West has on China, a developed economy that is able to produce high end capital that China desperately needs. But we cannot do that until the Chinese are compelled to respect patents and copyrights and for them to unpeg their currency. Unless we make like the British and later the other European powers and Japan had done in the late 1880s to the early 1930s in China, free trade economics will have to take a backseat. China will buy the high end capital as their own looming internal collapse is coming unless they can develop a robust domestic economy and wean off an export focused economy.

    We may be already be beginning to see this happen.

    Like

    • Marc A. Cirigliano permalink
      16 September 2011 3:05 pm

      It is in the Chinese interest to keep the game afloat, since their prosperity is based on selling the goods they make in US and European markets. As a US business man told me several decades ago, “Either we all make money or we all lose money.”

      Now, as to what we ought to do.

      We ought to be realistic about where we in the US really are with hard, soft and economic power. It’s no longer 1964. We should cut a deal with the Chinese by getting financial help and giving them the access they want to the official avenues of global financial power.

      Btw, China has major problems that will hinder its global assertiveness in the coming decades: massive labor and social dissatisfaction/unrest; horrific environmental problems; a potential water shortage; and, the historical impetus toward the devolution of its (16?) internal peoples/states. So, they aren’t going to take over the world.

      Cut a deal now, keep the game afloat and work with the Chinese to solve their own internal problems.

      Like

  8. Whirlwind permalink
    17 September 2011 3:18 am

    China sure has a grip on rare earth minerals“, New York Times, 15 September 2011

    Like

    • 17 September 2011 3:19 am

      It’s always fun to see how people’s belief are influenced by names. Greenland is not very green. Rare earths are not very rare. China gained control of current supply by cutting prices. As they raise prices old mines elsewhere reopen and new mines are developed. The US has the world’s 3rd largest reserves — with two large deposits at the Mountain Pass mine in California (once the world’s largest) and Bear Lodge Mine in Wyoming. There are others around the world, such as the mine under development in Kuantan, Malaysia.

      For more see:

      1. Publications by the US Geological Survey about rare earths
      2. Rare earths – a hidden but strategic battleground between the US and China, 5 May 2010
      3. Taking a Risk for Rare Earths“, New York Times, 8 March 2011 — “A colossal construction project {in Malaysia} could help determine whether the world can break China’s chokehold on the strategic metals crucial to products as diverse as Apple’s iPhone, Toyota’s Prius and Boeing’s smart bombs.”

      Also see “How to free the world from China’s rare-earth stranglehold“, Brad Plumer, blog of the Washington Post, 16 September 2011 — Excerpt:

      “Despite their name, rare-earth elements aren’t actually all that rare. At different points in the 20th century, countries such as Brazil, India, the United States and South Africa all held the top spot for rare-earth mining. But in the 1980s, China cranked up production massively, causing prices to crater, and managed to take over the market, as this chart from the U.S. Geological Survey illustrates:”

      Like

  9. Patrick Chovanec asks "Can China Rescue Italy?" permalink
    19 September 2011 5:54 pm

    “”Can China Rescue Itlay?“, Patrick Chovanec (Assoc Prof Economics at Tsinghua U in Beijing), 18 September 2011

    Like

  10. Young J. Kim permalink
    20 September 2011 1:20 am

    Fabius Maximus is right about rare earth metals and recently Japanese scientist have found huge undersea deposits that dwarf that on land: “Survey reveals wealth of important metals in ocean floor mud“, Nature, 3 July 2011

    That all said we need to recognize that China produces 97% of the world’s rare earth metals and rare earth metals are crucial to develop high end electronics. Consumer electronic is one such thing where the prices keep dropping every year. The huge amount of production as Fabius says is what makes rare earth affordable due to economies of scale. It takes a lot of effort and ore processing to extract those metals.

    Rarity is a relative in an economic sense. Before there was the process of electrolysis the cost of Aluminum was much higher than that of Gold. For this reason that the Washington Monument has is capped with the then rare and expensive Aluminum.

    Rare earths right now is necessary and the Japanese are overly concerned about China’s dominance on the resource. This to them echoes the past pattern of a Sino Centric Geopolitical order that had monopolized any continental access to resources. What China has done was essentially economic dumping. This also goes to the point that China has traditionally used economic coercion (not military coercion) to influence its relations with other states. This is how and why the Chinese Tributary System worked. Korea had to submit in order to be allowed the privilege to trade with China. The Japanese chose to invade to overturn the Sino Centric order, twice.

    Until alternative resources are mined cheaply or more cost effectively conflicts over resources are possible and in some cases likely. We will still fight over oil because hydrogen or other alternative fuel sources are not equal or cheaper than the cost of oil. If we find ways to mine rare earths on a huge scale on sources outside of China, then the potential for conflict may be greatly diminished. US mining production needs to be competitive in price to China for this to work.

    In my opinion with investment in mining capital and machinery both on land and undersea, the US can actually do it. It would be an item that the rest of the world would definitely buy and we can export to them.

    If there is a China threat it will not be solved by building more military weapons rather by economic competition and production.

    Like

    • 20 September 2011 1:49 am

      I think we’re, so to speak, on different pages here. China dominates the production of rare earths because they sold them at prices that were uneconomic — for everybody, including China. Now they have realized that doing so merely pollutes their own land and consumes valuable mineral resources at prices below long-term average value. China does not have a majority of the world’s rare earth deposits.

      “Until alternative resources are mined cheaply or more cost effectively”

      That’s not the case with rare earths. As China raises its prices, mining resumes at now-closed sites around the world. No new technology required. This process is fundamentally different than tapping VERY low quality reserves, such as minerals in seawater, that require prices far higher than today’s (and probably technology innovation as well).

      Like

  11. 20 September 2011 6:52 pm

    “My guess: the price might be hidden (much like the deal settling the Cuban Missile Crisis), but it will be high. Perhaps very high. The BRICs have no need to hurry, as Europe’s need for loans will only grow — unless (until) its leaders abandon for now the unification project.”

    I’m not so sure. The BRICs are following the same growth model as Japan did. Where is Japan now? They only have massive forex reserves BECAUSE they are manipulating their currency and keeping it artificially low. Creditors and Debtors are two sides of the same coin. And like Japan, I believe that when the BRICs do adjust it will actually hurt them more (e.g. Japan’s share of world GDP went down since their bubble popped).

    Although I agree that we need to abandon reserve currency status.

    Like

    • 20 September 2011 7:41 pm

      I do not believe that is an accurate picture of the situation.

      (1) Japan was doing fine until the imbalances in the global economy (with Japan’s mercantilism as a factor) lead to the coordinated tinkering of the Plaza Accord (1985) and the Louvre Accord (1987). These destabilized Japan, leading to the excesses — especially debt-financed over-investment by corporations — that popped in 1989.

      The poor economic performance since then (stable per capita real GDP financed by massive government borrowing) results from demographic change (ie, longer lifespans AND a crash in fertility) plus a dysfunctional political system (eg, the PM for a year program). The latter was predicted with great accuracy by Karel van Wolferen in his 1989 book The Enigma of Japanese Power.

      (2) The Bretton Woods II model followed by China and other emerging nations differs in significant ways from that of their Japanese predecessor.

      1. More finanicial repression (eg, internal controls on lending and capital flows).
      2. Pegging to the US dollar.
      3. External capital controls (eg, especially on flows inwards).
      4. Low debt levels of corporations

      The result makes Japan of 1970-1990 look like a libertarian’s dream.

      Like

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