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China's World Domination

And Why it's Not Going to Happen

Written by Geoffrey Pike
Posted July 10, 2015

If you are old enough to remember, think back to the 1980s...

After the recessions of the early '80s, there was a bit of renewed hope in America. The country had been through a time of high inflation, high interest rates, and relatively high unemployment. But things were looking up.

With that said, some Americans had a fear that Japan was going to take over the world, particularly by the latter part of the decade. Japanese companies were selling inexpensive electronics to Americans and also finding much success in the car market. Japanese people were even finding ways to invest in America.

Some feared the Japanese were going to continue to cut their prices and send American companies out of business. My response to that scenario: fine. They can cut the price of televisions to $10 apiece, and almost every American will be able to afford several of them while barely making a dent in their budget. If the Japanese want to start sending products over for free, that will be even better.

Of course, it didn’t work out that way at all. The Japanese stock market — the Nikkei — topped out just above 38,900 in December 1989. It is now around 20,000. That is over 25 years later. I hope investors did not follow the buy-and-hold strategy over there.

The 1990s was considered the lost decade in Japan. Many now refer to the lost two decades, which would include the 2000s. I think we are going for three straight now.

To be fair, the stock market isn’t everything. Despite the government running up massive debt, the monetary inflation in Japan was relatively low up until just last year. This is somewhat contradictory, but the Japanese government somehow managed to convince private investors to buy its debt at low rates without having to turn to the central bank.

Japan has not been a total catastrophe over the last 25 years. The people there generally have a high standard of living, at least compared to much of the rest of the world. To be sure, though, there is no longer much talk of the Japanese taking over America or the world, whatever that meant anyway.

Now It’s China’s Turn

There is not as much talk about China taking over America or the world as there was with Japan in the 1980s. But there is still a lot of hand wringing over China and its supposed threat to the U.S. as an economic power.

I continually hear complaints about China manipulating its currency. And what country with a central bank doesn’t? Are Americans going to complain about the Chinese central bank after the Fed’s three rounds of so-called quantitative easing that grew its balance sheet by five times since 2008?

The reason China manipulates its currency is because the central planners are a bunch of mercantilists. They do it to subsidize their export sector at the expense of Chinese consumers. In other words, it makes it cheaper for Americans to buy things.

Just as with Japan, if the Chinese want to send over ultra-cheap goods, that is fine with me. Americans can gripe all they want, but most are going to buy a Chinese product if it is equal in quality and cheaper in price.

I also hear that the yuan is going to overtake the U.S. dollar as the world’s reserve currency. This is absolutely ludicrous because the yuan is not even a freely traded currency. I am no great fan of the Federal Reserve and the U.S. dollar, but there is no way the yuan is going to become a reserve currency anytime soon.

There is no question that China has grown by leaps and bounds, particularly since around 1980. It has lifted hundreds of millions of people out of poverty. 

Americans should not see this growth as a threat. It is beneficial for others to get wealthy. China still has a lot of corruption and central planning to distort markets, but at least there is some semblance of property rights and entrepreneurship that did not exist before. 

A Massive Misallocation

While the U.S. economy still struggles from 2008, I continually hear calls for more government “investment.”

Usually we hear ideas for more government projects in infrastructure. We should build more roads and bridges, they say.

Now, this isn’t to say we don’t need more roads and bridges, but we should not be fooled that building more roads and bridges is the best use of resources or that it will lead us to more wealth or a more vibrant economy. 

You can look at an extreme example of this in China. The Chinese central planners have no problem building bridges and roads for billions of dollars where you can barely see any cars on them.

These go along nicely with the giant cities that can house a million people yet are virtually empty. China has a real estate bubble that is beyond the imagination. It makes the U.S. housing bubble of the last decade look like a blip in comparison.

The Chinese central planners had to keep the good times going. The central bank has not been shy about cutting interest rates and creating a lot of new money out of thin air. And while a little bit of steam was coming out of the real estate bubble, they all of a sudden grew a new bubble in the stock market.

In the last year, it went parabolic. The Shanghai index grew from about 2,000 to over 5,000 in less than a year. It was the NASDAQ of the late 1990s on steroids.

In just the last three weeks, stocks there have lost well over 30%. It is a crash.

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To make things worse, as of this writing, almost half of Chinese companies on the exchange have halted trading of their stocks.

Who knew they could even do this? Doesn’t this just set in more panic? What kind of a stock exchange allows companies to stop trading?

On Wednesday, the Chinese government announced that company bosses and senior management, along with investors who own more than 5% of a business, are prohibited from selling shares on the secondary market for the next six months. I thought this was a parody when I first read it.

This sounds like something coming out of a third-world dictatorship — something you would hear from Zimbabwe or Venezuela.

For those of us — me included — who think the U.S. is too socialist or Keynesian, let’s appreciate the fact that we don’t live in China. Unfortunately, now that times are getting tough, the communist roots are showing a bit.

The last week in China is showing the utter corruption and fraudulent nature of not just the markets but also the entire economic system there. 

Modern-Day Recession

The Chinese are going to experience their first modern-day recession, and it is going to be a doozy. Let’s hope they can get through it without becoming more totalitarian.

I am waiting to hear the pundits say nobody could have expected it to be this bad. There wasn’t anybody who was warning of a major financial bust like this.

Of course, this was easily predictable because this is what happens when central banks and politicians try to centrally plan an economy on a grand scale. This is an artificial business cycle, set up by loose money, low interest rates, and massive government spending. 

Some of the wealth that the Chinese have now is real wealth. They are certainly better off than they were a couple of decades ago, when the majority of the population was living in extreme poverty. 

But some of the wealth is illusory. There appeared to be greater wealth because of the distorted markets. The illusion is now coming to light, and it is going to hit hard.

The U.S. economy has its own distortions, thanks to the reckless monetary policy of the Fed for the last seven years. Thankfully, the misallocation of resources is probably not nearly as great as what there is in China.

This is a time for caution in the markets, even in the U.S. This means diversification. It means having some cash and gold for insurance. It means being selective with stocks and being careful not to overexpose yourself.

And if you have any investments in China other than perhaps a short position, then get out if you can.

China is not taking over the world. It has its own problems to deal with.

Until next time,

Geoffrey Pike for Wealth Daily

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