The Green Fields of Asia

Debt, Deflation, Default, Deficits, Demographics…

The letter D seems to have ascended to one of the more, if not the most, useful letters dominating descriptions of the financial landscape this morning. In fact, if we were going to play a game of financial Scrabble, rather than trying to figure out what’s going on in the markets today, we’d have to re-assign the value of the D tile…and give it ten points, in inverse ratio to its usefulness.

For example, the "deciduous dollar declined" yesterday against the yen in anticipation of a report, due out today, which is expected to show that the U.S. current account deficit widened to a whopping $132 billion in the third quarter.

At that rate, the U.S. must lure in $1.3 billion a day in unsuspecting foreign capital just to keep the consumer binge alive.

The dollar has dropped 1.3% since Treasury man O’Neill, the administration’s formerly vocal proponent of a strong dollar policy, was shown the door on Friday. Is there more where that came from? Probably, we suspect.

In fact, in a speech the press forgot, Fed governor Donald Kohn all but announced on November 22nd that the dollar’s strong days are numbered. Despite verbose coverage of the now infamous Bernanke anti-deflation speech of November 21, our own double-D, Dan Denning, editorial sage at the helm of the Strategic Investment, suggests that the Kohn speech a day later may have even wider-reaching implications.

"For the most part," Mr. Kohn told listeners at the 12th Frankfurt European Banking Congress, "the existing distribution of the current account surpluses and deficits among the countries of the world reflects market decisions regarding the global allocation of capital. Evidently, savers around the world have anticipated greater risk- adjusted returns on their investments in the United States than in surplus countries."

Foreign investors have effectively four choices for holding cash reserves: the U.S. dollar, the euro, the yen, and gold. Despite lower-than-expected returns on U.S. assets, none of the latter three have given investors a compelling reason to abandon the greenback.

"The surplus countries Kohn must have in mind are countries like Japan and China," says Denning, attempting to unpack the Fed governor’s comments. "China alone accounts for 21% of the U.S. trade deficit, even more than Japan. And that’s after China raised its U.S. dollar reserves $62.4 billion in the first 10 months of the year. Japanese dollar reserves are up by over $60 billion in the same time. What does this mean?"

"It means, despite acquiring huge amounts of dollar- denominated assets," Denning answers his own question, "these countries continue to run massive surpluses against the United States. The U.S. current account deficit is now 5% of GDP. The rest of the world pours its savings into America because American assets are better investments than anywhere else in the world. But while creditor countries send their savings to America, they neglect investment in their own assets. Americans gorge. Foreigners scrimp. Neither is economically healthy nor sustainable."

As we’ve noted in these pages, current account deficits of this magnitude are rarely, if at all, sustainable. "At some point," Kohn admitted, "reflecting both the decline of marginal returns as resources shift toward stocks of U.S. capital and other durable assets and inevitable flagging in the willingness of investors to place an ever-increasing share of their portfolios in dollar-denominated assets, the net flow of savings to the United States will taper off."

Your editors have been wont to ponder this very predicament: how long, we ask ourselves day after day, will foreign investors continue to send their savings across the seas to be gluttonously consumed by hungry heifers in the U.S. Now even governors at the most aggressive central bank in economic history appear to asking the same question.

Mr. Kohn is perhaps right when he suggests there is a dearth of alternatives to the dollar. Alas, we here at the Daily Reckoning are always on the lookout for the unexpected, the weird, the uncanny and the bizarre…and so, purely for the entertainment value inherent in both, allow me suggest two possible candidates: the Chinese yuan and the gold dinar.

In a move bound to rival the 1985 Plaza Accords – in which the then G-5 nations boosted the yen and European currencies against a strong dollar – Bloomberg’s William Pesek, Jr. suggests that perhaps now is the time to boost Chinese yuan. The yuan, pegged by Beijing at 8.3 to the dollar since 1993, barely reflects China’s ascending, albeit deflationary, role in the global economy.

"A yuan revaluation," writes Pesek, "could catapult China’s economy past a number of the biggest. Overnight, China’s economy could arguably become larger than France’s or the U.K.’s and assume the number 4 position."

Another possibility? "The gold dinar," writes International Forecaster Bob Chapman, "now circulates since 1992 in Spain, Scotland, South Africa, and Germany."

In late October, Malaysian prime minister Dr. Mahathir Mohamad agreed with an Iranian proposal to set up a secretariat in Malaysia to use the gold dinar among central banks of world Muslim countries. Of course, there is an existing International Monetary Fund (IMF) prohibition on the use of gold as a medium of payment. But "Iran is keen," said Dr. Mahathir, "so we might do this with them," effectively re-inserting gold into the world monetary system.

The gold dinar is still a flaky proposition. Likewise a "China Accord" forcing the yuan to float freely – thus becoming the target of speculators – would appear to be a net negative for politicos in Beijing. But in either case, these possible alternatives represent the buying power of a combined 2.4 billion people… some 30% of the world population.

"With a total Muslim population of 1.1 billion," writes Jay Taylor of the Gold Letter, "if even a small percentage of Muslims begin to demand Islamic Dinars as their medium of exchange instead of paper, it could have a dramatic effect on the price of gold." And an equally dramatic effect on the value of the U.S. dollar.

And on top of it all…even the Fed and the President seem prepared to admit that the dollar, having allowed the U.S. to live beyond its means for 57 years, has been the world’s reserve currency for far too long. Hmmmnnn…


Addison Wiggin
December 12, 2002

P.S. You may have noticed that Daily Reckoners Bill Bonner and Eric Fry are in absentia today. The former is on a plane bound for Baltimore, the latter is likewise on his way to surf and sun in Nicaragua. Not to fear, there’s always more to come…as the Daily Reckoning continues. Marc Faber sheds a little light on Asia emerging…below.

China, whose exports of cheap-o gee-gaws jumped 33% last month, is already exerting an enormous influence on the world economy. But what of the rest of Asia? Is it the market for the next 1,000 years, like so many seem to believe? Marc Faber, a resident of Hong Kong for more than 20 years, suggests there’s a little work yet to be done…but the potential is enormous.

by Marc Faber

In the early 1990s, Asia entered a period of economic, social, and political transition, which, in my opinion, has begun to change the face of Asia.

In the same way that a visitor to Asia today who had last visited the region prior to the Second World War would be stunned by its progress and by the changes that have occurred in the balance of power, a visitor to Asia in the year 2010 will find a totally different economic, social, and political landscape than the present one.

By then, a number of countries that until recently hibernated economically under a totalitarian or socialist/communist ideology – Myanmar, Vietnam, Laos, Cambodia, North Korea, and China until the late 1980s – or under policies of self-reliance and hostility towards foreign investors – India and Bangladesh – will have caught up with the rest of Asia, or may even have overtaken some of today’s centers of prosperity in terms of economic development.

Conversely, some of today’s "successful" Western countries facing intense competition from these "newcomers" will likely under-perform, or may even succumb to absolute declines in their fortunes. This is what changes are all about: they inevitably produce not only winners, but also losers.

Following the Second World War, several major trends became apparent in Asia: the end of colonial rule, the formation of sovereign nations, and the rise of communism in countries such as China, Vietnam and Burma. The end of colonial rule was initially accompanied by hostility towards the former colonial powers and a reluctance to allow foreigners to participate in the development of the Asian economies. The priority was to build nations, not economic growth. Furthermore, foreign investments were for a long time perceived as potentially destabilizing.

The end of colonial rule also shaped the political systems of Asian countries. Since independence had frequently been gained through guerrilla warfare or after a period of civil strife, very close ties remained between political leaders and the army. In order to gain independence, the opposition armies were usually organized into some kind of a feudal system, with each army unit having the right to collect "taxes" from the region in which it operated. Not surprisingly, after independence was gained, this system of privileges remained in place, so that we still find in some Asian countries these feudal-style political systems.

The leader of a country will assign some privileges (monopolies, tax concessions, state loans, etc) to some of his trusted followers (leading businessmen, influential local politicians, and army generals), and they in turn will give full support to the ruling party. This system functioned quite well from 1950 up to the mid-1980s because it guaranteed peace and stability (although at the expense of some freedom).

Domestic stability, in turn, fostered economic growth. Until the late 1980s, this feudal system, which incorporated political, economic, and military power at the top, was well accepted by the people because of the communist threat in the region and the memory of the "evil" colonial powers.

However, in the 1990s, cracks began to appear in Asia’s feudal systems, for a variety of reasons. More and more countries were liberalizing their economies and moving towards a capitalistic system with the participation of many foreign investors in the form of direct and portfolio investments. Free markets, capitalism, and foreign investors undermined the power of the privileged class, as capitalism lead to more structured political, legal, and economic systems. In addition, as political and social tensions eased in the Asian region – peace between Indonesia and Malaysia following President Sukarno’s "crush Malaysia" policy in 1963, the end of the Vietnam war and the demise of communism – governments could no longer justify their tight controls over the economy on the grounds of domestic security issues.

As a result, in the 1990s, Asia entered a transition phase characterized by significant changes in the political sphere – away from a feudal system and towards more pluralistic societies where the rule of law was increasingly challenging absolute state or military power.

I might add that Western countries, especially the U.S., supported totalitarian rule or military dictatorships in Asia, as long as the threat of communism existed. But when, in the 1980s, the communist threat receded and the Western powers developed a strong interest in opening up previously closed markets for exports, economic reforms in Asia became a priority for the industrialized countries because feudal systems based on monopolies and privileges were simply not conducive to free markets and free trade. Therefore, by pushing the Asian countries to carry out economic reforms, the Western countries encouraged their ongoing transition from ad hoc feudal hierarchies to more liberal and more constitutional systems.

So far, we have seen that the demise of communism in Asia has had a favorable impact on the region, as it has defused much of the tension that existed as long as communism was perceived to be a threat.

Although I am highly skeptical of the forecasts of futurologists who write thick books, I also think it highly probable that in ten to twenty years’ time, Asia will be far less dependent on exports to the West than it is today.

Trade within Asia will dominate, as Asia requires few products that are manufactured in the West. Exports to the Western industrialized nations, however, are here to stay because of the competitiveness of Asian manufacturing and IT services. In addition, I should like to debunk myth that is widespread among Westerners. I am frequently told that China and the rest of Asia still rely on Western knowledge and technology, and that Asians aren’t capable of innovation and invention. When I hear these arguments, I always have to smile.

The number zero was invented in India, without which science in the West could never have progressed at the pace it has, since Roman numbers were unsuited to complicated calculations. Francis Bacon thought that three inventions – paper and printing, gunpowder, and the magnetic compass – had done more than any religious conviction, astrological influence, or conqueror’s achievement to bring about the modern world and mark it off from the Middle Ages and antiquity. And guess where these inventions came from?

Moreover, if I look at the achievements of Japan in the manufacturing sector over the last 30 years or so, there is simply no doubt that Asians can be great innovators as well. Furthermore, in most Western high-tech companies and leading research laboratories, we find Indian and Chinese scientists.

All that Asia needs to do in order to really take off in terms of its own innovations is to create a more favorable social and political environment, which Western Europe enjoyed from the Middle Ages and the U.S. from the 19th century on, and which was one of the main reasons for the rise of Western civilization.

In other words, what is really required in Asia is the creation of the social environment and the institutions that catapulted Western Europe from the Dark Ages to the Industrial Revolution.


Marc Faber,
for The Daily Reckoning
December 12, 2002

P.S. The demise of feudalism in Europe during the 15th and 16th Centuries was precipitated by two major events. Innovations in the art of warfare (especially the invention of the cannon) led to a decline in the military effectiveness of armed cavalry – fielded by noblemen – and to the obsolescence of feudal castles as a military stronghold.

In addition, the rise of the merchant class along with a money-based economy in the city-states displaced the feudals, whose income had come principally from bartering agricultural products and from all kinds of other privileges. The rise of the merchant class came as a result of technological changes which promised commercial and industrial advantages, and the rapid expansion of overseas trade in the 15th and 16th centuries.

Overseas trade increased very rapidly after the opening of all water trading routes to the Far East and the discovery of the Americas. And, over time, the rise of the merchant class replaced the feudal political and economic system with a free market economy and a capitalistic system.

The origin of progress and economic development in Western Europe is extremely complex, but in essence, it highlights what Asia still lacks to a large extent. However, I am hopeful that the transition from the ‘Asian’ feudal society I described above to a well-structured market economy and an institutional capitalistic system, as opposed to a feudalistic capitalistic system – such as we still find in many Asian societies, including China – will get under way.

In this respect I am particularly impressed by developments in Taiwan over the last decade. In 1996, the then acting President Lee Teng-hui proved that the Chinese are not unsuited for democracy, as was then and is still claimed today by most of Hong Kong’s leading businessmen, including some Westerners. The elections that took place in Taiwan at that time were a milestone in Asia’s political history because they were truly free.

Editor’s note: Dr. Marc Faber, editor of The Gloom, Boom and Doom Report, has been headquartered in Hong Kong for nearly 20 years, during which time he has specialized in Asian markets. Dr. Faber is a member of Barron’s Roundtable and a major contributor to Strategic Investment.