The China Effect

Casey Research recently interviewed long-time friend of The Daily Reckoning, Ron Paul, for the December 2007 edition of International Speculator. Dr. Paul’s presidential campaign isn’t about the relatively trivial issue of who should govern, Tweedledee or Tweedledum. It’s about what the nature of the government should be – and how much and how fast we can cut it down. Read the full interview, below…

CR: Why would the typical American, who gets far more from government than he or she pays, even consider voting for Ron Paul?

RP: Even those Americans who receive a higher nominal amount in transfer payments than they pay in income taxes suffer from Big Government. Their standard of living is eroded by inflation, their wages are garnished by income and payroll taxes, their civil liberties are under constant assault, and their economic prospects are limited because of the drag the welfare-warfare state places on the economy. Furthermore, unless we reverse course quickly, future generations will suffer a declining standard of living and loss of liberty. Thus, I expect many Americans to vote for me not only out of concern for their own well-being, but out of concern for their children.

CR: What is your outlook for the U.S. dollar, absent any significant change in the current course of things?

RP: Unless we return to a sensible monetary policy and rein in government spending, I expect the value of the dollar to continue to fall.

CR: Do you think we could see currency or capital controls being implemented?

RP: History shows that governments tend to react to economic crises by increasing government control over the free market, so, yes, it is quite possible that the U.S. Government will respond to a future economic downturn with currency and capital controls.

CR: We have seen the other presidential candidates perform all sorts of linguistic gymnastics when asked how they would handle the looming fiscal problems of Social Security and Medicare. While the solutions will obviously not be quick or easy, where would you start?

RP: I would transfer some of the money saved by my cuts in foreign programs and unconstitutional domestic bureaucracies into the entitlements programs to keep the promises to those relying on the system. I would then work to transition to a market system, phasing in an option for younger workers to opt out of Social Security and Medicare taxes in return for agreeing to provide for their own retirement and health care needs without participating in a government entitlement program.

CR: Further on domestic issues, just what do you think the role of the federal government should be?

RP: Ideally, it should be limited to providing protection from foreign threats, securing the borders and ensuring free trade among the states.

CR: By what % would you estimate that federal government spending could be cut without causing any great hardship? Which agencies would you cut first?

RP: I don’t have an exact percentage, but I am confident that if the welfare state were cut, along with a corresponding reduction in taxes, private charities would quickly step up to help the truly needy – and do so in a much more effective and compassionate way than government bureaucracies. I would cut the Iraq war, foreign aid and all foreign commitments immediately. Domestically, I would work to shut down the Departments of Education, Energy, and Commerce. I would also work to eliminate all forms of corporate welfare and business subsidies.

CR: Any idea how much of the total federal debt could be paid off if the government sold all the land, buildings, equipment and other assets it doesn’t need for activities authorized by the Constitution?

RP: I do not have an estimate on that, but it is definitely something I would pursue.

CR: There is much talk about the Chinese deliberately keeping their currency cheap in order to undercut U.S. and European manufacturers. And we are increasingly hearing discussions about layering on more tariffs aimed at the Chinese. We assume you are anti-tariff, so do you do anything at all about “unfair” competition or just let the global marketplace sort things out over time?

RP: The United States does not have the authority to tell China, or any other country, what to do with their currencies. The values of currencies should be set by the market. Instead of worrying about the speck in China’s eye, I would focus on the beam in our eye by reducing the national debt, restoring a market in currency by repealing the legal tender laws and ending the continued debasement of the American currency.

CR: Much of the politicking this campaign season has certain religious overtones. Are you a believer in a strict separation of church and state?

RP: Yes. However, I believe state and local communities have the right to adopt policies such as school prayer without interference from the Federal Judiciary or any other branch of the federal government.

Doug Casey,
Daily Reckoning
December 18, 2007

Every day a new day. Every day a new battle. Every day along comes a new humbug.

Today’s most fascinating struggle is between the forces of inflation and deflation. Finally, it’s made the front page. The International Herald Tribune sees it this way:

“World economy faces double threat of recession and inflation,” says yesterday’s paper.

And yesterday, deflation delivered another head-butt. The Dow fell 172 points.

Today, in a TV interview, we were asked what we see ahead for the U.S. dollar.

“Not much,” was our reply. “It’s almost impossible to get much near-term visibility on the dollar,” we explained. “Because it is in this no-man’s-land between the opposing forces of inflation and deflation. On the one side, rising prices mean a falling dollar. On the other, falling prices mean the dollar is going up. We’re pretty sure the greenback is going to get shot to pieces…but we’re not sure by which side.”

Prices of assets – stocks and houses – are probably going down in the year ahead. And when they go down, the people who hold these assets feel a little poorer. Naturally, they’ll be less eager to part with the dollars they have left. So, they cut back on their spending. Soon, you have an economic slump…and you could even have a Japan-like slump, with falling consumer prices as well as falling asset prices. This is a classic deflationary situation, in which dollars become more valuable.

But that’s not all that is going on. Every central bank in the world is determined to prevent falling prices. They’re all joining hands to try to make sure prices continue to rise – by lowering interest rates, and making credit more easily available. Ben Bernanke says he’ll drop money from helicopters, if necessary, to keep the cash moving. Ultimately, all this extra cash and credit is going to have an effect…but maybe not right away.

And there’s another thing driving up prices – the China Effect.

Here’s an article sent to us yesterday describing China’s remarkable effect on world commodity prices, especially food (the following comes a recent issue of Mother Jones):

“Per-capita income in China is less than 1/10 of America’s and its per-capita greenhouse gas emission is less than 1/5 of ours. But if 1.3 billion Chinese were to consume at the level Americans do, we’d need several more Earths. China’s effect on world resources, quantified:

China is:

• The world’s largest consumer of coal, grain, fertilizer, cell phones, refrigerators, and televisions
• The leading importer of iron ore, steel, copper, tin, zinc, aluminum, and nickel
• The top producer of coal, steel, cement, and 10 kinds of metal
• The No. 1 importer of illegally logged wood
• The third-largest producer of cars after Japan and the United States; by 2015, it could be the world’s largest car producer. By 2020, there could be 130 million cars on its roads, compared to 33 million now.

More Facts:

• China produces half of the world’s cameras, 1/3 of its television sets, and 1/3 of all the planet’s garbage.
• There are towns in China that make 60% of the world’s button supply, 1/2 of all silk neckties, and 1/2 of all fireworks.
• China uses half of the world’s steel and concrete and will probably construct half of the world’s new buildings over the next decade.
• Some Chinese factories can fit as many as 200,000 workers.
• China used 2.5 billion tons of coal in 2006, more than the next three highest-consuming nations-Russia, India, and the United States-combined.
• It has more than 2,000 coal-fired power plants and puts a new one into operation every 4 to 7 days.
• Between 2003 and 2006, worldwide coal consumption increased as much as it did in the 23 years before that. China was responsible for 90% of the increase.
• China became the world’s top carbon dioxide emitter in 2006, overtaking the United States.
• Russia is China’s largest timber supplier; half of all logging there is illegal. In Indonesia, another timber supplier to China, up to 80% of all logging takes place illegally.
• 90% of all wood products made in China are consumed in the country, including 45 billion pairs of wooden chopsticks each year.
• The value of China’s timber-product exports exceeds $17 billion. About 40 percent go to the United States.
• More than 3/4 of China’s forests have disappeared; 1/4 of the country’s land mass is now desert.
• Until recently, China was losing a Rhode Island-sized parcel of land to desertification each year.
• 80% of the Himalayan glaciers that feed Chinese rivers could melt by 2035.
• In 2005, China’s sulfur-dioxide emissions were nearly twice those of the United States.
• Acid rain caused by air pollution now affects 1/3 of China’s land.
• Each year, at least 400,000 Chinese die prematurely of air-pollution-linked respiratory illnesses or diseases.
• A quarter of a million people die because of motor-vehicle traffic each year-6 times as many as in the United States, even though Americans have 18 times as many cars.
• Of the world’s 20 most polluted cities, 16 are in China.
• Half of China’s population-600 to 700 million people-drinks water contaminated with human and animal waste. A billion tons of untreated sewage is dumped into the Yangtze each year.
• 4/5 of China’s rivers are too polluted to support fish.
• The Mi Yun reservoir, Beijing’s last remaining reliable source of drinking water, has dropped more than 50 feet since 1993.
• Overuse of groundwater has caused land subsidence that cost Shanghai alone $12.9 billion in economic losses.
• Dust storms used to occur once a year. Now, they happen at least 20 times a year.
• Chinese dust storms can cause haziness and boost particulate matter in the United States, all the way over to Maine.
• In 2001, a huge Chinese storm dumped 50,000 metric tons of dust on the United States. That’s 2.5 times as much as what U.S. sources produce in a typical day.
• Currently, up to 36 percent of man-made mercury emissions settling on America originated in Asia.
• Particulate matter from Asia accounts for nearly half of California’s annual pollution limit.
• Environmental damage reportedly costs China 10 percent of its GDP. Pollution-related death and disability heath care costs alone are estimated at up to 4 percent of GDP.
• In 2005, there were 50,000 pollution-related disputes and protests in China.
• China’s middle class is expected to jump from 100 million people today to 700 million people by 2020.

These statistics are drawn from “The Last Empire: Can the world survive China’s rush to emulate the American way of life?” in the current issue of Mother Jones.

Gobble, gobble, gobble – the Chinese are eating up the worlds resources, putting huge upward pressure on prices.

“But wait,” said our interviewer, “if it is true that Americans are the world’s champion consumers…and if it is true that China imports much of its commodities for the purpose of making stuff for Americans…won’t Chinese demand go down with U.S. consumption? And won’t commodity prices crash rather than soar?”

“Yes…probably…maybe…” was all we could say. We are sorry to be so wishy- washy…but we are definitely, certainly, absolutely unsure. Most likely, a collapse in demand from the United States will lead to a collapse in commodity prices. Most likely, the collapse will be only temporary. Domestic demand from Asia will eventually make up for the shortfall from Asia.

But why pretend to see that far ahead? Let’s look at the near term. Next year, we expect a recession in the United States…a bear market in stocks…and further decline in house prices. As reported here yesterday, Lehman Bros. (NYSE:LEH) expects more than a million foreclosures next year…three times as many foreclosures next year as in 2007. What that means is simple: more people with less money in their pockets. Less money, need we remind you, is deflation.

But how much of it – for how long? We wish we could tell you…

What we can do, however, is advise you to be as well-informed as possible. No one has a crystal ball…we can’t tell you which way the market is going to go – but Agora Financial’s financial experts and market analysts can make sure that you are positioned to profit and that you portfolio is protected…no matter what the market does.

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*** Here’s today’s humbug:

“$45 Trillion gap seen in US benefits,” reports Yahoo Finance. The story line is very simple. Americans now expect to receive much more in Social Security, Medicare and other benefits than the government can possibly afford.

So, when the feds decide to fight deflation by making more cash and credit available, we have to ask – where does this money come from? If it is real…it must come from somewhere. It must come from the money that was slated to pay Social Security benefits…or pay for houses…or fund retirement plans…or one of millions of other uses. But all of that money is already fully committed. In fact, there is already a shortage of it.

So, the money must be unreal…it must be a kind of phantom money…the same kind of phony-baloney money that caused the credit bubble in the first place.

*** And here’s another question that came up in our interview: After U.S. consumers stop spending so much, who will take up the slack? The Chinese…or maybe the Indians?

There is no way Asian buying is going to replace U.S. spending in the near term. What’s more, China is probably more a cause for concern than comfort. The place is a giant Humpty Dumpty itself, waiting to fall off the wall. Its manufacturing sector depends on exports to people who can’t pay up. And its banking sector is jury-rigged by government regulators and stuffed with non-performing loans. Even when a banking system is run by capitalists it is still prone to booms and busts. But only a few years ago, China’s banking regulators were wearing those silly Mao jackets and waiving copies of his Little Red Book in the air. What will they do when the system blows up? It is bound to be entertaining…but hardly reassuring.

“China is the ’29 economy,” we pointed out. “It is the big growth story of the 21st century, just as the United States was the big growth story of the early 20th century. But it is also the biggest threat to world financial stability. When China blows up…the blast is going to be heard all over the globe.”

*** And finally, a note from our old friend Doug Casey:

“There are very few political figures for whom I have any respect. One exception is Congressman Ron Paul (R-TX). Ron has been a personal friend of mine for many years. I can assure you that he’s a ‘stand up guy,’ who has voted ‘no’ more times in Congress not just more than any other member, but more than the rest of that august body combined. He’s often called ‘Dr. No.’

“The fact that he has managed to get reelected numerous times – in Texas, of all places – in spite of his outspoken stands against the so-called ‘War on Drugs,’ the ‘War on Terror’ and other popular stupidities is one of the few things that make me think all is not absolutely lost in America.

“How does he do it? Ron’s an almost archetypical country doctor; he simply radiates honesty and sound principles. He’s about the last person you’d expect to see in Congress. The voters may not agree with everything Ron believes in, but they know they can trust him to do what he says he’ll d always vote for lower taxes, less regulation and, in fact, against absolutely anything not specifically authorized in the U.S. Constitution.

“His campaign for the U.S. presidency on the Republican ticket – once laughed at by mainstream apparatchiks from both parties – has generated a huge groundswell of national support. Recently, his campaign broke the record for the most funds raised online in a single day. That, in itself, raised a lot of eyebrows – and the money has since been put into high-profile ad campaigns libertarian-minded candidates could previously only dream of.

“Ron is famous for his principled rejection of fiat currency, and advocacy of hard money – the gold standard. That’s a matter of particular interest to us, with obvious investment implications. We thought, therefore, we’d get an update from Ron, to see if his thinking has changed any.”

Read on, below, for the full text of the interview.

Until tomorrow,

Bill Bonner
The Daily Reckoning