Two Problems for China, One Solution

“What I don’t understand,” China Premier Wen Jiabao said, “is depreciating one’s own currency, and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism.”

There was a time, long ago – like way back in 2007 – when the only mud slung from the Far East came from the hands of “radical” professors and low-level government officials.

A year ago – almost to the day – Wen expressed his first formal “concern” with the dollar, the “safety of [Chinese] assets” and America’s ironic demands that China get its currency in order.

Yesterday, at the close of the annual National People’s Congress, he turned it up a notch: “We are very concerned about the lack of stability in the US dollar. If I said I was worried last year, I must say I am still worried this year.”

“If there is inflation,” Wen ominously added, now referring to his own country, “plus unfair income distribution and corruption, they will be strong enough to affect social stability and even the stability of the state’s power.”

Inflation is already rearing its ugly head in China. And lord knows large income gaps and corruption are no strangers there.

“An authoritarian government,” warns Dan Amoss, “with control over a printing press and a banking system can sustain the unsustainable for much longer than skeptics expect. Imagine how much bigger the credit and housing bubbles in the US could have grown if politicians, rather than risk-averse bankers, had control over the banking system. Markets force investing mistakes to be corrected quickly, while politically driven economies compound investing mistakes until they run into insurmountable resource constraints, or destroy confidence in the integrity of the currency.

“As long as the status quo in China remains, artificial pressure on commodity prices will likely remain in place, with periodic pullbacks. If Western consumers’ appetite for Chinese exports wanes (which is likely), then the Communist Party will likely redouble its infrastructure stimulus to keep a restive population in a state of ‘harmony.’

“With yesterday’s announcement that China’s money printing and lending is seeping into its consumer price index, we’ll probably see a more aggressive effort to tap the brakes on the Chinese banking system. If so, we could easily see a sharp decline in the prices of steel and aluminum. China is normally a large net exporter of these products, but its stimulus plan has directed much of its production toward office towers, autos and bridges.

“With the long-term trend toward urbanization, demand for steel and aluminum will likely be up, but in 2010, we could easily see a free fall in pricing with all the new low-cost production capacity coming online.”

Addison Wiggin
for The Daily Reckoning

The Daily Reckoning