The Wall Street Journal (27/06, "Big Dragon, No Fire? China’s Might Masks Falling Profitability" by Henry Sender) informs us from Hong Kong: "From offshore, with Chinese attempts to acquire ever-bigger corporate targets making daily headlines, Asia’s largest dragon looks suddenly both wealthy and powerful. That view became more entrenched last week when Chinese oil company Cnooc Ltd. offered to acquire US energy company Unocal Corp. for $18.5 billion.

"Seen from within, China doesn’t look quite as invincible. An increasing number of economists in China believe such acquisitions are needed to help defend against a looming problem: declining profitability and other economic distortions at home that are contributing to China’s quest for opportunities abroad.

"‘China is running out of profits,’ says Jim Walker, chief economist at Credit Lyonnais Securities Asia in Hong Kong. He blames the pincer-like effect of rising input prices and wages as well as the reluctance to raise output prices for fear of losing market share and customers.

"At the same time, gradually tightening monetary policy is beginning to cool the frenzied over-investment and chill local demand. For the first time ever, Chinese executives will have to pay attention to the cost of capital and the return on capital.

"A survey from CLSA found that nearly half of China’s companies reported rising input prices in April – but only 18% planned to increase prices at all. By the end of last year, 14 out of 23 categories of companies listed on domestic Chinese exchanges reported falling profits. Meanwhile, manufacturing capacity continues to expand. By the year end, China will have the capacity to churn out six million cars for a market half that size.

"‘There is liquidity in so many hands,’ says Johannes Schoeter, head of Victoria Capital, an investment boutique in Hong Kong. ‘And there is more liquidity than there should be in the hands of property developers and state-owned enterprises.’

"Fueling the building craze is a banking system that still lacks effective credit controls. There are restrictions, for example, on the size of a loan based on the value of the value of a given property. By artificially inflating the value of the property, developers end up putting none of their own money in and use the first loan as collateral for a second one from a different bank."

Much as happens with credit card borrowing in the developed west. On reading of the misdeeds of compulsive growth in the nominally Communist megapower-in-the making, we are tempted to ask what warrants Western analysts casting the first stone.

"The banks are happy to lend because one way to bring down their ratios of bad loans is to increase the size of the total loan book.

"Such a boom is far less logical in the hinterland cities such as Harbin that lack the rising wealth to support such projects. Such cities are feeding fears that China is awash in too much cash and the boom will turn into a bust, with adverse effects on many parts of the world, which have come to depend on Chinese demand. Both Korea and Japan sell more to China than they do to the US (although some of what they sell to China ends up exported elsewhere). The new buildings stand empty for lack of buyers."

All this has a familiar ring about many regions of the Western world where the financial sectors continued churning out investment-seeking profits, while the whole has been kept going by an inverted pyramid of credit card and mortgage debt. The season has come for all kettles calling pots black.

In the same issue of The Wall Street Journal ("China’s Push if like Japan’s, Sort of" by Bernard Wysocki Jr. and Jacob Schlesinger): "The frenzy in Congress stirred by Chinese oil company Cnooc Ltd.’s bid for Unocal Ltd. of California harks back to a similar hand-wringing over Asian power. That came in the 1980s with Sony Corp.’s purchase of Columbia Pictures Entertainment Inc. and, more broadly, Japan’s increasing economic presence in the US.

"There are similarities: an expanding, export-driven Asian giant racking up a trade surplus with the US and recycling the dollars earned from these sales into US Treasury bills, properties and companies; a strong bureaucracy – the Minister of International Trade and Industry in Tokyo then, the Communist Party in Beijing now – seeming to steer the economic drive abroad; exports apparently lifted by an artificially cheap currency; and rivalry with the US in a strategic sector – semiconductors for Japan [then], oil for China [today].

"There are differences as well. Above all, Japan was then and remains a US ally, dependent on it for help on defense. There were limits on how far economic tensions could ripple. China has not similar ties to the US.

"Certainly the backdrops to the two periods are not unalike. Today, as 20 years ago, the strains come at a time of self-doubt within the US about its economic prowess. In both cases, the American appetite for foreign capital comes from Washington’s swelling budget deficit and a high level of household debt.

"The biggest parallel is this: The Cnooc offer generates anxiety in Washington in part because it follows months of economic tensions. A surge of Chinese textile exports had led the Commerce Department to impose import quotas. The Treasury Department has been locked in months of negotiations pushing Chinese counterparts to boost the value of the yen.

"American anger in the 1980s and early 1990s over Japanese purchases in the US was heightened by the fact that few, if any, US companies could do the same in Japan. Japan in the 1980s and early 1990s over Japanese and early 1990s was mostly hostile turf for expansion-minded American companies – the legacy of a post-World II strategy built around keeping foreigners out and developing domestic industry champions. A few big US companies such as International Business Machines Corp. and Boeing Co., Detroit’s Big Three auto makers struggled to open so much as a car dealership.

"While US executives often had little stake in keeping tension with Japan in check, today the huge flow of investment to China from the rest of the world, including the US – running at about $89 billion a year – is a form of diplomacy that keeps the two nations in a sometimes uneasy commercial embrace. That is because ‘China has a totally different model than Japan had,’ one actively based on encouraging foreign capital, says David Hale, head of Chicago consultants Hale Advisors.

"As a result, there are fault lines today in the US coalition of big and small business and organized labor that pushed for a harder line against Japan in the 1980s. The AFL-CIO talks of tougher curbs against China, as it did against Japan 20 years ago. But while Detroit’s Big Three auto makers took the lead in attacking Japan, they are largely silent about China. General Motors Corp. Ford, and DaimlerChrysler AG’s Chrysler Group are invested in building cars in China and want access to inexpensive Chinese parts and engineers.

"The Cnooc bid isn’t just about foreign investment in the US. It is about oil. That underscores another difference in US relations with the two countries. Japan was every bit as obsessed as China with oil, importing 99% of what it needed in the 1980s. But Japan was never as aggressive as China in securing its own resources.

"Tokyo did carve out a modest oil diplomacy in the 1970s and 1980s, curbing trade with Israel, to ease tensions with Arab states and stepping up trading with smaller suppliers in the Persian Gulf. By and large, it followed American diplomacy – and enjoyed the assurance of US military muscle to keep supply lines open."

"China, however, ‘is a potential security rival to the US, or at least a potential counterpart in conflicts in Asia,’ says Adam Posen, senior fellow at the Institute for International Economics in Washington. So Beijing ‘feels it cannot rely on US relationships to guarantee flow of oil. Quite the opposite,’ he adds. And Chinese oil diplomacy is creating rifts with the US in flashpoints throughout the world, particular as China seeks closer ties with US foes in Venezuela and Iran.

"Japan in the ’80s had a much more advanced economy than China has now and ‘was seen as a potential direct competitor to the US. China is still a very much a developing country,’ Mr. Posen says.

"By the 1980s, Japan had dozens of multinational companies that throttled US competitors. China has nothing today to rival such names as Toyota, Nissan Motor Co., Honda Motor Co. or Sony. China’s most famous brand has been Tsingtao beer.

"Japan’s acquisition binge in the US came largely after the Plaza Accord, which led the yen to double in value against the dollar in two years. That meant that every asset in the US – from skyscrapers to golf courses was half-off in yen terms.

"China is in the phase before currency revaluation. It isn’t likely to let the yuan float freely as the Japanese did the yen. Still, an overseas acquisition spree could follow a yuan strengthening, just as it did the yen depreciation."

Still the Chinese maintaining to some degree its export advantage by spending a decisive portion of the dearer dollars they earn on buying up overpriced domestic "ikons" in the US can hardly improve Sino-American relations. It was Japan’s bad luck that the doubling of the yen’s exchange value coincided with the peak in the US real estate market, so that the ikons that the Japanese financial houses loaded up with proved disastrous buys. I would wager my nickles and dimes that the Chinese, who – regardless of the mess they may be making of their own affairs – will apply the insights acquired by sitting on the Communist school benches as well as on those of Wall St. to avoid such a fatal misstep. They could delay the freeing of the yuan until the US real estate and financial markets have produced some worthwhile buys. However, that is hardly calculated to improve the long-term relationship. Stepping down with some grace from its present position as lone superpower is not in the American tradition – particularly in recent years when the disappearance of the Soviet Union has added both to the difficulty and the urgency of that role.

A few days later (The Wall Street Journal, 6/07, "Lost in the Fuss About Unocal Bid is that China is the Savings Winner" by Jesse Eisinger), we were offered some evidence of how the Chinese may have a better grasp of the reality of the US monetary condition than Washington and its journalists.

We cannot quarrel with the opening remarks on the American position in the Unocal matter. "If Congress wants to become hysterical about China, Cnooc’s bid for Unocal hardly is the place to start. China adds enough to its foreign-exchange reserves to buy a Unocal every month. Brad Sestser, senior economist for the boutique firm Roubini Global Economics, estimates that the amount of foreign assets the Chinese accumulate each month by exporting more than they import is around $20 billion, just over the $18.5 billion that Cnooc is bidding for Unocal. 70% of Cnooc is owned by the Chinese government.

"Worrying about China taking over one company seems muddle-headed when the country has become the most vital creditor of the debt-laden US. But somehow that fact has failed to concentrate the congressional mind. When the Chinese want to buy ‘our’ companies, members of Congress are better able to find reasons to object. ‘It’s because they’re Communists! Well, now they are, when they want to buy our companies. They are OK when they want to buy our debt,’ says Northern Trust economist Paul Kasriel."

So we have not a single American economic consultant but two who miss the crucial point of the American debt, even though it could have been found in columns of the very WSJ. It should draw our attention when a special group takes over a key institution and twists its functioning to serve interests directly contrary to those for which it was originally intended. The very language is rejigged to that end. A curious phenomenon of "intermittent vision" ensues. For a two-year period when the Federal Reserve and even the Bank for International Settlements to enforce "zero inflation." But then suddenly after precipitating the collapse of the Mexican banking system in December, 1994, the US then introduced accrual accountancy (a.k.a. capital budgeting) to bring onto the government’s books some $1.3 trillion of capital assets that had been written off in the years of their investment. That was enough to convince the bond rating agencies that the budget had been distorted through flawed bookkeeping. Mind you, all this was hidden from the public since President Clinton was a great believer in keeping the political center. And the political center holds devoutly that government cannot invest but only run up deficits. So it was in the Department of Commerce’s books rebaptized "savings." That it certainly was not since it was not in cash as that term implies but in poured concrete and steel, bricks, and mortar.

What brought about the Mexican collapse was the combination of allowing banks to accumulate bonds (denominated in US dollars at that!) and at the same time having the US Federal Reserve under Paul Volcker and the Bank for International Settlements (BIS) call for every higher interest rates to attain "zero inflation." Obviously the mountains of government bonds that banks throughout the world loaded up with – 100% on credit – would shed value and require a bailout all over again.

That ushered in the period when Mr. Greenspan turned mystic and started speaking in tongues that nobody could quite make out. He and the BIS started talking about "bad inflation" – over 2% or 3% – depending upon what Mr. Greenspan and his BIS colleagues had had for lunch, but never did they define just how "good inflation" below that functioned. However, it is now about a year since we last heard about "good inflation."

Obviously this and a whole barnful of other discoveries for which eminent economists were awarded prizes have vanished from the official memory. To mention only one, let me refer to the work of Theodore Schultz who in the 1960s reassessed the his own earlier work and that of hundreds of other young economists who had been sent to Germany and Japan right after WWII to study how long it would take those two countries to resurface as serious competitors of US exporters. In the sixties he marvelled at how wide of the mark their predictions were, and concluded that arose from their having concentrated on the physical destruction, while ignoring the human investment – a highly educated, disciplined population that came out of the war largely intact. His conclusion: investment in human capital – education, health, and social services, were the most productive investments a society can make. Only we and a few like us still keep the memory of Schultz’s great work alive.

It should have shocked the readers of WSJ to find its columnist missing the main point about the US debt. For so long as other countries accept US debt in dollar currency, Americans are not "mortgaging their future" but getting foreigners to accept as reserve currency what costs the United States next to nothing to produce. That is the essence of money in our day: it is token money, neither backed by gold, silver, nor cowry shells. How long other countries will continue accepting US legal tender bearing no interest precisely because it is money is a haunting question.

So long as the rest of the world accepts US debt as reserve currency they will find themselves in a plight not dissimilar to that of the real economy within the United States in financing their governments’ capital needs through their commercial banks at high interest rates, rather than through their central banks, the bulk of whose earnings revert to the government. This happens as dividends where the government – as in the case of Canada and the UK – is sole shareholder of the central bank, but even in countries where the central bank is owned by private shareholders. In the latter case it is because of the recognized right of seigniorage – the monopoly of the ancestral sovereign to mint precious metals.

It is high time that we started reclaiming our history and even our language.

PS. The Chinese, by the way, still have some sort of statutory reserve system. They may not readily clean up the incredible mess in their own banking system, but they have a good enough grip of what is wrong with our central banks and money creation to grasp the vulnerabilities of Washington.

-- from Economic Reform, September 2005