On The Emergence Of China, Or, Zhou Knew This Was Coming

After doing a bit of mountain hiking a few days back, I had a chance to get involved in a great afternoon conversation with the Alliance for American Manufacturing’s Mike Wessel, who also serves as a Commissioner with the U.S.-China Economic and Security Review Commission; the conversation was about how we’re doing when it comes to our relationship with China.

As it turns out, the two events went well together, because what I’m hearing from these guys is that we have a great big ol’ mountain to climb if we hope to get back to a level playing field in our interactions with this most important country.

There’s news to report across a variety of issues; that’s why today we’ll be talking about trade, human rights, cybersecurity, poverty and development, and the methods by which you can apply “soft power” to achieve hard results.

The entirely unanticipated result: all of this will reveal the naïveté of Ron Paul when it comes to foreign policy; we’ll discuss that at the end.

The King of China's daughter
So beautiful to see
With a face like yellow water
Left her nutmeg tree

--From the song “The King of China’s Daughter”, by Natalie Merchant

So let’s start with the background stuff: the U.S.-China Economic and Security Review Commission exists today because of the legislative wars surrounding China being granted Most Favored Nation status back in the day.

At the time, there were concerns about the way China does business on the international stage, and the Commission provides a follow-on monitoring program to examine questions regarding the Chinese human rights record, issues related to economics, cybersecurity issues, the intentions of the Chinese military, and lots more.

The Commission issues annual reports to Congress, and this year’s report has just been released.

Now normally I would present a point of view, followed by a counterpoint; today, we’ll do the opposite: there are folks I listen to out there, including Thomas P. M. Barnett, who would tell you that you are not going to be able to keep spending $900 billion a year on the defense budget if you can’t find an opponent worth $900 billion a year, and China looks like that kind of opponent, in a number of ways that Al Qaeda never could…even if, in Barnett’s opinion, China is a great big paper tiger.

Al Qaeda will never build aircraft carriers, or intercontinental ballistic missiles; they’ll never put to sea in submarines or build a stealth fighter, and they darn sure aren’t going to be mounting military operations in space or engaging in cyberwarfare.

And yet, if you’re a defense contractor, a General, or an Admiral, that’s where all the money is; naturally, if the money goes away, some of those Generals and Admirals are not going to have the chance to “graduate” from the military and become defense contractor representatives themselves.

Put it all together, and some would tell you that the biggest battle facing the Military/Industrial Complex today…is making sure we’re always nervously looking under our beds at night, just to be safe.

You should also know that our first Secretary of the Treasury, Alexander Hamilton, convinced his brand-spanking-new country to put in place a series of protective tariffs. The intent was to foster manufacturing in the then-agrarian United States; this was intended to create a climate favorable for non-farm businesses and to allow a far more disparate group of immigrants to come to the new Nation than what would have occurred if the only major business activities around the country were farming-related.

So with all that in mind, let’s talk China.

The U.S.-China Economic and Security Review Commission (the USCC) wants you to know that China is very much on a knifedge: the country is ruled by the Chinese Communist Party (the CCP) and the People’s Liberation Army (the PLA).

The USCC would tell you that the primary goal of the CCP and PLA leadership is to “protect their phony-baloney jobs” and the corruption that goes with ‘em (thanks for the line, Mel Brooks), and that they have to do a few things to keep those jobs safe: they have to find a way to make 900 million near-peasants into a middle class, quickly, because the peasants have seen how the other 300 million live, to secure markets and resources China has to begin to project power around the world, by military or other means, and they have to make extra sure that nobody in China, except the CCP, gets the opportunity to take over the political conversation – in other words, ensure that the “Arab Spring” doesn’t become the “Jasmine Spring”.

There’s more: in a country without something like Social Security, China’s population will age faster than any in history, and many of the 900 million seem to want to move from the country to the city in numbers so large that they literally can’t build cities fast enough.

So how does the Chinese Government deal with all this?

What China has been doing is seeking internal “quietude” by growing the economy through manufacturing, and they have decided to choose certain industries as the linchpin of “valuing up” that growth, so that China’s low-tech manufacturing becomes more high-tech. (Think computers and telecommunications, space, alternative fuel vehicles, aviation, green energy technologies, that sort of thing.)

China has decided that virtually the only way a foreign company can do business in any of the “chosen” areas is to mandate technology transfers that allow Chinese companies to obtain the methods and tools needed to compete with the foreign supplier down the road. (This is officially against WTO rules; China disputes that assertion. The USCC says they now make these demands in subtle ways that are less “enforceable”.) Chinese buyers are told to give preference to “state-innovated” technologies.

China also uses their currency as a way of “preferencing” the local economy. The Renminbi (RMB) is, according to most observers, deliberately undervalued in order to make Chinese goods cheap overseas and imported goods expensive at home. Mike Wessel would tell you it’s about 40% undervalued, and that that “trade tax” (my term, not his) costs the US budget about $500 billion a year, with a similar impact on State budgets. Despite much USA pressure and some recent upward valuation (roughly 6% last year), it looks like China is not going to move much on the RMB anytime soon.

Wessel anticipates China will spend about $1.5 trillion on anti-poverty subsidies to quell unrest over the next 5 years; that would become a lot more difficult if a revaluation were to occur.

During the 1990s China began to move to a free-market model that emphasized the growth of privately-owned businesses; Wessel says today China is going back to promoting the State-Owned Enterprises (SOEs) to the detriment of a free market.

This has been bad for our own industrial strategy, such as it is, which assumed we would be selling China lots of high-tech goods, even as they sold us cheap goods. That has not worked out; in fact, China is now the largest market for cars and cell phones, among other products…and those products are not being manufactured in the USA.

It’s reported that the theft of intellectual property is the normal way business is done in China; as an example Wessel notes that something like 80% of the software on Chinese corporate computers is stolen.

We are told that the PLA is looking to create an “area of influence” that extends from the South China Sea to space; to this end the first Chinese aircraft carrier is being readied for service, a stealth fighter is in development, antiship missile systems are being upgraded, and a “counterspace” capability has been demonstrated. (The idea is that Chinese satellites explode near other satellites, thus disabling them. The USA and Russia seem to have similar capabilities.)

Chinese military doctrine, Wessel tells us, advocates shutting down the “network-centric” model of US military operations; it is believed that a significant campaign of computer-based intrusions and attacks on the USA have already taken place, including two events that took place at Department of Defense-operated satellite-control facilities that seem to have been external attacks.

Wessel anticipates that a war with China would begin with China attempting to disable various USA computer networks and infrastructure; the resulting confusion would be used to China’s advantage.

Beyond that, Wessel worries that we’re buying so much of our telecommunications and computing infrastructure from China that we may be vulnerable to being spied upon by our own laptops; he cited two examples of this problem: a computer sale to the State Department that involved Lenovo laptops and classified data, and a sale of network equipment by Huawei to Sprint that might have allowed classified computer traffic to be compromised.

Chinese spying, Wessel would tell you, is widespread and not limited to government: trade secrets are up for grabs in a big way, and even the US Patent and Trademark Office had to upgrade its security after it discovered patent applications were being snatched out of the system and appearing as Chinese products, with Chinese patents, before the applications could even be acted upon in the USA.

Wessel also wants you to understand that China uses “soft power” to advance its interests: there are lots of “hosted” opportunities to study in China, former military officers of various nations, including the USA, are recruited as “representatives”, and there are lots of “get to know us” opportunities that have been created around the world; all of this is intended to “sell” China in ways we do not.

And with all that said, let’s talk about Ron Paul.

Paul’s attitude toward China seems to be that we should allow free, unimpeded trade, and that the currency manipulations about which many complain would not exist if we went back to a gold standard. Paul stated in 2001 that:

Concern about our negative trade balance with the Chinese is irrelevant. Balance of payments are always in balance. For every dollar we spend in China those dollars must come back to America. Maybe not buying American goods, as some would like, but they do come back and they serve to finance our current account deficit.

Free trade, it should be argued, is beneficial even when done unilaterally, providing a benefit to our consumers.

If I’ve been paying attention during the recent Republican debates, this is still what Paul believes about China, and here are a couple of thoughts about how he’s got it entirely wrong:

Paul may not like it, but Hamilton succeeded when he used tariffs to jump-start a manufacturing economy in this country, and not having free trade is working pretty well for China as well. Unfortunately, it’s working very badly for us.

On the one hand, Wal-Mart and all the others who import less-expensive products from China have done a great job of masking the fact that incomes have been either stagnant or declining for about 99% of us, but Wessel would say that’s been at the cost of sending millions upon millions of jobs to a country that is working hard on every level to ensure we can never again compete as a manufacturing nation – and while we thought we would make up that difference with our high-tech advantages, theft and spying and a devalued currency and “partnerships with benefits” and protectionist “state-innovation” rules have made sure we don’t.

A gold standard won’t fix this, and simply advocating that we allow China unfettered access to USA markets while they rob us blind seems a bit like suggesting everyone leave their houses unlocked so that the market can more efficiently decide which ones are the best for burglars.

So we’ve covered a lot of ground today, and let’s wrap this thing up with a summary of where Commissioner Wessel says we’ve been:

We have a competitor in China who will do more or less anything to keep its current political leadership in power, even as that leadership is forever worried that 900 million of its citizens will discover that you can overthrow a government.

The PLA is busy as well, with the South China Sea and everything above being the “area of influence”; computer warfare seems to be the next phase.

“Soft power” is also being applied; we have former military officers and Chinese language students and lots of other folks either hearing or telling China’s story all over the world and we don’t do a good job of answering back.

All the while, the CCP is working hard to create a higher-tech Chinese economy, by hook or by crook, and that’s putting the future of our own economy at risk, not to mention the operations of our government.

We, as a people, seem to be unaware of all of this, and that plays out in the form of ignorance in our politicians, with Ron Paul being a recent prominent example.

So now it’s up to you to figure out what all this means: is this really a substantial threat that we have to defend against (and there’s lots of evidence to suggest it is), or is this an effort to find a way to keep spending that $900 billion every year?

My take: Wessel’s not a defense lobbyist, even as he is trying to promote manufacturing in the USA, and there is a lot of evidence to support his thinking; with all that in mind I’m more inclined to believe he’s sending a warning we better pay attention to than he is seeing Commies under the bed.

Nonetheless, there are lots of folks who would like to keep stackin’ that big cheddar, at your expense, and even as we think very hard about China, we better also keep in mind that Northup Grumman could be just as dangerous.

On Punishing The Job Creators, Or, “The Poor Have It So Good Today”

You know what the problem is with America?
The poor don’t get just how great they have it.

I’ve hear this a lot lately; the basic thrust of the discussion is that all those cars, TVs, DVD players, refrigerators, and stoves that have found their way into the homes of the economic underclass are proof there’s really no such thing as “poor” in America.

If they were truly poor, the argument goes, well…think recycled corn.

And if the poor want things to get better, let ‘em pull themselves up by their own bootstraps – and if they can’t, then let ‘em rot, because that’s the best thing for the economy.

But I don’t buy all that, and by the time we’re done today, I hope to have given you a whole new perspective on how jobs get created in this country.

There isn't a rich man in your vast city who doesn't perjure himself every year before the tax board. They are all caked with perjury, many layers thick. Iron-clad, so to speak. If there is one that isn't, I desire to acquire him for my museum, and will pay Dinosaur rates.

--From the letter "A Humane Word From Satan", by Sam Clemens

We must have completely misjudged how many Americans live here about 15 years ago, because everywhere I go I see vacant buildings.

Empty retail space, empty office buildings, empty factories, and all of it apparently just thrown up for no reason whatsoever.

But then I recently saw some historical pictures from the 1990s, and it turns out a lot of those buildings used to have businesses operating within their now-abandoned walls – businesses which have since gone away.

And that’s when I began to get confused.

You see I’ve always known, just as you have, that it’s all about capital; that’s why it’s only the very wealthiest people who can create jobs in this country.

And I’ve always known that they can only do that when they are 100% certain that nothing was going to hurt their current economic condition, and that any sacrifice on our part, no matter how large, was crucially important to keep this very special source of economic vitality full and happy and creating jobs for America’s future.

And when I look at the statistics, I know we’ve been doing our part: the wealthy have been getting wealthier, faster, over the past 30 years than at any time in memory…and yet, for some reason, all those businesses were closing down.

So many, in fact, that I began to question whether America actually understands how jobs get created. It even began to cross my mind that maybe we’ve been coddling the wrong people.

I mean, what if the actual job creators…are the people who no longer work in those empty buildings?

It makes sense, if you think about it.

The common argument is that those with capital make investments, which creates jobs.

But why would anyone invest capital unless there was perceived demand for a product, or a need to do research to meet perceived future demands?

That seems to suggest demand drives investment; a good way to “prove” the point would be to consider what happens to capital without demand: building factories and ships and warehouses does no good if there are no buyers at the store.

Of course, I’m not the first to think workers drive demand: Henry Ford famously paid his workers double the prevailing wage; part of the idea was to create demand for all those Model Ts he was cranking out in his new factories.

So now that we know who the job creators really are, and we established years ago that we have to do every single possible thing on the face of the Earth to keep the job creators happy, happy, happy…how do we get started?

Well, here’s an idea: the Fed willingly gave more than $1.5 trillion to banks for bailouts, mostly by simply “creating” money; now I’m proposing we do the same for homeowners.

If you have a loan backed by Fannie Mae or Freddy Mac, let’s allow you to apply for a one-time $200,000 markdown on your mortgage – and let’s allow the first “tranche” of any markdown to apply to any back-due loan payments.

The amount of “haircut” (fancy technical term) you might impose on each loan could vary, but $1.5 trillion would allow 7.5 million writedowns at $200,000 each; if you limited the haircut to 50% of the loan value many would be less than $200,000. (It’s estimated that 11 million homes in the USA from are underwater; $2.5 trillion or less would cover all underwater loans.)

Since Fannie and Freddy back $10 trillion or so in mortgages, and you probably won’t be able to write down every loan, how would you decide who gets writedowns?

One way would be to create a “triage score” that incorporates things like the odds an applicant/borrower can pay off a restructured loan and the amount of foreclosed or underwater homes in any given community; the 7.5 million highest (or lowest) scores get the writedowns.

(One caveat: many who are having trouble today with home loans are also laid off; unless we can find ways to keep those folks in homes until they can find work, we’ll still have a substantial foreclosure problem.)

Writing down mortgages does several things: it quickly applies a “moral hazard cost” to those who deliberately lent to unqualified borrowers, it turns millions of “underwater” loans into homes with equity, it turns millions of “nonperforming” loans into “performing” loans, keeping millions out of foreclosure, it gives communities a chance to either stabilize or recover from “mass foreclosure-itis”, and it finally breaks the deadlock between banks and regulators over who will blink first on loan “haircuts” versus bank recapitalizations.

Wait? What was that last one?

Banks are scared to death that if they write down all these loans they will have to find new capital to make up the losses – and they probably won’t be able to raise that new capital by charging a $5 fee to have a debit card.

That could mean a few things: it could mean big banks are going to have to more sneakily raise lots of other fees and sell things to raise capital, or, perhaps, the Feds ease back a bit on capital requirements.

Or…it may mean that the banks end up having to get smaller. Consider this scenario: a forced haircut of significant size, followed by regulators who stand firm on capital requirements, followed by a less-than-stellar round of stock offerings or asset sales; next thing you know, “too big to fail” becomes “we have to spin off some part of the retail business for reasons related to the rules governing capital requirements”.

This could happen without the passage of new regulations or legislation beyond the initial bailout authorization – and even that might be within the power of Federal regulators already, since Fannie and Freddy, as the owners of many of these loans, have the power to forgive some or all of that debt, and capital requirements are not set by legislation.

And where does all that leave you?

Well, you’d have 7.5 million families that could more easily afford to make house payments than before, and those folks will probably take that money and spend it on things they haven’t been buying for several years: home improvements, cars, appliances, and the travel and entertainment markets could all see substantial bumps in sales.

Many, if not most of those families, would immediately go from being “underwater” to having equity, which always helps turn reluctant consumers into willing consumers.

Cities could begin to recover as well, as the number of foreclosures bottoms out; once banks are forced to write those properties down from “2006 value” to today’s market value they’ll be looking to sell ‘em at bargain prices; that’ll help soak up today’s housing supply “overhang”. All of this is good for beleaguered new home builders, who are today in a holding pattern.

And here’s the best part: if you get a handle on foreclosures, and put some cash back in some pockets, and start selling stuff…well, that looks like a bit of a jobs program, even if Congress might not be willing to sign up for one just at the moment.

So how about that?

If we make an effort to give to the actual job creators the same level of incentives that we gave to the “demand responders” since November of ‘08, we could actually find ourselves creating actual jobs with our money – and doing it by the millions, just when we need ‘em.

Considering how fast we were able to find ways to create TARP, QE1, QE2, an alternative auto industry bailout, and anything else a banker could ask for, including, I’m sure, partridges in pear trees…well, we should be able to knock this out over a weekend, assuming we can either make a really convincing argument – or do like the banks do, and lay out a million a day for lobbyists until it gets convincing enough to get things done.

Of course, if we have to we could also start Occupying the Offices of reluctant Members of Congress to help make the point; as long as the end result is some serious pampering of the real job creators, I’m all good.