The Ongoing Chinese Annexation Of The US Consumer

Recent conversations over the symbiotic relationship between China and the US all end up focusing on three key concepts:

  1. The lopsided trade balance (China exporting and the US importing)
  2. China's willingness to continue investing in US assets even with a declining dollar, a debt load which will likely one day result in a payment moratorium (the banana republic syndrome) and collapsing economic drivers
  3. Who can inflate yet another fiat bubble faster (opinions are split here, although China is conclusively in the lead for the time being) and deflate respective massive debt burdens

There is much more, but ultimately these three are what it all boils down to. And, continuing the simplified reduction, the key driver of all these three really has to do with consumption, which is not only what drives the US economy (70%+) but has been the driver for global growth over the past several decades.

The irony is that the US consumer is now essentially a vassal state of China's production complex, and all the unbalanced trade and credit flows do, is provide the funding to stimulate the US consumer to purchase even more Chinese products. A side-by-side compare and contrast of the two consumer classes demonstrates why the "IRR" on Chinese investment in the US will always be much higher than any concerns of debt repudiation or outright bankruptcy.

The chart above says it all.

The fate of China, for lack of its own middle class, is intimately tied with the ever increasing discretionary purchasing capacity of US consumers: the discretionary differential is staggering: a 35x multiple! And instead of fostering the growth of its own middle class, a long, tedious and expense process for what is essentially an overpopulated communist country, a much easier detour to feed its excess production capacity is merely to keep purchasing the securities that will fund the US consumer's purchasing and maxing out of assorted credit cards until such time as every single bathroom and shoe closet boasts at least 3 plasma TVs.

The implications are interesting - the US realizes that it has not only a loaded gun to the temple of China's US debt funding complex, but that every single chamber is loaded.

What are China's alternatives? An internally sourced credit bubble which will be a one-time boost to spur consumption by Chinese citizens has already fizzled, with the ironic outcome of instead purchasing refrigerators, the Chinese took all the cheap money and invested it in the stock market. Alas, the marginal utility to the overall Chinese economy from this gambling bonanza is nil, as very few Chinese companies have used the run up in the Hang Seng and the Shanghai Composite to lower their cost of capital. The last is an evil Catch 22 of market bubbles - nobody will buy equity offerings from companies, which every sophisticated investor realizes are so expensive only as a function of overeager retail spirits (let's see AIG try to price a follow on at $50/share - we dare Goldman to pitch that idea to Benmosche). And bubbles tend to pop. But in the meantime the excess liquidity will spur a one-time pick up in the purchase of all dollar-denominated goods (read great Dell and Intel results), with the trendline promptly reverting back to normal.

So the conclusion is that it always has and always will be about the US consumer. And any concerns that China may stop purchasing US securities are, unfortunately, groundless - China can ill afford to push the US middle class into a greater savings mode, and thus will cooperate as much as it can with the Federal Reserve in keeping both mortgages (for the illusory net wealth effect) and interest rates as low as possible for as long as it can. However, this being simply another fiat-funded bubble, and due to its Ponzi nature, a much more vicious one, the second this symbiosis ends for whatever unforeseen reason, the impact on China, and by implication on the US, will reverberate throughout monetary and fiscal policies and likely result in civil unrest both in the US and China, once Walmart can no longer provide cheap garbage to satisfy the American demand for constant credit-financed unneeded products, and once the China GDP illusion of minimum 8% growth is popped, resulting in an end to the Communist-Capitalist hybrid experiment.