Global Currency Armageddon to continue… (Part 1)

In the next couple of years starting in 2011, the currency Armageddon between China and the rest of the world (the United States at the front) is set to continue. Factions involved in this confrontation are expected not to back-down on their intransigence or demands because of the economic problems or better still trade imbalance problems currency discrepancies is creating among the nations.China to maintain its lead as the locomotive engine driving the world economy may not yield to any more calls for substantial revaluation of its currency the renminbi-RMB(the unit being the yuan) with proclivity of reducing its global competitiveness and supremacy. In nominal and purchasing power parity (ppp) terms, China is the second largest economy in the world after the U.S. Besides, it is the world’s fastest growing economy with a growth rate of about 10%. The exchange rate of the RMB to the dollar is 6.6494 (November 25 2010). Nevertheless in real GDP terms, the economy of the U.S (real GDP $14256 billion in third quarter of 2010) is about three times that of China ($4909 billion in third quarter of 2010).
Despite these statistics, the United States and the EU with its expansive deficit problems are pressing ahead to see leverage in global trade so as to curb it growing deficit. As at the third quarter of 2010, the U.S debt was over $13.5 trillion which is about 94% of the GDP ($14.7 trillion third quarter 2010). The debt which is made up of two-thirds public debt namely in Treasury bill, notes and bonds is said to have spiked from 51% of GDP in 1988 to its current state of approaching 100% of GDP. Now, China circumspectly appears to be on the defensive whiles the rest of the world led by United States is on the offensive. Furthermore, China is not likely to succumb to the offensive tactics being applied by the United States and other large economies due to some intrinsic reasons.
Coming to think of it there are numerous reasons that go to expound the complexity of this currency war and to reveal the difficulty in dealing with this problem. In terms of longevity, this currency war is here to stay and the world should be bracing for long term strategies that can gradually deal with it without any despicable spill-over effects. This article would like to throw some light on some six(6) reasons why the currency pressure on China may not produce the expected impact in terms of leveraging trade imbalance (or balance of payments) and economic growth horizons. The six (6) reasons are classified into (1) Capitulating developments (2) Extrinsic Austerity measures

Capitulating Developments

1. Revaluation of China’s currency since July 2005 by more than 22.2% has not worked to reduce substantially the widening trade imbalance or balance of payment between China and the U.S. and other developed countries. As at the third quarter of 2010, the current account encompassing balance of trade for some contending developed economies stood at: U.S -$127. 2 billion, EU -$25 billion, U.K -$10 billion, Germany $14 billion, Japan $1436 billion whereas that of China was $70500 billion. Though in October 2010 for the first time since 2007, China shocked the world market by increasing the deposit and lending rates to about 5.56% it did not reflect in the trade imbalance differential. Perhaps this action was to cool its heated economy and curb inflation which stood at 5.10% with a jobless rate of 4.20%. Obviously, this move has no direct quantifiable effect on currency revaluation and consequently on the increasing trade imbalance between China and the United States or western style economies.
2. The falling value of the dollar is what some nations of the world are waiting for. A fall in the value of the dollar is seen as loss of U.S global economic power and somehow military power. It is also seen as a transfer of power from the Western to the Eastern world and a defeat to capitalism. Opponents of the dollar still being used as the world reserve currency in spite of its fall are energized by these developments to argue their case out for a new world reserve currency. They view these developments as a loss of confidence in the U.S economy to lead the world economy and a justification for new world economy leader and world reserve currency change by the Central Bank. Just as they may have a case, replacing the dollar with another currency may not solve the world’s economic problems. Why? In the opinion of this writer, the solution for leveraging the trade imbalance is to have one currency for the world which may call for the creation of one government perhaps to be followed by one religion. Such developments may conform to biblical prophecy revealed in the book of revelation. In fact, no currency will be sustainable in the long term with respect to unyielding to global economic pressure. So even if the dollar is replaced with another currency such as the Euro, the problem of currency degeneration and the global economic instability will continue unabated. Meanwhile, It is possible that if the currency war perpetuates in the long term a new world order will emerge as world economies will gravitate towards one world currency leading to one government and perhaps one religion.
3. China has huge foreign exchange reserve which makes the country powerful even though such immense reserve has repercussion of triggering inflation locally. Perhaps, this may have been the cause of the 2010 interest rate augmentation by the Chinese government. As at September 2010, foreign exchange reserves for China was $2648.3 billion as against that of the U.S. which was $129 billion (July 2010 estimates). With huge foreign reserves equated to economic power, China has the ability to buy dollars which is a convertible currency as against selling their currency renminbi-RMB (the unit being the yuan) which is not easily convertible. Consequently, the Chinese government can continue to buy the dollars to maintain the dollar’s appreciation as against the depreciation of its currency unit (the yuan). In fact China’s large reserve has some advantages as well as disadvantages. The large reserve of foreign currency allows the Chinese government to manipulate exchange rates – usually to stabilize the exchange rates and provide a more favorable economic environment. This means the country is in a better position to defend its domestic currency (the yuan). It also authenticates China’s ability to pay its foreign debt thereby strengthening its high credit rating. However, such large reserve in U.S. dollar-dominated assets (U.S. bonds and dollar currency) is risky if the U.S. dollar weakens and the country’s debt mountain grows. Ultimately, there could be relative loss of wealth as a result of the weakening dollar and increasing threat of default in repayment. The option for China to deal with this risk is diversification of its foreign exchange reserves. Consequently, the country has resorted to converting some of its foreign reserves into gold reserves thereby increasing the safety of its foreign exchange reserves. The decision of China recently to increase its gold reserves as against holding dollar reserves is gradually producing a resonating effect of a steep rise in gold price on the world market. In fact there is a negative correlation here between the rising price of gold and the weakening of the dollar. That is as the dollar weakens gold price generally rises. The explanation for this trend is that as the dollar weakens, investors are moved to diversify their risk. Ultimately, they will resort to buying gold reserves so as to have a safety seat for their wealth creation. Additionally, the Chinese government and investors diversification into gold to protect their wealth is contributing immensely to the rush for gold invariably helping gold mining companies to accrue huge profits. Unfortunately, analysts do not know when this diversification will be curtailed and this suggest gold futures will continue to be on the ascendency. Nevertheless, investors should take a scrupulous second look at investing in gold if they want to continue their wealth creation and not be caught off guard. The fact is countries with huge gold reserves at some point in time may decide to flood the market with bullions, producing a breaking effect on the price and subsequently bringing it down. Another interesting safety action China has embarked on is to diversify its foreign exchange reserves risk through debt auction by buying treasury debts of some trusted credit-worthy countries such as Japan and some EU member nations. This is interesting because China has decided to buy the treasury debt of Spain in spite of the fact that Spain is on the bail out list of EU. China believes in the success of the economic reforms being pursued by these countries with whom they are engaged in the debt transaction. That is why China is resolute in pursuit of these risky debt transactions. However, there is no guarantee that reforms by these nations will succeed as the EU member debt crisis is not over and is likely to spread. Stake holders know that it is risky deal yet they are going ahead with it. Unfortunately such debt transactions can ignite an “economic bubble burst” for China which may spread to the whole world regenerating another global financial meltdown.
4. The currency war is not only about China since there are other countries such as Japan whose currency the yen is devalued. Since it is a convertible currency, it is easy to manipulate. Japan with a GDP growth of 1.10% (3rd. quarter), interest rate of 0.00%, inflation rate of 0.20%, jobless rate of 5.10% and balance of payments of $1436 billion has the capacity to manipulate its currency also. As at third quarter of 2010, the yen was being traded around 83 to the dollar. Unfortunately, China is seen as the only culprit in the currency manipulation issue. In fact, there are a host of countries involved in this act which is adding to the global trade imbalance. Every one of those countries involved has subtly taken advantage of the sticky situation to stay competitive globally whilst China bears the scolding and pressure.
In concluding the capitulating developments on the currency war, it can be deciphered that the current currency war is more complicated and profound than is considered to be. The problem is not between the United States and China. It is more than China revaluing its currency or the global currency being replaced or leverage in trade imbalance. Consequently, it may be difficult to solve in the short term and so the world must expect more of the impasse in 2011. See part 2 of this article for the rest of the analysis.

References: TradingEconomics.com

Author: Charles Horace Ampong

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Politics & Policies of Economic Management (Part 2)

According to the Bureau of Labor Statistics, increased consumer orders, stock price increases and increased money supply are reflective of increased consumer optimism. Current positive developments of these entities in the economy do suggest a conformation to this assertion and recovery on track. However, more months of data may be needed to validate the sustainability of the gains for these leading indicators as outlined in part 1 of this article. Now let’s talk about the politics and policies encompassing the national debt.

Regarding the national debt, it is a big issue and a bone of contention as one can envisage that Uncle Sam is really in debt. The only remedy could be a cap on spending and increase in taxes. Meanwhile, should the citizens be concerned or worried over the mounting debt? The answer is a yes and a no. Yes, because the debt cannot be kept forever without repayment. The government cannot continue in the long-term to refinance its debt as raising taxes and reducing spending will definitely become a viable option. Also, mounting debt will put a downward pressure on the dollar ceteris paribus and that could retard or derail the recovery.

The U.S GDP is projected to grow from $11,652 billions in 2008 to $14,751 billion in 2018 a ten-year period. This is gives a growth rate of 2.659% annually for the period. However, there is a precarious problem here when this growth rate is compared with the national debt and the gross debt growth rates for the country. The national debt (debt held by the public excluding intra-governmental obligations such as Social Security Trust Fund) is expected to grow from 54.6% of GDP in 2009 to 68.5% of GDP in 2014 or better still from 64% of GDP now(2010) to 77% of GDP in 2020 suggesting a growth rate of 2.03% annually. Similarly, the gross debt (debt held by public plus intra-governmental obligations and foreign investors) is also expect to grow from 86.1% of GDP in 2009 to 99.8% of GDP in 2014 a growth rate of about 2.67% annually. The growth rate for the national debt of 2.03% and gross debt of 2.67% annually should be of concern because these figures are almost equal to the expected growth rate of 2.66% for GDP in the next ten years. A comfortable figure should be a GDP growth rate that is excess or a multiple of the growth rates for the debt (national and gross). In fact, what the government must do is to institute policies that put “breaks” on the growth of the debt subsequently permitting its redemption in the nearer future. Next with regards to the answer of No to the question whether citizens should be worried, it must be said that the government can continue to refinance its debts in the shorter term but in the longer term this may not be feasible. Another non-viable option will be to print money to pay its debtors which of course will escalate inflation from its current figure of about 2.30%.

External debt such as debt to Chinese investors in the form of bond payments should be an issue of concern as it can lead to the transfer of economic power. The question is whether foreign investors (Chinese investors and others) are willing to accept refinancing as against making payments at maturity. Even if it is acceptable, for how long will it be? In fact, mounting debt and deficit could affect the country’s credit rating and create future financing problems. A cue can be taken from the Greece and Spain situation. It’s said that United States owes much of its debt to its citizens and that it can continue to defer payment for sometime. However, this should not be a creditable one as debt accumulation without remedial action can incapacitate a country as it has done to Greece. Greece may not be the last country to be incapacitated as there are several countries on the way to join the train. In fact, Greece debacle would continue to have a ripple effect first to Europe and then to the United States. Also, United States is not exempted from incapacitation that can result from the cumulative effect of rising debt. The country currently has a buffering capacity that has helped sustain it and lessened the negative impact of the rising debt. The economic buffers include the country’s high global competitiveness rating and efficient macro-stability policies that has kept inflation in check and promoted economic growth. However, the question that needs to be asked is the sustainability of these economic buffers in the long term.

Again, with regards to the growing deficit, borrowing to finance the deficit only adds to the accumulated national debt and so there is the need for strict adherence to the national debt “ceiling” (that is the limit on the national debt). Raising the “ceiling” may not be a viable option but rather cutting down on spending and increasing taxes is. It may be a painful action plan but the pay-off is great. Judiciously, remediation of the debt will also call for leveraging of the increasing balance of trade deficit between China and the U.S. As at now, the low value of the Chinese currency is causing some problems for U.S exports invariably affecting net export negatively, exacerbating the balance of trade deficit and dampening economic growth.

Currently, in the pipeline are series of regulations meant to promote leverage, transparency and probity in the financial sector with Wall Street being projected as the beacon of success if these regulations should work. This is a laudable step and should not be politicized if it seeks to leverage risks in derivatives and stock trading. As at now, options seem to be the only derivative with more leverage and consequently the one of choice for risk averse or low risk traders. Consequently, regulations that are pioneered towards leveraging risk in derivatives and financial sector by increasing transparency and promoting ethical transactions in this sector is commendable and should be welcomed. However, to some extent these regulations should seek to have minimal impact on financial innovation in the sector.

Unfortunately, due to the perception of some skeptics politicizing government regulations, it has culminated in an increased sensitivity of several companies business model to impending government regulations than to inflationary pressures. That is the business model of some financial companies has become more sensitive to impending regulation than to inflation. Cases in point are credit card companies’ responses to government’s propensity to regulate. There is the belief that government regulation will restrict their ability to make huge profits. So in reaction to that they keep increasing rates resulting in increased credit card cost for consumers. Though expectant inflation increase (called inflation psychosis) may be a contributing factor to rates increases from these companies yet government regulation is fast becoming the determinant for the rate increases. The bottom line is reduced regulation increases aggregate supply (through increased business investment) whilst increased regulation reduces aggregate supply. This presupposes any government regulation in the financial sector should be very “smart” regulations that promote sound attractive business environment consequently increasing aggregate supply.

Conclusion

The statistical figures and analysis presented in part 1 and 2 of this article does present an economy technically out of recession. However, it also suggest the need for intervention and remedial measures (including regulations) to contain the situation in the longer term as inaction will seriously “crowd” the recovery and create hardships in the future. Emphasis was placed on three factors that are critical for the economy whose remediation may require government intervention and policies. They included the growing unemployment rate, rising national debt and the indeterminate consumer confidence. It was iterated that the successful recovery of the economy in the medium-long term will be determined by these three factors. Also the outlook of the economy and the ability of the country to maintain its superior power economically and military-wise will also depend on these factors. The growing debt requires policies (mostly fiscal) that put brakes on the debt growth. There is also the need to protect investors (both foreign and local) through very “smart” regulations that produce the required leverage of risks, ensures transparency and ethical transactions or remunerations in the financial sector.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/  

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Politics & Policies of Economic Management (Part 1)

Pertinent views about government regulation evolution and how it impacts consumer-investors protection and innovation has been a sensitive subject of discussion, contention especially among analysts and largely investors and other professionals in the financial sector. The bottom line being the fact that government regulation is a double-edged sword because it does affect the cost doing business and the ease of doing business. And that sound government regulations should seek to create a business environment which reconciles the cost of doing business and the ease of doing business consequently setting conducive environment for investors. In this wise stimulating the inflow of investments and creation of jobs.

Strangely, regulations set by government have sometimes failed to convince the masses as to why the regulations are needed in certain sectors. The primary reason being differences in perception of people and an inherent resistance to change. For some skeptics, policies such as reforms at Wall Street and derivatives trading are deeper than they can imagine. They see such pursuits as being more of a political ideology or politically-oriented rather than policies that are healthy for management of the economy. For example, it is known by all economic analysts that fiscal spending is meant to increase aggregate demand and promote growth yet there is contention by some analysts on the massive stimulus spending by the current administration in the last year with regards to its capacity to create jobs. Unfortunately, such economic assertions by analysts may be paradoxical, unfounded and political since it is known by experience that stimulus package at least has been a primer for the rejuvenation of some major economies in the world including but not limited to United States, China, Japan and Brazil. The aftermath the current signs of recovery being witnessed globally. The following are some hard supportive, informative but comprehensive analysis substantiating the signs of recovery, contentions and issues of concern regarding policies for the long term economic management of the country.

The U.S economy according to the Bureau of Labor Statistics recorded a growth of 5.6% in the last quarter of year 2009 beating the expectations of most analysts. On average the country recorded 0.18% increase in 2009 as against a fall of 1.83% in 2008 and an increase of 2.53% in 2007. Perhaps, this is indicative of the recession bottoming out in late 2009. Next, in the month of March 2010, other economic indicators gave the following: Consumer Price Index (CPI) rose only 0.1%. Producer Price Index (PPI) rose 0.7% seasonally adjusted. Payroll employment had 162,000 jobs added in March and 290,000 jobs in April (a 79.01% increase meaning 128,000 jobs added). Productivity rose 6.9% in the last quarter of 2009. Again, productivity increased 3.6% in the non-farm business sector and 2.5% in the manufacturing sector in the first quarter of 2010. In fact, job gains occurred in manufacturing, professional and business services, health care, and leisure and hospitality and also in the government sector. Consumer confidence rose from March (consumer confidence index of 52.3) to April (consumer confidence index of 57.9). To appreciate these economic statistics perhaps there has to be a comparison of these figures with that of year 2007 when the recession is assumed to have officially started. On the other hand, the negative news was the slight increase in unemployment rate from 9.7% in March to 9.9% in April (a 2.06% rise). Let’s do the math here. When the percentage rise of 2.06% is multiplied by the more than 8.5 million people out of work, it translates into something more than 175,258 additionally meaning more than 8.67 million people may be out of work currently. Again, the figure 175,258 obtained is more than the payroll addition of 128,000 (March to April) which further validates the fact that more than 8.5 million people may be out of work. Also March average hourly earning fell by 0.2% even though weekly earnings were up by 0.1%. Interestingly, there is some contention by skeptics on the payroll employment statistic recorded. That the payroll employment included government temporary jobs such as the census workers meaning the payroll employment figures are overestimated. Here also the assertions may be political rather than true economic analyses. As a matter of fact the preceding statistics on the whole offers some blessings with regards to signs of recovery but calls for cautious optimism. We have every reason to remain cautious taking into consideration the sustainability of any gains for the leading economic indicators, the increasing federal deficit, national debt and balance of trade deficit. The balance of trade deficit as at February 2010 stood at $39.7 billion which further translates into an import to export ratio of about 9:1. That means for every dollar of goods exported about $9 dollars of goods is imported.

Now, the three non-trivial economic factors that should be of concern to everyone are an extended period of consumer spending slow growth, the high unemployment rate and the rising national debt. People may develop a funny feeling of recovery optimism considering the rise in consumer spending in April. With a rise in consumer confidence in April (the highest level since September 2008), it is expected to factor positively but not immensely into business hiring producing only a marginal change in employment. Should this trend in consumer confidence continue there is still need for caution regarding any recovery euphoria. In fact there is more saving than spending and also external investors are reluctant to invest in the economy because of the low interest rate of 0.25%. The propensity of the Fed to keep the rate at this level may have serious repercussions for the economy in the long term with regards to attracting foreign investors. Investments predominantly portfolio investment is being affected by this low interest rate. There is also the phobia of the dollar weakening in the future due to the mounting deficit and debt. Obviously, business will be affected and employment reduced leading to increased unemployment rate perhaps to something higher than 9.9% in the nearer future. In reality, whilst there is much worry when the unemployment rate of 9.9% is mentioned, it must also be made clear that unemployment is a lagging indicator which means more time is needed for it to show appreciable improvement. Perhaps it is right to forecast that the unemployment rate will max out in the next few months and then begin to drop. This will be realized when GDP growth becomes sustainable and recovery stabilizes. Over the next eight to twelve months, analyst should watch generally for sustainability of the gains in the leading indicators though some fluctuations are plausible. As a matter of fact, economists should be more interested in leading indicators as against lagging indicators or coincident indicators. The reason is that a leading indicator is a rate-determining factor for the emergence of an economy from recession. Upswings in leading indicators do suggest recovery is on track though lagging indicators such as unemployment rate and coincident indicators such as nonfarm payrolls may show otherwise.

Finally, the strength of the economy includes investor confidence. That is if foreign investors continue to find confidence in the U.S economy, then there is the likelihood of foreign investors still investing in dollar-dominated securities which will also help reduce the downward pressure on the dollar besides creating a surge in investments. Again, regarding consumer confidence there is some bit of mixed news even though it increased in the month of April yet it is purported not to immensely affect business hiring and for that matter reduce the unemployment rate in the short-term. The U.S economy is technically out of recession but growth will be gradual. In fact the situation can be likened to someone who has fallen into a bottomless pit. The way out of the pit for the victim has two levels of incline. The lower level has steep slope incline whilst the upper level has gentle slope. The journey up the lower level incline will be impacted greatly by gravitational and frictional forces on the plane such that progress appears to be stalled. The retardation effect of these forces may present the picture that no progress is being made. Nevertheless, little by little progress is being made up the incline. This is the situation the country is facing now. The economic forces of gravity and friction include the slowed growth in consumer confidence, mounting national debt, trade deficit among others. These may act in such a way it may appear that no progress has or is being been made. In other words, they present a picture of economic deceleration. In spite of this very soon the country will complete its journey up the steep slope and then enter the second level which is the gentle slope. Once it gets to the gentle incline, economic acceleration will be on track and the economic forces of retrogression will have less impact. Of course all these developments will depend on the kind of monetary and fiscal policies that will be in place.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/

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Five (5) Scenarios Depicting Government policies as a Two-edged Sword! (Part 2)

In the first part of this article, I discussed the influence of government policies on international trade and nationalization. I also elucidated on the hidden disparity between international trade and national security, nationalization and de-nationalization. In this segment (part 2) of the article, I would like to discuss the scenario regarding the impact of government policies on investor protection and innovation as a double-edged sword.
Also in this segment investor protection and consumer protection will be contrasted with innovation. Other issues to be discussed are the effect of corporate tax reduction and why corporate tax reduction may not be the solution for investment stimulation in a country. The following provides the deliberations on this scenario and perspectives.

Scenario 3: Investors and Consumer Protection Vrs Innovation - Most analysts will agree with me that technological innovation in the financial sector can be impaired or enhanced by government regulations. In my article titled “World Financial Systems in Limbo- What to expect”, I expatiated on this issue and how it is affecting the world economy. I will not want to go back to that. However, I would like to discuss three other notable cases of financial innovation that came about because of government policies. They are the emergence of the Eurobond, Asset-backed securities and the Sarbanes Oxley Act of 2002 (SOX). The third case which is the SOX Act could not be classified purely as an innovation but it emergence brought sanity into the accounting besides adding transparency.

Now, let’s consider the facts of the issues. The interest equalization tax which was instituted by the United States government in 1963 to dissuade U.S investors from investing in foreign securities led to the creation of the Eurobond market. Here, American investors had no option but to invest in these bonds and this caused the bond to gain popularity stimulating other governments and institutions to trade in this market. Strangely, in spite of the default risk associated with the Eurobond and inappropriate documentation governing its transactions, Eurobond market has become a source of financing for governments, banks, global investors, underwriters, traders among others. So, it can be deciphered here that government regulation led to the emergence of this bond which is a sort of financial innovation.

Another causal effect of government regulation in financial innovation is the creation of the risk management tool called Asset-backed Security management. It encompasses the securitization of some underlying assets of banks making it possible for banks to have clean balance sheets as the risk associated with their bad assets can be transferred to a third party in return for cash. For example payments for underlying assets such as mortgage loans, auto loans, and credit cards e.t.c as they become bad debts are sold to a third party by the bank in exchange for cash. In this way, the risk is transferred to the third party who works to liquidate such illiquid assets and use that to pay the bank. Having attained clean balance sheets, banks are then able to invest in new assets and loans. This concept of asset-backed security management was officially instituted by the United States Security Exchange Commission (SEC) on January 18, 2005. It was also the presence of this concept that paves the way for the U.S government in 2008 to buy all the bank bad debts and save them from collapse. As mater of fact, asset-backed security management regulation is a mixed blessing. On one hand, it has provided a debt cleansing insurance methodology for banks but on the other hand it has put tax-payers money at risk indirectly affecting the deficit. Remember the financial input from the government was predominantly the tax payer’s money.

Next on the list of government regulations is the Sarbanes Oxley Act of 2002 (SOX) and the Corporate Fraud Task Force which was instituted by SEC to bring sanity, ethicalness in the sector and obviate corporate accounting scandals inadvertently reinforcing the financial accounting sector. As is widely known, the Act was of three objectives; First, to increase accuracy and transparency in Financial Accounting reporting. Second, to buttress corporate or management accountability and probity in the sector. Third, to promote independent auditing procedures so as to curtail fraudulent reporting, conspiracy and deception. Again, though this Act has no direct correlation with innovation yet it reinforced and transformed the accounting sector setting the pace for ethical creativity in the sector. In fact, the presence of this Act has boosted transparency, accountability and probity in the accounting sector in the United States. Interestingly, opponents of this Act argue that this regulation has made the U.S less competitive in terms of financial resource attraction from global investors because of some stringent components of this Act driving away investors. They also contend that the country’s share of international Initial Public Offerings (IPOs) has gone down from 50% in 2000 to single digits recently because of this Act. They predict the country will gradually loose its competitive edge in the financial market and that Wall Street is negatively impacted by this regulation. No matter the sentiments of opponents, one thing is needful and that is investors must be protected. The Act offers this protection to some degree even though complete protection is impossible. For example investors can be protected from fraud but they cannot be insulated from huge bonuses and other immense fringe benefits given to CEOs of financial institutions and Wall Street. Also, complete protection is not desirable in today’s economy for two (2) apparent reasons: First, it can inhibit innovation with regards to the development of human capital in a firm. Second, there is an inherent increased cost of regulation. In totality the manager’s ability to be innovative will be impaired and also the government will incur high cost due to the running of extensive stringent corporate governance regulations. This also presents another scenario of the association between financial capital and human capital. Financial capital should be complemented by human capital for profitability of a firm. It is the human capital that manages the financial capital to ensure profitability.

In my opinion, every regulation or policy (fiscal or monetary) must be assessed from a cost-benefit perspective. A categorical assessment of the regulation will help in its classification as being under-regulation, over-regulation with regards to its expected impact on the market. That means advocates and opponents of the SOX Act must assess it from a cost-benefit analysis. It is undisputable that the presence of similar regulations prevailing in the United States has brought the products and operations of the Auto makers GM, Toyota and the rest under the microscope. Toyota has been scolded by congress for the massive recall of over $ 8 million defective products worldwide and misleading information to the public about these products in spite of thousands of complaints. Obviously, the company faces tough times ahead in terms of regaining confidence of its customers and maintaining its competitive edge in the Auto industry.

Regrettably, despite the presence of the SOX Act and other financial regulations, it is absurd that huge bonuses were declared recently for CEOs of some banks and institutions. The move actually incurred the displeasure of the government and most Americans as well. In fact, this revealed the limitations of the SOX Act and the existing financial regulations and set the pace for future revision of them to take care of such recurring contingencies. Again, it provides some justification for the push by the current administration with regards to the augmentation and overhauling of the existing financial regulations. As a matter of fact, regulations that will seek for reinforcement of accountability, probity and forestall unethical gestures such as huge unwarranted bonuses in the financial sector whilst at the same time promoting creativity or innovation in the sector is commendable.

Also, currently in the pipeline is the issue of government policy of tax breaks or incentives for companies that employ Americans or companies that do not outsource jobs. The dipolar nature of tax breaks suggests tax increases for firms that outsource jobs and tax decreases for companies that do not. Judiciously, giving tax breaks to some employers and denying others is obviously an incentive to increasing investment inflow and reducing outflows. Again, a reduction in corporate tax can stimulate investment and job growth in the green sector including but not limited to the renewable energy sector, biotechnology and healthcare. However, the issue becomes precarious when such tax breaks or incentives are predominantly corporate tax oriented. There are two issues that of concern here namely

• The influence of shareholders interest on companies as against stakeholders, and

• The economics of corporate tax reduction from the dimensions of ease of doing business and cost of doing business.
Shareholders for medium and large sized corporations do influence corporate governance in spite of their limited liability. They are interested in pursuits of projects that will increase their earnings and wealth. Consequently, management of companies may be under obligations to pursue projects in a foreign country if cost is low compared to the cost of doing business in the U.S. That means no matter the magnitude of the tax breaks or corporate tax reduction, if the cost of doing business at home is high compared to the cost doing business in foreign land such as India, China, Brazil or South Africa, American firms will continue to outsource jobs. In fact, shareholders may be more interested in management outsourcing jobs if that will increase their returns and equity as against a cut in corporate tax which will give marginal returns domestically. Analysts will bear with me that corporate tax has some degree of direct proportionality with cost of capital which is the determinant for investor’s rate of return ceteris paribus. Nevertheless, financial mathematics hypothesizes the inverse relationship between cost of capital and debt ratio for decreased corporate tax under some given conditions. The hypotheses is that cost of capital decreases with increased debt ratio for decreased corporate tax until a point where a firm’s ratio of debt to capital becomes so huge that the tendency for default or bankruptcy is highly probable. In that situation, any significant reduction in corporate tax may not reduce the cost of capital. The simple reason being that the interest on debt (which is tax deductible) becomes large and any corporate tax reduction by government may not reduce its cost of capital. Ultimately, large companies in America with high debt ratios stemming from the recession may not benefit much from the government’s corporate tax reduction because of the inherent high cost of capital and an expected increase rate of return. Also, there is a trade-off between the rate of return and the cost of capital for these companies. On a positive note, companies with smaller debt ratio may benefit as cost of capital will reduce even with increased debt ratio for decrease corporate tax. For these reasons, the government recent announcement to give tax breaks or incentives may favor companies with favorable cost of capital and debt ratio. What is not clear now is whether such situations will result in massive job creation that will reduce the unemployment rate drastically (halving it from the current rate of 9.7% to about 4.7%). From another dimension, the situation again becomes precarious because of corporate tax differential between United States and other countries. United States currently has comparatively high corporate tax of 39% which makes it one of the western countries with a higher corporate tax. The following are some corporate tax statistics: China has had to cut its corporate income tax from 33% to 25% in the last few years. South Africa also did cut its already low corporate tax from 12.5% to 10% to further stimulate investment inflow. Hong Kong did cut its corporate tax from 17.5% to 16.5% in order to remain competitive for Direct Foreign Investment inflow in Asia. In 2008, Germany cuts its corporate tax by a whooping 8.7% (from 38.9% to 30.18%). The comparatively low corporate tax of these countries puts United States in a disadvantage position when the positive effect of corporate tax reduction on business increase is considered ceteris paribus. United States may have advantage with regards to the ease of doing business but high corporate tax differential may knock that off.

Now, considering the economics of corporate tax contrast and its impact on the ease of doing business and the cost of doing business, there is much at stake. According to the World Bank Ease of Doing Business Index, a country’s ranking with regards to the ease of doing business is a quantitative measure of its business environment in terms business friendliness, simplicity of its regulations and also protection of property rights. Seriously, there is a contention here when the ease of doing business is compared with the cost of doing business. I must emphasize that the ease of doing business and cost of doing business are not the same for a given business environment. From the definition of ease of doing business, it presupposes that the measure is a partial quantification of systematic risk (that is risk due to interest rate, inflation, exchange rate, taxes e.t.c) and unsystematic risk (that is risk due to terrorism, takeover, unrest e.t.c). This means the measure is devoid of the impact of macroeconomic factors (namely interest rate, inflation, exchange rate, economic conditions e.t.c) and security (predominantly terrorism threat). Cost of doing business provides a broader measure of risk (systematic and unsystematic) and that is more non-trivial. Strangely, it is possible for a country to be ranked very well on the ease of doing business scale but the cost of doing business may produce a retardation effect on its business environment. Most countries that high ranked on the ease of doing business index rating may be low ranked on the cost of doing business index if it were to exist. Investors will not only consider the ease of doing business but also the cost of doing business in their investment proclivities.

United States is currently ranked third on the ease of doing business after New Zealand (2nd) and Singapore (1st). And does it mean that the U.S will be ranked well with regards to the cost of doing business so as to attract more investors to create more jobs? Certainly, much will depend on whether the Fed can maintain the current macro-stability of low inflation and interest rates, taxes or whether it will be compelled to increase taxes and interest rates in the coming months so as to prevent the economy from falling off the cliff again. As a matter of fact, the momentum for influx of investments does not depend only on giving tax breaks or incentives but also on maintenance of macro-stability and security in the nation. Remember, terrorism poses an unsystematic risk and threat which increases the cost of doing business. What a country needs to promote a sustainable prosperity are policies that are not only geared towards the ease of doing business but also the cost of doing business. Reconciling the ease of doing business and the cost of doing business provides conducive environment for attraction and retaining of investors. Ultimately, reconciliation of the ease of doing business and the cost of doing business should be the objective of every government. That is what the world and the United States needs. Watch out for part 3 of this article which will discuss the dogmatism of monetary and fiscal policies as opposed to the politics of managing an economy.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/  

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Five (5) Scenarios Depicting Government policies as a Two-edged Sword! (Part 1)

In these times of economic uncertainty, governments under a cowering atmosphere may develop the phobia of actuating policies and regulations in a desperate attempt to contain the situation. From a global perspective, the use of policies in the form of regulations and tax breaks to influence a country’s economic position has been rave about by some transformational leaders as a form of insurance for their economies even though in some cases it transcends the rules of the international trade game or globalization in the bigger context. Whichever policies are made in country, the fact remains that government policy in terms of reality is always a two-edged sword. Unfortunately, most in the world especially the capitalist countries are resentful of government regulations and policies. They see these policies as a threat to the progress of capitalism and also to their freedom. However, much as it appears to be a threat in some aspect, there are beneficiation dimensions when its economics of social cost and social benefits are evaluated. It is in the light of these fundamental truths that this article seeks to discuss the convolution surrounding the two-edged nature from the following scenarios and perspectives: national security versus international trade, nationalization versus de-nationalization, investors and consumer protection versus Innovation, monetary and fiscal policies versus Politics and finally environmental protection commitment versus Nash equilibrium.

Scenario 1 - National Security Vrs International Trade: Interestingly, the trade-off between economic gains, national security and sovereignty presents a very dicey situation especially in this era of terrorism rise and threats of rising military prowess of certain countries. Thus, governments in some instances are eclipsed between national security defense and their policies governing international trade. A paradigm of the case is when a country incapacitated by financial crisis or debt is torn between fulfilling budget constraints and national security. Take the case of United States or United Kingdom. In this epoch of mounting budget deficit when United States or United Kingdom has to choose between buying warplanes or national defense equipments from a low-cost country such as China or Brazil as against securing such gadgets from manufacturers in the United States or the EU at a higher price. Obviously, these countries will pay the higher price of increased budget deficits if they decide to buy the planes from manufacturers on its own soil. Nevertheless, they gain because national security and sovereignty is protected. On the other hand, if these countries should buy the defense items from manufacturers in China or Brazil, there is reduced budget deficit but national security is threatened. Subsequently, the decision on the path to take will depend on the contribution margin of the cost to be incurred with respect to the budget deficit versus the highly valued national security. Strangely, the scenario of national security and trade is absurd when social cost and social benefit are assessed from the perspective of international trade in Arms. International trade in Arms which used to be antipathized is fast becoming an acceptable norm in globalization. The driving force being threat of invasion and some countries desire for military prowess. Over the years the world has witnessed Arms being sold openly by some developed and developing nations to other nations as part of international trade. Information also has it that technology is being sold secretly to nations to augment their military capability. The curiousity surrounding such esoteric trade in Arms becomes more stronger when the investors from one country choose to export technology to another country as part of selling services to the country or customers or partners in that country. Regrettably, trading in Arms and secret technology puts the national security of the seller country and recipient country all at risk. On one hand, the technological secrets of seller country may be exposed to the recipient (buyer) country. On the other hand and in the long term, the seller country may become a threat to the recipient country because of an inherent access to its security intelligence. Undoubtedly, the security of the world is being marred by sale in Arms and secret technology both of which implicitly associates with the much dreaded activity “terrorism”. In fact, the world cannot be a safe place until the esoteric sale in Arms and secret technology is constrained and strongly repudiated by United Nations prompting every nation to come clean on any nefarious trade in Arms and nuclear technology. People are of the view that such an agenda is too ambitious and inconceivable judging from the fact that some nations have resisted similar attempts by the UN in the past. Nations cryptically trading in nuclear technology tend to be the most perpetrators of this kind of trade. I am an advocate of nuclear technology application in nuclear reactors for production of energy for social beneficiation purposes and will always identify with governments policies that promote that. However, any policy that circumvents energy production for beneficiation but promotes usage for antagonistic purposes is absolutely unacceptable and deleterious. Enriching Uranium by centrifuging for production of nuclear bombs is detestable and the world must boldly speak against it. United States is doing well by speaking against it but it needs the massive support of the whole world to deal with this growing menace. It is possible those countries that fall into the domain of nuclear technology abusers may feel isolated because of UN sanctions against them. They will try to placate their anger by pursuing policies that might enrage the world. But the world should not be perturbed by such tendencies and must still maintain the sanctions. Some contend that sanctions are not working but I am of the view that sanctions backed by constructive criticism and dialogue will immobilize these autocratic regimes and bring their unpopular pursuits to an end. I also believe the spread of democracy will definitely catch up on the whole world and help eradicate the bad “nuts” in the system. Only time will prove this assertion right. We are the world and we must not let a few dictate our future and freedom. Freedom is a gift from God and we must enjoy it.

Generally, sale in Arms and technological secrets has made the world unsafe and implicitly exacerbated terrorism in the world. Additionally, international trade restrictions have broken down because of some nation’s policies of self-centeredness and indifference to safety and freedom of the world. Sadly, some nations policies of neo-colonialism or economic imperialism for solidification of their national security pose a threat not only to international trade but also to the spread of democracy in the world.

Scenario 2 – Nationalization Vrs De-nationalization: Presently, there is the conglomerate effort by governments of some major economies to propagate global regulations for the financial markets and banks so as to prevent a repetition of the global financial meltdown. To some analyst this is called nationalization and an infringement on the current supposed de-nationalization existing in the capitalist economies. Again, on the pessimistic side of this issue are the analysts who see the predisposition by the leaders as protectionism and an inordinate desire to influence the economy to the detriment of market efficiency. They also see such tendencies as generally not resonating with stakeholders’ interest especially when the country concerned is of capitalistic proclivity. Howbeit, government regulations whether in financial, educational, health and industrial sectors suggest a form of influence of globalization and have several connotations associated with it. Unfortunately, in a period of economic uncertainty, governments may assume a desultory characteristic which makes them more susceptible to enforcement of regulations in educational, health, financial and even the industrial sectors. For example, the current administration of the United States governments and certain western countries are compelled to press for policies and regulations to control some salient sectors of the economy including financial and health center because of the current global economic uncertainty which has incapacitated a lot of families and made them liabilities on the government. It is true that times are hard and government will want to empathize with the masses by pressing for regulations. However, skeptics are worried about how far the regulations can go and its projected negative impacts on the market and most importantly factors of production. Again, such pursuits are seen as an inclination towards nationalization as against de-nationalization of the market economy. In America some economists have described the handling of the GM financial crisis issue as a proclivity towards nationalization. Recall when GM filed for bankruptcy, the government provided more than $50 billion (tax payers money) for its redemption besides taking a stake of 60% ownership of the company and the replacement of its CEO with a government approved one. Coincidentally, further down the road pockets of nationalization has taken place in the country. For example the interstate rail service takeover to form Amtrak and also Airport Security management take over by the federal government after September 11. All these are forms of nationalization that has beneficiation. For example, the recent changes in airport security with regards to whole body scanning of travelers infringe on our privacy and freedom yet it can be effectual in preventing terrorist from getting into flights to cause harm. Should we blame the government for nationalizing the airport security? No. Must we applaud the government for instituting the measure of effective scanning? Yes. What would have happened if the government had not taken over the management of airport security after the September 11, 2001 disaster? In fact, it is quite impossible for a country to exist without any pockets nationalization. In this period of financial failures and global uncertainty, at least some pockets of nationalization even in free-capitalist countries is inevitable. A little nationalization will not kill even though extreme nationalization like what is happening in Venezuela and certain parts of Africa is unacceptable and vicious. Currently, the question that is being debated is whether the domain of nationalization includes turning a private sector indirectly into a public good. For example the allegation currently by some that the health sector is being made a public good with the presumption of the act being synonymous with nationalization. Others believe that government intervention in the health sector may not correct the failing health system. I am of the view that the health sector will only become a public good if only all in America including illegals benefit from it and there is no way to prevent anyone unqualified from benefitting from it. Also there is immense additional cost to be incurred here if checks and balances are not in place. Unfortunately, after much publicized and heated debate in congress, a consensus has still not been reached on the reform proposals. There is an argument of an increased role by government in the sector affecting efficiency in the sector. Another contention is that employers will be burdened with huge healthcare costs. Whatever the healthcare reforms package will entail, it must be judged based on the economic principle of social cost and social benefit and not on the economics of externalities.

Globally, the predilection by some countries for international regulations for banks has been fueled by the recent developments of bad debts at Dubai Bank and also the huge national debts or financial crisis of some European countries with Iceland and Greece at the front. Though, the debt belongs to the individual countries yet it is turning to be a pervasive problem with consequences likely to affect Europe and the rest of the world. The coming of the EU to the aid of Greece will go a long way to reveal the strength of the relationship between the EU countries and the authenticity of the cordiality governing them. Meanwhile, Greece in order to win the approbation of the EU and satisfy the European Stability Pact that enjoins all members to maintain a debt level of 3% of GDP has decided to take some austerity measures including but not limited to VAT increases, freeze on pension funds and working rights limitations, reduction in healthcare benefits. Though this is going to create hardships for the people of Greece with upsurge in social unrest in the coming days, authorities emphasized the measures as being the heady way for the country to deal with its mounting debt and refinance its 17 billion debt bond. In addition to the Stability Pact, the EU may argue that there is too huge a price to pay to remedy Greece from its predicaments. Perhaps, the EU has decided to follow the footsteps of the United States where generally the rescue of states in financial crisis by the federal government is not popular because the tax payer prefers not to bear the cost of a state’s mismanagement. On few occasions the federal government may come to the aid of a state only if there is a justification for that. Sorry to say, EU is not considering the effect their inaction will have on the confidence of the member countries. But the facts are clear. There are a number of EU countries hanging in an imbalance with regards to debts and economic problems. So if the EU cannot extend some minimal level of credit to Greece to help ease the country’s debt burden then it presupposes in future any EU country that finds itself in a similar situation will be allowed to go bankrupt and collapse. In fact, some level of credit should have been extended by the EU to Greece to show to the world the strength of the Union and the care for its members. Indeed, this is a testing time for the EU and the Union’s ability to deal with such problems will go a long way to substantiate the competency of their unity and to brighten the way forward. Perchance any EU intervention to remedy the Greece situation is being categorized as nationalization by the Union.

Finally, it is feared globally that more of such bad debts and financial failures will occur in the near future with repercussions of consumer and investor confidence reduction if nothing is done. Watch out for part 2 of this article which discusses this phobia.

Author:  Charles Horace Ampong [MSc(Eng), MBA]
              GLG Consultant
    Blog:  http://www.charliepee.blogspot.com/

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The intricacies of China unseating Germany as the world’s biggest exporter! (Part 2)

In the first segment of this article, the author deliberated on the episode surrounding the call for revaluation of the currency of China to forestall the growing trade imbalance between China and the rest of the world. In that segment, the author attributed the demand for its export as not only due to its low valued currency but also to other factors such as government subsidies for firms and investors, expansion in its trade horizon internationally and piracy problems. It was deduced that piracy was taking market share from the western world and also reducing the required imports for China.
In this segment of the article, the author would like first to consider some pertinent issues surrounding the trade imbalance between China and the rest of the world especially the western world. Second, whether the growing trade imbalance poses a threat in terms of monopoly. Third, whether the world has options to deal with the situation.
From the perspective of exports and imports composition, the following are some trade statistics estimates for China;

Exports - $ 1.435 trillion (2008 estimates)
Main Export partners (2008 estimates) – U.S 18.6%, Hong Kong 12.7%, Japan 8.2%, South Korea 5.1% and Germany 4.2%
Imports - $1, 074 trillion (2008 estimates)
Main Import partners (2008 estimates) - Japan 12.2%, South Korea 10%, U.S 6.6%, Hong Kong 4.9% and Germany 4.5%

According to the Center for Trade Intelligence report in 2007, China generally exports low tech goods which include but not limited to computers, printers (storage units generally), cell phones, video recorders, television, electronic integrated circuits, puzzles, toys, telephones, handbags, wallets, non-knit women and girls suits, leather footwear among others. Its topmost exports are computers, printers, storage units, office machine parts, cell phones, video recorders and radio transceivers. The topmost imports includes but not limited to electronic integrated circuits, computer and office machine parts, television radio and accessory parts and crude oil. Also, based on the report, China had much trade surplus with countries like Hong Kong, United States, Netherlands, United Kingdom and Spain in descending order of surplus magnitude whilst it had trade deficits with countries like Angola, Saudi Arabia, Philippines, Japan and South Korea in ascending of deficit magnitude. These statistics do suggest that China tends to have surpluses with the western world and on the hand deficits with developing world. Perhaps, the net is the surplus since the surplus with the western world is huge compared to the deficit with the developing and under-developed world. Ultimately, it is right to say that the trade imbalance with the world is the result of high balance of trade surplus with most countries including United States and United Kingdom. From the structure of its exports, it presupposes that China would need much technological innovation to keep up with its exports. Hence, the country cannot do without high tech machinery and other industrial inputs from the western world. Infact, resilience and low-tech manufacturing alone cannot support its exports. An economic analysis suggest that in the long term the trade imbalance should not pose a threat only if the country’s surplus in totality is expected to dwindle which is currently becoming evident. This is because recent reports have it that China’s total trade surplus has shrunk to $196.07 billion down 34.2%. As an analyst, the decrease is not shocking considering the global slump in demand. Also, it can be inferred that if the global slump continues and domestic demand in China continues to increase, then import would also increase. Increased import is possible because of the country’s large population. Next, the increased imports would factor into the exports bringing down the surplus. In the longer term, this would reduce drastically the surplus and pave the way for fair competition between China and the world. It must be emphasized that the dwindling in surplus should come predominantly from an expected increase in its imports as against its exports. Nevertheless, the resilience of the Chinese manufacturer to keep exporting may prove this analysis wrong. Eventually, these developments do not suggest a monopoly of the market by China and so there is no need for paranoid expectations.

Now, there is another salient reason why China is enjoying export superiority and that has got to with price elasticity of products in the current global recession. In the current slump of global demand, two things are imminent: the market has become competitive and goods are likely to be price elastic which makes it difficult to make profit. Under such prevailing conditions, any attempt to raise price could lead to a loss. Contrarily, lowering price can lead to increased sales and possibly profit. Apparently, the ability of China to present low priced products promotes its sales, exports ensuring more revenue and profitability. Again, China seems to be successful in this era because of its ability to take advantage of the price elasticity of goods in the current global slump in demand to make more sales and consequently profit. Furthermore, the country is exhibiting economies of scale in the production of its goods and this is also a plus for exports.

The whole story of the trade imbalance does not depend solely on the mentioned factors but it is indirectly enhanced by the country’s growing capital investment predominantly its direct foreign investments and portfolio investments. These two components of capital investment are serving as a backbone for its increasing export as they are consumer confidence boosters for the Chinese economy. The increased direct foreign investments and portfolio investments by China in other economies coupled with the huge accumulation of foreign exchange rate reserves is creating consumer confidence internationally in China’s capability and its products even though there are cases of a down side to the quality of its products and also its investments. Additionally, the country’s huge foreign reserves can be used to intervene in the foreign exchange market to influence its currency the yuan. Such action plan China may not do unless under severe pressure to strengthen or weaken its currency. Until then market forces will determine the yuan rate as it is allowed to float. Interestingly, for those economies with strong currencies as against China, opportunity is however available as well through the attraction of Direct Foreign investment and portfolio investments. On the downside products from such countries are expensive and unattractive but on the upside if their economy offers favorable low tax rates on earnings, have high interest rate and a stable exchange rate, they qualify as feasible candidates for Direct Foreign investment and Portfolio investment. Now, I would not like to end this article without talking about the impact of inflation on China’s goods pricing in the midst of the country’s stunning GDP growth. China’s inflation rate is comparatively high. Consumer Price Index (CPI) measures inflation and according reports, this value climbed 1.9% in December 2009 year-on-year. However, the low-value of its currency coupled with government subsidies overrides the potency of inflation. On the other hand, this is not sustainable as inflation can be a problem considering the increasing domestic demand in China. The increasing demand due to the large population coupled with a droop in supply of goods (imports) could trigger an increased inflation (demand-pulled). Additionally, increased demand for raw materials by its industrial and manufacturing sectors as against a fall in global supply of raw materials can augment inflation (cost-pushed) in China and globally. In reality, it is not the CPI alone that will be affected by these developments but also the Producer Price Index (PPI) which should be a bother to producers in China. These developments may also prompt increased interest rate in China to curb inflation.

Finally, the world may not have enough feasible options to deal with the imbalance situation except of course to pressure China to revalue its currency. However, with regards to the subsidies from the Chinese government, it is an internal affair which cannot be influenced from an external source. The rest of the world may have to agree with China to promote a free and fair market. Another option is for the world to do nothing and allow the global slump and market forces to deal with the situation in the longer term. The imposition of tariffs and quotas may have only a minimal effect and should not be resorted to.

Conclusion

The recent economic news about China unseating Germany as the world’s largest exporter has undoubtedly enlightened the world about the emergence of China as the new economic world super power and possibly a locomotive engine for the world economy. Behind these developments is the assertion that the feat has been enhanced by the low value of the Chinese currency the Yuan making its exports attractive and more competitive. Consequently, it is expected that in the next few months or years, China will be compelled under growing pressure to revaluate its currency to make its products less competitive so as to obviate the growing trade imbalance between China and the rest of the world. However, it is not only the low currency that is responsible for low priced exports but also other factors namely government subsidies, China’s trade horizon, piracy problems and price elasticity of goods in the global recession. Unfortunately, addressing these problems may prove a herculean task as there are not many options available for the world.

Author: Charles Horace Ampong [MSc(Eng), MBA]
GLG Councils Consultant
Blog: http://www.charliepee.blogspot.com

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The intricacies of China unseating Germany as the world’s biggest exporter! (Part 1)

In the January 10, 2010 edition of the yahoo.com news, it was promulgated that China has overtaken Germany as the world’s biggest exporter even though full confirmation is expected in February 2010 when the final figures for Europe’s biggest economy is released.

The assertion from the perspective of the author of the article is a reflection of the economic strides China has made to reach a pinnacle of an economic super power and also a vivid sign of a gradual shift of power from the West to the East. According to the article, the total export in 2009 for China was more than $1.2trillion as against $1.17 forecasted for Germany.
Really, this is not the first time China has overtaken Germany with regards to economy issues. More so, this is germane and a memento to what happened in 2007 with regards to the two countries. Recall in 2007, China overtook Germany as the world’s third biggest economy and obviously it should have served as a signal that the country is on course to unseat Germany as the world’s largest exporter. At least, the incident should not preposterous to the world considering the fact that the symptoms were evident enough.

In my article titled “Another Economic Bubble Burst Ahead- China, I prognosticated the possibility of China becoming the locomotive engine driving the world economy as it is predestined to lead the world in the industrial sector, technology sector and the financial sector. Believe it or not, the attainment of the status of the world’s largest exporter coupled with technology and strong financial base suggest a paradigm of the country being the “locomotive” engine driving the world economy. If China continues to maintain its GDP growth rate of over 8% whilst that of the western world hovers around growth values of less than 3%, it is likely China will dethrone Japan as the world’s second biggest economy by the year 2015 and if possible in the years after overtake United States as the world’s largest economy. This hypothesis is based on the 2008 GDP growth estimates where China recorded 9.6% with Japan having -0.4%, Germany 1% and U.S 1.1%. Optimists argue that it is not possible for China to overtake United States as the world’s biggest economy and they could be partially right. However, the world did not envision China would overtake United States in Auto sales in 2009. Again, analyst did not envisage China overtaking Germany so soon and here we are it has happened. Indeed, the moment may be right and China could be said to be on its way to the throne. As an analyst, I am of the view that China can overtake Japan but not United States. There are several factors involved here which will be discussed in a later article. But for now, I will touch on one of the factors namely the economic statistic GDP (purchasing power parity) per CAPITA which is only an indicator of the standard of living. Though this is not a true measurement for standard of living it can be used as a proxy for accessing the standard of living of countries. China has a population of about 1.3 billion with an estimated growth of 0.655 % (2009 estimate) whilst the U.S has a population of about 307 million and an estimated growth of 0.975 % (2009 estimate). China has estimated GDP (ppp) per CAPITA of $2,033 and is ranked 131th out of 207 economies in the world in terms of per capita income. United States value is $44,155 and is ranked 8th also out of 207 economies. Hypothetically, the standard of living of the people in the United States should be about ten times better than that of China. Doing the math here, it presupposes that the ability of the citizens to impact the economy (in terms of GDP growth) through their purchasing power is ten times more. This also means the ability of the United States to maintain its economy size judging from the fact that the U.S economy depends much on domestic consumer spending is more predictable as against China. If China’s economy is to be dependant on domestic spending in the midst of global slump in exports, then the low GDP (ppp) per CAPITA signals a disadvantage compared to United States. China may increase its GDP growth but it would have to leverage its per capita by bridging the wide purchasing power parity gap between its urban and rural population segments. Subsequently, it may call for policies that would increase the standard of living of its people across all segments.

How be it, China cannot overtake the U.S in terms of economy size until this population segment factor and other factors are diligently pursued and completed. Meanwhile, in terms of global competitiveness they are ranked nearly the same (U.S is 5.59/134 whilst China is 4.73/134). However, in terms of attracting and retaining investors or Foreign Direct Investment, U.S is better ranked than China. Reminder is the growing impasse between Google and China about the internet security breach prompting threats of Google leaving China. What is not clear is whether China would accept the departure of Google. If Google should leave, what effect will it have on the credibility of companies or nations doing business with China? Now, proponents of GDP per CAPITA economics may argue that the GDP per CAPITA statistic is not a good measure for standard of living and personal income levels in a country. Nevertheless, all things being equal there is a systematic level of correlation between GDP per CAPITA and standard of living in most countries. That is to say GDP per CAPITA decreases as the standard of living decrease and vice versa.

Strangely, the yahoo.com news article attributed the feat of China to its ability to enact policies to deal with the world recession. The article emphasized that its policies were able to cushion the economic shock from the global economic crises whilst other nations were overwhelmed by the crisis. It must be stressed here that much as the policies and global recovery were contributing factors, the real cause of China’s survival and stronger emergence is bottled up in its exchange rate policies and government subsidies and financial assistance package from the stimulus. In fact, the combine policy framework of exchange rate manipulation and government subsidies promotes low pricing strategy for its exports ultimately increasing the attractiveness of its products and also its market share of the world’s export. Now, the global imbalance cannot be completely removed as the Chinese government would want to enact policies and strategies that will give Chinese products an edge in exports in addition to promoting less import. Really, in the midst of all these developments there are two questions that would need to be addressed by the world and they are

1. Whether China the current locomotive engine of the world economy would bow to another currency revaluation pressure
2. Whether the trade imbalance between China and the world is a threat in terms of monopoly and whether the world has other options to deal with it.

The objective of this two part article is to discuss in circumspect the ramifications of the unanswered questions and what it means for the world.

Currency revaluation issue

In the next few months and perhaps years there is expected to be a growing pressure on China by the United States, Germany and the other economies of the world about the urgent need for China to revaluate its currency the Yuan to correct for and curtail the growing trade imbalance between China and these economies. It is an undisputable fact that China has trade surplus with almost all these countries as these economies are drowning in mounting trade deficit with no end in sight. The fact is China has been through such barrage of criticisms before with regards to the impact of its low valued currency on exports. Recall in 2005, China under growing criticism of the impact of its low valued currency on international trade was compelled to revalue the Yuan by a whooping 2% against the dollar. Additionally, a policy change of pursuing a floating exchange rate system for its currency was effected. The corollary was the creation of a currency (the Yuan) whose value was based on a set of major currencies which could deviate as much as 0.5% within a day. Yet again, the western world in the nearest future may be agitating for another round of revaluation. Europeans and the United States may be perturbed because competition with China is becoming difficult primarily due to the Yuan being relatively low in value which makes the products from China less expensive for foreign countries and that of EU and U.S more expensive. However, criticisms may not be feasible this time. It is likely China may not vouchsafe to the western countries led pressure to revalue its currency. Apparently, the world may be forced to seek for other options of dealing with the situation which could call for inferior tactics such as imposition of trade tariffs, quotas e.t.c. on Chinese exports. But one wonders if such option will yield the expected results as well judging from the fact that an action plan of this sort may seem more visionary to China than pragmatic and results-producing. On the other hand, China may argue that revaluation of the yuan will have marginal impact on the exports trend and subsequently the global imbalance using the developments in 2005 as the basis for argument. In retrospect, the revaluation of its currency in 2005 produced a marginal effect on the attractiveness of its exports and consequently China may not yield to the exchange rate policies again. Analytically, revaluation may not reduce the competitiveness of Chinese products neither would it correct the international trade imbalance due to the fact that there are other factors other than exchange rate policies that contribute to the attractiveness of its exports. These are factors that are contributing immensely to the low priced exports therefore exacerbating the global trade imbalance.

Now, the factors other than exchange rate that make its exports superior in terms of global demand are government subsidies, expansion of China’s trade horizon and piracy problems. Government provides subsidies for exporters which culminate in lower cost of production. These firms and investors receive free loans and some free factors of production such as land which has led to lower cost of production and lower pricing of exports. There are also cases of other government fiscal inputs such as increased tax rebates on exports, increased tax refunds and improved export credit insurance during the year 2009. Let’s not forget also the 4 trillion yuan ($586 billion) stimulus package injected into the economy by the government. All these factors are incentives that culminate in a lower cost of production and substantiate lower pricing of its exports in addition to making it more competitive. Ultimately, if China should revalue its currency again to make its products expensive, the effect on trade imbalance would be marginal. But the question that remains is whether the government would remove these incentives for its exports to be expensive and to plummet.

Currently, China has judiciously widen its trade horizon with several countries in the world and should the western world reduce their imports of Chinese goods, there is the possibility of China expanding its trade with the East (The Asian block), South America (predominantly Brazil based on BRIC alliance), and Africa where it has made unimaginable strides. This is even against the background that the western world is the major trading partner of China. Turning their attention away from the western world will be a desperate move as the country would want to maintain its superiority in exports. On the other hand, people in the western world attracted to China’s low priced products because of the propensity to make some savings in this era of economic hardships. So the situation is very paradoxical with regards to the export between China and the western world.

Another factor that has contributed to reduction in market share for the western world is the lack of restrictions on piracy in China. Individuals engage in fictitious production of products that are similar to those produced by EU or United States firms operating in China and abroad. For example low-tech goods or electronic gadgets such as CDs and DVDs can easily be produced by individuals and this is taking market share from other countries. The other serious defect of this problem is the reduction in imports as well for China. China much as it exports lots of low-tech goods also imports many as well. However, due to piracy products in the system, there is less import demand compared to actually what the import should have been. This is to the advantage of China obviously increasing its net exports and GDP as well.

All in all, the demand by the world on China to pursue exchange rate policies to correct the imbalance in trade may not suffice because of these factors and secondly China would want to maintain its position in the world economy. Nevertheless, on a positive note the growth of China is good for the world. Like a German analyst said, growth in China is good for the other economies of the world as the country’s demand for capital goods such as machinery, raw materials, oil and high value products used in its industrial sector also stimulates exports from other countries such as Germany and United States. However, what remains to be known is whether future policies would seek to monopolize the world economy by promoting vertical integration in the Chinese industrial sector. An action plan of vertical integration will ultimately reduce the importation of heavy duty or high valued products by firms in China. Read the next segment of this article!

Author: Charles Horace Ampong [MSc(Eng), MBA]
GLG Councils Consultant
Blog: http://www.charliepee.blogspot.com

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Another Economic Bubble Burst Ahead – China? (Part 3)

In the second part of this article, the author elaborated on some of the negative and positive ramifications of China’s pace of economic growth. Now, in this final part of the article the author will continue with the implications of the economic growth, changes that needs to be made and the collaborative effort required to forestall any future economic failure.
Judiciously, to allay the fears of skeptics and expedite its strategic investments on the international scene, the Chinese government would have to deal with the political and economic freedom parameters especially corruption which is a real killer of economic growth as outlined in the second part of this article. Meanwhile, it is expected that China’s strategic investment in the developing and underdeveloped part of the world would increase because of its estranged relationship with the western world. Furthermore, with the Chinese government and investors loosing interest in investments in the low interest US treasuries and bond primarily due to the fiscal imbalance (that is massive U.S deficit) and the plummeting of the dollar, Chinese investors may be compelled to pursue a new sense of investment direction. Unfortunately, such a redirection of investment has negative impact on the U.S deficit whose source of funding is substantially through the sale of treasuries and bonds to these investors. As a matter of fact, a greater percentage of United States huge foreign debt is underwritten by China. Accordingly, a reduction in the purchases of the US securities would lead to a rise in interest rates which could partially affect the investment sector in the U.S exacerbating the unemployment situation. Moreover, it appears China is under pressure in the last few years to distance itself from the U.S its main trading partner and pursue its ambitious economic agenda. For example, in 2005, China decided to unpeg its currency the renminbi (whose basic unit is the yuan) from the dollar and to let it float followed by the revaluation of the currency. Also, in the past year China together with the BRIC countries (that is Brazil, Russia, India & China) tried to convince the world about the volatility and incompetency of the US dollar as a world’s reserved currency and the need for a switch to another currency. Supposedly, the dependence of the United States foreign debt on China must be an issue of concern for both countries because of its proclivity towards power transference from United States to China. All these developments are a foreboding of what is in the pipeline.
The next issue of concern is the effect of its population on the sustainability of its economic growth. There is a wide disparity in income distribution and purchasing power between the rural poor and the urban rich in China. Consequently, the urban rich percentage contribution towards domestic demand far exceeds that of the rural poor. These factors coupled with demographic and migration report from the United Nations predicting that by 2015, the percentage of the urban and the rural population would be almost equal ( 50% each) substantiates the need for strategies to bridge the purchasing power disparity. Thoughtfully, it would require initiating more projects in the rural areas to improve upon their lives so that their contribution towards domestic demand can parallel that of the urban folks. Remember, a prior analysis in the first part of this article revealed that a higher portion of the GDP growth emanates from domestic demand. That supports the notion that if China is to maintain its economic pace in the midst of the global slump in demand for exports then it would have to close the standard of living gap between the urban and rural folks.

Another subject worth deliberating on is the energy needs. Environmental pollution concerns are imminent when one considers China’s growing energy need. As matter of fact currently over 70% of its energy comes from coal and natural gas both non-renewable energy sources and potential contributors to acid-rain formation and global warming. The growing energy needs suggest an increase in dependence on oil and coal. However, the country cannot continue to depend on non-renewable sources energy for it supply and should consider stepping up its investment into the renewable energy source to obviate any future environmental disasters. The growing international pressure on countries to pursue environmental friendly industrial practices encompassing cost effective measures and accountability for carbon emissions should gravitate with the concerns of Chinese authorities. Truly, in the past environmental cost has been trivial and the contribution of the cost of damage to the environment on operational cost has been negligible. The story is expected to change after the just ended climate change conference in Copenhagen as several nations operational cost would increase due to the active inclusion of environmental cost in the cost of doing business. In the interim some austerity measures may be required from China. For example, the country would have to step up its regulatory framework in order to be able regulate effectively and efficiently its growing industrial and manufacturing sector. Remember, China is second to the US in the industrial and manufacturing sector of the world. Obviously, effective regulatory measures would increase cost but it’s worth it for the Chinese people and the rest of the world. Studies show that pollution cost forms about 7-10% of China’s GDP each year. That means if the country is to effectively pursue the UN regulations agree upon recently, this cost would definitely increase operational cost and reduce expected profits.

Another factor that needs to be considered is the need for human capital the key to higher productivity and sustainability. The lagging behind of human capital can greatly retard productivity as is being experienced by a country like Denmark currently. In actuality, there is a causal relationship between productivity and human capital. Accordingly, if China is to keep up with its pace of economic growth then there is the need for revitalization of its educational sector to augment its human capital. It is true that China is advancing in technology ahead of the world but this is only sustainable with increasing level of human capital which is an integral part of the bedrock of productivity. Also, human capital is paramount to innovation, entrepreneurship, research and development all principal promoters of productivity. Innovation is needful in the energy and infrastructural sectors to meet its growing energy needs and its urbanization programs.

Now, in spite of some negative connotations associated with the economic growth, China should be commended for attainment of this high level of economic growth. Having the highest amount of foreign exchange reserves and recently overtaking Germany as the world’s largest exporter in 2009 is a laudable accomplishment which epitomizes China as an unprecedented economic super power and also an industrious nation. The fact is that no country can achieve such a distinctive status without infringement or petty international violations. Ultimately, much as the western world would want to see China comply with trade laws and the likes, they should also be ready to work with the country to ensure the sustainability of its economic growth. It is an indisputable fact that China is currently the locomotive engine of the world economy with worldwide strategic investments whose tentacles permeate even to the remotest parts of the world. So any expert in how a train operates would tell you what happens to the coaches when the engine derails or fails. In fact, there is a high probability of the coaches also derailing or failing if the engine derails or fails. Thus any failure of the Chinese economic system would spread pervasively to almost every economy of the world sending the world into another era of recession. By now, the world has learned from experience the repercussions of the failure of the United States economy plunging the world economy into recession and would not want a repeat of such an occurrence with China. Let’s not forget the fact that just as no economy was immune to the impact from the United States case, so be it for no economy in the world should the unexpected happen to China. Therefore, China would need the assistance and cooperation of the world especially the major economies to be able to control its macro-economic and political factors to ensure the sustainability of its economy and prevent economic super heating which is antecedent to an economic bubble burst. There are some who believe that all the pursuits of China have the objective of marginalizing United States and Europe and would want to be pessimistic about the future of the Chinese economy. However, united we stand divided we fall. Passivity is the key.

Finally, I would not want to complete this article without elucidating the fact that the attainment of such an economic status of leadership in manufacturing, technology and possibly the financial sector can be coupled with the attainment of superior military power. In reality, superior military power is primarily a result of the adoption of a superior military technology. Thus, the propensity by an economic super power to adopt and use its technological know-how leadership to create a superior military is inevitable. Another dimension of the technological leadership is the ability to infiltrate other country’s military system or security systems or better still hack the system.

Conclusion

Several economic empires have come and gone and unfortunately the demise of these empires termed economic bubble burst has often sent economic shock waves to the rest of the world. It is in the light of these developments that the world is wondering whether China the reigning economic empire would follow the same fate. Macro-economic factors describing the Chinese economy namely GDP, current account balance, CPI, inflation and foreign exchange reserves are currently favorable. Superficially, it is possible to think that China’s pace of economic growth is sustainable and there is no cause for alarm. However, a critical look at the economy reveals the need for a review of its policies that governs its economic freedom, political freedom and its international deliberations all of which can gravitate towards the initiation of an economic bubble burst. The long term absence of which could wreck the current pace of economic growth with reverberations to the rest of the world. Finally, it must be emphasized that China cannot do it alone and would need the cooperation of the world especially the major economies to ensure the sustainability of its economy and that of the world.

Author: Charles Horace Ampong
GLG Councils Consultant
Blog: http://charliepee.blogspot.com

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