Is China "Wagging the Dog?"

 

“Quand le Chine s'eveillera, le monde tremblera.”
“When China awakes, the world will tremble.” – Napoleon Bonaparte, 1803

 

“As for the United States for a relatively long time it will be absolutely necessary that we quietly nurse our sense of vengeance…We must conceal our abilities and bide our time.”

Lt Gen Mi Zhenyu, a top PLA stategist (China), 1996

 

“Wag the Dog” is an interesting expression.  It means that attention is diverted away from the real issue to the issue of lesser significance, thus making the issue of lesser significance the most important reason in the public’s mind.  Obviously a dog wags his own tail.  But what if the tail, the seemingly insignificant part of the dog and the part that often gets overlooked, was the most important part the dog?  Then, the tail would “wag the dog.” 

"There’s a crisis in the White House, and to save the election, they’d have to fake a war."

1997 movie "Wag the Dog"

Is China, in their own way, wagging the dog?  China publically states their fear of our rising deficits, our burdensome national debt, and the fear of inflation in the United States.  “We have lent a huge amount of money to the US, so of course we are concerned about the safety of our assets.  Frankly speaking, I do have some worries.”  (Premier Wen Jiabao March 13, 2009).  But while we seem consumed with worrying over what China thinks of the dollar, they are quietly stockpiling massive amounts of natural resources, including gold and other rare earth elements in an attempt to hedge their Treasury positions, alleviate their fears, and protect their national interests.  However, their method of hedging has serious repercussions to our economy and way of life.  The question we should be asking is, are they accumulating carrots so that they can rule over us with a stick?  Are they in effect “wagging the dog?”

China, a Sleeping Giant, Starts to Awaken

China has been a sleeping giant for many centuries.  She has been sleeping for long enough that today most do not fear her.  She is viewed as weak and timid by many.  “China may have growing financial muscle, but it still lags far behind as a technological innovator and creator of global brands….By any measure, China’s power is still dwarfed by America’s.”  (Economist Oct 22, 2009)  This is precisely what China wants us to believe.

With a population of over 1.3 billion, a strong work ethic, and an awakening desire for economic and military might, China has the ability to wake up from her long slumber.  Over the last couple of decades, she has been moving towards a market based economy, all be it controlled.  She has allowed foreign corporations to enter, providing her citizens with jobs, money and the hope of a better future.  Granted the wages are low and the working conditions horrid, but so too where the wages and conditions in early America when she was just starting to awaken and become powerful superpower. 

http://www.pbs.org/independentlens/butte-america/film.html

Chinese Miners (Telegraph UK)

Chinese citizens are starting to awaken and hunger for more.  Government policy is shifting from production to consumption in hopes that the decline in worldwide exports can be offset by an increase in domestic consumption, thus keeping Chinese workers employed and happy.  GDP continues to grow at a rapid pace despite the world’s financial crisis while the US is continuing to stagnate as domestic demand falls.  The US consumer is mired in debt and unable to maintain previous levels of consumption.  Meanwhile, the Chinese consumer has been saving for decades and is ready to consume.

CHINA

                            2008    2009    2010   2011

 GDP                            9.0     8.3    10.2    9.3

 INFLATION (CPI)                5.9    -1.1     0.1    1.0

 CURRENT ACCOUNT (pct of GDP)   9.8     6.4     5.4    5.9

 FISCAL BALANCE (pct of GDP)    1.1    -1.8    -0.9   -0.3

Source:  www.oecd.org/china

Today, both America and China are at turning points, but at opposite ends of a cycle.  While America’s power is declining around the world, China’s is rapidly rising.  China has learned from the United States that it is critical to the health of your economy to acquire the means of production.  Without them, your economy becomes a slave to their holder.  China is gathering the carrots.

 

China Slowly Awakens, buying Gold

China is currently the fifth largest holder of gold and has boosted its gold reserves by 76% since 2003.  According to Hu Xiaolian, director of the State Administration of Foreign Exchange (SAFE), China’s gold reserve was 1,054 tons in April 2009, roughly 2% of its foreign currency reserves.  (Bloomberg April 24, 2009)  China does not have to publically disclose purchases made through SAFE which is a separate entity from the People’s Bank of China; therefore, given China’s typical lack of transparency, they are likely to have higher reserve amounts than they are publically disclosing.

China is also actively encouraging her citizens to buy gold and silver.  China’s main state-owned television station, Central Television, has run several news programs educating the public on how easy it is to invest in gold (see video clip below).  Every bank is now selling gold bullion bars in four different sizes to Chinese citizens.  The popularity of gold is quickly soaring in a country with 1.3 billion citizens.

What is China trying to accomplish by selling gold to her citizens?  Is she protecting her citizens from a falling a dollar and the potential for high US inflation?  Is she trying to empower her citizens through the ownership of wealth?  Or, is she simply trying to drive up the price of gold in order to more effectively hedge her US dollar holdings? 

While China is encouraging the private ownership of gold, America is blatantly discouraging her citizens from holding gold by enticing them to sell their gold for record amounts of cash.  Cash for gold advertisements can be found on every TV station, in every newspaper and in many store windows.   

At a time when Americans should be buying gold, they are instead selling gold in mass quantities for quick cash today at the expense of their security tomorrow.  Worse yet, they are being encouraged to do so.  When the Federal Reserve and the Treasury lose their power over interest rates due to the rapidly expanding money supply and Federal debt, interest rates will rise, and the dollar with be of little value.  Gold prices will soar.  Who will benefit by owning gold?  The Chinese.  Who will not?  The Americans because they sold it for quick cash.  China awakens and is diversifying her wealth through gold.

 

China Slowly Awakens, buying Oil

China is currently the world’s second largest oil importer and demand is expected to grow by 20% in the next six years.  China does not want to be dependent on foreign producers of oil and subject to the whims of foreign governments and cartels.  She has learned from the mistakes of the Western world.  Therefore, China is currently working to secure the means of production.  China does not want to be dependent on anyone, and would instead like for others to be dependent on her.

Several deals have either been completed or are in negotiations including:

In 2008, China National Petroleum Corporation signed a development contract in Iraq.  This year, they struck oil at the Ahdab field in Wasit Province, southeast of Baghdad.  Relations with the local Iraqi people have been strained as China has hired and brought in its own people to work rather than hiring local Iraqis.  Also, all profits are China’s, and money from the deal is not helping local citizens.  China has invaded, and Iraqi citizens have lost.  (see NYT Sept 5, 2009)

CNOOC and Sinopec are buying from Marathon Oil (XOM) a $1.3 billion stake in offshore development rights in Angolia. (see CNN Money Aug 17, 2009)

China National Petroleum Corporation is interested in buying all of YPF, an Argentinean oil company.  (see CNN Money Aug 17, 2009)

China National Petroleum Corporation is interested in a majority state in Iraq’s Rumaila oilfield, currently owned by BP.  Rumaila is Iraq’s biggest oil field.  (see CNN Money Aug 17, 2009)

CNOOC and Statoil Hydro signed an agreement for a working interest in four prospects in the Gulf of Mexico.  (see China Daily, Nov 6, 2009) 

An oil and gas platform in the South China Sea. (China Daily)

China is diversifying her interests as to not arouse the suspicions of any one government.  In the United States, where they have met some resistance when attempting to purchase Unocal, they have decided to move incrementally buying pieces rather than whole companies.  At a time when oil reserves are peaking, Western governments are selling their oil reserves for quick cash.  China is eager to accumulate more carrots while they are still cheap.

 

China Slowly Awakens, buying Natural Resources

China has a virtual monopoly on rare natural resources.  Over 95% of the world’s rare earth minerals are mined in China, primarily in Inner Mongolia. 

“A draft report by China’s Ministry of Industry and Information Technology has called for a total ban on foreign shipments of terbium, dysprosium, yttrium, thulium, and lutetium. Other metals such as neodymium, europium, cerium, and lanthanum will be restricted to a combined export quota of 35,000 tonnes a year, far below global needs.” (see Telegraph UK Aug 24, 2009)  Countries may soon find it hard to obtain these metals.

What does this mean?  John Michael Greer explains the implications, (bold emphasis is my own)

Those of my readers who don’t track the latest fads in technology may not know that these have become crucial to many cutting edge technologies. Lanthanum, for example, is used in high-tech batteries, and neodymium goes into the permanent magnets used in electric motors and wind turbines. The innards of the Prius and other hybrids, to say nothing of the as-yet-imaginary electric cars being hyped by what’s left of the American auto industry, depend on rare earth elements, and China currently produces well over 90% of the world’s supply of most of them. The report thus sparked claims of an imminent shortage in these minerals and, predictably, a flurry of speculative interest in (and hype-ridden articles about) mines outside of China that can produce the same minerals

A couple of details of the proposed restrictions somehow failed to make it into most media and internet accounts, and they are by no means minor issues. The first is that there’s nothing that new about this news; in each of the last three years, the Chinese government has cut the export quotas for rare earth elements from China’s mines. More important is the fact that the Chinese are not preventing the export of products containing rare earth elements; they are simply moving to ban the export of the raw materials. In effect, what the Chinese are saying is that they are no longer willing to accept the Third World’s designated role as a source of raw materials and cheap labor to be exploited for the benefit of somebody else; if the future is going to run on technologies based on rare earth elements, those technologies are going to come out of Chinese factories, and the wealth produced by them is going to be concentrated in Chinese hands.

John Michael Greer, Energy Bulletin Sept 3, 2009

The following is a list of rare earth elements and their uses that China currently has a monopoly on.

Terbium – Low energy light bulbs.

Neodymium – Hard disk drive magnets, wind turbines, and electric motors of hybrid cars

Cerium – Catalytic converters for diesel engines

Lanthanum – Catalytic converters for diesel engines

Europium – Lasers

Various rare earth metals are also used in Blackberries, iPods, mobile phones, navigation systems, air defense missiles, water filters, and new uses are being found all the time.

Many of these elements are needed by China simply to satisfy her own demand.  While their methods of extraction are dangerous and violate many human rights standards, China is non-apologetic.  “China will agree to have a human rights dialogue with the U.S. on some cases, but the arguments have changed compared to the past. Now we say, ‘We are a different country, we have our own system, our own culture’.” (NYT, Nov 15, 2009)  China is accumulating her carrots and is non-apologetic about her methods.

 

When will the Dragon’s Full Roar Be Heard?

As she awakens, she is also building her military might so that she may protect her resources and exert her power.  China has been pouring money into its military in an effort to transform it into a professional and high tech force to be reckoned with.

China's increasingly advanced weaponry could undermine US military power in the Pacific.  Defense Secretary Robert Gates said on Wednesday.

Echoing US intelligence guidelines released on Tuesday that warned of Beijing's military modernization, Gates said US naval carriers and air bases in the Pacific faced new threats from China.

"In fact, when considering the military-modernization programs of countries like China, we should be concerned less with their potential ability to challenge the US symmetrically -- fighter to fighter or ship to ship -- and more with their ability to disrupt our freedom of movement and narrow our strategic options,"  Gates said in a speech to the Air Force Association.

"Investments in cyber and anti-satellite warfare, anti-air and anti-ship weaponry, and ballistic missiles could threaten America's primary way to project power and help allies in the Pacific -- in particular our forward air bases and carrier strike groups,"  Gates said in National Harbor, Maryland.  (Breitbart, Sept 16, 2009)

While her increasing power is beginning to be recognized and we are beginning to see the stick, it is her accumulation of carrots that should be most concerning to us.  We must start seeing China for what she is and not what she wants us to see.

“Economics does not exist in a vacuum, and the power of high finance can find itself suddenly overmatched when it has to contend with the sort of power that grows out of the barrel of a gun.”  John Michael Greer, Energy Bulletin 

 

And finally, the following op-ed piece from the Wall Street Journal on Sept 9, 2009, illustrates how easy it has been for the Chinese to “wag the dog.”  While Bernanke believes that he saved the world and Obama believes that he is God’s gift to the world, the Chinese are laughing at us and quietly shaping history.   

Dear Esteemed Chairman and Savior of the World Economy (Bernanke):

On behalf of your many Chinese friends and all of the Chinese people, we wish to congratulate you on your recent reappointment as Chairman of the American Federal Reserve. We could not be more pleased to know that the man who saved the value of our Fannie Mae mortgage-backed securities last year will be the Great Monetary Helmsman for another four years.

We also note with satisfaction, and admiration, your many recent assurances, via the Wall Street Journal and various eloquent speeches, that you and the Fed have no intention of permitting a revival of dollar inflation. This is a source of great reassurance to the Chinese people, not to mention the bureaucracy in Beijing that made the decision to invest $1 trillion or more in dollar-denominated securities.

As you can imagine, this has become a source of some political controversy inside the government of the People's Republic, as we have also noted it has become in the irresponsible American financial press. Fortunately, we don't have the latter problem. But please know that we share your disdain for any voices in the unpatriotic media who would question your resolve to maintain the value of the world's reserve currency.

At the same time, and with the deepest respect, we also note with concern your decision this year to purchase U.S. Treasurys, which directly monetizes the debt built up by irresponsible democratic politicians. (This is one reason we Chinese are so skeptical of democracy; it always leads to a welfare state!) We must admit that that Treasury decision caught us by surprise, considering the many lectures over the years from our American friends about the importance of an independent central bank. Then again, the last year has seen America do many things that we once thought a capitalist economy would never do, wouldn't you agree?

With this in mind, we have decided to hedge our dollar bets and buy gold, oil and other commodities which will rise in value if the dollar falls. You may have therefore noticed that oil has risen above $71 a barrel, despite slack global demand, and in particular that gold has climbed this week above $1,000 an ounce.

Perhaps you have seen reports that we Chinese are doubling our reserves of gold and buying other related metals. Please do not be alarmed. This is the normal process of diversification that any trillion-dollar creditor would take, just in case the Federal Reserve's definition of an "extended period" for monetary easing turns out to be even more extended than we already assume it will be. We will only be too happy to cease this flight from dollar assets when we observe your determination to tighten money; surely this must be why President Obama selected you over the distinguished White House economic adviser, Lawrence Summers.

Once again, on behalf of all of the Chinese people, our heartiest congratulations.

Sincerely,

Ministry of Finance

Beijing

 

China is awakening from her slumber, and we cannot afford to ignore her.  In a world that will increasingly be shaped by resource scarcities, she is slowing purchasing various means of production that are essential to maintain our way of life.  She will have the carrots AND the stick.  We will be at her mercy.