The Chinese Communists to embrace Free Market Capitalism more than President Obama

Posted by PITHOCRATES - December 21st, 2013

Week in Review

During the Eighties Democrats said the Japanese economy was the smart way to go.  Government partnering with business.  With government helping to make that messy capitalism more ordered and manageable.  Improving economic efficiency.  And economic output.  But all that government intervention and cronyism brought on a deflationary spiral.  Japan’s Lost Decade.  Which they’re still trying to recover from.

Over the last decade Democrats said the Chinese economy was the smart way to go.  Government partnering with business.  With government helping to make that messy capitalism more ordered and manageable.  Improving economic efficiency.  And economic output.  But it doesn’t appear the Chinese agree with them (see China factories stuck in cruise control by Charles Riley posted 12/15/2013 on CNNMoney).

After a long period of steady progress and faster growth, China’s factories have lost some momentum in the final months of the year…

…analysts said that sluggishness in the manufacturing sector suggests economic growth has started to weaken, a trend that will continue into next year…

China’s party leaders have spent much of the year plotting a course for economic reform that aims to deliver results by 2020.

Beijing’s plan calls for opening its financial markets and promoting greater foreign investment. The leadership also hinted at changes in how companies file for stock market listings, the introduction of a bank deposit insurance scheme and an acceleration of interest rate liberalization.

The roadmap seeks to roll back government control of state-owned enterprises and allow for greater competition with private firms.

The Chinese export economy created economic activity.  But the key to that was their low labor costs.  With the power of the state keeping labor costs low.  Which helped to make their exports inexpensive.  But it did not help grow a middle class.  Which meant all of China’s economic growth relied on those exports.  And when nations were suffering anemic economic growth those export sales fell.  And without a prosperous middle class there was nothing to replace those sales.  Causing the Chinese economy to lose momentum.

And what is China doing to regain that momentum?  Reduce the role of government in the economy.  Unlike President Obama.  Which could forever change the balance of power in the world.  For if the Chinese privatize their economy while the Americans strangle theirs with more government involvement the Chinese economy will grow greater and overtake the American economy.  Allowing the Chinese communist do something the Soviets could never do.  Beat America economically.  Because the Chinese communists embraced free market capitalism more than President Obama.

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China is Restructuring their Economy to make them less Dependent on their Export Economy

Posted by PITHOCRATES - April 6th, 2013

Week in Review

Those who support more government regulation of business nod approvingly to the way China does business.  The Chinese government manages the economy.  They pick the winners and losers.  They decide where investment capital goes.  And their economy is surging because of it.  Something many in the United States see.  And want to emulate.  Only if the U.S. government had the same power over business the Chinese have they lament.  Then we would see great things in the U.S.  Or so they say.  But would we?

It should be noted that the only booming part of the Chinese economy is their export economy.  That is, it’s not ordinary Chinese enjoying this economic boom.  It’s those in other countries getting those cheap export goods.  And why are they so cheap?  Some will say because of unfair trade practices.  And because of cheap labor.  Which is why the same people who want the U.S. economy to be more like the Chinese economy, more government control, also want to limit the import of those cheap Chinese goods.  For they’re destroying American jobs with their cheap labor and unfair trade practices.  Yet they want the U.S. economy to be more like the Chinese economy.  Even though it is only that cheap labor that makes it all possible (see China issues plan to rejuvenate old industrial base by Aileen Wang and Nick Edwards posted 4/2/2013 on Reuters).

China will expand an urban regeneration plan for ageing industrial cities as part of efforts to restructure the economy and promote more sustainable growth, the National Development and Reform Commission said on Tuesday.

The plan, to run from 2013 to 2020, covers 95 prefecture-level cities and 25 municipalities and capital cities that were once the core of China’s heavy industrial base. A blueprint issued in November 2011 covered 62 cities.

The NDRC said in a statement on its website that investments would be made to help former industrial centres upgrade technology while also providing financing support and encouraging financial innovation – including bond issuance – to raise capital for the program…

Annual personal disposable income for those cities is targeted at 29,900 yuan ($4,822) by 2017 and 13 million new jobs will be created during the same period.

Obviously the Chinese way isn’t working.  If it were there would be no need for such a mammoth restructuring of the national economy.  But they apparently need this restructuring.  As the export economy did make the Chinese government rich.  And those connected to the government rich.  But the ordinary Chinese worker earning those cheap wages sure didn’t get rich.  Which is why they are not helping to sustain the economy.  Making China totally dependent on their export economy.

They are targeting $4,822 in annual disposable income.  This is NOT the disposable income they have now.  It’s what the government hopes they will one day have.  Which really isn’t a lot of money.  For that comes to $401.83 each month.  Or $92.73 each week.  And only $13.21 a day.  So if this was your disposable income in the U.S. you may be able to afford a house or a car payment.  But not both.  Or much else.  Such as that smartphone with those expensive monthly charges.

Of course people will say that it is different in China.  Where the cost of living is less than in America.  So they will be able to buy more with their lower disposable income.  But, again, the reason why their cost of living is less in China is because of their cheap labor.  For that’s how the Chinese system works.  They can underprice the goods of most nations because they don’t pay their people much.  For there are no powerful labor unions negotiating better pay and benefit packages in China.  No.  In China they use the power of their communist government to keep labor cheap.  So they can pick winners and losers.  And get rich in the process.  While the average Chinese worker does not.

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The Price for China’s Booming Export Market is some of the worst Air Pollution

Posted by PITHOCRATES - January 13th, 2013

Week in Review

The Chinese economy has boomed in the last decade or so.  Liberals in America think it’s because of the Chinese Communists managing the economy.  For they believe brilliant government bureaucrats are smarter in things economic than free market capitalists.  But there’s more to the Chinese economy than those government bureaucrats.  Such as low-paid labor.  And no environmental laws (see Air pollution in Beijing goes off the index by LOUISE WATT, Associated Press, posted 1/13/2012 on Yahoo! News).

People refused to venture outdoors and buildings disappeared into Beijing’s murky skyline on Sunday as the air quality in China’s notoriously polluted capital went off the index…

Air pollution is a major problem in China due to the country’s rapid pace of industrialization, reliance on coal power, explosive growth in car ownership and disregard to environmental laws. It typically gets worse in the winter because of heating needs.

This is how you get a booming economy.  You exploit workers.  And pollute the air.  This is the Chinese secret.

The Chinese can export goods at prices below our costs.  Because they pay next to nothing for labor.  And give them no benefits.  They also don’t burden businesses with costly regulations.  Like environmental regulations.  The Left’s relationship with Big Labor keeps labor costs high.  And excessive regulatory costs make the cost of business high.  China has neither.  Which is why they have a booming export economy.  And why the Americans cannot compete with them.

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China has no Pension or Health Care Benefits for their Rapidly Aging Population unlike in the West

Posted by PITHOCRATES - September 22nd, 2012

Week in Review

The Chinese economy is cooling off.  Worse, they have some even more bad news in their future (see Ageing China: Changes and challenges by Damian Grammaticas posted 9/20/2012 on BBC News China).

Life expectancy in China today rivals that in the West – it is one of this country’s impressive advances. Except China has not yet built a social safety net to provide pensions, affordable healthcare or homes for all its elderly.

Yet another reason why the Chinese economy is outpacing those in the West.  While Europe and the United States have suffered from the effects of an aging population China hasn’t.  At least, not yet.  While those in the West keep raising taxes and selling sovereign debt to pay for pensions and health care for the elderly and retired China has been growing their economy and using its proceeds to buy the sovereign debt of those Western nations.

So what is it like living in a nation without a social safety net?

“We don’t get a government pension because I never paid taxes. We don’t have any savings,” he says.

Because he has children and a wife, he does not qualify for a place in a care home – only those without relatives are eligible.

Of Henan’s 8.5 million elderly, just 2% are cared for in nursing homes. So Niu Yubiao and his wife fend for themselves.

The couple have seven grown-up children. But like other young people in the area, they have left home to look for work. Niu Yubiao has no idea where they are.

The reason why they don’t have any savings is not because they are greedy and materialistic.  It’s because they live in abject poverty.  And barely earn enough to survive.  This is what it’s like in China once you leave the modern cities on the coast.  The economic miracle of China has not reached the impoverished masses in their interior.

Today, there are 180 million Chinese aged over 60, just over 13% of the population. That will double to 360 million in fewer than 20 years, when China will have more retirees than the entire population of the US.

By the middle of the century, their ranks will soar again to 480 million.

China is ageing so fast that a process that took up to a century in the West will happen in the coming 30 years here. And as the ranks of the elderly swells, the working-age population is starting to shrink…

China’s incredible economic growth has been built on its vast, cheap labour supply. But the numbers entering the workforce have started falling. China’s birthrate has collapsed – at its peak in the mid-1980s 25 million babies were born every year. Now there are about 15 million births a year. The dramatic drop is the result of a richer, developing society and of the one-child policy…

Currently, China funds only meagre pensions, and there are six workers paying taxes for each retiree – in 20 years’ time, there will be just two workers for every pensioner.

This is the current problem in the advanced economies in the West.  A declining population growth rate following the post-World War II baby boom is bankrupting their nations.  For those social safety net programs the Chinese don’t have were implemented in these Western countries before the baby boom turned into a baby bust.  Now the elderly generations in these nations grow faster than the younger generations.  More seniors are retiring and consuming government-provided pensions and health care while fewer are entering the workforce to replace them and pay the taxes to fund these programs.  So they have increasing government expenditures at a time of declining government revenue.  Thanks to a lower population growth rate.  Which has overwhelmed governments.  Causing greater budget deficits and soaring levels of debt.

As bad as things are in the Western countries what’s waiting for China is of such a massive scale that one shudders to think what will happen.  For even if China continues to enjoy high economic growth their aging population will bankrupt them.  Either by caring for the elderly.  Or by driving up labor costs and/or labor unrest as their baby bust fails to replace those leaving the workforce.  Bringing that economic juggernaut to a crashing halt.

But the scenario is even bleaker.   For they have driven much of their economy with artificial economic growth.  Fueled by Keynesian policies.  Artificially low interest rates.  And government interference into the private sector.  Much like what gave the U.S. the subprime mortgage crisis and the Great Recession.  And much like what gave the Japanese their asset bubble and their Lost Decade.  For all demand-side stimulative growth (i.e., Keynesian growth) ends in Great Recessions or Lost Decades.  Because this kind of growth is inflationary.  And when you inflate asset values you make asset bubbles.  Which ultimately burst.  And when they do they bring down those inflated values to market prices.  The longer those inflationary policies were in place the higher those asset values soared and the more painful the deflationary fall.  Just ask anyone in Japan.  Or in the U.S. with an underwater mortgage.

So China has some unpleasantness in their future.  Perhaps a deflationary spiral.  Along with an accelerated aging population.  Either one by itself is bad.  But together it could be more than the Chinese economy can handle.  And the fallout of any Chinese crash will ripple through every other nation’s economy.  Where we all will feel it.  And suffer the consequences.  Because we are all Keynesians, too.  At least, the economic policies of our governments are.  And when China can no longer buy U.S. sovereign debt there will be no more deficit spending.  Just massive spending cuts.  Or, if they choose to simply print money, massive post World War I Germany inflation.  Where it will take a wheelbarrow full of money to buy a loaf of bread.  Like in post World War I Germany.

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Problems in Xinjiang between Ethnic Uighurs and Migrant Chinese over Jobs fueled by Oil and Gas Deposits

Posted by PITHOCRATES - March 3rd, 2012

Week in Review

Trouble in Xinjiang province.  Han Chinese migrants are coming in and taking Muslim Uighurs’ jobs (see China violence: 12 dead in Kashgar city in Xinjiang posted 2/29/2012 on BBC News China).

Xinhua news agency reported that rioters killed 10 people, while police shot dead two of the rioters.

The report gives no detail as to what might have triggered the violence.

Security has been high in the north-western province since riots in 2009 in the capital Urumqi between the Muslim Uighurs, who are the largest ethnic group, and Han Chinese migrants…

Almost half of Xinjiang’s residents are Uighurs, Turkic-speaking Muslims with cultural and ethnic links to Central Asia.

Many complain that large-scale migration of Han Chinese workers from the east has cost them jobs and is eroding their culture.

China has invested heavily in Xinjiang and the region’s rich oil and gas deposits are vital to its booming economy.

Now I’m no expert in Muslim Uighurs-Han Chinese relations but I’m guessing the problem is the oil and gas deposits the Chinese want that they have.  To power their economy.  And I’m guessing the Uighurs are not too happy about this intrusion into their autonomous part of the country.  And into their culture.  For they may be in China.  But their people aren’t Chinese.  At least the Muslim Uighurs are not Han Chinese.

Oil is the lifeblood of a modern economy.  So the oil and gas deposits in Xinjiang are going to become even more important to the Chinese economy.  And the Chinese government.  Which means things aren’t going to get better anytime soon in this north-western province.  Which questions the ultimate staying power of the Chinese economy.  For China is a large country.  With a lot of diversity.  And unlike in the United States, the Chinese aren’t saying their diversity is their strength.  Instead they no doubt see it as their curse.  For in an economy that is growing on its exports fueled by a cheap labor force, that diversity will only point out the inevitable income disparities.  And cause discontent.  Which will be further fueled by these cultural and ethnic differences.  As they always are.  Especially when cheap migrant labor comes in and takes people’s jobs.

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We’d do better Emulating Bourbon Country than China

Posted by PITHOCRATES - June 25th, 2011

A Generous Government robs the Private Sector

The economy.  It’s bad today.  It’ll be bad tomorrow.  And probably will still be bad when many are thinking about retiring.  I say thinking.  Because that’s all they may be able to do about retirement.  Think about it.  As they keep working well into retirement age (see Retirement As We Know it Is “Dead”: EuroPacific’s Pento by Peter Gorenstein posted 6/22/2011 on Yahoo! Finance).

“Americans are have negligible savings, the real estate market is still in secular decline, stock prices are in a decade’s long morass, real incomes are falling, public pension plans are insolvent and our entitlement programs are bankrupt.”

Pento believes these issues could be resolved if the government takes the right steps. What might those be? He recommends lowering taxes, reducing inflation and balancing the budget as a means to increase the value of the dollar. If the dollar had more purchasing power and interest rates were higher, retirees would be able to live off their fixed income, he says.

Please note the common theme in the resolution.  Less government.  Less government spending.  Les government taxing.  Less government quantitative easing (i.e., stop depreciating the dollar).  Because it is all of this government intervention into the private sector that has killed so many private sector jobs.  Reduced our real incomes.  Bankrupted our entitlement programs.  And destroyed our pensions (because fat pension funds are just too tempting to ‘borrow’ from to pay for more spending.  And by borrow I mean steal).

A generous government is a government that robs the private sector to pay the beneficiaries of the public sector.  But they have taken so much that they have given the private sector the worst recession since the Great Depression.  Which, in turn, has starved government coffers.  Talk about killing two birds with one stone.

There’s no Recession in Bourbon Country

Despite being in the worst recession since the Great Depression thanks to all that government intervention into the private sector, there is some positive economic activity out there.  One area in particular that is near and dear to my heart.  Bourbon (see Bourbon’s popularity feeds growth of Kentucky distilleries by Bruce Schreiner, Associated Press, posted 6/25/2011 on USA Today).

The producers are aiming to quench a thirst for bourbon — especially premium brands — that is steady in the U.S. and rapidly expanding overseas, thanks in part to the comeback of cocktails appealing to younger adults, lower tariffs, robust marketing and a larger middle class in emerging markets.

A tariff is a tax on an import.  To protect the domestic competition.  Or so goes the theory.  Protective tariffs destroyed a lot of American industry that had no incentive to improve (textile, steel, automotive, etc.).  But that’s another story.  Thankfully, bourbon is an American spirit.  All proper bourbon hails from Kentucky.  Thanks to those freshwater streams through the limestone bedrock of those rolling hills.  So there are no foreign bourbon markets to protect.  Keeping tariffs lower than they may be otherwise.  Thus providing a healthy export market. 

Industry observer F. Paul Pacult, editor of the quarterly newsletter Spirit Journal, said bourbon makers are showing an adventurous side with premium offerings that reflect an “intramural competition.”

“There’s more innovation happening in Kentucky right now than any other place in the world,” Pacult said.

Now Kentucky is bourbon country.  There are a lot of distillers competing against each other.  And yet the bourbon market as a whole is growing.  There’s no recession in bourbon country.  Which just goes to prove the old maxim.  Competition makes everything better.

The industry’s biggest boost, though, has come from exports.

Producers of bourbon and Tennessee whiskey reaped $768.2 million in export sales in 2010, up from $303.8 million in 2000, according to the spirits council, citing statistics from the U.S. Department of Commerce and the U.S. International Trade Commission.

The biggest overseas customers include Australia, Japan, the United Kingdom and Germany, but the industry is looking at two seemingly bottomless markets — China and India — along with other emerging markets in Asia and Africa.

China and India.  Those two countries driving up the price of oil.  Because of exploding demand in their emerging middle classes.  Countries that gave up much of their communist/socialist ways.  Who turned their disdain for capitalism to ‘dain’ (which I think means the opposite of disdain).  And they have smoking hot economic growth.  Hard to believe that a communist country, China, is schooling the United States in free market capitalism.

Crony Capitalism and Corruption in China

Or are they?  Oh, they are getting more Western.  But not like the UK or the USA during the Industrial Revolution or the booming times that followed.  But after the growth of Big Government in those counties (see The long arm of the state posted 6/23/2011 on The Economist).

Chinese students used to aspire to a job with a foreign company. Now they are more likely to want one with an SOE [state-owned enterprises].

This may seem an odd choice, since the dynamism in China’s economy is mostly generated by non-state firms… In 1999 government-controlled firms owned 67% of industrial capital; a decade later their share had fallen to 41%. But in the industries that pay the highest salaries, state firms dominate.

A new shorthand has entered common parlance: guojin mintui, meaning the state [sector] advances and the private retreats. ..It has been tightening its grip on some industries it considers “strategic”, from oil and coal to telecommunications and transport equipment. It has been devising market-access rules that favour state firms. And to the chagrin of private businesses, it has allowed state companies to remain active in a surprising range of palpably non-strategic sectors, from textiles and papermaking to catering. In recent years property development has become a lucrative sideline for government businesses. “The tentacles of state-owned enterprises extend into every nook where profit can be made,” writes Zheng Yongnian of the National University of Singapore.

Already the young people are choosing the public sector over the private sector when it comes to their career.  Because the bloated public sector pays more.  With this higher pay they must be attracting the best and brightest to these SOEs.  So these SOEs must be kicking the non-state firms’ asses.

Some Chinese economists worry that the government’s response to the global financial crisis will bolster state enterprises and their bad habits at a time when they urgently need reforming. As the confederation’s researchers put it, much stimulus spending has involved “swapping from the left hand to the right hand”: the state lending to the state…

Unirule noted that the profits of state-owned industrial companies had increased nearly fourfold between 2001 and 2009. But their average return on equity was less than 8.2%, whereas that of larger non-state industrial enterprises was 12.9%. Factor in the low cost of borrowing enjoyed by SOEs and their access to land at below-market prices, the report said, and their real return on equity between 2001 and 2009 was minus 1.47%. They are, in effect, destroying capital.

Apparently not.  They actually have a negative return on investment.  So the SOEs are just deadwood propped up by government spending and special privilege.  Reminds me of another Asian country awhile back.  Where there was private sector/public sector partnering.  Where capital was shuttled from the left hand to the right hand.  Anyone like to guess the country I’m thinking about?  Anyone?  No?  Here’s a hint.  China and this other country hate each other.  Bitterly.  Which makes it rather ironic that they’re now following their example.  That Asian country is Japan.  During the Eighties.  A decade of spectacular growth.  That was more bubble than growth.  And we all know what happened in Japan in the decade that followed.  Not a whole hell of a lot.  Because the bubble popped.  And they suffered a devastating deflationary spiral similar to the Great Depression.  It was so bad that they called the Nineties the Lost Decade.

Some foreign businesspeople complain that market-opening measures initiated in the 1990s and early 2000s have run out of steam.  Many saw China’s accession to the WTO ten years ago as a great impetus for reform. But when the country reached the end of its transition period in 2006, its will faltered. Many foreign companies still report doing good business. But especially since the global financial crisis, the government has been widely accused of twisting rules in favour of its state-owned or, sometimes, private-sector favourites…

Local governments sometimes play a decisive role in determining which firms succeed and which fail. Take Himin, a manufacturer of solar water heaters based in the city of Dezhou in the northern province of Shandong. Himin is a private company, but it is the local government’s champion. Together Himin and the government have devised a branding strategy for Dezhou as China’s “solar city”. The government has helped Himin to grow by requiring apartment buildings to be equipped with solar water heaters and by subsidising solar-heated bathhouses in villages.

This is not capitalism.  This is crony capitalism.  Not much different from mercantilism.  And not a sustainable economic model.  Unlike entrepreneurism.  Like they’re doing in Kentucky.  While the nation is suffering the worst recession since the Great Depression, distillers are investing and innovating, competing against each other as they book record exports.  Without any partnering with their government.  While Himin is in bed with government.  A government that giveths.  And can just as easily taketh away.  And with business dependent only on their relationship to government, you can bet that there isn’t a lot of investing and innovating going on at Himin.  Because they don’t have to.  So why would they?

This scheme to encourage what the government calls “indigenous innovation” focuses on seven “strategic” industries, from alternative energy and low-carbon-emitting vehicles to information technology. First Financial Daily, a Chinese newspaper, reported that investments by these industries could amount to as much as $1.5 trillion over five years, of which the state is likely to contribute 5-15%. Mr McGregor says the scheme involves creating new Chinese technologies on the back of foreign ones supplied by companies eager for a share in the government’s massive spending. Some Chinese scientists have complained about the likely waste involved in state-directed R&D, but the party loves big projects too much to listen.

Good innovation doesn’t need government money.  Investors are more than willing to finance a good thing.  What investors don’t like to invest in are bad investments.  Which is typically what the government invests in.  Because a good investment can attract private capital.  So that leaves the bad investments for government to fund.

People flocking to the government for financing are just like ants at a picnic.  They just want to get in while the getting is good.  But they have little of value to offer.  They’ll just pull a lot of money out of the private sector that could have been put to better use.  By producing real economic growth.  With a positive return on investment.

Worse is the state directing private investment.  People risking capital know what good R&D is.  People risking other people’s money don’t.  And they’re far more tempted to consider political reasons than good science.

China’s state-sector reforms in the 1990s went for the low-hanging fruit. A decade ago angry workers were easily cowed into submission by police or bought off with handouts. But any further reform would affect the interests of people in the top echelons of the party as well as their families, who have extensive connections with state-owned firms.

Zhu Rongji, the former prime minister whose reforms obliterated many of China’s state-owned firms in the late 1990s, has also gone on the attack. In April he made a rare public appearance at his alma mater, Tsinghua University. He handed over copies of a four-volume collection of his speeches, due to be published later this year, and pointedly invited readers to “make comparisons with the situation today”. To his supporters, the present looks grim.

Top echelons of the ruling communists, as well as their families, are well connected with state-owned firms?  No wonder they have negative returns on equity.  They’re stealing money from these SOEs.  This is everything the communists said the capitalists did.  And here the wealthy communist elite are doing it themselves.  Exploiting the poor working class.  How ironic.

Maybe the Chinese are just drunk with power.  Or on that fine Kentucky bourbon.

You’re going to Work until you’re Dead

The Chinese economy is a house of cards.  Much like it was in Japan in the Eighties.  And it will crash.  One day.  Just as the Japanese economy fell.  And no doubt a round of deflation will follow.  Like in Japan.  The Chinese are already raising interest rates to stamp out inflation.  To try and stop a bubble in their economy.  Much like the rest of world is.  Well, pretty much everyone but Ben Bernanke in the U.S.  Who may still try another round of quantitative easing.  Silly Americans.  Adding inflation to high unemployment only gets you the misery of the Seventies.  Carter‘s stagflation.

Although some of that economic activity may be somewhat artificial, it is producing surpluses.  Enough for the Chinese to buy U.S. debt.  So the Americans can continue to pay for their entitlement programs.  Such as Social Security.  And Medicare.  Which everyone and their brother knows will go bankrupt in the not so distant future.  Just as the Baby Boomers start retiring en masse to stress these programs like they’ve never been stressed before.  Now imagine the Chinese economy crashing.  And their surpluses turn to deficits.  And they can’t buy U.S. debt anymore.  That’d be one painful scenario.  Unable to borrow money, the U.S. would have no choice but to cut spending.  In a big way.  As in all those entitlement programs.  Which account for almost half of all federal spending.  Ouch.

Retirement as we know it dead?  You better believe it.  You’re going to work until you’re dead.  Even if you saved for your own retirement.  Because a broke government is a desperate government.  And if they can’t raise enough money taxing income, and the Chinese aren’t buying our debt, they’ll start taxing your wealth.  Your savings.  Your assets.  Your retirement.  Some nations already do.  So it’s not unprecedented.  Which would make a Chinese crash rather depressing. 

Gee, I’d hate to be in our shoes.

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The Rules of Supply and Demand Apply to Gasoline, Too

Posted by PITHOCRATES - October 18th, 2010

What’s the Difference Between Underwear and Gasoline?

Go through your wife’s or girlfriend’s underwear drawer.  What do you see?  What kind of underwear does she have?  Silk?  Nylon?  Satin?  Cotton?  Chances are you’re not going to see only one type.  There’ll be a little variety.  If you don’t see her get dressed, can you tell what she’s wearing?  Probably not.  The underwear she’s wearing will have no impact on her life.  Whatever she does on any given day will probably be the same regardless of her choice of underwear on that day.

All right, now think about what kind of fuel she puts into her car.  What are her choices?  At best, maybe two.  Far fewer than her underwear choices.  Chances are that she’ll be running her car on gasoline.  If it’s a late model car and she’s a hardcore environmentalist she may be using E85 (an alcohol-based fuel made from food).  However, if she finds herself having to refuel in a bad part of town late at night she’ll probably be switching back to gasoline pretty darn quick.  You see, you just can’t drive as far on a tank of E85 as you can on gasoline.  For when it comes to fuel, gasoline is king.  It packs a lot of energy per gallon.  It’ll let most people refuel on the weekend at that safe gas station close to home.

So what’s the difference between underwear and gasoline?  Choice.  If the price of gasoline goes up, we have but two choices.  Pay more.  Or drive less.  If the price of cotton goes up, we can pay more or wear less cotton.  And when there’s other fabric available (silk, nylon, satin, etc.), wearing less cotton is a whole lot easier.  And that choice will never put anyone in danger.  Like stopping to refuel in a bad part of town late at night.

Market Forces Driving Market Prices

Well, cotton prices are going up (see Flashback to 1870 as Cotton Hits Peak in the Wall Street Journal on line by Adam Cancryn and Carolyn Cui).  Floods in Pakistan and heavy rains in China have significantly reduced the supply of cotton.  And when supply goes down, what happens to prices?  They go up.  How much?

The sudden surge in prices—cotton has risen as much as 56% in three months—has alarmed manufacturers and retailers, who worry they may be forced to pass on higher costs to recession-weary consumers.

Ouch.  56%.  Even gasoline doesn’t go up that much in three months.  But will we, the consumers, absorb that increase? 

For the apparel industry, rising prices have upended roughly two decades of cheap cotton. Consumers have become used to relatively low prices, making it hard for garment producers to pass on the rising costs, especially as the economy struggles to recover.

Probably not.  Why?  Because we have fabric choices.  Wearing something other than cotton is no big deal.  It’s easy to do.  And life will go on just as it did when we were wearing cotton.  We won’t notice the difference.  Which is why it’s hard to pass these price increases on to us.  It’s not the same with gasoline.  With gasoline, we don’t have other choices.  Maybe E85.  But we’ll have to buy more of that to drive just as far so we might as well pay the higher gasoline prices.  At least our wife/girlfriend won’t have to stop to refuel in questionable parts of town.  But cotton isn’t gasoline.  People will buy other fabrics if cotton prices go up.  So manufacturers will look at ways to keep from passing on these costs

The most at risk are discount retailers that compete on price and sell large quantities of cotton-based basic items, such as T-shirts. But clothing manufacturers of all price levels may be forced to decide between absorbing the costs or passing them on. Some say they also are exploring different materials, including synthetic blends.

Because consumers have clothing choices, clothing manufacturers will switch to less expensive fabrics to offer what the consumer will choose.  Gasoline producers can’t do this.  There’s only gasoline.  Sure, there’s E85.  But E85 is not gasoline.  When you choose E85, you get less.  It’s not the same with fabric.  There may be a difference in the feel of cotton and a synthetic blend, but you’re not going to incur additional costs with a synthetic blend (i.e., you won’t have to buy more of the synthetic blend clothing for the same amount of ‘wear-time’ of the cotton).  So the consumer won’t just whistle a happy tune and pay these higher prices.   

Compounding this problem of supply pressure on prices is the demand pressure.

Meanwhile, demand from Chinese cotton mills has shown no signs of slowing. The U.S. Department of Agriculture said China bought 267,700 running bales of U.S. upland cotton last week, more than half of the total bales exported and more than the country usually takes.

The clothing manufacturers may be suffering, but, surely, the cotton farmers must be loving this.  Just like Big Oil must love those high oil prices, right?  Sure.  As long as someone is buying at these prices. 

However, the lofty prices are making some cotton farmers worry.

“I hope it won’t go too high. If you can’t put it into clothes and clothes become too expensive, prices will come down,” Mr. Wilkins said.

And that’s the problem.  As prices go up, we buy less.  When we have choices, we just won’t pay high prices.  And in free-market capitalism, there are always choices.

Drill Baby Drill – If You Want Affordable Gasoline

There are no other fuels to compete with gasoline like there is with fabrics.  But we still have a choice.  We just drive less.  That’s a choice.  Before the great recession resulting from the subprime mortgage crisis of 2008, gasoline had peaked around $4/gallon.  It doesn’t cost that much now.  Prices came down because a lot of people bought less $4/gallon gasoline than they did $2.75/gallon gasoline.  But that price will go up again.  Not because of Big Oil’s price fixing (if they could fix prices gasoline would not have come down from those $4/gallon prices).  But for the same reason cotton prices are going up.  Exploding demand in China. 

Until there is a viable alternative to gasoline, gasoline prices will always be more volatile than clothing prices.  But the laws of supply and demand will have similar affects on each.  A reduction in supply (a poor cotton harvest or a lack of new oil drilling) will raise prices.  An increase in demand (hungry Chinese cotton mills or a growing Chinese middle class buying and driving cars) will increase prices.  Both of these together will really increase prices.  It’s not Big Oil.  It’s not Big Cotton.  It’s simple economics.

How do you make these prices go down?  Well, with little control over the Chinese economy, our only choice is to increase supply.  And when it comes to gasoline, that means we need to drill more.  The more oil we pull from the ground the more we can refine.  It’s just simple economics.

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