Last week’s Economist had a couple of nice articles on China’s National Day on October 1st, when the Chinese showcased their military, including the DF-31 nuclear-tipped ICBM, which can hit any city in America.  Most of these armaments have “Made in China” tags, not unlike all of our clothes and toys.

The Economist leader on the subject lamented this show of militarism, even comparing modern-day China to Prussia/Germany and Japan in the late 19th century.  I recall attending Bastille Day celebrations along the Champs Elysee in Paris in years past, when the glory-obsessed French showcased their military hardware; yet nobody got bent out of shape about French militarism.

Yet the rise of China should rightfully be compared to the rise of powers-past, such as Germany, Japan, Russia and the U.S.  We should consider how status-quo powers such as Britain might have mismanaged some of these rises in the 19th century and how we might avoid such mismanagement with regard to China today.  The blame for German militarism rests largely on the shoulders of Germans, this is true, especially on the fragile shoulders of Kaiser Wilhelm II and his cabal (though even Bismarck shares some of the blame).  Even so, the Western Powers could have better managed Germany’s rise.  They lacked an agenda for providing Wilhelmine Germany with enhanced international privileges to match its rising power.  Matching privileges with power is key to peacefully managing a power’s rise.  And, anchoring a rising power in the institutions of the status quo is likewise critical.

With the Concert of Europe and the Congress system of Metternich dead by the late 19th century, there were no international institutions to anchor Germany.  China, by contrast, is a card-carrying member of the U.N. Security Council, the WTO, the IMF and World Bank, the G-20, G-2, and other institutions.  Furthermore, although China may still feel somewhat dissatisfied because Taiwan and other East Asian assets (such as oil reserves in the South China Sea) are not being handed to it on a silver platter, Chinese privileges in the world are being equated step-by-step with Chinese power.  The ”peaceful rise” of the dragon is taking place, at least in part thanks to Western statecraft.

The parallel with Wilhelmine Germany is a nice one, but on one key parameter, China falls short of authoritarian Germany.  Germany of that era was a pluralist, if not a liberal, society.  There was the Reichstag, in which the Social Democratic opposition was well represented.  Sure, the Kaiser and his ministers were not beholden to the German parliament.  Yet the nascent democratic institutions were there, whereas Chinese communism has not provided such vehicles for democratic development.  Likewise, Bismarck had provided Germany of those days with the most progressive social security safety net in Europe, neutralizing in part the appeal of the left.  In China’s Workers’ Paradise, the social safety net is woefully inadequate.

A few months ago, observers worried that the global financial crisis could weaken the Chinese Communist Party’s hold on power.  As long as the CCP delivered economic growth north of 8% a year, few questions were asked by the populace.  But this social contract was seen as at risk.  These days, observers are applauding the resilience of the Chinese economy at weathering the storm.  However, China’s recovery has been driven by a huge fiscal stimulus and a massive state-directed lending boom, which could lead to banking sector weakness in the future.  True, China is much less-leveraged than the US or almost any Western nation, so it has room to be a little profligate.  Nevertheless, an economic shock in China, followed by political turmoil, cannot be ruled out.  Note that China’s leaders told Beijingers earlier this month to stay home in their crowded apartments to watch the National Day Parade on television, instead of thronging over to the Forbidden City, which couldn’t have a more suggestive name.  Since 1989, popular protests are the nightmare of China’s leaders.

Turkish Prime Minister Recep Tayyip Erdogan Source: Google Images

Sovereign risk in Turkey was once talked about in the same breath as Brazil’s.  Not so anymore.  One is going hat in hand to the IMF, likely to get $45 billion in the coming weeks; the other is largely self-financing.  What went wrong in Turkey?  Always keep your eye on the current account deficit, folks, even when Wall St. analysts tell you its nothing to worry about because it’s financed by FDI, or some such Bernanke-esque bunk.  Current account deficits mean borrowing from abroad.  And that means vulnerability.  Turkey went into the global crisis with a 5-6% current account deficit, while Brazil went in with small surpluses.  Keep your eye on America as well and its sovereign credit risk — current account deficits there have been nearly halved to 2-3% from 5-7% a couple of years ago, largely due to the US recession.  But the U.S. still can’t kick its foreign borrowing habit, Obama’s protectionism notwithstanding.  Likewise, watch out for “twin deficits.”  That’s when government deficits move in tandem with current account deficits (the former often driving the latter).  The US has these, as does Turkey (where government deficits are in the range of 5-7% of GDP, versus Brazil’s 3-4%).  Turkey’s overall government debt burden remains modest at under 50%, versus Brazil’s near-70%; however, Brazil’s government debt burden is headed down, while Turkey’s is rising.  Hence, Fitch moved Brazil up to investment grade not long ago, while Turkey languishes at BB-.  They both were BB- only a few years ago.  Sometimes the rating agencies get it right, even though it often takes them some time to do so.

So, the Turkish prime minister shows up hat in hand at the IMF’s doorstep, while President Lula’s Brazil is considered a rising power.  Have a look below at the CreditSuisse report from today on Turkey’s negotiations with the IMF.  Deputy Prime Minister Babacan, whom I met with in the past and perceive as smart and wily, is thankfully in charge of these negotations.

From CreditSuisse:

Turkey
Berna Bayazitoglu
+44 20 7883 3431
berna.bayazitoglu@credit-suisse.com
Prime Minister Erdogan denounced yesterday the claims in the local media that the IMF has offered a sizable financing package to the Turkish government which it cannot turn down. As we reported in the Emerging Markets Economics Daily yesterday, Erdogan told the Wall Street Journal on Monday (5 October) that the Turkish government has resolved one of the sticking points with the IMF, namely the IMF’s request for an independent tax revenue administration, and added that “he would like to see a new IMF program for Turkey agreed soon.” This was the most upbeat assessment that Erdogan has offered on the subject in a long while. Looking for an explanation for the change in Erdogan’s tone about an IMF agreement, the Turkish media claimed yesterday morning that the IMF might have offered a large financing package to Turkey (amounting to $45bn) which Erdogan cannot turn down. However, at a reception later in the day, Erdogan denounced local media stories that the IMF has made a new offer to Turkey.

Nevertheless, Erdogan’s statements in the Wall Street Journal add strength to the possibility that the government might invite an IMF mission to Turkey soon. As we noted in the Emerging Markets Economics Daily yesterday, speaking at various conferences in the last few days at the IMF/World Bank annual meetings in Istanbul and somewhat in contradiction to Erdogan’s statements in the Wall Street Journal, Deputy Prime Minister Babacan (who is the senior policymaker in charge of policy discussions with the IMF) had said that the discussions on the tax revenue administration and local governments’ spending were still continuing and that the IMF was studying the government’s medium-term economic plan and fiscal program.

The Statistics Office will release the industrial production data for August tomorrow. We forecast that industrial production was down 4.7% yoy in August, slowing from a contraction of 9.1% yoy in July. Our forecast is more optimistic than the consensus forecast (according to Bloomberg) of a 5.2% yoy contraction.

During the Great Depression, international trade contracted by a third, as countries around the world erected barriers to trade, aggravating a sharp decline in output already under way and throwing millions out of work.  Thus far, in the Great Recession of 2008-09, the end of which some observers may have called too soon, the major powers have avoided trade protection.  Enter the Obama administration.

Last year, I published a piece calling for those supporting Democrats in America’s national elections to make sure they keep the Dems honest on trade.  Concerns about Obama’s commitment to free trade, due to his campaign strategy in Midwestern states last year, were dismissed as mere election-year politics.  His commitment to satisfying his friends in America’s trade unions is now abundantly clear, not only because he parrots their unfair accusations about abuses by the Colombian government, but also in the latest action by the Obama administration to raise tariffs against Chinese tires (see NYT imes article).

Trade wars can spiral out of control, even if this is not the original intention of protectionists.   During the 19th century, Britain, the unrivaled power at the time, ensured global prosperity through its commitment to free trade.  The U.S. since 1945 has played this role, through both Democratic and Republican administrations.  Doubts about President Obama’s commitment to free trade, a key pillar of international cooperation and a key strategy for broad-based global prosperity, have re-emerged, a point quite ably discussed in this Economist article.

Photo:  Chinese workers loading tires for export.  Source:  www.financialpost.com

What would President Monroe say?

China: Learning to enjoy the Brazilian bear hug. Presidents Lula and Hu. Source: Xinhuanet

An Economist article discusses the growing presence of Great Powers, especially China, in Latin America, flouting nearly two centuries of U.S. dominance in the region, since the articulation of the Monroe Doctrine in the early 1820s.  In the near term, this worry is overdone.  Longer-term, if the U.S. continues to damage its sovereign creditworthiness, i.e. by not putting in place a medium-term fiscal consolidation program (that is, to reduce America’s rising government debt) – a program that should include putting health care reform on hold, then America’s relative decline will accelerate and this will affect its projection of power in the Western Hemisphere. 

In the 1820s, as revolution in Spain led to unrest in its colonies in the Western Hemisphere, the Holy Alliance of autocratic east European courts – Russia, Austria and Prussia, threatened to intervene in these colonies.  President Monroe in 1823, backed by the British Navy, warned Europe that any extension of European power to the Western Hemisphere would be “dangerous to our [U.S.] peace and safety.”

Nowadays, as the world moves increasingly toward a multipolar system, power projection in Latin America is largely in the form of commerce.  China, India and others seek, above all, the region’s raw materials to fuel their rising economies.  True, with economic influence comes political influence.  True as well, such powers as Russia and Iran seek direct political influence through arms sales and energy deals with the likes of Chavez’s Venezuela, Cuba, and Evo Morales’s Bolivia.  But these countries are on the fringe.  More of interest to U.S. policymakers are China’s economic relations with the major economies of the region, notably Brazil.  China’s economic relations with Brazil have been hand in glove — raw materials fueling a manufacturing juggernaut, while with Mexico, they have been competitive.  Brazil is also a manufacturing nation and will one day find China an unwelcome competitor. 

So, the thrust of the foreign “intervention” is commercial and good for Latin America.  This is good for the United States as well, insofar as China supports growth in the region and the U.S. no longer has to be relied on so heavily as the source of demand and investment for the hemisphere.  In previous U.S. downturns, Latin countries hovered on the brink of default (or in fact defaulted), whereas this crisis they have weathered, due in part to demand from China and elsewhere. 

China, for its part, is “intervening” in Latin America as a rule-abiding member of the global capitalist system, wrought by the U.S. and its allies.  This should not worry American policymakers.  Sure, they should keep an eye on the mischief-making of countries like Iran and Russia that seek to upset the U.S. in its own backyard, much as Krushchev did with Cuba in the middle of the last century (however less dramatic and threatening the current mischief-making is).  Again, the smartest thing U.S. policymakers can do is get America’s fiscal house in order – by first of all, postponing health care reform — and revive the formidable U.S. economy — upon which the country’s power projection is based — not least through continued banking overhaul, workout of real estate loans, policies to increase household savings, and a reform of monetary policy (by discarding Greenspan’s discredited approach).

The economic news out of Asia just keeps getting better. With GDP figures for the second quarter rolling in, it is now predicted that emerging Asia will grow by more than five percent this year, compared to a contraction of 3.5 percent in the Group of Seven rich countries. So much for Asia waiting for the recession to end in America – the decoupling debate is alive and well.

The cover story of this week’s Economist details Asia’s remarkable rebound. “Asia’s rebound has several causes. First, manufacturing accounts for a big part of several local economies, and industries such as cars and electronics are highly cyclical: output drops sharply in a downturn and then spurts in the upturn. Second, the region’s decline in exports in late 2008 was exacerbated by the freezing up of global trade finance, which is now flowing again. Third, and most important, domestic spending has bounced back because the fiscal stimulus in the region was bigger and worked faster than in the West. India aside, the Asians entered this downturn with far healthier government finances than rich countries, allowing them to spend more money.”

The Economist also argues that “if anything, the crisis has reinforced the shift of economic power from the West to the East.” The increase in spending by consumers in emerging Asia will offset the fall in the United States and the euro area and help rebalance the world economy. Still, “Asia cannot replace the American consumer: emerging Asia’s total consumption amounts to only two-fifths of America’s.”

While some are wondering if Asia will be able to sustain its recovery without creating asset bubbles, it may be unwise to underestimate the Asian tigers.

Illustration by Bill Butcher and graphs from The Economist.

Australian mining giant Rio Tinto knows that when it does business with a sovereign government, it is dealing with an entity that writes, executes and adjudicates laws on its territory.  Read about the China-Rio Tinto issue in a previous post. 

Every multinational knows, especially those in industries such as mining and energy that operate in funky locales, that the sovereign can seize your assets, throw your officers in prison, and undertake other such mischief as it pursues its interests, whether economic or political.

So, as the Chinese goverment has orchestrated an assault on Rio Tinto in recent weeks, claiming corruption and over-invoicing, it is sending a message to Rio Tinto, its backers in the Australian government, and the wider world — you can make money over here, but do not cross us.  A NYTimes article today suggests that the Chinese government is easing its pressure on Rio Tinto as negotiations over a mining contract resume, which became acrimonious in late June.  

Lest we forget, all sovereigns, even liberal democracies, have the power to encroach on private property.  A libertarian paradise exists nowhere on Planet Earth.  “Eminent domain” is a concept in the United States, whereby the state has the inherent right to seize private property for its purposes, be it a public highway, utility, a military facility.  Financial compensation by the goverment is due the private owner of the seized asset.  You would feel like you were up against the Chinese government, if your local mayor decided he needed to build a road across your lawn.  Hence the American phrase, “You can’t fight City Hall.” 

With the retreat of colonialism after World War II, a wave of nationalizations and expropriations by sovereigns in former colonial lands changed the landscape of international commerce.  Does anyone remember the Oil Embargo of the 1970s?  With the arrival of the Washington Consensus in the 1990s, which despite what naysayers say is still largely the consensus, most reforming emerging market sovereigns resist nationalization and expropriation because this destroys a country’s business climate and limits the inflow of capital.  Almost everyone knows this, unless you’re Hugo Chavez or Evo Morales.  Note the fact that the Brazilian government under President Lula, an icon of the Latin American left, was on the receiving end of an expropriation threat, when Bolivia’s Evo Morales called for the nationalization of natural gas refineries owned and operated by Petrobras, Brazil’s energy behemoth, a few years ago.

So, shed no tears for Rio Tinto…

The NYTimes published an article today detailing a set of energy deals concluded between Russia and Turkey in Ankara, with Prime Ministers Putin and Erdogan present.  The deal was with Russian energy giant Gazprom, allowing state-owned Gazprom access to Turkish territorial waters, a benefit Russian czars and party chairmen since Peter the Great (pictured above — who ruled Russia from 1682-1725) have sought by force (or threat of force).  Now, in true “Western” fashion, Russia, Inc. is signing a business contract that provides benefits to Turkey as well.  Turkey desires to become an energy hub and has obtained a Russian commitment to build a pipeline across its territory.

The Times article explains how Western interests have competed with Russia for energy agreements with Turkey in order to avoid Russian dominance of the Eurasian energy pipeline system, and the consequent vulnerability of energy-hungry Western Europe.  Russia has used pipeline cutoffs before for political purposes, e.g. with the Ukraine.

Turkey for its part, with a less pro-Western government than heretofore, headed by the moderate Islamist AKP party, probably does not mind playing what the Brits over a century ago called, “the Great Game,” or the Great Power competition in the East.  Has Vlad the Great bested Peter??

China's rising presence in Africa. Source: Google Images

An article on a corruption investigation in Namibia related to Chinese investment there appeared in the NYTimes on Friday.  China is confronting the growing pains of being an “imperial” power, as this giant nation increases its FDI and access to raw materials and markets in Africa, Latin America and elsewhere.  Just like imperialists that came before, since the scramble for Africa in the late 19th century, bribes and other forms of less-overt control are hard to resist.  I explored China’s challenge of cleaning up corrupt practices related to international commerce in an earlier post, and my colleague David Kampf  looked into the BRICs rising profile in Africa. 

One question is whether China, as it rises, will follow the path of the U.S. (and other Western powers) of attempting to reduce corrupt practices in international commerce.  The U.S. Foreign Corrupt Practices Act of 1977 sought to eliminate the bribing of foreign officials and increase the transparency of business relations.

US-China Strategic and Economic Dialogue. Source: Google Images

In the first official meeting of the US-China Strategic and Economic Dialogue this week, which puts the Democratic stamp on the brainchild of Hank Paulson, Bush’s Treasury Secretary, Chinese Finance Minister Xie Xuren called on the U.S. to reduce its widening fiscal deficit.  In response, U.S. Treasury Secretary Geithner assured the Chinese that, once growth resumed, the Obama administration would do just that.  See today’s NYTimes article on the subject.  Yet a recent Economist article emphasizes the inconsistency of this goal with Obama’s laser focus on health care reform, which many believe will not be deficit-neutral.  The Chinese worry about the value of their massive holdings of U.S. treasuries (appx. $1.5 trillion).  Fiscal profligacy would mean dollar weakness.  One wonders why in the middle of a financial crisis, U.S. lawmakers feel that universal health care is so important, so much so that they are willing to risk U.S. sovereign creditworthiness.  Obamanomics is like Reaganomics in reverse.  Reaganomics argued that tax cuts and massive defense spending hikes would ultimately lead to higher revenues and a balanced budget.  Not very likely.  Obamanomics argues that fiscal stimulus and health care reform that reduces costs will yield more robust GDP growth and therefore room to cut deficits over the medium term.  Wishful thinking.  I guess Democrats understand that their massive legislative majorities will not continue forever, so they had better get their pet projects done now or never (including getting Judge Sotomayor confirmed).  Hopefully, America’s standing in the world, and therefore the value of China’s foreign exchange reserves,  will not suffer as a result.

If the positions of the sun and the moon influence the future global balance of power, the solar eclipse seen today in Asia could mark the dawn of a new Asian century. This was the longest eclipse since July 11, 1991 (only months before the official dissolution of the Soviet Union) and there won’t be another eclipse as long until 2132.

Or, maybe not.

Photo from Yang Lei/Associated Press.