Monday, May 21, 2007

This Week's Theme: Why The Truth Can't Be Told

Why China Is Being Scapegoated

We're tackling a big topic today with lots of charts: Why Congress is scapegoating China.

Here's the issue in a nutshell. We all know the U.S. runs a big trade deficit with China, a deficit which is growing. (As this chart shows, we also maintain a deficit with Japan, Germany, the EU and virtually every other trading nation.)

The problem, our astonishingly stubborn elected officials believe, is that China's currency, the renminbi or yuan, is undervalued. China pegs the yuan to the dollar; a few years ago it was 8.25 to the dollar, and now it's under 8.

Congress apparently believes those who say the yuan is undervalued by 40%--meaning it should be about 5 to the dollar. If this came to pass, then Black and Decker would instantly move their factories from China back to the U.S. as it no longer made financial sense to have factories in China.

This is so wrong-headed it boggles the mind. First, Black and Decker et. al. have factories in Asia because that's their fastest growing market. It makes sense to make stuff there--and many of the components are made there, too. Second, wages in China could rise 40% (via the currency devaluation Congress so keenly desires) and that would mean the factory wage of $200 per month would rise to $280--compared to an average U.S. wage of $3,000 (don't forget the mandated benefits and healthcare).

Did anyone notice that unemployment in the U.S. is at multi-decade lows of 4.5%? Is "saving jobs in America" really our most pressing issue? And how does devaluing the yuan actually "solve" that problem? All it does is make Chinese products 40% more expensive to U.S. consumers.

If you're making widgets in China, are you moving the factory back the America now? No, you're squeezing your Chinese suppliers to find 30% cuts in production costs, or moving the factory to Vietnam, where the average wage is $150/month. As this chart reveals, U.S. corporate profits have been on an absolute tear during the rise of the trade deficit with China, skyrocketing to the unprecedented height of $1.3 trillion--fully 10% of total U.S. GDP.

Gosh, do you think there's a connection? Of course there is. You know that $200 iPod that's made in China? Well, about $20 stays in China, because the factories assembling the iPod are owned by Apple, and many of the components are made in factories owned and operated by Taiwanese, Korean and Japanese corporations. China owns very little of the supply chain for the iPod. Manufacturing in hyper-competitive China is a low-profit venture; as I have posted here before. BusinessWeek stated that average profit margin for manufacturers in China is 1%-4%.

Did Steve Jobs become a corporate god by generating profit margins of 2%? No. The real meat of the money--the $180 of the retail price--goes to Apple (huge profit margins), the wholesalers /distributors, and the retailers--all in the U.S. But does Congress even "follow the money" in the real world? Clearly, no.

With a gracious thank-you to Mish, here is a link to Stephen Roach, Economist for Morgan Stanley, stating that Congress is in no mood to listen to reality; across both parties, politicos have already decided the solution to America's ills: Past the Point of No Return. Correspondent James C. recently contributed this observation to the Readers Journal:

I have some strange measures of the American consumerism patterns. I count self storage buildings in the areas that I travel and also monitor how many bags of trash people take out on trash day. (I have never claimed to be normal) There is some virtue to this kind of study. One has to purchase, and then throw away, a lot of stuff to have 5-6 bags of trash at the curb each week. Our household consists of my wife and myself. We usually have one bag of trash each week. Across the street is a household consisting of a husband and wife and they generally have at least 5 bags of trash. Are they 5 times as happy as Barbara and I?

I call Fred, the neighbor above, the "Tool man". He has every conceivable gadget that the Chinese can make. His yard is a little bigger than ours. I mow with a 20" push mower. Fred had three riders, a push mower, a gas leaf blower, a gas trimmer, a gas sidewalk edger, and a gas snow blower! Our society just can't go on like this. Yet when I try to talk to clients about this kind of stuff, they glaze over or say something like, 'that is depressing, I don't want to talk about it anymore." I think this kind of attitude seals our doom!

As this chart reveals, Americans are saving not just zero, but actively spending money they don't have--a negative savings rate. The only other instance where Americans drew cash from savings was during the Great Depression. But we're living in a time of "prosperity," remember?

So where is all this wealth that consumers are spending so freely coming from? From the extraordinary rise of real estate values in the U.S. As this chart shows, real estate assets as a percentage of U.S. GDP has reached unprecedented heights. (That's a phrase which gets repeated here often.) To view charts showing unprecedented consumer debt accrual via re-financing ( a.k.a. "the housing ATM"), please scroll down to the entry of May 11.

Lest you think U.S. consumers are profligate wastrels while Congress is a gleaming tower of fiscal virtue, consider this chart. Yes, that's bankruptcy looming on a national scale-- mandated expenditures (entitlements like Social Security and Medicare, and debt on the national interest) will soon balloon so far above tax receipts that even the profligate borrowers in Congress and the White House will be unable to borrow enough money from the rest of the world to fund the gap.

The problem isn't the (often American or Japanese/ Taiwanese/ Korean-owned) factories in China or the yuan--it's that Americans save nothing and spend borrowed money lavishly. If you need proof, please read LUXE POPULI Spending for luxury items is increasing four times as fast as overall expenditures as ordinary Americans go for the gold.

But like the distracted yuppie parent who can't bear to rein in their bratty, irresponsible child's excesses, Congress dares not tell the American public that they need to spend less and save more. But Why? Here's the answer: the bankers would stop making money.

I can already here "free marketers" howling in outrage at my fingering bankers, but let's look at reality as carefully described in last week's BusinessWeek: The Poverty Business: Inside U.S. companies' audacious drive to extract more profits from the nation's working poor.

Here's how it works: find people are who are poor credit risks, then offer them some credit--at an outrageous price and profit margin. What choice do they have? Basically none.

Federal Reserve data show that in relative terms, that debt is getting more expensive. In 1989 households earning $30,000 or less a year paid an average annual interest rate on auto loans that was 16.8% higher than what households earning more than $90,000 a year paid. By 2004 the discrepancy had soared to 56.1%. Roughly the same thing happened with mortgage loans: a leap from a 6.4% gap to one of 25.5%. "It's not only that the poor are paying more; the poor are paying a lot more," says Sheila C. Bair, chairman of the Federal Deposit Insurance Corp.

HAPPY AS SHE WAS with the Saturn she bought in December, 2005, Roxanne Tsosie soon ran into trouble paying off the loan on it. The car had 103,000 miles on the odometer. She agreed to a purchase price of $7,922, borrowing the full amount at a sky-high 24.9%. Mainstream financial institutions are helping to fuel this explosion in subprime lending to the working poor.

Wells Fargo & Co. and U.S. Bancorp now offer their own versions of payday loans, charging $2 for every $20 borrowed. Based on a 30-day repayment period, that's an annual interest rate of 120%. (Wells Fargo says the loans are designed for emergencies, not long-term financial needs.)

Terms of the Tribute MasterCard are a world away from the money-back and frequent-flier offers familiar to more prosperous cardholders. Marketed by Atlanta-based CompuCredit, a giant in the subprime card business, Tribute MasterCard offers no such fringe benefits. Rose Ajuria's card carries an interest rate of 28%, compared with about 10% on a typical card.

McBride graduated in 1992, owing $45,000 on student loans. That debt became her main financial burden, she says. The 9.5% interest rate isn't particularly steep, but she tended to view the payments as less pressing than putting food on the table or paying rent. Late fees piled up. Today she owes $159,991, up from $117,000 only 18 months ago. When dunning notices arrive, she tosses them in the stove. Personal bankruptcy proceedings in 2003 dissolved dozens of McBride's liabilities. But by law her debt to student lender SLM Corp. (SLM ), better known as Sallie Mae, wasn't affected. Every month, $450 is garnisheed from her wages, reducing her take-home pay to $1,338. The garnishment doesn't even cover interest and penalties, let alone the principal. Says McBride: "There's no way this thing will ever be paid off."

Did I mention that "you owe us forever" Sally Mae was recently bought by a private equity firm? I wonder why--could it be the debt which even bankrupcty can't trim? And who muscled that bankruptcy law through a complacent Republican-ruled Congress a few years ago? Your friendly U.S. bankers. If you foolishly believe the bankers have no political influence, I advise you to study the bankruptcy laws. Contributor/blogger/attorney Fred Roper can help set you straight on just how pernicious and anti-consumer rights this "bankers law" truly is.

And if your naivete needs more bashing, please read this from the S.F. Chronicle Bankers oppose fee, rate limits. The chart above shows how banks have become extraordinarily dependent on mortgages for their profits (total earning assets).

This chart depicts how housing has become the linchpin for the American homeowner: the value of housing as a percentage of disposable income has skyrocketed to--you guessed it--unprecedented heights.

So let's add all this up. Bankers are making vast, unprecedented fortunes selling debt to Americans--mortgages and home equity lines of credit to homeowners, mortgage-backed securities to investors/speculators, and sky-high consumer debt to subprime/low-income consumers.

Meanwhile, back at the ranch, American corporations have exploited cheap manufacturing in China to reap record levels of profits--fully 10% of the entire U.S. GDP is corporate profit. The essential ingredient in all this stupdendous profiteering is, of course, the American consumer's debt and spending binging.

And that's Why The Truth Can't Be Told. If Americans were told that their profligate spending is the problem, and saving more is the answer, then guess what? Fewer loans and debt equals contracting profits for banks, and more savings means contracting sales and profits for U.S. retailers, manufacturers and the entire supply chain. In other words, the profit party stops. So let's blame China instead.

To view the charts, pelase go to my main site

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