Mutter from the gutter (always an interesting if not necessarily a wholly reliable source) last week came from the French Finance Minister when he claimed that the venerable Alan Greenspan had apparently admitted that the US had “lost control” of its budget “at a time when racking up deficits had been authorised without any control (from Congress)”. My apologies for the poor English but it is a quote from Monsieur Breton the French minister. Apparently the US response was on the lines of a frosty “things can get lost in translation”. Although such comments have no doubt been taken out of context, such a “French fries” spat not only reflects the differences between the parties, but also underlines the concerns that we should still have over both the level and continuing growth of the US deficits. This of course, can only be further exasperated by the extra costs that will be incurred as a result of the destruction wreaked by both recent hurricanes.

Carrying on with the subject of somewhat tense relations, I have in the past made frequent mention of the symbiotic
relationship between the world’s current only superpower and potentially the world’s next superpower. “Mutually
beneficial or mutually destructive?” would of course be a fascinating, but somewhat fruitless debate. More important though is to look at the impact and reaction of either party to the current global economic situation. The US has of late encouraged the opening up of China to global economics at various levels, as a trading partner from a political desire to see the end of the last major communist power on the planet.

However, events and reactions have moved on significantly from here. Here are some of the key issues in my view.
Capitalism has been allowed into China albeit under the auspices of a continuing centralised communist dictatorship, but the country is still not a capitalist nation. Inward investment from manufacturers, often from the US but in the early days in the 1990’s mainly from Europe, Germany & Switzerland in particular, seeking lower costs, have been a growing trend for the past decade and this surge has more recently broadened out to encompass financial services with banks buying into the local bankrupt banking entities. Next year their relatively small percentage holdings will be able to grow to full takeovers – now here is an opportunity for banks to potentially make money, but more likely lose fortunes in a financial fashion fad.

Many American corporations have benefited from these lower manufacturing costs and labour in China, as can be seen from their healthy profits over the past three years and especially their earnings per share. This last element is especially interesting as earnings per share can rise not just because companies have grown, but also because they have cut their costs – by transferring manufacturing to China! Good news for corporate America and their shareholders, good news for China – so who’s complaining? Well US workers to start with - and here lies one of the issues that populist politicians are going to have to deal with their more xenophobic attitudes about foreign goods and trade. This of course is made worse when those “damn foreigners” start buying US companies. We have been here before though, as during the 1970’s when we saw the influx of Japanese companies buying into the US, but the difference then was that they at least established assembly plants in the US.

Then there is another issue. If the US politicians start complaining too much then they should remember who has actually been financing their expansion over the past four years. The growth of the US economy has been paid for by debt issued by the US Treasury, and that debt was financed by those foreigners again – and especially those oriental ones and particularly those communist Chinese ones. This is a tangled web which is too complicated for simplistic and populist political rhetoric from trumped up local grandees up for re-election. These issues of global trade will no doubt come to the fore within the next year with the next round of Doha WTO talks, when issues of free trade and protectionism will be thrashed out, and the EU and the USA will have to decide what type of relationship they want with the “Dragon”. Having financially been let lose it will be naive to just assume that it will just compliantly do the bidding of the West. The growing strength of the emerging national giants of Brazil, Russia, India and China (the BRIC) could, as the acronym implies, cause some difficulty for the cozy over confident developed world.

Speaking of over confidence – he is at it again - Alan Greenspan using the “e” word. Last week he made reference to asset bubbles being fuelled by “market exuberance”. You may recall his comments about “irrational exuberance” in the equity markets back in 1996. It took nearly another four years for investors to take any notice, but his warning was certainly prescient, if not timely. The same may be the case again, but we have been warned.

And finally………… from the “must have” stocking filler book for this Christmas “The Meaning of Tingo”, there is the perfect word for those politicians pontificating at their party conferences over the past few weeks – Capoclaque.

Apparently it is Italian for someone who coordinates a group of clappers. Along with the term Pukau which is Malay for a charm used by burglars to make people fall asleep before stealing their goods, this surely encapsulates our politicos meeting at our seaside resorts this autumn.

Have a good week,

Justin A. Urquhart Stewart
Director
Seven Investment Management, a division of Killik & Co

The comments and views expressed by Justin are not the opinion of Elements and we are not responsible for any of the articles written by Justin.