Can China Change the Rules of Global Capitalism?

This is shaping up to be one of those weeks (or months...or years) in which geopolitics has a big influence on stock markets. The Australian corporate earnings season isn't in full throttle yet. And there's not much data coming out this week that gives us more insight into the economy.

But how much more insight do we really need? We know the world is in the early stages of recovering from the greatest debt binge of all time. The central bankers are trying to keep the party going and prevent debt deflation. But the accumulated liabilities from the boom have to be written down or written off. Balance sheets must be rebalanced.

And we also know that markets are giving way to politics. The free market is waning. Government run markets, on the other hand, are waxing.

For example, it appears China is beginning to throw its considerable economic weight around. It's doing so in a tentative, experimental manner, not sure if it will offend but not seeming to care all that much. And why should it? The world is perfectly happy to do business with the largest emerging market of the next fifty years. Other issues-human rights, the environment, and the Rule of Law-are secondary.

It should be interesting to watch. If economic Empires were like teenagers, they'd be temperamental, volatile, and inscrutable. And so China-which to be fair is a venerable 5,000 year old culture-is entering its economic adolescence. Proud, confident, and slightly unpredictable.

For instance, is China trying to put Australia in its place by arresting Rio Tinto executive Stern Hu? Is this a not-so-veiled message that if Australia wants to benefit from China's industrial growth and stimulus pending, it had better be more compliant on things like, oh...say...iron ore pricing? Is Australia just now discovering that the new economic order comes with certain terms and conditions that are not negotiable?

And here's the really interesting question: If China is flexing its economic muscle, can it simply change the rules of global capitalism? China's market is large. Its savings are legendary. And the Western model of capitalism doesn't have a lot of moral authority and the moment. So will businesses be willing to do business in China, on Chinese terms, at the risk of landing their executives or workers in jail if they run afoul of ambiguously defined laws?

From a Chinese perspective-and we're only imagining here-it must be a bit too much to be lectured by anyone in the West on the Rule of Law or corporate ethics. After all, there's been plenty of Law breaking/flouting/changing in capitalist economies over the last few years. Does China's government intervene, intimidate, and manipulate any less than governments in America, Britain, France, Germany , and Russia?

The fact that we're even asking that question-unless it's a really dumb question-is not good for markets. It means that in currency matters, business matters, regulatory matters, and tax matters, investors have less and less certainty about the environment they're operating in.

Not that investors ever have total certainty. But the more variable and unpredictable (and capricious) the action of the State is, the more you can expect investors to lay up their stores in cash and sit on the sidelines. When you can't trust a currency or a sovereign bond...well then you're probably going to become very conservative about your future capital spending (and borrowing). All of which argues for either a second dip to the American (global) recession or anemic economic growth.

And then there was this bit of dollar subterfuge from the G-8 summit in Italy. "We should have a better system for reserve currency issuance and regulation so that we can maintain relative stability of major reserve currencies' exchange rates and promote a diversified and rational international reserve currency system," said Chinese State Councilor Dai Bingguo, according to today's Age.

How about that? China has 70% of its foreign currency reserves in U.S. dollars. It's walking a fine line. It would clearly like to rattle its currency saber in order to keep American deficit spending (and potential dollar devaluation) from threatening the value of those investments. But by repeatedly brining up the dollar's weaknesses, it does the very thing it wants to avoid; threatening the value of its dollar-based investments.

Free markets-one simple. Now complicated.

French President Nickolas Sarkozy tried to defuse the situation, but he only managed to sound like a moron. "These are complex subjects where positions have to evolve, but we can't remain based on a single currency," he said.

Then, proving that politicians knows more about dating leggy models than running an economy economics, he added, "We have to ask ourselves: Shouldn't a politically multi-polar world correspond to an economically multi-monetary world?"

If the Lion is the King of the Jungle, should he not also be King of England?

You can argue about where political power comes from. Some say trade. Some say sound institutions governed by the Rule of Law. Some say the barrel of a gun. For example, a nation can have a small economy. But with a small nuclear arsenal, it's going to punch above its weight geopolitically.

But economic power is not based on exclusively on coercion or the ability to intimidate your trading partners/strategic rivals. A "multi-monetary" world would be fine by us if it meant there was a free market in money. You would be free to use whatever money suited you best, and you would judge that money on its stability and its utility.

Yet as we begin the week, it's becoming plain to see that there's no such thing as a "multi-monetary" world right now. It's really a "bi-monetary" world. There is government printed (fiat) money-backed by nothing except the economic potential of the economy from which it comes (or the coercive power of the State which issues it). And there is free market money.

Free market money-at least in a world rife with mistrust about government money-is going to be gold and silver. In a geopolitically influenced market, a bi-metallic view on money may turn out to be the biggest winner.

And for what it's worth, we believe the larger cost of the credit bubble-in addition to the trillions in household wealth wiped out and trillions more in misallocated capital-is how far from its traditional roots Western capitalism has strayed. When people are free, when rules are clear and fair, when money is sound, and when private property is respected and money is not confiscated by the State, political liberty and economic liberty thrive side by side. Indeed, one is not possible without the other. More on the subject this week.

Dan Denning
for The Daily Reckoning Australia

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