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How Australia-China Relations Are Caught in the Monetary Battle Space

In today’s Daily Reckoning we revisit an old friend: China. That is, we revisit the importance of China to Australia’s economic, political, and demographic future. And we’ll take a look at China’s large influence on Australia’s present. And since we’re talking Pacific Powers in the Asian Century, Japan will make a cameo appearance.

There is a geopolitical aspect to the resource story that can’t be ignored. In fact it was almost a year ago that the entire China-Australia relationship was explored at our After America conference in Sydney.

By the way, almost all of the speeches are still topical and relevant. Steve Keen made a cameo appearance. There was Dylan Grice, Satyajit Das, Dr Paul Monk, and the entire cast and crew from The Daily Reckoning. We’ve nearly run down our final inventory of the six disc DVD set. But there are some copies left if you check soon.

In the meantime, Japan has entered stage left. ‘Japan accused China’s navy of locking weapons-guiding radar onto Japanese naval forces twice in the past three weeks – a serious escalation in the countries’ long-running territorial dispute that has heightened fears of a looming military conflict between the two Asian giants,’ reports the Wall Street Journal.

It’s hard to imagine Japan and China going to war over a couple of islands. But then, devaluation makes for unhappy bedfellows. Nobody thought war between the European powers was likely in 1914 either. You put some well-armed warships in the same neighbourhood and who knows what can happen?

Still, it seems unlikely two such large and mutually dependent trading partners would come to blows over unpopulated islands. This is probably a test to see how the US will react as China begins to flex its military muscles in the region. Around 37,000 US soldiers are stationed in Japan. Does the US back Japan as a regional power to counter-balance China? Or does it do nothing? The Chinese are probably keen to find out.

The fact of the matter is that the US is a declining economic power in the Pacific. That makes for an interesting strategic contest. How much longer can the US afford to deploy so many military assets in the region? Even if President Obama has signalled a ‘strategic pivot‘ toward the Pacific, there is the small matter of American deficits.

No discussion of Pacific power politics would be complete without a look at America’s finances. They are not good. You know that’s the case when an $845 billion annual deficit is presented as good news. Yet that’s exactly how most people are spinning yesterday’s report from the Congressional Budget Office (CBO).

In relative terms, the CBO’s projected deficit for 2014 IS actually an improvement on four straight years of trillion dollar federal deficits. But $845 billion is still a pretty big gap between what the government spends and takes in through taxes. CBO reckons that $85 billion in automatic spending cuts on March 1st (the sequester) plus higher taxes will reduce this year’s deficit, while also slowing GDP growth down to 1.4%.

CBO goes on to say the deficits will shrink over the next three years to just $430 billion by 2015, or 2.5% of GDP. That’s the level that most economists think is sustainable, which goes to show you that most economists are idiots. This entire process is an attempt to sustain and justify a government that never balances its budget.

But even the wonks and bureaucrats can see the grey wave on the horizon. CBO says that over the next ten years, ‘Deficits are projected to increase later in the coming decade, however, because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt.’

The ageing of the Western world is a fascinating subject. Our own Kris Sayce reckons this demographic trend could turn out to be the single-most important investment story of the next twenty years. As populations age and healthcare spending soars (public and private) a huge chunk of the economy will revolve around health. And where health is, technology can’t be far behind. That’s the angle Kris is taking.

For the here and now, though, Australia is affected by America’s deficit disorder in two ways. First, the larger the US debt gets and the slower the US economy grows, the harder it will be for the US to spend half a trillion dollars a year on defence. America might say it wants to be a Pacific power for the next 50 years. But everyone in the region – China, Japan, and the US – will know that the reality on the ground is different.

Secondly, everything you can say about America’s rising health care costs can probably be said about Australia’s as well. Can GDP grow fast enough to generate the tax revenues the government needs to support the Welfare state? Can it do so when the resource boom is over? It’s not going to be easy. Expect higher taxes.

And what will China do? It’s America’s largest creditor. Will it sit idly by as the US racks up unpayable debts, or debts that can only be paid in a depreciated currency? Probably not.

Gold imports from Hong Kong were up 94% to an all-time high last year, Bloomberg reports. The mainland wants more gold. Bloomberg calculates that the mainland imported 834.5 metric tonnes of gold in 2012. December 2012 was a record month, with imports of 114,405 kilograms.

It’s like there’s a currency war on, or something.

China hasn’t passed India as the world’s largest gold consumer yet. But at this rate, and with rising per capita incomes, it will. We suspect that by the next time China announces its official gold reserves, it will be pretty difficult to buy gold for less than US $2,000/ounce.

Regards,
Dan Denning
for The Daily Reckoning Australia

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From the Archives…

The RBA’s Interest Rate Bait Isn’t Attracting Many Bites
1-02-13 – Greg Canavan

A Prediction for 2013: Days of Abundant Natural Resources to Continue
31-01-13 – Chris Mayer

The Evolutionary Path of Boobus-Politicus
30-01-13 – Joel Bowman

The Unbalancing Act Happening in China’s Economy
29-01-13 – Greg Canavan

Marginal Utility: Steps Toward a Better Life
26-01-13 – Jeffrey Tucker

Dan Denning
Dan Denning is the Editor-in-Chief of The Daily Reckoning Australia and the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 as a small-cap analyst. From 2000 to 2005 he was the managing editor of Strategic Investment, where he recommended gold and warned of the US housing bubble. Dan has covered financial markets from Baltimore, Paris, London and, beginning in 2005, Melbourne Australia, where he is the Publisher of Port Phillip Publishing. To follow Dan's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
Dan Denning

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1 Comment

  1. Jason says:

    The article mentions the ‘aging of the west’, but China is aging at a faster rate. Demographically Asia is currently in the grip of a fertility collapse, the population of China will begin to decline by 2023, Japan is already in decline and Korea will be next in 2018. Just last week it was reported that the number of working age Chinese was shrinking and that they are now outnumbered by the number of ‘dependent Chinese’ i.e oldies. The other ignored demographic facts are the effects of decades-long gender selection practices in China, India and other parts of Asia, these will cause serious demographic issues in about 15 to 20 years time. Birthrates across Asia are plunging and many are lower than the lowest European rates. Immigration from Asia will begin to dry up as the Asian nations will not be able to afford to lose working age people from their shrinking working age demographic cohort. Asian birth rates outside of Asia are also falling with most already subreplacement, so the idea that China and Asia face ‘no problems’ is a myth, they are facing a serious demographic problem that cannot be ignored by money hungry Australian miners and politicians.

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