"Bomb" was an unfortunate choice of words

In my last post, I suggested that global central banks were in the process of shifting towards monetary policies to better target economic sectors that were experiencing slow growth (see Central banking 2.0: Smart bombs over carpet bombs). The metaphor I used substituting the shock-and-awe policy of carpet bombing the economy to using "smart bomb".

Well, perhaps the word "bomb" was an unfortunate choice of words.

I was catching up on my reading from the weekend and I came upon this item from Bloomberg indicating that China was trading barbs with the US and Japan over territorial claims in the South China Sea (emphasis added):

Rebuffing criticism from the U.S. and Japan, China sent a clear message at an international security meeting that it will press ahead with territorial claims that have caused friction with Japan and smaller neighbors.

After U.S. Defense Secretary Chuck Hagel described China’s actions in the South China Sea as destabilizing and Japanese Prime Minister Shinzo Abe said Japan did not welcome dangerous encounters by jets or warships, Chinese Lieutenant General Wang Guanzhong broke from prepared remarks to call their speeches “unimaginable.” The leaders were at the annual Shangri-La security dialogue in Singapore last weekend.

The forum highlighted the growing pains in Asia as China emerges as a military and economic power, challenging decades of U.S. dominance. Even as Chinese officials spoke of their desire to play a cooperative role in the region, Wang, the deputy chief of general staff of the People’s Liberation Army, said Hagel’s speech was “full of hegemony, full of words of threat and intimidation,” and Abe’s speech was understood to have targeted China without mentioning the nation by name.

Uh-oh...


Good old Keynesian stimulus?
When I wrote that China was seeking "targeted stimulus" of its economy, I really didn't mean a good old fashioned Keynesian stimulus program consisting of military spending. Nevertheless, that may be happening as a side-effect of China's economic ascendancy.

The tension buildup in the region has served to boost Chinese defense stocks. I constructed an equally weighted Chinese defense stock index consisting of the following:

• Aerospace Communications (600677)
• Hafei Aviation Ind (600038)
• Beijing Aerospace (600855)
• Xi An Aero Engine (600893)
• Sichuan Chengfa (600391)

The chart below shows that Chinese defense stocks have been steadily rising since mid 2013, while the Shanghai Composite Index has been flat over the same period.

Well, these tensions were more or less inevitable. Indeed, smaller regional neighbors like Singapore have resigned themselves to China's rising influence in the region and they are trying to adjust to the new geopolitical reality:

The U.S. dilemma in handling China’s rise is mirrored in the balancing act of smaller nations in Southeast Asia. Ministers from Singapore, Thailand and Indonesia acknowledged at the forum the inevitability of China’s influence, highlighting the importance of engaging the nation while voicing concern about the South China Sea.

During the 1990`s, I had suggested to my colleague the China specialist, that it was inevitable that military tensions would rise between China and the US. If we assume that Chinese military were to spend a constant amount as a percentage of GDP, which is natural given that it does have strategic interests in the region. Just by virtual of its fast growth, China would be seen as threat to the US and other Asian countries one day. I further added that since my colleague was born in Mainland China, it may be uncomfortable for him and his family should that day arrive (even if he acquired American citizenship). He disagreed and pooh-poohed the idea that China and America should come into conflict.

It seems that the day of rising Asian tensions is getting closer.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

White House's Keynesianism + Easy Fed = Inflation

I chanced upon the recent speech by Christina Romer of the Council of Economic Advisers’ entitled Back to a Better Normal. It sounds to me that she is advocating a standard Keynesian fiscal response to the Great Recession. The first clue came when she stated that the problem was one of aggregate demand and the problem was cyclical:

Deficient Aggregate Demand Is Key. The high unemployment that the United States is experiencing reflects a severe shortfall of aggregate demand. Despite three quarters of growth, real GDP is approximately 6 percent below its trend path. Unemployment is high fundamentally because the economy is producing dramatically below its capacity. That is, far from being "the new normal," it is “the old cyclical."

She continued by stating that “rise in long-term unemployment is readily explained by the prolonged collapse of aggregate demand.” That is to say that the problem is not structural, but cyclical:

In short, in my view the overwhelming weight of the evidence is that the current very high -- and very disturbing -- levels of overall and long-term unemployment are not a separate, structural problem, but largely a cyclical one. It reflects the fact that we are still feeling the effects of the collapse of demand caused by the crisis. Indeed, at one point I had tentatively titled my talk "It’s Aggregate Demand, Stupid"; but my chief of staff suggested that I find something a tad more dignified.

If the problem is aggregate demand, then standard Keynesian solutions are called for. Romer appears to have gone all out for Keynesian economic solutions. She sounds even quite sanguine about the problem of the fiscal deficit:

The sensible way to address the deficit is with a long-run plan. It would be penny-wise but pound-foolish to try to deal with our long-run problem by tightening fiscal policy immediately or foregoing additional emergency spending to reduce unemployment. Immediate fiscal contraction would inevitably nip the nascent economic recovery in the bud -- just as fiscal and monetary contraction in 1936 and 1937 led to a second severe recession before the recovery from the Great Depression was complete. And nothing would be more damaging to our fiscal future than a protracted recession and permanently higher unemployment. But, a credible, comprehensive plan for deficit reduction would create a favorable climate for investment and ensure that the economy remains strong.

The Obama White House appears to have embraced the solutions advocated by Richard Koo, Chief Economist of Nomura Research Institute, whose prescriptions are to spend until it hurts and then spend some more. That's Keynesianism squared.

With the Federal Reserve leaning accommodative, this policy choice is very risky and could spark off an inflationary cycle that runs out of control. The BIS recently issued a report that concluded that all roads lead to inflation. My Inflation-Deflation Timer model has already moved to an inflation reading.

Investors should be prepared accordingly.


Full disclosure: I receive a small commission if you buy Richard Koo's book from Amazon.com