The Old Mercantilism and the New

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The United
Nations Population Fund in June released a report, "The
State of World Population 2007
." In discussing China, the
report provided the official estimate made by China’s government
that 18 million people migrate from rural areas to cities each year.
These are predominantly men.

Consider the
meaning of this figure. This is approximately 1,500,000 people each
month. This is the equivalent of Phoenix’s population, or a little
more than Philadelphia’s.

Think of what
it costs in resources and labor to build enough living space and
infrastructure to make room for an influx of residents that would
equal the population of Phoenix, month after month.

These are poor
people. They do not come with capital, other than their willingness
to work at whatever wage will feed them and provide minimum shelter.
They are moving from low-productivity farms. They are younger sons
who will not inherit the family farm, or else they are the oldest
sons, who correctly see no economic future in small-scale farming.

They cannot
afford wives. Even if they could, 17% of them would not find a wife.
The policy of one child per family, announced in 1979 and enforced,
has created a historically unique population distribution: 1.2 marriageable
age men for each marriageable age woman.

Millions of
men cannot find single women who are willing to marry them. Women
can now afford to be picky. So, there is tremendous pressure on
young men to get to a city, find employment at above-average wages,
and find suitable living quarters. There is no time to waste. These
men are highly motivated.

They are competing
against women in factories. So, there is even more pressure to get
into the labor force. There is only one way for men with no capital,
poor educations, and short time frames to do this: wage competition.

This wage competition
is felt in the open labor markets of the West. The products exported
by China are produced by laborers who are desperate. They will work
for wages that are a small fraction of Western employees. The downward
pressure on Western wage rates comes through the actual products
exported by China. Western companies must meet the competition by
keeping prices low. They can bargain with workers. If they fail
to survive, the jobs disappear. Think "Detroit."

This process
will not end in my lifetime, or theirs. China is estimated to be
37% urban. It is expected to be 60% urban in 2050. This means that
the mass migration of young men from rural areas will continue.
The wage pressure will be permanent.

To this wage
pressure is added a similar movement from rural India to urban India.
These two nations account for at least a third of the world’s population.
The move from farms to cities is masculine, irreversible, and permanent.

The only way
that the West’s workers can compete is to compete in those sectors
of the world’s economy that rely on advanced education, innovation,
and very high capital investment per worker. This requires, above
all, a social climate favoring entrepreneurship: consumer-directed
innovation. This requires low or no taxes on capital gains, low
government regulation, and a reduction in the supply of lawyers.

The United
States has about a million lawyers, the highest number on earth.
Tax-supported state university law schools crank them out by the
tens of thousands per year: a subsidized industry. Meanwhile, the
U.S. Government’s Federal Register prints 76,000 three-column
pages of regulations per year.

The household
savings rate in the United States has now gone slightly negative.
Americans assume that tomorrow will take care of itself. After all,
look how inexpensive it is to buy goods that are made in China.
And the government has guaranteed Americans that the physical crises
of old age which once depleted family capital will be paid for by

So, young men
from rural China move to the cities. They hope to get wives for
themselves by manufacturing toys for Westerners. We keep buying.


Consider the
effects of Deng’s one child per family plan. It has produced side
effects. The biologist Garrett Hardin has defined "side effects"
as "effects we don’t like."

The problem
in China is selective abortion. Asian rural societies for millennia
have wanted sons. Sons support parents in their old age. Daughters
marry into other men’s families and will support their in-laws.
So, from 1980 on, Chinese families began aborting females, just
as Western commentators said at the time that they would. But the
Communist government ignored these warnings.

In April, 2006,
CBS News’ "60 Minutes" devoted a segment to China’s population
problem: "China:
Too Many Men
." The report did not discuss infanticide.
Instead, it discussed abortion. The technology of the law’s enforcement
made abortion a low-cost option.

To make sure
the women kept their birth control devices in, the government
— starting in 1982 — sent portable ultrasound machines all over
the country. They are compact and lightweight and even some small
villages got as many as two or three. But in a classic case of
unintended consequences, pregnant women realized that the machines
could also identify whether they were having a boy or a girl.
And, as a result, by conservative estimates, more than 8 million
girls were aborted in the first 20 years of the one-child policy.

This figure
is far too low. The
United Nations’ estimate is 100 million worldwide
, with 80 million
for India and China combined. Understand, this is not the total
number of aborted females. It is the net deficit — in addition
to the 50-50 abortion ratio.

The Chinese
abortion policy was enforced by law, though officially not for females
only, so the deficit in China could be as high as 60 million females.
No one knows.

The government
today claims that it is illegal for a physician to inform the mother
of her baby’s gender. He would be fired if he did this. But the
free market has intervened. Chinese mass production has made the
ultrasound machines inexpensive.

machines are inexpensive in China; they cost about $360 and, as
60 Minutes saw, they are small enough to be hidden in a closet
or even in the trunk of a car to do scans on the run. And that’s
made it difficult to crack down.

We showed
the minister some Chinese newspaper photos of a van parked in
a Beijing suburb doing ultrasounds in the back.

need a more enforcement," Zhao said.

one of the ways that this imbalance came about is through abortion.
Millions and millions and millions of abortions. Why didn’t the
government clamp down on that?" Stahl asked.

me go to another point," the vice minister replied.

This is what
every government bureaucrat prefers to do when confronted with the
unwanted effects of government policy. Call it verbal abortion.

Her "other
point" was that China’s abortion rate is going down, but
she didn’t explain why abortions are still free and legal right
up to the ninth month, even as the boy-girl imbalance grows.

China now faces
a major problem: crime goes up when young unmarried men increase
as a percentage of the population.

The politicians
now are trying to respond to the effects of their earlier — and
continuing — population-control problem by setting up counter-programs.
They are imitating the National Socialist and Fascist regimes of
the 1930’s. They are offering subsidies for female children.

And so the
government has launched a campaign to convince parents that having
daughters is a good thing: propaganda street banners preach that
preferring boys over girls is old thinking; while school fees
for girls have been reduced, and laws changed so daughters can
inherit land.

And state-run
TV programs show the government handing out cash to parents with
only daughters. A pilot project rewards these parents from age
60 on with what amounts to $150 a year, a doubling of their yearly

These programs
are not working, any more than the European socialist regimes’ subsidies
worked in the Great Depression. The imbalance is getting worse.


Karl Marx offered
a stage theory of history: from primitive communism to feudalism
to mercantilistic capitalism to free market capitalism to socialism
to final communism. China is proving him wrong. It has moved "backward"
in Marx’s stages from socialism to mercantilism.

The Chinese
government is still Communist in terms of its centralization of
political power in a one-party state. Like all Communist parties,
the Chinese Communist Party is filled with old men. They grew up
in a very different world. They survived Mao’s purges through unquestioning
loyalty to Mao. Then, three years after Mao’s death in 1976, they
declared their loyalty to Deng, accepting his reversal of central
economic planning.

What are they
really loyal to? This: political stability, with themselves at the

They now find
that they are sitting on top of a Chinese firecracker factory of
enormous proportions.

What they must
achieve above all is low unemployment. If unemployment rises, the
dreams of wealth for the urban masses will get sidetracked. There
are now 400 million people living in cities, compared to 900 million
in rural areas. These cities are political powder kegs: "fireworks

To kick-start
the Chinese economy after 1980, the Communist Party adopted a strategy
used by the Asian tigers after 1950 to grow their economies: export
to the Industrial West. The Communist politicians did not allow
strictly free market competitive forces to govern the allocation
of workers and capital. They would not turn loose of the steering

What was the
steering wheel? The money supply. The Chinese central bank has copied
what Keynesian economists recommended for decades, from Keynes’
day until today. They increased the money supply in order to increase
effective demand. They, like all Keynesians, see effective demand
dependent on government central planning: tax (fiscal) policy and
monetary policy. Keynes emphasized fiscal policy, yet his system
depends on monetary policy: lowering real wages through monetary
inflation, thereby increasing employers’ demand for workers.

Full employment
is the key of political survival all over the urban world. When
there are unemployed men in the streets, there may soon be revolution
in the streets, especially if these men are recent arrivals from
the countryside and have no local roots, especially wives and children
to feed, clothe, and house.

Thus, China’s
politicians did not block the decision of the bureaucrats of the
People’s Bank of China when they adopted policies of very high monetary

Once adopted,
the stimulative effects begin to wear off as wage rates rise due
to more money in circulation. Price inflation is manifested in wage
inflation. Wages constitute well over half the cost of production
— close to 70%. So, rising wages in terms of money tend to undermine
the policy’s goal: to increase employment by keeping real wages
low. Workers can pay more as money wages rise, meaning real wages
are rising.

What has kept
money wages from rising among the urban masses is the influx from
the farms.

Chinese export-oriented
firms can keep hiring new workers. To do this, they need buyers
abroad. Buyers abroad want to buy cheap yuan. This has forced the
Chinese central bankers to retain monetary inflation, so as to lower
the international value of the yuan, so as to keep foreign consumers
happy with low-cost Chinese goods.

Chinese central
bankers have bought what most central bankers have bought: government
debt instruments. They buy their own governments’ debt certificates.
But if they are pursuing modern mercantilism, they also buy the
debt certificates of the governments to which the national planners
intend to sell the exported goods.

This means
the United States.

As of May,
2007, China held about $1.2 trillion worth of foreign currency reserves.
This is not all in dollars. This
figure rose by $136 billion in the first three months.
increase was so rapid that the People’s Bank of China raised the
foreign currency reserve requirement from 4% to 5% for private banks
that hold foreign currency investments.

To keep the
economy booming, the People’s Bank of China has forced down the
overnight interest rate — the equivalent of the United States’ Federal
Reserve-manipulated federal funds rate — from 2.7% in late 2006
to 1.6% in mid-May. Paul
Kasriel of the Northern Trust Company has provided a useful graph
of this.
He has also offered a graph of the increase in the
rate of growth for reserve money base. The year-to-year rate fell
to 8% in early 2007. It moved up sharply to 23% by March.

Kasriel’s analysis
is on target. The Chinese central bank is trapped. It wants to expand
exports, which means it must keep the international price of the
yuan low. This means that it must increase the supply of yuan. But
it is now facing rising prices domestically: up from 1% in early
2006 to 3% today (official figures), an increase by a factor of
three — high. Kasriel poses the problem very well.

A slowdown
in bank reserve provision would lead to a rise in the overnight
interbank interest rate. The rise in this rate also would put
upward pressure on the yuan/dollar exchange rate. And the PBOC
also announced that it would allow the yuan/dollar relationship
to vary more on a daily basis — from 0.3% to 0.5%. Under current
conditions, the only way the PBOC can rein in consumer and asset
price inflation is to slow down the provision of bank reserves
and that will entail a rise in the yuan relative to the dollar.
The PBOC has to make a decision — does it want to maintain a relatively
steady yuan/dollar relationship or does it want to prevent Chinese
inflation? It can’t have both.

Adding fuel
to the fire is a shift from the mercantilism of Bretton Woods to
something new.


Early mercantilism
goes back to the seventeenth century: trade wars that turned into
real wars, such as the Anglo-Dutch wars of the mid-seventeenth century.
The Bank of England was founded in this period: 1694. The goal of
government policy was to increase the supply of gold in its treasury.

Adam Smith
challenged this outlook in The
Wealth of Nations
(1776). He called for freer trade and
the abandonment of export-driven policies that led to gold in government
treasuries. The West had generally moved to Smith’s position by
1850. But in the aftermath of World War I, governments reverted
to mercantilism. But there was a change. The goal since 1922 has
been to increase the supply of foreign governments’ interest-paying
debt obligations, not gold, in the central bank’s coffers. This
policy favored Great Britain until World War II broke out in 1939,
and favored the United States thereafter. It was put into law by
the Bretton Woods agreement of 1944.

When Nixon
severed the dollar from gold on August 15, 1971, the threat to foreign
governments was that they would buy U.S. government debt obligations
with their central banks’ newly created fiat money, only to be paid
back in newly created fiat dollars. That is, central
bank counterfeiters
trusted each other less. But since governments
wanted to subsidize their export markets, central bankers continued
to abide by the new mercantilism of Bretton Woods. U.S. debt certificates
piled up in central banks’ portfolios.

The central
banks of China and Russia have been big buyers of these debt certificates.
China exports trinkets; Russia exports oil and natural gas. In exchange,
they receive promises to pay interest. But what will the money which
is paid as interest actually buy? The main export of the United
States: more debt. The West gets the trinkets and energy, while
the central banks in China and Russia get paid money which buys
. . . what?

What, indeed?

There are hints
that there is a new form of mercantilism coming. China, meaning
the People’s Bank of China, purchased 9.9% of the Blackstone hedge
fund in May. It paid $3 billion. The PBOC has set up a rumored $300
billion fund for purchasing foreign equities and other unnamed assets.
This is a shift from debt to equity, from foreign governments’ promises
to pay to actual ownership of foreign companies and assets.

If pursued,
this will change the face of international trade.

Why Blackstone?
Because Chinese bureaucrats will get access to inside information
about the previously private hedge fund’s investment strategy. The

had a good article on this purchase.

Like China,
whose proposed Blackstone stake is part of $300 billion that the
government plans to set aside this year for investment purposes,
dozens of countries have set up what are now commonly referred
to as sovereign-wealth funds. They manage money drawn from reserves,
natural-resource payments and the like. China is chiefly concerned
to diversify its foreign reserves, but other sovereign-wealth
funds own national, as well as international, assets.

But China is
not alone. Other export-driven nations are beginning to enter the
equity markets. The numbers are potentially immense.

The top 12
each have anything from $20 billion to hundreds of billions of
dollars to invest (see table). Recently, Japan, Russia and India
have reportedly been considering setting up funds along similar
lines. Some estimates put the size of the funds at $2.5 trillion
by the end of this year (in contrast, hedge funds are thought
to have a mere $1.6 trillion), with another $450 billion in transfers
from reserves being added annually. Including capital appreciation,
the amount could swell to $12 trillion by 2015.

The central
banks will become the equity buyers of last resort rather than the
government debt buyers of last resort.


I think China’s
next move is obvious: commodities. It is building the equivalent
of a city of Phoenix every month. It needs cement, copper, and everything
else needed to grow new cities and expand old ones.

At some point,
the Chinese central bankers are going to buy commodity futures.
They will not be selling short.

The central
bank through its sovereign-wealth fund can take ownership positions
for 10% down or less. Then, at some point, it can begin taking delivery.

The commodity
futures markets operate on the assumption that no more than 3% of
the investors will actually take delivery. The threat of "longs"
taking delivery is the sword of Damocles over the heads of "shorts."

When Bunker
Hunt in 1979 began taking delivery of silver, the price moved from
about $6/oz to $50 in January, 1980. The futures exchange changed
the rules, forbidding anyone to go long unless covering a short
position. This bankrupted Hunt in 1980, but it was a gross violation
of contract.

The Chinese
are not Bunker Hunt. They have deep pockets. A change of rules on
one national exchange is not the same as it was in 1979 — not when
the long demanding delivery has $1.2 trillion in reserves (in 2007).


The Chinese
Communist Party has a tiger by the tail: a 17% per annum increase
in the M-2 money supply, and a need to provide employment for 1.5
million new arrivals every month in Chinese cities.

The Chinese
economy is now dependent on long-term monetary inflation higher
than anything ever seen in a major nation in peacetime. The bust
side of the monetary boom-bust cycle now threatens the legitimacy
of the rulers of China. They dare not let it happen. But if the
central bank slows the rate of monetary inflation to a single-digit
rate for a year, it will happen.

The basic infrastructure
needed to accommodate 1.5 million arrivals each month must consume
vast new quantities of commodities. This is the real world. These
are real people who want real roofs over their heads. Their employers
require oil, electricity, and cement.

The invisible
digital economy eventually affects the see-touch-feel economy. Nowhere
is this connection more politically explosive than in China.

The Chinese
central bank is trapped. It will try to walk the tightrope between
exports and domestic price inflation. How? By means of a 17% year-to-year
increase in M-2 and a 23% year-to-year increase in the monetary

If the bureaucrats
fall off, taking the domestic economy into depression, the economic
fallout will be international.

In any case,
if the central bank moves to the new mercantilism and away from
Bretton Woods mercantilism, the days of low interest rates will
end in the United States. If Uncle Wong decides that Uncle Sam’s
promises to pay cannot be trusted, and therefore cement is a better
deal, the U.S. government’s fiscal policy will soon have feet in

this happens, the U.S. debt-driven economy will face the problem
faced by Luca Brassi in The
. He sleeps with the fishes.

26, 2007

North [send him mail]
is the author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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