The Old Mercantilism and the New

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 taxpayers.

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.

Ultrasound 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.

“We need a more enforcement,” Zhao said.

“Well, 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.

“Let 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 income.

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 top.

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 factories.”

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 wheel.

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 inflation.

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. This 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 Economist 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 base.

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 cement.

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

July26, 2007

Gary 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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