America and China's Tainted Products: Inflection Point?

05/25/2011 12:10 pm ET

Tainted products have been flooding out of the US and China. You have heard both stories. You have not heard it presented this way. We have been selling the world trillions of dollars
worth of tainted structured financial products and home mortgage backed securities. China has been selling compromised toothpaste, dog food, toys and pajamas. The Middle Kingdom's production miracle economy has been pressured by greed and razor thin profit margins. The American financial innovation machine and consumer binge has given in to spiraling credit need and excessive greed. Both engines of the global jet economy are showing some troubling signs. Such times are delicate and can be inflection points, or moments when trajectory/direction changes. The present housing and financial debacle -- just beginning to come to light -- further stresses the environment.

Domestic and international economic momentum has been carried along by the emergence of Chinese production/export alongside American financing/import. This is a real oversimplification but, is not untrue. The US has specialized in financing and borrowing to consume. According to IMF Statistics, the US borrowed 64% of total internationally available funds in 2006 [pdf]. We have the globe's largest GDP and 70% of that GDP is consumption. Our massive trade deficit, around $800 billion in 2006, speaks to this. China has experience export growth of 500% across the last 17 years. In late 2007 or 2008 China is set to pass the US as the second largest exporter on earth. Our GDP is 5 times the size of China's -- at official exchange rates. Chinese and American economic vitality -- despite what many claim on both sides of the Pacific -- are intertwined. There are obvious examples of this -- Wal-Mart -- and subtle examples -- cheap credit and consumer goods.

America is lent to at staggering levels. Our banks, investment houses and financial firms have driven financial product innovation and revolutionized the ways that debt is traded, valued and structured. China has grown from a bit player to a manufacturing behemoth. Much of the export operation of China is guided by foreign multinationals into markets they know and have operated in for years. 2006 estimates suggest that over 55% of Chinese exports are done by non-Chinese multinationals. Wal-Mart alone accounts for about 10% of Chinese export final retail sales. Multinational financial firms from the US-dominant -- Europe and Asia thrive off of global finance. At the start of 2006, 80% of global financial assets were owned in and by the US, the EU and Japan. Finance is concentrated and the US remains central. Manufacturing has become more concentrated around China. From South America to Africa and the Middle East, the global economy relies on China and America for imports, exports, capital markets and investment opportunity. America and China represent two sides of the same unbalanced coin.

The two nations rely on each other ever more. As of July 2007 China and Hong Kong together held $465 billion in US Government debt- second only to Japan. From April to June 2007 China -- including Hong Kong -- bought $37 billion in American mortgage backed securities. Across roughly the same period we had pet food, toothpaste and toy import scandals. All of this occurs as the US imported $83 billion worth of Chinese goods and services in the first quarter of 2007 and exported $19 billion to China. Despite recent fears about Chinese product quality and accusations about American beef and soy beans, the nations' economic futures can not detach without great disruption and loss.

The growing discord -- expressed in traded threats, recalls and bluster -- between the US and China is threatening to the entire international economy. The increasingly suspicious and tainted reputation that American financial and Chinese manufacturing products are attaining is an international issue of the utmost importance. America's economy relies on cheap imported credit and vast earnings from finance. China's economic growth, employment and future rest on vast manufacture for export. In lock step, both look to be taking overly long walks down fairly short piers.

This is not a doom and gloom report. I just wish to call readers attention to the fragile state of the global economic architecture at this moment. In so doing I hope to introduce some basics into an often emotional and reality detached conversations about China. Our firms make goods and look to China for growth. China's vast savings and the hundreds of billions in dollars they accumulate from exporting to the US are loaned back to us. China is presently sitting on $1.34 trillion in reserves. In return we take their products. They support the dollar, provide us with savings to borrow and don't really mention that we pay low interest. As the US Dollar falls and Renminbi rises, China will experience tens of billions in losses. We offer to pay them back in a declining dollar and use much of the money we borrow on military hardware, with which we threaten them. They need to employ millions and millions of people seeking to move to cities, industry and modern service employ. The Chinese political situation requires new opportunities, jobs, incomes and modernity be offered to hundreds of millions of people. The migration and modernization occurring in China 1990-2010 will be larger than the entire European industrial revolution! It would be fair to say that the two nations are co-dependent. There are many groups benefited and hurt by the present arrangement, that is another article.

The Chinese growth story and the American position in the world are fragile and are two sides of the same coin. They form a major part of the structure of the world economy and its recent vitality. As you read this article, many increasingly fear tainted US financial products and Chinese exports. If confidence and growth are slow to return, or increased hostility emerges, it could mean an inflection point in the global economy?