Sex: the answer to our global economic woes

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Now that the transition of power in the US and China leadership contests has passed smoothly, it is occurring to investors that neither brings any actual certainty to the markets.

Both countries appear to face similarly unsolvable problems. In China, the business model is damaged and possibly broken. Manufacturing is leaving China for Mexico, the US and Eastern Europe because China’s cost advantages have now been lost.

Higher wages, expensive transportation bills and inability to maintain sufficient quality control have cost China dearly. Firms as diverse as GE; Caterpillar; Brooks Brothers; Tire International; and even Wham-O, which makes Frisbees and Hula Hoops, have all returned production to the US.

Tensions rise

Increasing tensions with neighbours like Japan, Vietnam and Korea over disputed territory, such as the supposedly oil and gas rich Senkaku Islands, now threatens to further damage China as a production location. The recent attacks on Japanese factories in China are a frightening symbol of what might happen if the Chinese ever become enraged by US policy. Panasonic, Canon and Honda have all been forced to suspend manufacturing operations in China due to social protests.

The US Secretary of Defense has recently said that America’s and China’s warships are within half a nautical mile of each other. The markets probably ought to be discounting the risk a bit more.

Meanwhile, Washington has to address the fiscal cliff. The debt problem is so big that even if every single citizen paid 100% of income in tax it would not be enough. Even if virtually all government spending were eliminated beyond interest payments, Social Security, Medicare and Medicaid, the US would still have a debt problem.

President Obama has signalled his intent to tax the rich even harder. The House Republicans have responded with: ‘No new taxes’. It’s a Mexican standoff that could end in a Thelma and Louise moment where each side dares the other to go over the cliff. Both sides can then blame the other. The market is not sufficiently discounting this possibility. The only thing that will force them to act is a sudden, sharp, painful fall in the stock market. Short of that, they are not as fearful of the cliff as the markets are.

The way forward

The solutions, in both America and China, will be similar. Both countries will pursue inflation, while vehemently denying it, as a means of easing the pain for their citizens and of eroding their respective debt problems. China may be rich with cash reserves but the banking system is poor from losses. China’s room for manoeuvre is even less than America’s given its vulnerability to inflation and civil unrest and lack of value added technology-driven businesses.

America is a lucky country. It has a long history of using inflation to default on its debt. America paid for the American Revolution, the Civil War, WWI, the Vietnam War and the Great Society with inflation. Inflation will be used to address the current debt mess. The only major debt problem America did not solve this way was WWII. Those debts were solved by sex. You may laugh, but the baby boom turned out to be the answer.

New people, new productivity, new GDP creation all occur when the demographics turn positive. One wonders if central banks might consider sex as a possible alternative to quantitative easing?

Anyway, it’s a thought. It should occur to the Chinese. Their demographic time bomb makes it singularly hard to resolve their economic problems. Maybe, given the testiness over the South China Sea, we ought to bring back the slogan ‘make love not war’.

Opposites attract

The US and China are mirror images of each other: America has the agriculture, raw materials and energy supply that China lacks. America has the innovative domestic economy that China desperately needs. Ironically, the solution may be for the US dollar to strengthen and the renminbi to weaken, so that both countries can recalibrate.

After all, one billion Chinese are not going to go home quietly when they are told they are simply not competitive any longer. The world has a vested interest in helping China build a new future and can take some comfort from the fact that the Americans are already doing just that.

Dr. Pippa Malmgren is is the president and founder of Principalis Asset Management.

This article originally appeared in Citywire' Global's Dec/Jan double issue.