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Chinese Mercantilism and Yuan Devaluation

Only 40 years ago, China was an agricultural nation, and yet in what seems like no time at all they have become the world’s second largest economy – second only to the US. How is this possible? I have drawn the comparison both on About Money and on my blog about the methods China has used to burst into heavy industry and those Louis XIV and John Baptist-Colbert employed in 17th century France. In fact, there are many, many parallels that help us understand why China is where it is today.

Like France in 1661, China’s economy was agricultural and found it difficult to compete on the world market. Both countries had the decision to change their economic focus by the government – for France, they focused on glass and textiles (both very lucrative industries at the time) and China’s Central Party focused in on  heavy industries such as aluminum, steel and copper production, as well as building airplanes and ships. France and China both introduced factories and built dormitories, or in some cases entire cities, up around the factories to house workers. These factories also saw the implementation of a minimum wage for the first time. They worked to create a trade surplus by using foreign policy to limit imports and because the government implemented the work, they largely ignored supply and demand. Perhaps most infamously, both poached from foreign industry – France by attracting artisans and China by proposing joint ventures, and both offered attractive incentives. This economic method, in which the central government drives economic growth, is called mercantilism. China’s central government controls foreign policy, land, military, and banks – and they decide which industry is of major importance. In China’s case, heavy industry.

Yet the credit bubble bust and the commodities speculation may have hit China hardest of all. They invested billions into infrastructure and factories to meet the demands for copper, steel, and aluminum, but because only 50% of those contracts intended to collect on the product, they have found themselves up to their ears in overcapacity. To deal with the oversupply, there has been speculation that China is selling its steel at 10% under the cost to manufacture. To compensate, China has seen a devaluation of the yuan, but despite what we may be told by our presidential candidates, if allowed to float, China’s currency will decrease, not increase. In December of 2015, China spent $100 billion to support its currency, and spent another $3.4 trillion in foreign currency reserves – and yet history tells us that it is impossible to support a currency. I believe it will even take another devaluation. This is not a short-term problem, and we need only look across the Sea of Japan for an example. When Japan took an economic fall, they chose not to close banks and tried to work through the problem, but we find them 30 years later still struggling to recapture their former economic power. We can only watch and wait to see if China goes a similar way.

In the meantime, China’s misfortune does spell potential growth for the American investor. We have the opportunity to purchase raw commodities at or even below the price to manufacture. As I have said before, although 2016 will be a hard year for investors, it will not be a hard year for investing. I believe that you simply need to keep your eyes open and be in the right place at the right time to take advantage of what is out there.

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