In response to one of my recent posts, The Sceptical Market Observer: A New Set of Crisis Villains, Clif Carothers sent me a very insightful and elaborate comment on the relative evolution of the economies of China and the United States over the last 35 years. He claims, very convincingly, that China has deliberately and successfully exploited Europe and America’s wealth to leverage its own development. Less a conspiracy than a brilliantly executed plan, the bottom line is that China’s strategy worked. The brilliant exposé below should be an eye opener for most.



Originally entitled “Kyoto Protocols Would Have Accelerated China’s Plan to Reverse-Exploit EurAmerica”, I changed the title of the piece because Clif’s thesis covers much more ground. It is a fascinating story and I am very proud to present it here.



If you are patient and read the whole piece, you will get to the Kyoto Protocol part of the story. America’s response to Kyoto somehow suggests that not everyone is sleeping at the switch. But as Clif discusses towards the end of this post, the level of awareness about what needs to be done in this country needs to be raised if we are to succeed in getting back into the game.



Here it goes:



My set of Villains...



China had a better strategy and executed it brilliantly



Multinational Corporations (MNCs) saw an opportunity to ride the wave of America's destruction for profit and the business of business is profit so...



Bankers are in the business of transferring capital flow to the highest returns and those are to be found in China so..



Politicians are in the business of getting elected and that comes mostly from having more campaign funds from MNCs and bankers than one's opponent sooooooooo....



In 1978, the year China emerged onto the world stage with its four modernizations, China, a country with four times the population of the United States, had a paltry gross domestic product of $216 billion, less than eight percent of the United States. China exposed her strategy of four modernizations to the world as if to say, “Please invest in China and we will ensure that our workforce is educated, and that our business infrastructure is stable for your investment.” Yet, this openly expressed strategy, that may have seemed to the rest of the world as a difficult but noble goal for China to achieve, was only the tip of China’s Grand Plan, and only the part she wanted the world to see.



EurAmerica’s history with China was one of gunboat diplomacy, exploitation, and forced trading. When China opened her borders again in 1979, EurAmerica’s merchants were enthusiastic to exploit an opportunity again. Yet, China had not forgotten EurAmerica’s role in the Opium War, the Sino-Japanese War, and the Boxer Rebellion. China would never open her border again to be exploited. When she finally opened her border in 1979, it was from a position of power, deep strategy, and long lived planning that suggested EurAmerica was finally ripe for reverse exploitation. China’s grand plan was to emerge as the 21st century world power.



What boldness of purpose China must have felt as she aligned her nation’s efforts to that decade’s long task. Looking back today on her impossible achievements, one must give pause to the monumental economic goal she set for herself in 1978, indeed greater than America’s technical goal of landing on the moon early in 1961. Yet, with such a miniscule $216 billion GDP and few material assets how could China possibly build her empire to surpass that of the United States?



Through a hybrid statist-capitalist political structure, China would create a conduit through which American businesses would willingly draw down the wealth of Europe and America and transfer it to China in order to share in the prosperity of that wealth transfer. Through the centralized imposition of forced savings on its people, China would provide low cost labor to sell goods at low enough prices to cause EurAmerica to look the other way as their neighbors’ jobs went to China. Through low interest loans, China would entice EurAmerican politicians to spend beyond their means to temporarily ease the pain of EurAmerica as China’s sucked away their life force. These were the basis of her strategy.



Similarly to how a business cycle contains early adopters and late stage laggards, China planned a capital extraction cycle for EurAmerica, in which China would extract capital in multiple phases, each phase having an optimal extraction strategy. First extraction would be through the early adopter “gold rush” investors rushing into China to stake a claim. China would also plan for early majority, late majority and laggard’s capital extraction.



In 1978, China assessed America’s assets:



• America’s most valuable assets were intellectual capital that resulted from 200 years of publicly funded primary and publicly subsidized secondary education



• America’s physical assets included business assets, commercial, and residential real estate worth $7 trillion in addition to public assets of land, buildings, and infrastructure



• America produced 26% of the world’s GDP at $2.8 trillion and consumed a quarter of the world’s goods



• America’s debt was as low as it had been since WWII as a percentage of GDP and its 110 million workers were capable of doubling their loans to provide China more capital



• America’s Baby boomers were entering a peak spending phase followed by peak saving



• America’s constitutional republic allowed a relative few capitalists to control the direction of her economy



By 1978, multinational corporations had steadily grown in number and size for two decades. China’s success depended on corralling MNCs through direct foreign investment to create massive inflows of capital quickly monetized as hard assets and infrastructure.



China would entice merchants to invest by offering access to the future potential purchasing power of its people. However, given China’s low household incomes, market penetration would be low to start. Therefore, to entice the early adopters, China would create special economic zones that provided the perfect investment opportunity of cheap educated labor, loose regulation, low taxation, strengthened business law, and enhanced infrastructure and transportation, in which businesses could produce goods at very low arbitrage costs to sell back to their home countries for high margins.



With low cost of goods from special economic zones, early adopter businesses were highly profitable and banks poured investment into China as a result. But, China could not complete her Grand Plan to multiply her GDP 50 times by enticing early adopter investors alone. She had to implement a plan timed to extract maximum dollars from EurAmerica at each phase of her exponential growth.



During the next stage, the early majority stage, China manipulated baby boomers’ peak spending phase:



• China’s low prices secured America’s baby boomers as loyal customers



• Prior to America noticing a substantial loss of jobs, China secured free trade agreements, and mined American businesses for their intellectual capital.



• She reinvested profits back into America’s debt to keep America’s interest rates artificially low in order to spur on higher levels of consumer spending and government borrowing.



• China supported lobbying of America’s mass investment vehicles to fund MNCs. 401Ks and IRAs, created in ‘80and ’81, funneled money through the stock market into MNCs for investment into China.



Then, America was drawn into the late majority stage as America’s baby boomers entered their peak saving years. 401Ks and IRAs artificially fed the stock market frenzy. Baby boomers sensed they knew how to invest in a bubble market that kept rising. With access to low interest rate loans kept low by China’s reinvestment, speculators borrowed money to bet on the rising stock market. America ultimately increased its debt to pump up stock values to build more Chinese factories.



Inevitably, the stock market bubble burst, leaving America’s baby boomers with lower retirement savings. The stock market that seemed destined to go up forever finally reversed rapidly decreasing valuations. However, the debt that had funded its escalation remained.



During the late majority phase:



• More businesses began to invest in China just to remain competitive with businesses that had moved offshore earlier.



• Tens of thousands of businesses transferred factories to China to obtain low cost labor



• Millions of Americans lost jobs



• With a generation of education completed, China now was able to take more advanced jobs as well as factory jobs. America’s bastion of protected, more technically competent jobs was not a bastion after all.



• American retail outlets for Chinese goods grew exponentially



• China continued to loan its excess profits back to the American government to keep interest rates low.



After having lived through the weakness of the stock market, real estate appeared to be the baby boomers’ best retirement savings alternative. In the early stages of the Great Ponsi, housing prices went steadily up. With low interest rates, Americans could now borrow on the value of their homes to continue funding China’s growth. China’s final stages of extraction saw the housing bubble increase beyond what had ever been experienced before.



Even though American jobs were increasingly being driven offshore, the frenzy of increased housing prices allowed additional borrowing from Americans, feeding the China gold rush further. This behavior was not unexpected, following a pattern of historical boom-bust cycles and was part of China’s planning. As a result of the stock bubble and the housing bubble, America’s total debt had risen to over $55 trillion. With such exuberance in the housing market, secondary debt markets participated in credit default swaps to the tune of an additional $42 trillion. China now had extracted close to the maximum of America’s value, leaving America with the corresponding debt.



So China extracted maximum value, first in trade secrets and early adoptive money, then by IRAs and 401Ks, then by stock market and home equity loans, then by 2nd mortgages and housing speculation. China monetized the massive cash flows as quickly as possible, building infrastructure and excess manufacturing capacity, while leaving America holding debt in exchange.



Without any other rising asset values to borrow from, America has tapped out its debt. Having maxed its debt, America can only print money to finance its trade deficits. Without further real debt derived money extraction to give China for infrastructure investment and without a real ability to pay for low cost Chinese goods, America is fast losing her worth to China as an infrastructure vehicle. Recognizing that maximized extraction and rapid monetization of America’s wealth is nearing its end, China is now finalizing the implementation of her strategy, that of pulling out of American debt before other countries that maintain reserve currencies create a run on the dollar.



In thirty short years, China was able to accelerate her GDP from $216 billion to $11 trillion. She amassed reserve capital of $3 trillion. She reversed America’s fortunes from the greatest creditor nation to the greatest debtor nation. She gutted America’s factories while creating the world’s largest manufacturing base in her own country. A measure of output that highly correlates to GDP is energy consumption. In June of this year, 2011, China surpassed the United States as the largest consumer of energy on the planet. While the U.S consumes 19 percent of the world’s energy, China consumes 20.3 percent.



In 1992, the world came together to discuss the impact of climate change resulting from energy consumption. The talks resulted in Kyoto protocols being initially adopted in 1997 that attempted to create a framework for reducing greenhouse emissions. The protocols called for 33 industrialized nations to reduce their greenhouse gases to 1990 levels and then to maintain emissions at those levels. Although it called for emerging countries like China to voluntarily lower levels, it did not require them to be mandated.



Of course, all of the countries who had no requirements to reduce their emissions signed the agreement. The United States, under scrutiny from environmentalists and others did not sign. China did sign. This was an additional strategy perhaps not envisioned in 1978 that nonetheless would have assisted in accelerating America’s slide had we signed.



GDP highly correlates to energy usage. In 1990, America’s real GDP was about $8 trillion as compared to $14 trillion in 2011. Kyoto would have caused America to either:



• Invest billions in the attempt to lower our energy usage per dollar of GDP



• Pay billions to other countries to have them produce less so that we could grow our GDP from $8 to $14 trillion



• Or, maintain our GDP at 8 trillion



In the meantime, China’s GDP in 1990 was $1.3 trillion and has since grown to over $10 trillion. China’s energy use has correspondingly grown as well until the point that this month, she overtook America as the greatest polluter. Kyoto was a grand idea that was doomed from the start because of the flaw that allowed the now greatest polluter to play by different rules. It attempted to cap the economic growth of America while allowing other countries to grow unfettered.



China had a Grand Plan that has been executed with the finesse expected of a centrally planned economy. Kyoto added nicely to that plan. America has been thwarted by China’s plan but now has the ability to reverse course. Given China’s size and growth rate, she will pass us soon if she has not already and her stride will be too great for us to catch her. However, by avoiding traps like Kyoto, and understanding that economic gamesmanship can accomplish a much greater destruction of a nation’s wealth than warfare ever could, perhaps America can once again right its course.



ME: When a reader then asked Clif , “Are you concluding that the US does or doesn't have a prayer in hell of recovering any momentum or GDP growth to nice numbers ever again?” here was his answer:



The remaining debt capacity of any size that is capable of being used to support renewal remains with America's MNC's and they have not yet been incentivized to return home. The capacity for new jobs is contained in our private small businesses but access to credit has been denied to them by our current banking structure. It needs to be bypassed. Our contracted economy remains too risky to hire new employees. Their wages must be subsidized to reduce risks. America continues to allow our trade secrets to leave offshore for a fraction of their worth. We must revisit our private property laws as they pertain to offshore sales and investments. China and other countries continue to bring goods into our country at a net negative benefit to our citizens. An overhaul of our trade policies is needed.



One hundred percent of our federal tax revenues are spent on the three Ms of military, Medicare and Medicaid. It's an abomination of national compulsion that must be reversed. Our deficits will soon trigger a massive run on the dollar; we are that close. We obviously must incur massive cuts in public spending. Public spending cuts of the size needed to reverse course on our debt crisis would trigger a depression without an offsetting spend on the private side, thus the incentivizing of MNCs and dollar shifting from unemployment benefits to employment vouchers that are required for the offset.



These changes are all quite doable and could help avert what will otherwise be America's darkest days ahead. The challenge will be to fill our representative democracy with those that both understand the problems we face and that have the courage to act boldly on them.



ME: And a further comment on the nature of the “Republic”:



As a furtherance of the discussion, a potential villain is that an upgrade to our Republic form of government is required. It suited us well and certainly better than earlier versions of Republic governments before ours had suited their people. However, Madison was right to be concerned. Yet all the protections placed within our federal system may not have been enough.



When asked by a political commentator whether or not he would relax his stance on Medicare and Social Security being off the table as far as debt ceiling negotiations were concerned, Senator Bernie Sanders of Vermont stated today (that was around July 8th) that the vast majority of Americans have stated they want the wealthy to pay more instead of them having to sacrifice to solve the nation’s debt issues. It seems logical that if most are suffering while a privileged few are prospering, that the prosperous may be in some obscure way responsible for others’ misery and that they should be the ones that pull us all out of the economic fire.



When it comes to solving our nation’s fiscal crisis, we are now in the “not in my backyard” stage of negotiations. No-one wants to feel the pain that we will all ultimately endure. The old saying that misery loves company is true for American politics. If any of us are called to sacrifice, we demand to see equal sacrifice by others as well. However, in this early stage of “not in my backyard”, we still are desperately hopeful that the evil doers will be caught and that justice will prevail without any of us having to sacrifice what we all had hoped would be our future prosperity.



Unfortunately, the size and scope of America’s travail is too great for any one American faction to accept full responsibility for its cause or to create a solution through their own efforts. We all must understand our small participation in America’s deterioration in order to rise to the calling for the responsible citizenship that will be required if we are to reverse our nation’s course.



If we cannot dispose of personal responsibility in our quest to blame others for our national predicament, neither can we blame fate itself. For those that say nothing can be done to right our ship of state because it was merely happenstance that placed China in the good fortunes of becoming the next great empire and not some nationalistic conspiracy that created China’s opportunity for preeminence, I would ask, did China’s leadership not conspire to achieve world fiscal dominance? Did America not conspire to achieve world military dominance? Did England not conspire to achieve world colonial dominance?



Do most world achievements occur through mere happenstance or are they the result of the greatest minds of the time conspiring to set the stage for dominating implementation? Interestingly, studies have shown that the difference between individual achievers and the vast majority of lesser men is that achievers create a written plan and then set about to implement it. If that is so for accomplished individuals, would it not be more so for great societies? No, fate is not the purveyor of our misfortune.



Our founders wrote in the federalist papers of their concerns for the eventual collapse of our country when they expounded on why previous republics failed. In creating our newest form of Republic, they studied the failures of others stating that when elites were able to place puppet politicians in the functions of government, their republics failed. While our founders created a system of bicameral government, overlapping terms of the house, president, and senate, shared system of government between local, state, and federal systems, all designed to thwart the overtaking of government by the elite, but they failed to realize the concentration of power that capitalism would eventually afford our elite over our political system as the centuries progressed.



China certainly had a strategy for mining America's wealth but it could not have been exercised if not for the weak underbelly of our political system. That underbelly was the dependence of political leaders on the fortunes of business and banking for their re-elections. This was the incipient crack through which the corruption of our American Republic began, and it is this symbiotic poison that we must now severe if we wish to avoid being dashed against the historical rocks of other failed republics, some of which also were the world’s political giants of their time.