CHINAMERICA: The Uneasy Partnership that Will Change the World

ChinAmerica

PART I

BEATING AMERICA

THE DEVASTATION OF EUROPE AND JAPAN during World War II gave the United States a unique opportunity to dominate international commerce and, later, to dominate the world political stage as the biggest superpower. Before the war, Britain, France, and Germany were viewed as the world’s superpowers, but that ended in the ashes of fires and bomb fragments in Dresden, Coventry, and throughout the rest of the Continent. During the decades in which Europe, Russia, and Japan recovered from the war’s devastation, the United States was able to exploit its own unchallenged economic and political power. The result was a new world order.

Another momentous economic shift is happening now. The rise of China as the second most economically powerful country is occurring in a historically short amount of time. The Middle Kingdom passed Germany, France, and the United Kingdom in 2008, and it raced ahead of Japan in 2009 to become the second largest economy on Earth.

Furthermore, the Great Recession of 2008 to 2009, and the slow economic progress thereafter by the United States and the West, accelerated China’s pace. China is closing the gap with America in terms of gross domestic product (a key measure of economic output). While forecasters such as PricewaterhouseCoopers and others differ on exactly when China will overtake the United States, they agree that it will occur and that it is only a matter of a few decades.¹

It is painful and bewildering for the American Colossus, which almost single-handedly rebuilt Western society after the devastation of World War II, to face the reality that it will lose economic supremacy. Essentially, the United States is in the same position that Europe was in after World War II—watching another car roar past it on the economic highway.

In the following chapters, I review the situation at the crucial inflection point: in 2009 China’s economy grew 8.7 percent while the rest of the world’s economies declined. I describe how China and the United States are locked in a battle over national wealth. In addition, I explain how military strategies and tactics are being used by some countries and companies to successfully conquer new territories. Other countries, unfortunately, have ignored or misapplied these strategies and are now vulnerable to economic invasion.

Indeed, CEOs have replaced generals as the leaders of conquering armies. It doesn’t matter if one views this as a good thing or a bad thing—it is a fact of life in the twenty-first century. Global competitiveness at the corporate level is the way to win the international battle for wealth.

1

THE FRONT LINES OF THE CHINAMERICA WEALTH BATTLE

AS THE SUN GOES DOWN in the United States, the day starts in China.

Figuratively speaking, the financial sun has been rising in China for several years, and it is starting to set on the United States. How long the sun shines on China, and how long the United States will remain in twilight, depends not only on China but also on the actions of the United States.

The industrialization of China since the 1980s has been nothing short of astounding. In a historically short amount of time, China has built a huge base of educated employees working in a vast network of factories producing a broad array of consumer and industrial products, primarily for export. In addition, the surge in production has provided hundreds of millions of Chinese with televisions, cell phones, and other touchstones of a thriving middle class.

The frenetic growth of Chinese manufacturing and the rise of the middle class are leading to a conflict with other nations, especially the United States. The pollution pouring from Chinese factory smokestacks and effluent pipes is a source of tension worldwide. But it is also the visible symbol of a more profound confrontation: the demand for increasingly scarce and strategic natural resources.

China is absorbing large quantities of increasingly expensive copper, oil, iron ore, wood, and other commodities from around the world. The huge surge in demand for raw materials has inflated the prices of these commodities for the entire developed world. So not only has the cost of wire and cable jumped but so too has the price of steel, cement, and other materials. Housing and school construction costs in Boston, Birmingham, and Boise as well as in Beijing skyrocketed during the economic boom times before the economic crash of September 2008.

Since most developed countries have been importing copper wire, steel, wood furniture, and other finished goods from Chinese factories that were absorbing all of these raw materials, trade imbalances have become more skewed. The flood of clothes, televisions, laptop computers, cell phones, automobiles, and other manufactured goods from China to the rest of the world has triggered a massive flow of dollars, pounds, francs, lira, yen, rubles, and other currencies in the opposite direction. While the United States has been importing an increasingly large amount of finished goods from China and other parts of Asia for decades, the surge in commodities prices has led to an even larger trade deficit. This massive deficit is the source of another long-term conflict with China.

In fact, a substantial amount of the world’s wealth has moved to China. As of September 2009, the Chinese government held foreign exchange reserves of almost $2.3 trillion,¹ roughly a quarter of the foreign currency reserves of the entire world. How much is $2.3 trillion? According to the reserve rankings by the International Monetary Fund, it is more than the combined foreign exchange holdings of Japan, Russia, and the entire European community. Here’s another way of understanding the financial power in China’s treasury: $2.3 trillion is more than five times the amount of foreign exchange reserves that Saudi Arabia has accumulated from exporting oil as of May 2009. Or consider this comparison: The United States had $83 billion in foreign exchange reserves in September 2009.

Published estimates have indicated that roughly 70 percent of the foreign currency reserves held by China are in U.S. dollars or their equivalents.² No wonder several U.S. late-night talk show hosts chortled in November 2009 that President Barack Obama’s visit to China was arranged so that he could visit our money. The tension over the shift of American wealth to China is growing quickly.

In fact, while all nations compete to increase the wealth of their population, China and the United States appear to be headed toward a particularly contentious conflict. The Chinese realize that wealth is created by the amount of goods produced and sold to others, not by the amount of goods consumed. The Chinese understand that the growth of the wealth of nations is based on having a positive trade balance, along with an efficient infrastructure and the fair distribution of the resulting wealth among the population. A positive trade balance occurs when the value of exports exceeds imports. A positive trade balance also is a measure of competitiveness against other countries, and wealth is built by having superior competitiveness.

Beginning in the late 1970s, the Chinese people were forced to sacrifice in the short term to accumulate wealth in the long term. They focused most of their efforts on manufacturing goods for export. That attitude continues to this day.

Contrast that approach to building wealth with the behavior of the majority of the U.S. population in the twenty-first century. An entitlement mentality prevails among most of the middle-and upper-class populations. If people have been wealthy for a long time, they develop an attitude of entitlement—they indulge in a high standard of living without worrying about the consequences of living beyond their means. Instead of building personal and national wealth, many Americans are focused only on consuming, and they are hampering the rest of the country’s population’s quest for a better life.

The conflicting motivations between China and the United States are leading to a war over wealth. Indeed, some would say that a war has already begun: there have been several trade sanctions enacted by the U.S. Congress, and there is a growing number of complaints that Chinese companies have been selling goods in the United States at prices that are less than their cost of manufacture. This technique to capture foreign markets is called dumping.³ The Chinese retaliated against the sanctions in October 2009 with new registration requirements for companies that want to sell products to the Chinese government.⁴ These trade restraints must not be allowed to escalate into provocative actions—neither side will survive armed conflict or the economic equivalent, trade protectionism in the form of tariffs or other barriers.

The tariff warnings and dumping complaints reflect what happens when a nation loses economic power—it feels threatened. A nation that perceives itself to be losing wealth will feel insecure in its relationships with other nations. Meanwhile, a nation that perceives itself to be gaining wealth and therefore economic power will want to exercise that power in its relationships with other nations. Strong economic power usually leads a country to want to expand its power by controlling additional resources, or manipulating weaker competitors so that its own economic and political supremacy continues. The declining fortunes of the United States and the continued increases in the wealth of China could ultimately destabilize the current political structure of the planet.

There has to be another path to defuse the tensions and avoid conflict that would damage both sides. This book is about how China and America can develop a mutually beneficial relationship, a modus vivendi. A partnership I call ChinAmerica would benefit both countries, helping them unwind their mutual suicide pact, as highly respected international expert Fareed Zakaria described the situation in the 2009 preface to his book The Post-American World. The ChinAmerica partnership will help the Chinese and American governments and populations achieve their goals without gravely damaging each other.

The crucial foundation of a successful partnership between China and America is a better understanding of what led to the current dichotomy in the fortunes of China and the United States. ChinAmerica explores the behaviors and decisions made by American leaders and the population over the past few decades that led to the decline of America as the unchallenged leading industrial giant, and to the current economic crossroads. In addition, ChinAmerica explains how 2,000 years of wars and political change strongly influenced China’s economic behavior.

ChinAmerica is more than a summary of the past though. In Chapter 5, I describe the behavioral and governmental policy changes that must be effected for the ChinAmerica partnership to succeed. If executed, my turnaround plan will help China and America achieve equilibrium in their relationship, and that balance will be based on mutual respect and dependence. The China market would be a large opportunity for U.S. companies if China would be more open to American imports of automobiles, construction equipment, and electronics devices. In addition, an invigorated U.S. market would prove lucrative for American as well as Chinese companies to sell more goods.

If the appropriate actions are not taken, it is likely that Chinese corporations will gain increasing percentages of global markets, as well as their domestic markets, for a wide variety of manufactured goods. If that happens, U.S. citizens and the U.S. government will suffer. Indeed, the United States’ economic and political strength will decline precipitously. And if the economic strength of the United States continues to decline, China will have a smaller export market.

Some would say the economic strength of the United States has already declined, due to the unprecedented levels of its buying imports from China and the government’s skyrocketing deficit spending. Indeed, imports from China had been growing for decades, but as the U.S. economy recovered from the dot-com bust of 2001, those import levels were turbocharged, as Figure 1.1 shows.

In addition to the trade imbalance with China, the United States also is importing large amounts of oil and manufactured goods from other countries. All those automobiles from Japan, South Korea, and Germany, wine from France, Chile, and Australia, and designer watches from everywhere cost money too. In 2008, the U.S. trade deficit was almost $700 billion,⁵ the total of more than 20 years of negative trade balances. The large trade deficits between the United States and China are a key indicator that American trade and manufacturing policies are failures.

FIGURE 1.1

U.S. Trade Deficits with China

Although, the trade deficit is diminishing America’s wealth and political power, it is not the only deficit that plagues the United States. The U.S. government has been spending more than it takes in as taxes since before 2000. The fiscal deficits of the past decade were incurred in part to support the wars in Iraq and Afghanistan and to make up for huge tax cuts.⁶

The burgeoning fiscal deficit of the U.S. government also made the trade deficit worse. This spending spree by the government, and additional cash in the pocketbooks of the wealthiest Americans, triggered a tidal wave of consumption in the early years of the twenty-first century. The middle and lower classes also joined in the fun, courtesy of overeager and underregulated mortgage brokers, credit card companies, and other providers of easy money. Access to funds from home equity loans and no-interest mortgage loan refinancings launched the flood of spending.

The economic meltdown on Wall Street in September 2008 made a bad fiscal deficit situation much worse. The administration of President George W. Bush borrowed $700 billion to prop up AIG, Bank of America, Wells Fargo, and a host of other rescued banks and other organizations holding worthless mortgages. After the stock market crash wiped out a substantial portion of the net worth of most Americans, the Obama administration organized a $585 billion stimulus program to restart the economy with jobs and rebuild America’s deteriorating infrastructure, again financed by the U.S. Treasury’s borrowing more money. The Obama administration announced in October 2009 that the fiscal year deficit was in excess of $1.4 trillion, up 212 percent from fiscal year 2008.⁷

The U.S. government’s policies to increase consumption without stimulating domestic manufacturing increased the trade imbalance as well. For example, many foreign companies, such as Toyota and Hyundai, benefited from the Cash for Clunkers program funded by the stimulus package.⁸

Another troubling ramification of the twin deficits is their impact on the value of U.S. currency. The deficits weakened the value of the dollar, although the negative impact of the deficits on the value of the dollar and the purchasing power of the United States has been moderated by the willingness of foreign countries to hold dollar reserves. Since the dollar is the leading global currency, these dollars buy goods from other countries. This means that it is vitally important for the United States to ensure that the dollar remains the leading global currency and to avoid any dramatic weakening of the value of the dollar. Without this effort to maintain the primacy of the dollar, there will be low levels of incentive for countries such as China, Japan, and others to be willing to hold dollars.

If other countries, such as China or Japan, were to decide to dispose of their dollar reserves, the dollar could weaken rapidly, and the buying power of the United States would decline rapidly. In 2009 the Chinese appeared to be loathe to sell their dollars because they knew that the surplus of dollars on the currency markets would depress their value even more. However, the precarious position of the dollar leaves the United States vulnerable—an example of how economic weakness can lead to political weakness.

Building economic strength to maintain and extend political strength is not new. Kings, queens, emperors, and dictators throughout the history of Europe and Asia were focused on these objectives for hundreds of years before the New World was discovered and settled. To understand the why and how of ChinAmerica, it is important to grasp that corporations are now viewed by government leaders as the key tools to building the wealth of their nation. In Chapter 2, I will explain how economic power from corporations became the prerequisite for political hegemony.

2

HOW CEOS REPLACED GENERALS

IN THE PAST, THE WEALTH of nations depended mostly on military prowess. While internal threats always loomed large—usually societal unrest such as the American and French revolutions—the most common and potent threats were from external military forces. As invading armies took control of territory, they plundered the riches of their victims and enslaved the citizens.

Today’s external threats are corporations that invade and obtain a substantial share of a market outside of their home country, reducing the wealth-generating potential of the defeated territory. Corporations are the armies of the late twentieth and the early twenty-first centuries, attacking vulnerable external markets while protecting their markets within their home turf as well.

Just as it was and is important for nations to have strong armies, it is critical for corporations to be strong within the present economic environment. These days it is corporations that conquer territories and markets—think about how the armies of Toyota, Honda, and Nissan conquered the U.S. automobile market and helped bring about the bankruptcy of GM and Chrysler. Or how Sony, Toshiba, Panasonic, and Sharp essentially wiped out the U.S. television industry. They are two industries that were essentially invented in the United States but conquered by overseas corporate armies. CEOs have become the new generals, leading the troops to save the country and grow wealth.

Corporations build wealth by creating products and services that can be exported, providing employment, generating a return for the stockholders who provided the capital for the corporation, and by paying taxes to a government that provides infrastructure and security. Corporations that succeed in these roles also develop key technologies, products, and services that increase the health, well-being, and standard of living of their populations, as well as build wealth and security.

Let’s examine these roles in more detail, highlighting the countries that have been supporting their corporations in their pursuit of national wealth.

Providing Employment

Don’t forget that there are direct and indirect benefits of having large corporations that employ many workers. The direct benefits include the ability of workers to have salaries, buy products, and pay taxes. The indirect benefits include a stable society, in which there is the opportunity for upward mobility in terms of responsibilities, status, and standards of living.

In many industries, the supporting infrastructures can provide four to five times the employment that is needed for the core industry. An example is the network of component suppliers and professional services providers that support the automotive industry. GM, Ford, Chrysler, and other automakers do not make the seats, tires, window glass, engine control electronics, and other parts of a car but instead buy them from other companies. This overall industry ecosystem provides a large and diverse employment base.

A big and thriving corporation will need a wide variety of skill sets to maintain its operations and find growth opportunities. Corporations employ managers, engineers, technicians, and assembly workers, and they offer additional job opportunities as employees learn and improve their efficiency. Corporations also provide employment for new graduates, which creates the motivation for citizens to improve their education level. The Finnish cell phone giant Nokia exemplifies this approach, providing excellent employment opportunities for graduates in Finland as well as in other countries in Europe.¹

Political and business leaders in China, Taiwan, Japan, Germany, and other countries have long recognized the importance of corporations in generating exports. Unfortunately, U.S. political leaders have been slow to recognize the dire need for American companies to be strong enough to increase their exports. U.S. government funding to encourage and support exports of manufactured goods woefully lags behind the efforts of European or Asian governments. In addition, many American CEOs have been slow to focus on the export opportunities because the American domestic market has been among the largest in the world. That situation has changed now because of the recent growth of the Chinese market and contraction of the U.S. market. This change has made the shift to an export mentality a business imperative.

American government officials all but ignore the following important roles of corporations: generating exports, generating wealth for shareholders and other stakeholders, generating tax revenues, and creating technologies.

Generating Exports

Globally competitive corporations successfully export products. A global marketplace helps corporations expand their production runs, spread their unit costs of production over a larger base, and stay attuned to prevailing trends and pricing patterns around the world.

A global perspective and healthy level of exports helps protect the local markets. Features, quality, and pricing lessons learned from selling in foreign markets can prevent overseas competitors from invading a local market and winning market share from the domestic company. But if the domestic companies fail to learn those lessons, trading internationally can lead to the erosion of their home market share. The state of the U.S. automotive manufacturers in the beginning of the twenty-first century is a painful example of this phenomenon. Weaknesses at domestic manufacturers General Motors, Ford, and Chrysler led to the growing level of cars being imported from Japan, Germany, Sweden, South Korea, and elsewhere or made in U.S. factories under the direction of overseas owners.

The cost of losing domestic market share to imports is difficult for a country to overcome. Consider the trade imbalance impact of the weak domestic automotive makers in the United States. If 10 million automobiles are imported at an average value of $20,000 per automobile, the total level of imports is $200 billion annually, plus the value of the replacement parts that need to be imported for 5 or 10 years thereafter. Only a small number of industries can generate exports of $200 billion annually. For example, worldwide 2008 revenues of the movie studios in Hollywood were approximately only $28 billion.²

It is true that globalization of procurement, assembly, distribution, and sales of products has been diminishing the true financial benefits of exports beginning in the late 1990s. An iPod from Apple, an inkjet printer from Hewlett-Packard, or a laptop PC from Dell may have an American brand on it, but device assembly may have been outsourced to a company in China, Taiwan, or Mexico. That outsourcer bought parts made in the United States, Singapore, Taiwan, and elsewhere to assemble the device according to specifications from the American company. Consequently, when those devices are sold in China, Japan, Korea, or other markets, they are not U.S. exports since only the brand, the intellectual property, and the design came from America.

The shift to globalization has warped the true value of exports for many industries and countries. Computers, printers, automobiles, cameras, and other complex products’ carrying the corporate brand and nationality of one country doesn’t mean that the product was assembled by the brand or in the country associated with the brand. CEOs defend this practice by saying that it is better to have some of the value of the exported product accrue to the brand name rather than none. When it comes to the U.S. trade imbalance, that means it is better if an American consumer in San Francisco buys a notebook computer from Apple rather than Sony because more of the consumer’s cash stays in the United States.

Generating Wealth for Shareholders and Other Stakeholders

Since the underlying operating principle of a market economy is that risk should be rewarded, corporations need to generate profits to develop new products for revenue growth and provide a return for investors. Shareholders who are rewarded for taking risks are encouraged to invest in new businesses, which progresses to a virtuous cycle of increasing exports as well as domestic production. Successful corporate investments help create national wealth.

When many CEOs and boards of directors of major corporations focus on short-term returns from stock options and stock buyback plans instead of long-term growth, they are effectively strangling future export growth. Asian corporate leaders, who are not rewarded with the lush stock options programs common among large U.S. corporations, are much more focused on long-term strategic success, which is based on increasing exports.

Generating Tax Revenues

Corporations pay taxes, which covers the costs of government services. When U.S. companies close domestic factories and open them in Asia, America not only loses the jobs but it also loses the tax revenues. The 500 largest American companies passed a dubious milestone in 2008: they paid more in foreign taxes than