A Look at China, the Communist Party, and their Future

Although in the U.S. the stock markets are demonstrating a lackluster performance, the overall tally of the day is not discouraging. We expect the Euro to strengthen towards the end of the year, as the dollar rises against other currencies mostly because of the year-end reaction to the past month's strong price action. The Chinese, after all, don't seem likely to allow the yuan to appreciate any futher. So, today we'll take a longer-term look at China's role in the world as a growing power, since there is not a lot going on in the markets.

These days in Asia, we observe a widening gap between the tensions over Taiwan, and the situation in Korea. Although the Chinese have achieved a considerable thaw in their relations with ROC, their attitude towards Japan and its ambitions and claims in China's zone of interest is growing more and more aggressive each day. And it is tempting to think that their blatant refusal to rein in North Korea is indirectly a ploy to keep the Japanese busy and worried. In addition to the Korean threat, China directly presses Japan to submit in many international avenues, and sometimes in the most unlikely manner, aiming to inculcate a notion of contrition in Japanese politics, perhaps, so as to create a more malleable partner in future conflicts and controversies. Still, this aggressive and combative approach is almost always restricted to symbolic acts that are aimed at humiliating the Japanese and rarely assumes a military aspect.

The true extent of China's intentions against Japan are difficult to gauge, but it is almost certain that the Communist Party in power at the moment presents the most benign set of possible partners that the West and China's regional partner's can have. Similar to the situation in the Middle East, in China it is far from certain that a greater degree of democratization will contribute to stability in the region. By all accounts, the existing administration, under the leadership of Hu JinTao, and Wen Jiabao, is directing all its efforts at keeping China out of any major trouble while at the same time satisfying the population's craving for a more assertive, stronger, perhaps even more aggressive China. The fact that the country's moves against its regional partners, including Japan, have been almost entirely made in a symbolic context so far is evidence of the desire to strike a balance between populism and commonsense at the highest levels of the Chinese leadership.

China, as a developing nation, has no shortage of crazy people who would do everything to regain the lost of honor of the past centuries. The case of the major general who claimed war against the U.S. would be acceptable even if it decimated everything east of Wuhan, or of the professor who deems it sensible that China demand the Okinawa islands from Japan as it had been a part of the Chinese cultural sphere for centuries (Japan itself, in fact, had been a part of that sphere in many ways), confirm that the present reasonably well-behaved, yet strongly patriotic Chinese leadership is the best that the rest of the world can hope to have from the country, given that the vast majority of the population has little more than chauvinism and dreams of irredentism to provide them a sense of self-worth and meaning agains the supremacy of the Western civilization in almost every field. Peace and prosperity in the world depends to a large extent on the management of these masses over the next decades, since any hasty decision or action would easily lead to catastrophic results.

On the back of all these, and the long-term economic problems that imperil the development and stability of China, one is naturally tempted to speculate on the future of the CCP, and its longevity. At the moment, at least, there is no sign that there is a credible opposition to the rule of the communist party in any way. Protests and demonstrations are not extraordinary in this country, and authorities have a reasonable degree of commonsense in allowing an extent of freedom to the common person without political aspirations as long as he does not threaten the power of the party, and the stability of the regime. This, in turn, leads to a degree of complacency among the populace, who are, as it is often remarked, far more interested in raising their living standards than running after a distant idealistic vision of democracy and freedom, whatever they might mean in a Chinese context. Any opposition is directed towards reforming of the CCP itself within its authoritarian context towards a more ethical, and responsible structure, rather than dismantling it and replacing it with anything else.

This is how the situation in China is regularly analyzed, but we find it a little too optimistic and simplistic in light of the historic context, and the recent trends in the country. The Chinese Communists have benefited massively from the stability of the post-Soviet Era, and the so-called Pax Americana, as they were able to exploit the liberalization of international trade to the maximum extent possible under the corrupt and inefficient leadership of the communists. This will not last forever however. And while it is true that for now the party does not see any opposition to its version of nationalistic despostism, this paradigm is not necessarily different from Russian, German, Korean, or Taiwanese benevolent dictatorships of the past, and there is no reason to assume that its fate will be any different.

We must then wonder if the CCP will find itself as capable of ruling the country in the future, once the current money supply induced boom comes to an end, as it inevitably will. Will the Chinese be as happy to tolerate the CCP dictatorship if they find it incompetent? Given that economic downturns marginalize societies,and amplify the voices of extremists and radicals, should we expect the CCP to be able to keep them under control against all temptations toward populism, even if it does manage to survive itself? And how will it manage its relations with the country's growing oligarchy of extreme rich, who are, by all accounts, prospering not necessarily due to merit, but for the most part because of "traditional" nepotism that is common to almost every nation in Asia and Africa? Will it choose to integrate them into the party structure, which will surely turn the party into a thoroughly corrupt mechanism, or will it exclude them, and risk the creation of a powerful opposition in the country? And how will the nation's relations with its neighbors progress, in particular with Japan and its ally the U.S., as China says no to any kind of compromise, which it regards as a slap on the face against an ascendant nation with thousands of years of glorious history?

These questions demand their answers. Most people nowadays do not think much about the fact that China is still ruled by a small clique with a totally anachronistic analysis of history, even if they do quite well in the material world of economic analysis, or at least seem so in light of the unlimited resources that they can keep wasting with little cost. But once this situation comes to an end, we'll experience one of the most interesting times in history as China seeks a place under the sun, and the Chinese saying about living in interesting times is only a fitting reminder of the challenges that await the international community in managing this momentous event.

Markets Hibernate, But the U.S. Housing Market May Bring an Unpleasant End to the New Year Party

Data released Tuesday show that the U.S. housing market is not at all out of its difficulties, at least as far as pricing is concerned. "The S&P/Case-Shiller index of property values fell 0.8 percent from October 2009, the biggest year-over-year decline since December 2009," according to Bloomberg. On the one hand, few people seem to expect a turnaround in the housing sector soon, but on the other, housing is expected not to become a drag on the economy as the foreclosure stock is eliminated gradually, helped by falling prices and increased affordability. So if we continue to have such negative readings on housing, the Fed may be tempted to act once again to prevent these attitudes becoming too entrenched. In general, we think that the Federal Reserve`s current operational strategy involves a long-term, Japanese style commitment to easing, which would imply that the programs, plans, names and presentation that come with the packages are for cosmetics purposes only, with more surprises always in store in Mr. Bernanke`s Santa hat in case that the spoiled children in the markets cry too loud about neglect and lack of support.

The numbers are not surprising, because the de facto freeze on the sale of foreclosed property understood to have been effected by some banks has intensified the expectation that prices will fall quite a bit further from their present levels, apparently compelling some sellers to accept discounts as the final months approach, in return for the opportunity to dispose of risk. Other background issues, like unemployment numbers, depressed consumer sentiment and spending, rising savings rates, trade and protectionism issues that could suppress growth and investment for many years may have contributed to the fall, but given the optimism inspired by the QE2 plans, we think that most of this fall in prices must be related to the rise in foreclosure stock that has been an issue for a while.

Has the housing market found a bottom? Probably not, because house prices are notoriously slow to shift trends, and the 30% fall from the peak, while significant, does not in any way imply a rapid rise from the bottom of similar proportion in the coming years. After the delusional price action of the first half of this decade, we believe that house prices will remain dormant for a long time to come.

The Fed can inflate stock prices, but it cannot excite and stimulate consumers to spend unless its workmap is being supplemented by actions of the legislature that aim at  giving some bargaining power to workers, and thereby improving the effectiveness of the transmission of the stimulus from the government to the people. The main cause for the lack of a strong relationship between falling mortgage rates and stagnant housing market trends originates from this cut-off between the two mentalities, in our opinion Political concerns aside, there is the practical and obvious fact that the Federal Reserve cannot be stopped from doing what it wants to do, given its independence. But as long as the average person doesn`t want to take risk because he can`t see his future, while the shrewd speculator is very much willing to take his dollars and dump them into some bubble somewhere in Asia without scruple, all that will happen is that the stimuli, packages, and plans will at most contribute to a worsening of the imbalances around the world, without having a perceptible impact on the housing market, or any other market where the actors are not speculators (because of past burns), as today`s news show.

Ben Bernanke is an academic and he is essentially experimenting with the world, putting his ideas about the Great Depression, and the Japanese Bust into test by using us as guinea pigs in his mental laboratory. Whether one blames him for that or not, is a matter of taste and philosophy, so doesn`t have a lot to do with practical issues like profit and trading.  It is clear that if one wants to emerge as a winner from this difficult experimental phase for the world economy, what the Fed Chairman is trying to do to our lives must be understood and analyzed well. Blind blames, and excited rhetorical flourishes may entertain us, and perhaps help discharge some of the frustration felt over being helpless and clueless as the powerful play with the lives of others. But since the game has its rules, and getting outside of those rules is both costly and risky, it is for now a good idea to do away with the discussion about who is right or wrong, while focusing on whose opinion will count for the foreseeable future. The Case-Shiller survey results only show that the Fed must do more if it wants to get concrete results from its experiment, but it doesn`t say much about whether  the Fed`s preferred course of action is justified or not. Fortunately, for us traders information of this kind and amount is highly fruitful, as we may conjecture plausibly that the Federal Resevre will continue to do what it has been doing for years, with all the predictable and exploitable outcomes that come to mind with that understanding.