Washington, DC -- (ReleaseWire) -- 04/07/2015 --BENNETT: Dr. Derek Scissors is a resident scholar at the American Enterprise Institute (AEI), where he is an expert in Asian economic issues and trends. He publishes AEI's China Global Investment Tracker, which follows large Chinese investments, excluding bonds, around the world. The leading recipient of these kinds of investments so far is United States which has received almost $70 billion between January 2005 and December 2014. That's interesting. China has just established the Asian Infrastructure Investment Bank, also referred to as AIIB, which is seen as a rival organization to the World Bank and Asian Development Bank, which are dominated by the United States, Europe and Japan. Derek, welcome to Financial Myth Busting.
DEREK SCISSORS: Thanks, Dawn for having me.
BENNETT: China has just established the Asian Infrastructure Investment Bank, also referred to as AIIB, which is seen as a rival organization to the World Bank and Asian Development Bank, which are dominated by the United States, Europe and Japan. Since the World Bank and the Asian Development Bank are beholden to the old Bretton Woods order, does that mean that the AIIB will dance to China's and Russia's tune instead?
SCISSORS: Well, it won't dance to Russia's. Russia is a minor financial player and has a very struggling economy. I do think the AIIB will dance to China's tune. I don't think that's much of a change over the situation we had before. Prior to this, China had a very large bank called China Development Bank giving most of these loans and certainly it's an arm of the Chinese government, so China Development Bank obviously danced to China's tune and now we are calling it Asia Infrastructure Investment Bank. Name change, not a change on the ground.
BENNETT: The geo-political importance was apparent immediately, though, by the U.S.'s negative reaction when the U.K. announced they are going to join the AIIB. Does this mean from a geopolitical point of view that China and Russia have now outmaneuvered the United States?
SCISSORS: I do think the American reaction was a mistake, but If you are talking about the Chinese influence in these countries, none of that is going to change. That was already happening. China Development Bank, for example, had loaned more money to African states than the World Bank had, so we were already seeing this Chinese financial influence spread around the world and the U.S. is acting like this is a big deal and getting into a tiff with its allies for no reason. So I do think that there was a mistake here made by the United States and the mistake was treating the Asia Infrastructure Investment Bank as if it's important. The important thing already happened, which is China has a lot of money and it's spending it and we need a strategy to counter that.
BENNETT: With our allies are joining this bank, I wonder if the AIIB is a first strike at ending the U.S. dollar's domination?
SCISSORS: No. Those are two really different issues. I do it was a smart move by Chinese because they are re-branding something that they were doing already. It's like you have a business and the business is doing well, it's active all over the world, but you have a brand name that people don't like. And you just change the name and suddenly everybody else wants to join in your product and co-produce with you and license things with you. That's what happened with the AIIB. It's still Chinese money doing what it was doing before but now everyone wants to join in because it says 'Asia' instead of 'China.' I think that's clever. But with regard to the US dollar's dominance, since AIIB is going to be lending in dollars, the Chinese currency, their renminbi is actually a derivative of the dollar, it's pegged to the dollar. So they are two different things here. U.S. diplomacy has suffered a setback and we will suffer from more setbacks unless we think about what to do about the Chinese money. But the Chinese actually use dollars so the dollar remains the king.
BENNETT: The Obama administration made a big point of asking our allies not to join this bank, which certainly makes it feel like they think that it's a threat to United States led institutions like the World Bank and the IMF. Do you think the Obama administration is overreacting?
SCISSORS: I definitely think they are. As I said, China was already acting on its own outside of current institutions. I am not a huge fan of the IMF and the World Bank. It doesn't really bother me that they have a competitor. I would prefer for it not to be a Chinese competitor, but it is what it is. This was already occurring. So the Obama administration threatening our allies or pressuring them, or publicly rebuking them doesn't make any sense. All it does is it takes a move by China to re-brand their organization and we have sort of given them what they want by looking silly, essentially. But Britain, our very close ally, Australia another close ally seem to be defying us. So we turned this into a loss of diplomatic influence that wasn't necessary.
BENNETT: Do you think our administration has lost its ability to lead, or do you think their case just isn't compelling?
SCISSORS: I don't know why we did this and I am in Washington, based in Washington, working on China all the time. It's not like I shouldn't be aware of the reasons. It doesn't make any sense and a lot of people think it doesn't make any sense because I think it's a fairly minor issue. The administration certainly has a chance to recover, if we can get a good—and that's important—transpacific partnership agreement that's much more important in Asia than the Asia Infrastructure Investment Bank. But they have to be able to deliver. I think right now there are some doubts about the Obama administration's perceptiveness and its credibility. They need something to counter that.
BENNETT: Do you see the AIIB as an anti-dollar alliance?
SCISSORS: No. Again, they're using dollars. I see the AIIB as the tool of China to—the same kind of tool it had before—where it's trying to enhance its diplomatic influence. It's trying to maybe weaken the ties among U.S. allies. But it's a diplomatic tool, it's not a financial tool. Financially, the dollar is still in charge because the Chinese are afraid to move off the dollar standard. They're not afraid, however, to try to poke at the US. And they're doing that and we're not responding very well.
BENNETT: Maybe they use the dollar now but have set up an infrastructure for to use the renminbi or the yuan in the future, though?
SCISSORS: They have, and they lack the nerve to use it. I mean let's not forget, we're not the only ones with political leaders who don't necessarily do the thing they're supposed to do. The Chinese have accumulated a huge pile of dollars because they've been afraid to make their renminbi an international currency. Well, you know what happens when you have a huge pile of one kind of asset. You don't want that asset to disappear. So they now have a stake in keeping the dollar on top. I've said this, I used this line before: the biggest seller of dollars is the Federal Reserve, undermining the dollar, and the biggest buyer of dollar, supporting the dollar, is the People's Bank of China. So, you know, the Chinese do have the infrastructure in place for the renminbi to challenge the dollar but they're afraid to pull the trigger.
BENNETT: You run something at AEI called the China Investment Tracker which follows major investments that China is making abroad, minus bonds. The United States is the biggest recipient of this. Why is tracking how China invests important to our listeners?
SCISSORS: Well, if you're selling something, the Chinese might want to buy it. The U.S. is the number one recipient for Chinese bond investment too, and we all knew that. But the Chinese put out numbers—and your listeners have probably heard this before—that aren't reliable. And their numbers on their investments outside of bonds are not at all reliable, which is why I started following it independently. We've had a surge of Chinese investment in the U.S. in the last three years, record after record, in terms of annual investment. They're buying up especially American property but they're also interested in agriculture, they're interested in energy. And there are two elements to this. There's the positive element: which is if you have an asset it's always good to have another buyer, and the Chinese are another buyer, buying real estate in Los Angeles and San Francisco.
BENNETT: I wonder if this is like the 1980's all over again, when Japan was buying up all American assets, but instead of Japan, now it's China. Should we worry about that?
SCISSORS: There are similarities and differences. Japan went crazy buying American assets and ended up blowing a lot of their money, and I think that's what China's doing, as Japan did. On the other hand, Japan was and is a treaty ally of the United States, and China certainly is not. So we need a mechanism to make sure they are not buying technology out of Silicon Valley or elsewhere that we don't want them to have. And that mechanism we use right now is called the Committee on Foreign Investment in the United States. It's a government mechanism, and we need to make sure that CFIUS is doing its job, because this increasing rush of Chinese investments could hide some smaller investments where they're trying to buy technology we don't want to sell to them.
BENNETT: When a Chinese firm bought the iconic Waldorf Astoria, you said in one of your pieces that this wasn't something we should be upset about. Why not?
SCISSORS: Because they overpaid, that's one thing. And second, there's no real strategic gain to this. If the Chinese want to buy hotels in major U.S. cities or overpay for people's properties, fine let them. If it benefits Americans, we believe in a free market economy. You have a buyer, you have a seller, they obey the law, that's fine. I think what we work on is not selling technology—as I said before—and then making sure after they come here that the Chinese have to obey the law. So the things I worry about are not the Waldorf Astoria, the things I worry about are Chinese accounting standards. The SEC is investigating the Big Four accounting firms for their China operations because they don't disclose properly and they say it's Chinese law that makes them not disclose properly. That's unacceptable. When you come here as a foreign investor, you have to obey American law. So that's the kind of thing I worry about, rather than hey, they paid an extra hundred million for the Waldorf Astoria.
BENNETT: Do you think the Chinese will get away with breaking our laws in the end, because so much of their money is coming into the United States and we need it here in our economy?
SCISSORS: I do worry about that. I mean, you got to remember that most of the investment is by either state-owned enterprises or private enterprises who are run by communist party members. They're not used to the rule of law at all. Even if their intentions aren't malign, if they're not thinking about harming the U.S., they don't really know how to behave here. And so I would expect a lot of either law breaking or law tempting, if you will, activities. And we have to be ready for that. You know, I'm watching it and I don't see it. I see people either worried about the technology, which I understand, or have a knee-jerk anti-China reaction that involve violating free market principles, which I oppose. I don't see people thinking: we're going to have a lot of Chinese presence here. When we've had a Japanese presence here, but Japan is a society with a rule of law, China isn't. We're going to have problems with Chinese firms and individuals breaking the law, what are we going to do about it?
BENNETT: You sound pretty bearish on China. I wonder if the rise of China has already passed its apex. What are the biggest headwinds you see threatening its economic growth, which seems to be so much greater than ours?
SCISSORS: Yeah, I do think it has. I am a China bear. In 2009, when they engaged in the world's biggest stimulus by ordering their banks—their banks are arms of the government, they can order them to do things—ordering their banks to loan money even though the economic environment was weakening, I thought it was a terrible mistake. And it's gotten them into the trouble that you'd expect. I'll just give you a number: The U.S. cumulative American government national government deficits 2009-2014 is 6.3 trillion dollars, which is a lot. McKinsey & Company thinks that from 2007-2014, which is two years longer, the Chinese added 20 trillion in debt—more than three times what we added. So their biggest problem—which sounds strange because they have so much money invested overseas—is domestic debt. And there's no way to avoid that. Europe can't avoid it, Japan can't avoid it, we can't avoid it, China can't either. It's going be an anchor around their neck for years, maybe decades, because there's so much of it. And, you know, the Chinese will lie about their economic statistics and they'll report anything they want. But when a bullish outlet like McKinsey, which tries to sell things, says 20 trillion dollars in new debt, that's a sign that China's in a lot of trouble.
BENNETT: Are you talking in terms of the shadow banking system over there?
SCISSORS: That's a good question. The official debt is more like 8 trillion, which is already huge, so McKinsey is trying to get an assessment, and others are too, of how much unofficial debt is being accumulated and they came up with another 11 trillion. That may be too high, but even if China's only added 15 trillion over this period, it's much too much for any economy, even ours and certainly theirs, to absorb. You add that to the fact that China's also, because of the one child policy, going to become a rapidly aging country very soon if it hasn't already. When you have an aging society and a lot of debt, what you look like is Japan. And Japan has seen essentially no growth for 25 years. That is what I think is in China's future.
BENNETT: Last year, I think, they bailed out some of these loans, without letting them default. They seem to be following our route in doing that. Can they continue to do that? At this point, they still are a closed economy.
SCISSORS: You can't send money freely out of the country, that's the big thing. So everybody's savings deposits who don't get around the law some way because of political influence or illegal activity—everybody's savings deposit is hostage. You think it's your money but if the bank needs it, it just sends it someplace else.
BENNETT: What about Alibaba, the company that went public this past year here in the United States? Was that their way of trying to be more open about their accounting, more open about their business practices and their goals?
SCISSORS: Funny, my somewhat paranoid view—or it's not really paranoid—my cynical view of what Alibaba is doing is that Alibaba, which makes money on the web, realizes it doesn't want to be based in China which has a very love-hate, mostly hate, relationship with the web because it allows the free flow of information. And so I think Alibaba, as much as it makes money on China and it does most of its business in China still, was looking to move a lot of its operations elsewhere and that's why it listed in the U.S., because if you're a web company, you'd much rather be exposed to the United States than exposed to China. That's my view of that. It's not that they were trying to be good citizens, they were trying to protect themselves against the Chinese government.
BENNETT: You think going public here gave them the liquidity to diversify outside of China?
SCISSORS: Exactly. And it gives them an area of operations that is not a subject to inference by Chinese authorities.
BENNETT: Derek, what do you think the average American thinks about China? Is China an economic competitor to us or is it a merely a trading partner? And what about the flip side of that? What does the average Chinese person think about America?
SCISSORS: The average American probably—my sense of this is, they are disquieted, it's a little nerve-wracking to have China seem to be growing rapidly all the time; they don't pay attention to every little detail like McKinsey reports on Chinese demographics so they are still thinking that China is a rising power and it's a single party state run by the Communist party. So it makes them nervous but also we are not in the conflict with China. China is not beheading people, China is not invading Ukraine. So I don't think China is nearly at the level of the Iran or Russian or non-governmental organization like ISIS. I think it's something that makes Americans nervous and on the other hand they probably know some Chinese, not just Chinese Americans but actual Chinese. There are a lot of Chinese in the U.S. studying or doing business, and that's probably a positive. So I think there are mixed feelings and the predominant one is kind of a mild nervousness.
BENNETT: Again, what's the flip side to that? How do you think the average Chinese person thinks about Americans?
SCISSORS: Well, in the same way that an average American doesn't spend that much time thinking about China. China is a very big country. You are inland Chinese and you are not thinking about the U.S. that much. I think most Chinese still think of America as some place they would love to go see and visit and maybe live because living standards here are so much better than they are there. I think something that a lot of Americans don't know is that the average American makes about thirteen times as much every year as the average Chinese. That's a big gap and I think the number one thing Chinese think about America is called in Chinese "Mei Guo," a beautiful country. They think America would be a wonderful place to visit and perhaps live.
BENNETT: There is a paranoid theory that China wants to overtake the U.S., and part of that strategy is that they could dump U.S. Treasury bonds that they own on the market for nothing, perhaps leading to a collapse of a dollar. Do you agree with that?
SCISSORS: Well, it won't work. The famous line: If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem. It's easier to talk about dumping treasuries than actually doing it. If you are a seller and China decides for some reason it's going to sell all these treasuries, you have to have a buyer. There is only one buyer that's going to come in and buy it near face value because there is only one buyer that has enough money and that's the Federal Reserve. So, who they are going to sell to is the question. The funny thing is anyone who would buy them would pay them back in dollar assets, they would just be swapping treasury bonds for other kinds of dollars because the other currencies aren't big enough in the world and Euro is actually getting worse. So they are stuck. They can try to sell treasuries and put pressure on our bond market for couple of weeks but the only things that comes out of that is that Chinese have to write down and divide their treasuries because they have to sell it at discount.
BENNETT: They are engaged in a lot of bilateral agreements even with our own allies about getting more countries to do more trade in renminbi, in yuan. Do you think that's going to affect us?
SCISSORS: The IMF is going to meet next week and they will make a big fuss about adding the renminbi to the list of reserve currencies, which is now the dollar, the euro, the yen, and the pound sterling. And that sounds like it is important and these currency swaps you mentioned with our allies sound important, they are not. The only thing that matters right now is if renminbi is still pegged to the dollar. The difference between the renminbi value against all other currencies and the dollar's value against all the currencies last year was a total of 2 percent. That's because the Chinese are afraid to have their own currency so they use ours. As long as they are afraid to have their own currency, afraid to have the speculation, the rises and the falls in their currency, then all the rest of the stuff doesn't matter. What the U.S. has to watch for is that moment where the Chinese actually get their nerve up to de-peg from the dollar.
All data sourced through Bloomberg
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
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