Deeper & Deeper in Debt
I have a very personal dislike of debt, or credit, depending on your perspective. Yet it is a very important part of business life, and when you are small business having your credit terms abused by many (often larger) customers you need debt to finance the credit your clients demand. So it comes as no surprise that the stories of banks withdrawing credit facilities sends fear through even the most hardened of entrepreneurs.
As someone who deals a lot in China, and hears a lot of stories about how much cash is sitting in China, I couldn’t help but wonder whether the western strategy of outsourcing work to the far east had a part to play in the lack of cash available this side of the world. My theory was based on the following thought process;
A UK business borrows money to finance their business, which is used to pay for manufacture in the Far East. Eventually the UK runs out of finance so demand for manufacture in the Far East drops driving them into recession (demand for their produce drops), yet they have a lot of cash in reserves. The UK Government in a drive to boost the economy borrows more money to from our already deep deficit getting the country deeper in debt, this debt is used to finance the banks debts, which in turn is used to finance the debt of business, with the theory of buying more (debt). Using debt to finance debt just doesn’t sound right, and I couldn’t help wondering whether a better strategy would be to encourage the eastern countries to buy from the west to help finance the west to start buying from the east again.
We all rely onb each other everywhere in this world in which we live, and the theory seemed to make sense.
So I put the questions to my local MP, Sally Keeble from Labour, and also to the Conservative candidate Mike Ellis. I must say Sally wasn’t keen to get involved in the conversation, cutting me short saying “the Chinese need to focus on their own problems” and the UK Government has a strategy in place to recover our economy. I wasn’t convinced, especially as she cut me short and asked for any other questions.
Michael Ellis took the time to give a more detailed response, albiet he obviously included a sales pitch for his party!
Your assessment of our position vis a vis low cost production from Asia these last few years is accurate. They have been producing lots of goods for us, most of which we, as both individuals and companies, have paid for with credit. This has resulted in large reserves for the Chinese government. So again your description is spot on. It is also true that most people feel the Chinese want to increase demand at home.
However, they are in as much of a bind as we and the Americans are, despite their large cash reserves. Our credit-fueled buying has allowed the Chinese to expand their capacity to meet our needs and this has resulted in more wealthy and middle class Chinese, but nowhere near enough to make up for the sudden drop in consumer demand we are now experiencing here – and that their factories are feeling as a result.
It takes a long time to build a stable consumer class, usually requiring a large middle class, and when combined with a Chinese culture that still understandably values saving I think they have a long way to go to build anything close to the internal demand needed to soak up the production capacity they have right now.
In fact they have kept their cash reserves in the USA and the UK mostly to ensure their currency remains relatively low in value compared to ours so as to keep the cost of their goods low – hoping we will continue to buy. This has provided an additional benefit to us in the West because their demand for government bonds keeps the interest rate low on our government debt, which again you rightly point out we are now creating lots more of…the CBI were just complaining about that today as you may have seen.
If the Chinese took all their cash home, our currency would weaken further than it has already, the cost of our government debt would soar, their currency would strengthen and their exports would get much more expensive to us, driving down demand from us for their goods and creating more unemployment and slower growth for them! We are in a sense all in this together in the most complicated way….
In short – it would be great if the Chinese had the capacity to create more demand internally, and I am sure they will over the coming decades, which one hopes will increase our share of exports. However, their using their cash reserves alone would likely make a small immediate impact and would have some rather scary immediate consequences for everyone.