The link between Chinese labor and US stocks... - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 13 October 2014
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Burlington, Vermont

New England is stunning this time of year. Just what you'd expect. The leaves turn brown, yellow, red....putting on their best outfits and strutting their stuff in the cool autumn air.

Autumn, especially in New England, is the loveliest time of the year. The sun barely clears the top of the trees, even at noon. The light, filtered through the colored leaves, gives the whole earth the rich and heavy air of a funeral parlor.

Perhaps that is why there are market crashes in the fall. Investors feel the approach of death.

The stock market fell hard on Thursday...and then kept falling on Friday. Before the week was over, investors were worried.

Last week, we talked about the increase in volatility. This was predicted by our friend, economist Richard Duncan. As QE comes to an end, he said, so will the easy money supporting the stock market.

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Shrewd investors are looking ahead. Without the Fed behind it, what is the likely return from the US stockmarket over the next 10 years "Negative" says our chief researcher, Stephen Jones. The simplest way to look at it is this: stock prices are high. From these heights, stocks typically fall more than they rise - even without the withdrawal of QE. Stock prices always regress to the mean, which will mean 10 years of losses for stock market investors, says Stephen.

Wait a minute, you might object. 'These prices are supported by earnings.'

But Stephen insists that corporate earnings have been inflated by debt. The money had to come from somewhere. And it could have only come from debt. So, if the credit expansion stops, those earnings will deflate.

That's why the feds are so desperate to keep interest rates low and liquidity high. When rates rise...the whole gig is over. Earnings will fall. Stocks will fall. Credit will contract, and the economy with it. Tax revenues will shrink. Bonds will crash. Have we forgotten anything? Yes...the whole model of modern government and finance will collapse.

In fact, it will be the end of the world as we have known it.

We (your editor is speaking for himself) were born at the beginning of the biggest boom in history. In Phase I, that boom was first fueled by output - of babies, autos, TVs...everything. Later, in Phase II, it was fueled by credit. From '64 to 2014, credit in the US increased 50 times, as the economy shifted from manufacturing to finance, that is, from making things to buying them with borrowed money.

But now, 66 years later, the leaves are beginning to droop on the whole shebang.

The IMF announced last week that now the Chinese economy is officially larger than that of the US, on a purchasing power parity basis. In dollars, Chinese output may still be below the US. But when you adjust for what the local currency will buy, China is bigger...and getting bigger all the time.

One interesting feature of the report: since the beginning of the financial crisis in '08, the Chinese economy has grown not twice as fast as the US, but nine times as fast.

But China is not immune to the seasons either. From Chongquing province comes news (via the Wall Street Journal):

    Electronics company Foxconn's offices in Tuchung, Taiwan, in June. The company said about 1,000 employees walked off the job at a plant in Chongqing, China, for several hours this week. Agence France-Presse/Getty Images

    About 1,000 workers at a Foxconn plant in southwest China assembling printers and computers for companies includingwent on strike for several hours this week demanding higher pay.

    The Taiwan-based company, formally known as Hon Hai Precision Industry Co. said the workers walked off the job for four hours Wednesday at its production site in Chongqing. About 20 workers went on strike Thursday morning but further details on that stoppage weren't available.

    Foxconn is working with its labor union and workers to resolve the dispute, the company said Thursday in a statement. The company said the strikes didn't disrupt production.
Why is this important? It's another leaf turning yellow, says David Stockman. Chongquing province is on the Western edge of China's productive landmass and population centers. Go further west and you run into the Gobi desert. Lots of sand, but few people. If China is running out of cheap labor there, it's running out everywhere.

A key component of the Phase II of the great credit expansion was the entry of approximately 500 million workers into the international labor pool. Gradually, as American shoppers went to WalMart, they found more and more "Made in China" labels and Everyday Low Prices. This phenomenon largely offset the Fed's inflation. In short, the US found that it could inflate credit all it wanted, without causing an alarming rise in prices or interest rates.

But now, that party is over. The strikes in Chongquing suggest that even on the furthest fringes of China, bargaining power is shifting to workers. The well of cheap labor from impoverished Chinese peasants may have been pumped dry. If that is so, labor rates will rise in China...and prices won't be far behind.

Don't expect an immediate mark-up of flat-screen TV prices. This is a big boat the Chinese are turning. It will take years to manifest itself.

Besides, it is just October. There is still November and December ahead. And don't be surprised if volatility spooks the Fed so that it goes back into QE mode - or worse.

Relax. Enjoy the season. Leaves - like wine and women - can be at their best, just as they begin their decline. And as a passenger on the Titanic was heard to remark after the ship hit an iceberg, the band never sounded better.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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