Financial Crisis, the West, the East, Gold, Manufacturing and Trade Deficit: How it all Ties in Together

by Andrew Alexander
The views represented in this article are solely those of the author and may not be construed as in any way representative of the views or policies of Oxford Royale Summer Schools.

High-speed trains ChinaHigh-speed trains in China

As much as he is often regarded as an embarrassing anachronism, the court jester of a British imperial era which was already slipping through the fingers of his generation, it would take a liar or a fool to open a book of Rudyard Kipling’s verse and not find within it sentiments equally applicable to the present day.
If is still the manifesto of the decent man outside the satchel-and-sandals posturing of the metropole, The Thousandth Man is still the standard for real friendship which bonds deeper than the social media, the white man still seeks his burden in the wider world, although these days he builds advocacy workshops rather than railways. And then there are the opening lines of The Ballad of East and West:

“OH, East is East, and West is West, and never the twain shall meet,
Till Earth and Sky stand presently at God’s great Judgment Seat…”

We live in a globalised world and a more open world. That transmission of ideas between cultures is easier, however, does not mean that take-up will be greater. The resilience of the separate political and economic cultures of East and West is fundamental to understanding the world as currently constructed.

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Take gold as an example. Gold in the West is part of a healthily balanced portfolio. In a financial markets sense, it is used primarily as a trading instrument, a hedge against falling confidence in the ability of governments to redeem their debts without heavy devaluations. It has acquired this status as a result of folk memory – because it acted many centuries ago as a store of value in a world where governments were apt to diminish the precious metal value of coins, it is assumed so to act now. In the West it is seldom bought in great quantities to hold, and governments and sophisticated investors are wary of holding a large portion of their portfolios in a dormant asset which offers no yield. It is, then, seen as a short-term holding capable of turning a paper profit on negative news-flow, and tends to be held through market-based instruments such as ETFs.

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Gold Flow to the East: What do India and China Know that We Don’t?

Image shows someone holding a gold bar.
Eastern countries are investing heavily in gold.

In the East, it’s a different story, thanks to two distinct groups. The Chinese government is amassing physical gold holdings at an astonishing rate – importing over 2,000 tonnes through Hong Kong in the two years to October 2013, as well as producing another 200 tonnes domestically. This amount not only makes it the second largest holder of physical gold in the world, it is an amount so vast that it exceeds China’s total gold holding in 2009 (when it was already the world’s sixth largest holder) each year.
India is the world’s other large gold importer – despite making up only 2.7% of world GDP, its population imports more than a third of global mine production. Here, gold operates not only as a traditional method of making savings, but also as a hedge against rupee depreciation. Unlike in China, where the state is hoarding the yellow metal, India’s politicans have actively campaigned against gold imports, as these contribute to a dire balance of payment situation and further currency instability. As in China, however, physical purchase and long-term holding is deeply ingrained in the country’s economic mindset.
One way to affirm the truth of this analysis is to look at holding patterns in the world’s largest gold ETF. The most popular ETF (GLD) is traded in New York, as well as in Tokyo, Shanghai and Hong Kong. In New York, in the year to October 2013, an average of 11m shares, or $1.4bn, was traded every day. In terms of volume this was 700 times the daily average in Tokyo and Hong Kong, and 350 times the level in Shanghai. In other words, interest in non-physical, instantly tradable gold has been a decidedly Western phenomenon. Over the same period, the East has been on a physical buying boom. China’s gold imports through Hong Kong between January and July 2013 were larger than its imports for the whole of 2012; in fact, in the first six months of 2013, China imported an amount of gold equivalent to 80% of the entire world’s mining output the previous year.

Image shows the Great Wall of China.
East and West have historically different attitudes to investment.

The differing attitudes towards gold tell us a lot about how the relative hemispheres feel about finance. The traditionally Christian West takes its lead from the Parable of the Talents – money should be invested to make money rather than left in a dormant and defensive asset. The East takes its lead from four millennia of existence in a world where the market means the small trader or the state, and nothing in between.
In many ways, these attitudes make East and West perfect bedfellows – the West can use monetary policy to inflate asset bubbles across speculative classes in a bid to reflate its economy and draw money out of bonds, the East steps into the bond funding gap, content to trade security for the absence of yield.
What is more important, however, is what this tells us about the likely paths of the two hemispheres going forward. The assumption inherent in globalisation is that it is the Western model of governance which will eventually prevail globally thanks to its ability to raise living standards by prioritising short-term consumption spending. The financial crisis has thrown this into doubt. As a point of fact, if not a point of conscious ideology, the financial crisis has forced the West towards the governance models of the East.

Western Governments are Manipulating Money Supply and Interfering with Capital Flows

The West has spent the post-crisis years vigorously chasing Eastern capital. This is not limited to the U.S.-China treasury loop, but includes innumerable examples from elsewhere. I shall list only a few: the government of the UK becoming the first non-Muslim state to issue debt through the vehicle of sharia law compliant sukuk bonds in October 2013; the role of Qatari government capital in salvaging the British banking system by supplying capital to Barclays in 2008; the London Stock Exchange launching an Islamic Market Index; China’s offer to bail out Greece, Portugal and other Euro-denominated basket cases in 2010 when the Eurozone countries were engaged in one of their periodic bouts of inactivity and navel-gazing.

Image shows Qatar, with skyscrapers in the background and an old-fashioned boat in the foreground.
Qatari investment helped save British banking in 2008.

At the same time, the West’s policy response to the crisis saw it abandoning many of the fundamental tenets of the liberal market creed. Through quantitative easing, it accepted the principle that it is legitimate for states to intervene directly to manipulate the market pricing mechanism in the bond and currency markets. Through the bank bail-outs and subsequent state interference in their operation, which has extended from forcing RBS to sell perfectly decent loan books for political reasons to forcing out its chief executive for criticising government strategy, the West has also accepted the notion that the state has a role in the capital deployment activities of the banking sector.
The result is that the West is no longer able to regard the East as its monetary inferior – a collection of societies whose organisation of capital through oligopolistic governing groups is so inefficient and archaic that they must liberalise or face ruin and revolution thanks to a population sick with the lower living standards which state interventionism brings. State interventionism is now the cornerstone of monetary policy in the West.

The West Wants to Emulate the East, but Can’t

Ask a Western politican, though, and finance is not the area in which they wish to emulate the East. Instead, it is the latter’s ability to produce transformational infrastructure projects which catches the eye. Politicians in the liberal market economies envy the ability of the East to organise its capital in a less speculative, less myopic manner. The financial crisis has concentrated minds in the West on the infrastructure deficit, but unlike the Great Depression, it has not inspired any concentrated effort to tackle it. Instead, central bank money is being recycled through the bond markets and creating fresh bubbles in those asset classes whose collapse led to this depression. By any standard, this is capitalism at its most divisive and most socially useless.

Image shows Chinese high speed trains.
China has succeeded in building high-speed rail where Britain has failed.

The West knows this. It wants desperately to emulate the East and it is unable to do so precisely because of the proliferation at home of the checks, balances and restraint on government action which it once advocated for the Orient. Let’s take trains as an example – specifically high-speed ones. George Osborne’s October 2013 trip to China saw him pointedly board a high-speed train between Shenzhen and Guanzhou, part of a Chinese super-fast network running to 5,800 miles.
Contrast this with Britain’s attempt to build its second high-speed rail route from London to Birmingham, Manchester and Leeds. Despite the acres of press coverage, construction is not expected to start until 2017 and will not be completed until 2032. Likewise, Crossrail 2, a new route under central London, has been on the table for two parliaments and has only recently begun the public consultation process.
The Western conception of statehood emphasises the individual – the inviolability of both intellectual and physical property laws, the conceptualisation of the state’s role in terms of responsibilities rather than powers, and the emphasis on human rights which exist both as concepts superior to and with primacy over executive power. The Eastern model, whether in semi-Communist China, military Singapore, or the dictatorial –stans, emphasises the absolute power of the state, framing this in a utilitarian model where this power exists over and above the rights of some people because it is exercised for all people.
Western politicians have become much more hesitant in criticising Eastern authoritarianism after the crash. George Osborne famously wrote in the Spectator in 2005 that any engagement with the Chinese had to be on the basis of a frank criticism of their human rights record. Such talk was absent when he visited in 2013 to seek Chinese capital for the City of London and Chinese nuclear expertise for the remainder of the UK.
The attempt to convert the East to the West’s conception of human rights and state responsibilities seems now to be over. The sight of Western economies drowning in debt yet obligated to increase spending on welfare entitlements while cutting infrastructure and military spending has seen to that. But, the West is also unable to follow the East – the marvels of economic growth, great infrastructure projects and government foresight come at an appalling cost to individual liberty. There is no common ground here, only differing conceptions of what it is appropriate for the state to sacrifice on behalf of the individual for the benefit of the collective.

Globalisation’s End Game

Image shows someone using an iPhone to take a photo of a beautiful sunset.
Recent Apple devices boast of being ‘designed in California’ – but they are, of course, made in China.

Yet, the hard-nosed East does not own the future. For all the sentimentality and hopeless myopia which comes with the Western model of governance, there comes with it also a splendid ability to realise the potential of its citizens. Providing entrepreneurial types with a system which incentivises them channels their energies into producing ideas which improve the general living standard. In the Eastern system, these types are either discouraged or pushed into political agitation by the dreaded hand of the state.
The result is a symbiosis that keeps both East and West locked into their present positions. The West needs Eastern capital to feed its governments’ insatiable appetite for debt spending. The East supplies this capital in the full knowledge that it will soon reappear on the income statements of exporters. These exporters make their profits through the manufacture of products designed for Western markets. The lack of an innovation culture in the East means that their designs still originate from the West. Thus, the dance goes on. Neither side is capable of changing its current pattern without destroying its political system, something both are loath to do. As a result, both sides are locked into their current roles. Globalisation has reached its endgame, and East and West are as far apart as they ever were.

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Image credits: banner; gold; Great Wall; Qatar; trains; iPhone.