One of the issues I've maintained a consistent opinion on for the past several years is avoiding China. I haven't addressed this specifically in almost a year, which was in the column "Once More, With Feeling: Avoid China."
Because of the accelerating outflow of capital from China and the decreasing inflow of foreign direct investment (FDI), coupled with the rhetoric being used by Donald Trump and his team about China, this is an appropriate time to do so again.
One of the principal issues necessary for economies, both domestically and internationally, to remain stable is for capital to be constantly allocated so that the benefits of it are broad-based.
When capital is allocated in such a fashion that the benefits are not broad-based, the potential for economic, social and political pressure within and among countries increases. When a misallocation of capital occurs, it's critical to understand why, and what the proper public policies are to counteract it.
If government leaders assign blame for misallocation of capital, or allow private-sector -- especially financial-sector -- leaders to assign blame where it is not warranted, it will lead to misguided public policy choices that will perhaps exacerbate the targeted issue.
With respect to how the economic relationship the U.S. has with China is playing out, some troubling issues are recurring and still aren't being properly identified.
The nature of the issue of trade between the U.S. and China has mandated for decades that the U.S. run a deficit with China and they run a trade surplus with the U.S.
The key to maintaining the long-term economic viability of that structure is that the Chinese properly manage the inflow of capital from the U.S., both in the form of payment for goods and FDI.
For FDI, that requires domestic Chinese regulations that maintain an equal status and opportunity for foreign capital and its owners, as is applied to domestic capital.
For capital received in payment for goods, the Chinese have an obligation to recirculate a substantial portion of that capital back to the U.S., either in the form of buying sovereign debt or some other investment in the U.S. private sector. That investment helps maintain the opportunity for U.S. consumers to access debt capital in order for them to buy more Chinese goods.
It is the domestic responsibility of both the public and financial sector leaders in the U.S. to ensure that the inflowing Chinese capital is deployed into the economy so that the opportunity to benefit from it is broad-based. This ensures that consumers have the financial capacity to access debt in order to continue to purchase Chinese goods.
If the financial benefit of the Chinese inflow accrues only to capital owners and not to labor and consumers broadly, U.S. consumers cannot continue to purchase Chinese goods, and trade and financial flows between the two countries begin to deteriorate.
That's the exact situation we have now and is the principal reason the Chinese are having to liquidate the U.S. Treasuries they carry in foreign reserves rather than purchasing more and providing capital to the U.S. markets.
The crux of the matter in the immediate is that the Trump team is referring to this as currency manipulation by China. But in fact, it is a situation mandated for China due to the misallocation of the Chinese inflowing capital to the U.S. that is not being managed by either the public sector or the financial sector in the U.S. for the benefit of all consumers.
It is accumulating in assets that benefit the owners of capital, but not labor and consumers.
That particular issue isn't China's fault. That's a domestic U.S. error by both public policymakers and the owners of capital, which are concentrated in the financial sector.
This is leading to the recirculation of capital flows between the two countries to break down, principally because the ability of U.S. consumers to purchase Chinese goods is decreasing.
China's response to such is not currency manipulation, it's just a countercyclical requirement that is being caused by U.S. public- and private-sector policies and the resulting misallocation of capital.
The failure to recognize such and, worse, to blame the breakdown in money flows on China sets the stage for public policy responses from the U.S. that will be pro-cyclical and exacerbate the situation for both the U.S. and China, rather being countercyclical and alleviating or reversing the capital flows in both directions.
As a result, the probability of a financial, economic and probably social crisis in China is increasing, and the leadership options will soon probably turn toward capital controls, which will cause the problem to get worse, but which the Chinese will have to do.
In any event, investors should continue to avoid China.
Speculators wishing to play the downside of the China trajectory can do so through the inverse ETFs: ProShares Short FTSE China 50 (YXI) , ProShares UltraShort FTSE China 50 (FXP) and Direxion Daily FTSE China Bear 3X ETF (YANG) .
