There are times when it may behoove us to step away from our daily lives and interests in an attempt to make sense of the events going on around us, and the economic and financial events of the last month certainly qualifies the present as one of those times. After sorting through recent financial, economic and political events, it struck me that many of the economic issues that had been nagging at me for years had gotten under my saddle for a reason: The economic world has drifted into a chronic state of non-equilibrium.

Part 1:
Chinese labor and manufacturing costs are often substantially understated

It’s obvious China is no democracy. The government and/or businesses can arbitrarily set wages and costs resulting in artificially low total costs of production.  Coal-fired power plants are being constructed at a rate that rivals the 90’s proliferation of Starbucks stores, and dangerous mining conditions, dubious environmental regulations, and regulated electrical costs provides absurdly cheap power to feed China’s insatiable appetite for growth.

To see how sideways things have become, let’s look at a couple of examples.  In the United States, it now costs about as much to buy a nice roast, a couple potatoes and some carrots to cook in the microwave as to buy the microwave itself, and reasonably complex inkjet printers can be purchased for under $30 USD.  The majority of Chinese goods are not just cheap; they are disturbingly, perplexingly, eerily cheap. This is not indicative of a world economy in balance.

In the last two decades, the low price of Chinese goods have led directly to artificially high demand for their products.  Across the United States and Europe, houses, flats and garages have been filled with millions of tons of nondurable Chinese goods, and containers from container stores and mini-storage units catch the overflow. If televisions are cheap, why not have one in each room? If silk blouses are only $20, why not buy five? And since economic times have been so good for so long, why not buy on credit or with equity borrowed from primary housing? Now the debts have come due, while the goods bought during this unprecedented spending spree have little or no current value, and contribute little toward quality of life.

As China enjoys its day in the sun, the manufacturing base in developed countries has been seriously eroded by its inability to compete with China’s seemingly unfair competitive advantage, forcing many American and European manufacturers to either become distributors and shut down domestic production facilities or go out of business. As factories and assembly lines close, displaced workers accept lower-paying positions in the service industries which lowers purchasing power and widens the income gap.  I personally and economically have no problem with letting Bush’s tax cuts expire. However, while raising taxes on businesses and the wealthiest individuals to restore purchasing power to a displaced middle class can provide a temporary fix, it is not a viable long-term economic solution. New domestic high-tech design, production and manufacturing jobs must be created to reverse the trend toward low-skill service jobs, or the long-term economic prognosis is poor.

Of all the issues that face us, China may prove the most problematic. Protectionism is not typically a good economic policy, but the developed world is not on an even playing field, and cannot stand by while China gobbles up the remaining manufacturing base. The Chinese are already working their way up the food chain to large durable goods such as heavy equipment and automobiles, and everything being equal, the results are likely to be the same.

Part 2 Part 3 Part 4