The China government is paying people in China to buy cars:

June 10 (Bloomberg) — Zhao Hang, who helped devise China’s auto-stimulus package, is facing demand from car buyers battling an unexpected consequence — two-month waiting lists.

“Eight friends have asked me to make calls or write notes to contacts to help speed purchases,” Zhao, president of the government-linked China Automotive Technology & Research Center said in an interview. “Given the world economic situation, demand for cars is surprisingly strong in China.”

Beijing drivers, used to leaving showrooms with new cars the same day, now have to wait about three weeks for a Hyundai Motor Co. Yuedong Elantra, China’s bestselling car, or as long as eight weeks for a Honda Motor Co. CR-V sport-utility vehicle. Carmakers failed to predict a 14 percent sales jump caused by an economic rebound, tax cuts and subsidies and are now trying to raise Chinese output even as they cut U.S. and European production on plunging sales.

One of the Economic Undertow themes is that the availability of petroleum products was greatest in 1998. Oil was in such surplus relative to demand that West Texas Intermediate could be had for $12/ barrel. This price level existed from the end of 1998 to Spring of 1999. One conclusion that can be drawn from this is that Peak Oil took place over ten years ago on a dollar- for- dollar basis.

Since then oil prices have leaped from $12 per barrel to $71 a barrel:

This increase would be similar in effect to a Fed Funds rate increase from 1.5% to over 9%. There is as much oil in every product as there is credit. Lowering interest rates is irrelevant when energy costs are spiralling upwards. Notice the ‘Green Shoots’ period occurs when oil prices plummeted from last summer’s $134 high to $34 in February. Economies thrive on cheap energy.

The Chinese are adding more consumption pressure … this drives up energy prices and cuts demand for Chinese goods, the income from these is what allows China to buy cars in the first place. Why not ‘buy’ energy conservation, instead?

Wolfgang Munchau gives another perspective in Financial Times:

Among countries with large current account surpluses, the three biggest are China, Japan and Germany. I am focusing on Germany here. The German household sector will maintain its high savings rate. The German government increased its deficit during the crisis, but is now looking for a quick fiscal exit strategy. The Bundestag has recently voted through a constitutional balanced-budget clause, which requires cuts in the deficit almost right away. Japan will probably maintain its larger fiscal deficit for longer, but if we take Germany, China and Japan together, we will not see a sufficient and sustained fiscal expansion to compensate for the sectoral shifts elsewhere.

Global current account surpluses and deficits add up to zero. So if everybody is saving more, who will be dissaving? It will have to be the corporate sector in the countries with large net exports. So if the US, the UK and Spain are heading for a more balanced current account in the future, so will the surplus countries.

The current account balance can also be expressed as the sum of the trade balance, net earnings on foreign assets, and unilateral financial transfers. In several countries, including the US and Germany, the gap between exports and imports serves as a good proxy for the current account. A fall in the trade deficit in the US, UK and Spain implies a fall in the combined trade surplus elsewhere. And as some of the shifts in the US and the UK are likely to be structural, this will have long-term effects on others. In particular, it means the export model on which Germany, China and Japan rely, could suffer a cardiac arrest.

What about the argument that a large part of German exports goes to the rest of the eurozone? This is true, but there are imbalances within the eurozone too. Spain has been running a current account deficit of close to 10 per cent of gross domestic product. As that comes down, so will Germany’s equally unsustainable intra-eurozone surplus.

Through what mechanism will this export-sector meltdown come about? My guess is that in Europe it will happen through a violent increase in the euro’s exchange rate against the US dollar, and possibly the pound and other free-floating currencies.

Exchange rate devaluation would greatly help the US and others to reduce their current account deficits, but it will impair the economic recovery in countries with large trade surpluses and free-floating exchange rates. Last week’s remarks by Angela Merkel, who criticised the Federal Reserve and other central banks for running inflationary policies, sharpened investor perceptions of transatlantic policy divergence and decoupling. Many investors are now starting to bet on a strong appreciation of the euro – the last thing Ms Merkel wants.

Since the Chinese would maintain their peg for as long as possible this dénouement -if it was to take place as Mr. Munchau describes it – would take place further in the future than would the Eurodebacle … but it would take place nevertheless. China would effectively import America’s inflation, an analog to what happened during the 1930’s when one country after another sought to hold their currencies to gold pegs.

In the end, all the powers went off gold, but only after suffering mightily in the meantime.

The auto sales effort in China is classic Keynesian economic policy. The question is how this policy fits in with the ‘menage a trois’ of stimulus, the rise in energy costs and the likely relative revaluation of currencies. It seems likely rising energy costs derail similar stimulative efforts in the US. Any stimulative effects on China’s and USA’s economies are constrained by the yuan-dollar peg. Second, the China stimulus flies in the teeth of the Chinese savings habit, partly because saving is the only way for Chinese citizens to acquire goods and services; this runs alongside a long- standing cultural propensity to save. While the PBOC is unlikely to abandon the dollar peg until events force them to do so, they could cheat by printing more yuan. The outcome of the ‘Munchau Scenario’ is a decline in liquidity. Monetary authorities are working strenuously against this illiquidity outcome, including the Chinese, peg or no peg. This is why the Chinese government is paying people to buy cars.

There is a hazard to increasing liquidity. It effects borrowing, specifically sovereign borrowing:

In 2009, the federal deficit will be larger as a share of the economy than at any time since World War II. The current deficit is due in part to economic weakness and the stimulus, and in part to policy choices made in the past. What is more troubling is that, under what we view as optimistic assumptions, the deficit is projected to average at least $1 trillion per year for the 10 years after 2009, even if the economy returns to full employment and the stimulus package is allowed to expire in two years.

The longer-run picture is even bleaker. We estimate a fiscal gap – the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt/GDP ratio at its current level –about 7-9 percent of GDP, or between $1 trillion and $1.3 trillion per year in current dollars.

Recent trends in credit default swap markets show a clearly discernable uptick in the perceived likelihood of default on 5-year U.S. senior Treasury debt, a notion that was virtually unthinkable in the past. While it is difficult to know exactly how to interpret these results, it is clear that – although fiscal policy problems are usually described as medium- and long-term issues – the future may be upon us much sooner than previously expected.

A Chinese banker suggested the US issue Yuan- denominated credit instruments, the Chinese could print dollars to pay for them! One can laugh, but why not take this one step further: China can issue the US dollars they feel are required for liquidity and the US can print the Yuan denominated bonds that the US feels the Chinese need to buy to balance their current accounts. Both would be instructed to construe self- interests as narrowly as possible … Eventually, the understanding would arise that narrow national interests require both countries to act altruistically. America issuing Chinese debt and currency – and vice versa – would remove the gravitational effect of cronyism that is the driver for much of what passes for policy in both countries.

If things were to go wrong, the citizens could blame the others’ central banks and treasuries.

Conventional efforts to manage currency flows, savings rates and deleveraging tend to cancel each other out , at the same time ‘unintended consequence’ pitfalls multiply. Pegging the dollar/yuan makes one currency the proxy of the other. Inflation in China is held in check by deflation in the US. If the Chinese abandon the dollar peg currency inflation will manifest itself in China. Economic Undertow has long maintained the conventional wisdom that the yuan is underpriced is wrong. If the Chinese themselves felt the yuan was strong they would trade it and reap the benefits. It isn’t and they don’t.

Any upward revision of currency would be sort- lived; there are too many hasards to the government in out- and- out deflation: the Chinese are printing and they will print some more. There is little in the way of finance in China to ‘trap’ excess liquidity. With any increase in velocity, inflation leading to hyperinflation is not out of the question. Unlike America, there are few asset alternatives to the yuan in China. The Chinese’ savings are so much fiat scrap paper. Given enough Chinese stumulus savers’ hands will be forced; to spend now or lose everything. Once the savings emerge from tin cans buried in tens of millions of back yards, the race will be on.

Chinese hyper- inflation solves everyone’s problems. It removes Chinese savings ‘surplus’ and transfers it to the government, it inflates the value of dollar assets, inflating Chinese sovereign reserves at the same time. It balances current accounts. It takes pressure off the Euro and the Yen. The ‘people’ suffer, but who cares? The Chinese would rationalize that all wealth derives from the government rather than the people. They would execute a few malcontents, mop up excess yuan and pretend nothing at all had happened.

At the end the Chinese government would wind up much richer than when the crisis began. Is the Chinese government that cynical? You better believe it.

At bottom there are two interrelated issues; excess credit and declining energy availability. Creating credit then stashing away the excess does not solve anything; most of what the Fed has spewed as liquidity is in the Fed vaults, as bank reserves. Stashing away cannot substitute for an overall reduction of credit which is a necessary preclude to any kind of recovery. At the same time, the declining availability of energy – particularly oil and petroleum based energy goods – requires reduced demand.

The suggestion here on the blog that nobody reads is for both actions to be taken as vigorous policies from here forward. The consequence is for events to see to themselves and an acceleration of the crisis.