The New Opium Wars

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Monday, 25 October 2010, 7.20 am, 9.20 am and 7.20 pm)

Lately, there’s been talk about a ‘Currency War’ and a ‘Trade War’. This is when nations weaken their currencies and put up barriers to trade. The problem arises because countries like China persistently export more than they import.

In the 17th century, this was also a problem. It came to a head in October 1860, exactly one hundred and fifty years ago this month, with a treaty ending the Second Opium War. China under the Qing Dynasty was defeated by France and Britain.

In its aftermath, Beijing’s two Summer Palaces were looted and destroyed. Among other penalties, China handed over Kowloon to Britain. Probably, the worst penalty China suffered was the forced liberalization of the opium trade.

China could not have foreseen this disaster when it first traded with Europe in the 16th century. By the mid 17th century, with Europeans hungry for Chinese goods, China was exporting more than it imported. It’s a bit like the situation today.

At that time, goods were paid in gold and silver. This means that the flow of bullion was from Europe to China. The Europeans didn’t like this trade imbalance and were desperate to sell something in return.

Eventually, a product was found which Chinese consumers wanted. This was opium. Its strong demand among Chinese addicts soon corrected the trade imbalance.

The sale and consumption of opium was actually prohibited by China in 1729. Despite the prohibition, opium was smuggled in and sold with the support of the British East India Company.

This was a London-listed company which enjoyed special privileges from the British government. It’s a bit like some Wall Street banks today enjoying special privileges from the US government.

For more than a hundred years, China did nothing about its opium problem. Finally in 1839, it took strong action against British merchants in Canton. But that started the First Opium War. Further disputes started the Second Opium War. In both wars, China was defeated.

Today, the global economic situation is very similar to that in the 17th century. China is still a net exporter. Instead of bullion, China is accumulating foreign currencies.

To address the trade imbalance in the 17th century, the British East India Company sold opium. To address this decade’s imbalance, Wall Street banks sold China and the world a modern version of opium. This is their mortgage-backed securities, or MBS, which are investment products derived from US housing loans.

The total MBS issue is huge – more than US$10 trillion. But the toxic ones, valued at US$1.2 trillion, are the ones issued during the peak years of the US housing bubble. The growing scandal over the flawed US foreclosure methods means that many MBS investors might not get their money back.

Now that the MBS market is frozen, it can’t do more to address the trade imbalance. In the 19th century, the Opium Wars sort of resolved the trade imbalance. Today, the trade imbalance has to be resolved either through a Currency War, or a Trade War

There are two reasons why I consider these MBS today’s opium? In 17th century China, one of the appeals of opium was the belief that it could enhance one’s sex life. Likewise, before the recent Credit Crunch, the appeal of MBS was its superior rate of return. Presumably, getting rich faster enhances one’s sex life.

There is a second reason why I lump MBS and opium together. When you buy opium, you get to enjoy its aroma. But you cannot get your money back. Likewise, with these toxic MBS, you get to enjoy some dividends. But you are not supposed to get your money back.