I am going to talk here a little bit about the looming trade war between China and the United States. But I am going to come at it from a side angle via some historical analogies.

Common folklore in the United States says that the Soviet Empire collapsed in large part due to the efforts of American President Ronald Reagan and not due to internal forces. Others downplay Reagan’s role and see internal forces as more significant.

The Chinese new year has only just started, and already trade tensions are ratcheting up. This is perhaps appropriate — astrologers tell us that the year of the Tiger is often a year of instability and conflict — and I suspect things will almost certainly get worse. The timing of various domestic political events in the US, China and Europe will make it harder than ever for any of these countries to back down before 2012 (by which time, presumably, the world will have ended anyway).

Fox Business -- China in a Real-Estate-Fueled Bubble? Roubini Global Economics Senior Analyst Rachel Ziemba weighs in on China's economy. (Click for Video 5:20)

Today’s report that China’s holdings of Treasurys slipped to US$889 billion in January 2010 surely added grist to the fire surrounding the heightened tensions in the pivotal bilateral relationship.  These tensions are coming to a head in U.S. and Chinese legislative sessions and imply that coming weeks and months may be filled with more posturing as we wend our way to a series of bilateral and multilateral meetings.  Policy makers from both countries are starting to draw lines in the sand and it remains to be seen how far they will go to defend these lines. This posturing, if it is posturing, could be counterproductive in the long-term. Both sides are sorting out how strong their hands are...More on this to come from us later this week.

This is the second post paying homage to the Pettis explanation of the role of China's foreign reserves.

The bank of China holds massive foreign reserves. That is agreed. What is far less clear is what these reserves can be spent on. The man in the street might say - "use the money to build hospitals and schools".

“This Budget belongs to ‘Aam Aadmi’. It belongs to the farmer, the agriculturist, the entrepreneur and the investor. The opportunity is great. The time is right. I have placed my faith in the hands of the people who, I know, can be depended upon to rise to any occasion in national interest. I have placed my faith in the collective conscience of the nation that can be touched to scale undreamt of heights in the coming years.”

With these words, India's Finance Minister concluded the much-ballyhooed annual Union Budget Speech.

While there are plenty of schemes and sops for farmer and agriculturists - over $25 billion, about 10% of the budget, has been allocated to various schemes for rural development - there’s not much that is enthusing for entrepreneurs and investors. In his second budget after a conclusive election victory, the Minister has continued to reward his party’s core constituency and vote bank, not necessarily in ways that would actually empower or ameliorate them.

The Minister said that disinvestment would allow people to participate in the profits of public sector companies. The current program of disinvestment is a misnomer - “monetization” would be a more accurate characterization. The government proposes to sell minority stakes in public sector units to pay for the social sector schemes believed to help the bottom of the pyramid. Privatization and strategic sale of government-owned companies is what is actually beneficial to the economy.

Loosening government-control over companies results in more efficient management and lower prices for consumers, also freeing up capital for investment in critical areas such as infrastructure. India doesn’t need to borrow money from the World Bank to build roads. The raison d’être for disinvestment is change in management control, which the Minister is not achieving by monetizing minority stakes.

There are no bold pronouncements and no liberalization in this year's Budget. All in all, it was devoid of vision and rather stale.

I don’t think India should be content with a GDP growth rate of 7% or 9%. The country's true potential is at 12%-plus, for two reasons - India’s GDP stands at about $1.2 trillion and we are starting from a low base. Secondly, India’s demographic profile is also very amenable to support high-growth rates.

In fact, India has the best demographic profile among the BRIC countries - over the next two decades, over 240 million people will join the workforce, averaging nearly a million people every month for the next 20 years.

The Finance Minister and policy-makers in the Ministry have an affliction for introducing cesses, additional duties and special excise taxes. Maybe they should apply a special additional deflator of 3-4% to discount India's real GDP growth rate - for a growth rate of 5-6% eminently qualifies as a recession given the country's potential.

Short-sighted, politically-driven policy making year after year is holding the country back. We saw glimpses of what is achievable when there were reformist Prime Ministers at the helm, from 1991-1996 and 1998-2004. Without those years of breakthrough liberalization, nobody would ever think of classifying India as a world-power, and we’ve just scratched the surface.

But this year’s budget did have some silver linings. There is a clear political commitment to implementing a new direct and indirect tax code, which could be a significant step in taxation reform. The Minister also mentioned that foreign direct investment in retail could be allowed soon, a measure that has been long overdue.

Fiscal consolidation was the other major theme. The Government committed itself to cut its fiscal deficit to 5.5% of GDP, though the underlying  assumptions for achieving that target include sustained global economic growth, high revenue from and investor appetite for the equity monetization program in state-owned companies and auction of 3G telecommunications licenses.

This was particularly welcome given the difficulty European and other developed economies are facing in cutting deficits. India stands out in embracing fiscal responsibility, and it is a very welcome signal to foreign investors.

On a lighter note, the Minister exempted toy balloons from a central excise duty, acknowledging the joy mothers feel when their children played with balloons. He also reduced duties on corrugated carton boxes, latex rubber threads and pepper among other items. Though the Minister started his speech with a flourish, talking of how the Budget should be more than a mere statement of accounts, that's now how the speech actually played out.

India's potential remains untapped, as its political masters toy with the economy and important policy pronouncements.

After such a long entry last week I thought I would spare my readers and do something much briefer.  A few days ago I read a good article (“Stuck on Neutral”) about Japan in the August 18 issue of the Economist.  You can find the article on the Economist website if you are a premium subscriber, but if not, it has been partly reprinted elsewhere.

China’s annual theatrical production of transparency, “The Two Sessions,” opened today (March 3) in Beijing. Starting Friday, the National People’s Congress (NPC), China’s legislature and nominally highest political body, will air some of the current policy debates within the Communist Party (and their predetermined solutions). Today’s Chinese People’s Political Consultative Conference (CPPCC) will demonstrate the Party’s willingness to hear suggestions from a carefully cultivated group of outsiders. Clearly the NPC is the more important of the two meetings, though its impact on actual governance remains negligible as decisions are ultimately taken by the State Council. Here’s RGE’s take on what to look for behind the stagecraft: some modest shifts away from the loose monetary policy language used last year, a reiteration of efforts to contain the housing bubble and a push to loosen the household registration system for migrant workers.

Forget the Eurozone for just a minute. Japan's problems are big: Toyota is a major exporter/employer. Last year 48% of all new standard passenger vehicles sold in Japan were Toyota (or its Lexus brand). The WSJ article describes Toyota's status in Japan as the following:

In short, Toyota is to Japan what General Motors Corp., in its heyday, was to America. And for a beleaguered country that has suffered a series of institutional blows in recent months—the collapse of the long-ruling political party, the bankruptcy of its champion national airline, a renewed bout of deflation— the global humiliation of Toyota may be the most psychologically damaging blow of all.

A credit-fueled investment boom successfully boosted China’s growth to 8.7% in 2009, but cheap money drove up asset prices as well, especially in property markets. As China’s output gap closes, loose money is now set to become inflationary, particularly if China’s potential growth rate has come down slightly, as RGE thinks it has. The People’s Bank of China (PBoC) has twice hiked banks’ required reserve ratios (RRR) in 2010, following a return to net liquidity reductions through open-market operations in October 2009, but RGE suspects that the tightening moves have had little effect. As discussed in a recent RGE analysis, “China: No Exit,” which is available exclusively for RGE clients, China’s monetary policy has shifted toward a neutral stance in recent months, but it will have to tighten further if inflation and the property bubble are to be contained.