First, some house cleaning.
My current schedule doesn’t allow the long-winded, big picture style that I seem so fond of. I like blogging, and I plan to continue blogging. That said, for this blog to work, I need to shorten the scope to something that fits my schedule and feels somewhat unique. Pursuant to that idea, I plan to post more pictures that I take in Beijing with a somewhat regular frequency- at least once per week.
Knowing myself, I will certainly try to fit small, localized anecdotes into a bigger picture of understanding China, however the economic talk is anticipated to dull to a mummer. Since I am anticipating economics to dull to a mummer, I am deciding now to go out with a bang and give my general economic thoughts regarding China as of Sunday, July 23rd.
Since 1978, when China began its process of reform, China’s share of world GDP has increased more than 600%. Powered by huge amounts of investment, China surged to ‘catch-up’ to the world that seemingly left it behind. With fervent nationalism that extols the arduous journey of a lovable underdog, the Chinese economy is often seen as a well oiled machine, destined to set the rules of the developed world. Rule sets be damned- there is a new ideology and way to do business.
China’s Share of Population and GDP
Chinese Real National Income Per Person
McKinsey has reported for more than a year that Chinese consumer confidence is at an all time high. As speculative asset prices soar, Chinese purchasers feel on top of the world.
But as I sit in my small apartment in Beijing, my view of the Chinese economy couldn’t be more bleak. I don’t believe China is the next super-power. I doubt if the country can survive the next decade in its current form. Forget any foreign powers. Forget trouble in the South China Sea. Forget China’s aide to North Korea. Look at one graph: China’s growth in debt.
Now, this is the part where a lot of people will list my implicit assumptions about the nature of Chinese growth- which I have no mention of here- or compare Chinese debt to other regions of the world. Ignore that for just a moment. I personally don’t believe, based on anything I’ve seen in China, that debt growth can stop. I think it must rise, and I don’t think debt can rise forever.
I don’t believe that economics is a cannon taught to students and the outside world. Instead, economics is a set of theories that try to explain the world as we see in evidence and mechanisms. So, for example, some people believe in the capital asset pricing model (CAPM)- which, in non statistical language, states that an asset with a high co-variance with the other assets in the portfolio adds to the risk of the portfolio. The asset’s returns move in the same direction as the returns of the other assets, and these movements are large or volatile. The problem is that this financial economic cannon is not observed or perhaps true. For further reading go here or here. You could also read this pdf.
In fact, I believe accurately valuing capital and risk will be the death of China with the dagger itself being a continuous rise in debt. As countless others have stated, Chinese households share an incredibly low share of China’s GDP. This means that China’s wealth is increasingly tied to speculative assets and promises of future wealth creation.
But it get’s worse and more difficult to explain. Even if China fixes the nationally directed causes of it’s lack of household wealth, it hasn’t built modern institutions at a local level to price correctly or lessen its debt burden.
It is true that interest rates, state owned enterprises, pollution, lack of credible investments, a large population (this deserves more mention), and law have led to China’s lack of household consumption at the national level. Although many of these factors have already changed and many could be changed quickly (if Beijing was able to control its vested interests, and as I look at coal use and increased business with North Korea, you’ll have to excuse me for having doubts) the culture these factors have created and the lack of local institutions will ensure that the factors for debt creation and price distortions continue.
Let me give you examples.
1.) Beijing can’t enforce an indoor smoking ban.
2.) Do you remember that woman that was mauled by a tiger last year in Beijing, the one that exited her car in a carnivorous animal enclosure (video). That same enclosure makes headlines with relative frequency. Examples include this family that exited their vehicle in March and this black SUV feeding a bear yesterday.
3.) There isn’t developed code enforcement. Companies that break rules or operate inefficiently aren’t proportionally dealt with. On Thursday, July 20th this year an estimated 50 policeman raided a street with popular nightlife destinations. The Beijinger reported that all stores on the street were ordered to hand-over POS systems. The Beijinger also reported that three divisions of police were present for the shake down. The police descended on the street for code enforcement. The code in question: outdoor seating. It took 50 police from 3 divisions to tell restaurants and bars to remove patio furniture from the sidewalk.
4.) This Caixin article that describes perhaps the most valuable real estate in China.
From the article:
Beijing) – An unsettled land deal between a subsidiary of Anbang Insurance Group and the Beijing city government has left several real-estate developers in limbo and the land they paid billions of yuan to sit idle for more than six years. Across the street of the busy construction site of the 118-story China Zun tower, which will be the tallest building in downtown Beijing, several land plots enclosed by brick walls have remained barren and empty, surrounded by mushrooming skyscrapers in the city’s central business district, where land available for construction has always been scarce and pricey. “It has been idle like this since I came [to work] here about five or six years ago,” a gate guard said. The four plots, labeled by city land authorities as plots Z3, Z4, Z5 and Z6, are adjacent to one another in the same block, within sight of the landmark World Trade Center towers in the eastern part of Beijing. They were known as the last untouched land in the central business district. In a highly-watched auction in December 2010, the four plots, with combined construction space of 580,000 square meters, were sold to different companies for a total of more than 11.8 billion yuan ($1.72 billion). But construction on the plots never began. Sources close to the matter told Caixin that development has been hindered due to “government reasons,” as the Beijing Municipal Bureau of Land and Resources hasn’t been able to transfer the land to the bidders.
According to a document from the Beijing land and resources bureau seen by Caixin, CBD Development said it won’t transfer the land because needed work hasn’t been finished for preliminary development and it wants a larger fee for its job. The dispute has blocked further development on the land. A fixed rate – usually 8% of the total costs of initial development – is paid to preliminary developers as profit. But “Anbang is not willing to take the fixed-rate payment,” an industry source said. “We have repeatedly negotiated with the government, and officials have talked with the preliminary developer many times – but nothing works,” said Xu Li, chairman of Shanghai-listed Beijing Vantone Real Estate Co., which bought the Z3 plot with partners. Beijing Vantone and partners made a full payment of 2.5 billion yuan for the plot as early as January 2011 and planned to start construction of a commercial and office complex on the site in 2012. The Z3 winners estimated that the complex would generate about 700 million yuan in rent every year for investors. But not a single brick has been laid on the ground for the project, leaving the investors holding losses and unpredictable risks.
The most valuable land in Beijing was sold years ago and remains undeveloped. The CEO of Anbang is currently under arrest. There is no new information about this land deal.
My purpose of this blog post is to show the difficulty of rebalancing, and I believe the course is already set. China won’t rebalance. The inefficiencies and institutional constraints are simply too great. The problem is that the scope is seen as a national problem: national income accounting, national policy, the centrality of a Marxist state.
This is wrong. I highly recommend reading this article from the Economist. Some key points from the article:
1.) There are still more than 150,000 SOEs in China.
2.) Two-thirds are owned by local governments.
3.) These state owned enterprises eat about half of all bank loans though they represent less than one-fifth of the economy.
4.) State owned enterprises are largely holding China’s increase in debt.
From The Economist: Chinese SOE fixed asset investment
Chinese private companies can’t find valuable investments within China, but China is leaning on them to keep investment going. State owned firms aren’t efficient, and they’re largely distorting at a local level that didn’t develop institutions necessary to help private firms.
The Chinese government has done nothing but obfuscate for 4 years, although there have been countless buzzwords and reassuring speeches.
Also from The Economist:
Back in 2013 Mr Xi seemed to grasp that change was needed. He vowed that market forces would play a “decisive role” in allocating resources and declared that reform of SOEs was a priority.
Decisive role indeed. I believe the course is set.