国际规则集合

当我还是一个高中生的时候,有一个关于经济学的全国性的讨论。而事实上, 这个讨论只是围绕着一个问题展开:我们的经济是否在衰退。我们可以准确的预测行星的运行轨迹,但是在2007-2008之际的热点问题是:“我们的经济是否即将沦陷?”

今天我想和大家说一说即将到来的全世界范围的经济讨论。首先,我会阐述美国2007的大衰退,其次,我会介绍一些经济问题,而最后我会提出一些简单的建议

US Real GDP Growth

上边的图表清楚地显示了美国国内生产总值在2003年到2010的变化情况。其中红色部分非常明显, 而这就是“大衰退”的开始。2007年以前,美国银行曾经向无偿还能力的人批准抵押贷款。 然后银行将这些抵押贷款用作其他负债的资产,因为在当时抵押贷款被视为安全资产。 谁可能无法支付他们的房子呢? 所以当人们无法按时还款时,银行用抵押贷款做资产而产生的抵押贷款和负债上损失了很多资金。

紧跟大衰退后的问题是:“银行为什么要提供这些高风险的贷款?”在2006年至2014年担任美联储主席的本·伯南克在危机前就已经有了答案。 他早就知道美国存在的经济问题,而他也从这一点上判断出来的。

US current account

该图片表明了美国的贸易逆差。 伯南克在2005年写道,美国的贸易赤字问题展露出一个非常重要的问题。

由于近几年来企业对设备和结构的投资相对较低,而且由于美国和其他许多国家的税收和金融体系旨在促进房屋所有权,最近大部分流入发达国家的资本体现在较高的房屋建造率和较高的房价。

本·伯南克

一个国家贸易账户的对立面是该国家的资本账户,如果美国存在贸易逆差,那么美国的资本账户应该有盈余。

  • 2006年,美国境外资产增加了17,649亿美元
  • 2006年,美国在海外的资产增加10,458亿美元
  • 2006年美国资本账户盈余= 7191亿美元

这意味着各国在美国的投资超出了美国在其他国家的投资。同时,它还表明美国的银行体系通过贸易顺差而获得了大量的过剩现金。

伯南克先生曾担心外国资金降低利率和贷款标准。所以当伯南克先生看到贸易逆差时,他便担心美国的资本账户。

Trump Tweet

自高中以来,关于经济学的讨论产生了非常大的变化。而现在讨论的中心是贸易规则的变化。 目前的讨论集中在两个方面:贸易账户和技术竞争。

但是,对于资本账户的流向很少有人关注。 还记得伯南克先生认识到贸易逆差并担心在美国的外国投资吗? 事实上,美国的资本账户要比伯南克先生所认识的要糟糕得多。

American Capital Account

2008年之前的下行指标表明,美国大量资本通过银行业的渠道而外流,然后通过购买非国债证券重新进入美国。 流入美国的资本总额主要是欧洲银行通过影子银行系统贷款购买个性化的抵押贷款支持证券,而该证券和导致经济衰退的证券是一样的.

1.)截至2008年中期,美国主要货币市场基金资产的50%是外国银行的短期债务,欧洲银行占有绝大部分。

2.)欧元区贸易账户整体保持均衡,而实际上英国是赤字国家,它们流向美国的集体净资本并未反映其银行在设定整体信贷条件方面的影响.

3.)2006年美国贸易逆差 – 占GDP的6.5% 

2006年流入美国的总资本账户–占GDP的23%

这次演讲的中心内容想要表达的是经常账户可能不会像总资本流动,尤其是银行业部门产生的资本总额流那样,提供有关整体信贷状况的信息。

  • 蚂蚁金服等中国金融机构需要将P2P资金分为专用账户。
  • 中国现在处于适当的位置来提出用于投资大型项目或地方政府融资的特定基金类型的意见。
  • 中国学术机构应该模拟这种风险,以更好地改善国际合作。
  • 亚洲基础设施和投资银行对超额资本提出政策建议有着很大的话语权。而该资本可以用类似于最新的中国P2P法律的方式进行管理。

经济学的新讨论将改变我们的交易方式,而且在不久的将来就会发生。它不会仅仅专注于贸易和技术,我们还必须研究国际资本账户。 中国和中国的学术机构有能力为新的贸易体制做出贡献,并更多地研究资本账户净流量和净额。

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Three New Rule Sets

When I was in high school there was a national discussion of economics. Actually, there was a national discussion about one economic question. The question was, “are we in a recession?” We can predict the movement of the stars, but here we are, in 2007 and 2008, and the great question of the time was, “is the boat sinking?”

Today I want to frame the coming international economic discussion. First, I’m going to talk about the Great Recession. Second, I will introduce problems with economics. Last, I’m going to make some simple recommendations.

US Real GDP Growth

This shows United States GDP growth from 2003 to 2010. This red part is quite obvious. It is the start of the “Great Recession.” Before 2007 American banks approved mortgages to people who couldn’t make payments. Then banks used those mortgages as assets for other liabilities or as bets, because mortgages were seen as safe assets. Who wouldn’t pay for their house? When people didn’t make payments, banks lost money on the mortgages and the liabilities those mortgages were bet against. Of course this is a large simplification. There are many other note worthy stories, but this blog post if only interested in the most essential fundamentals.

The biggest questions after the recession was, “why did banks make these high risk loans?” Ben Bernake, who served as American Federal Reserve chairman from 2006 to 2014, had an answer before the crisis.  Mr. Bernake knew there were economic problems in America, and he knew it from this.

US current account.jpg

This is America’s trade deficit.  In 2005 Ben Bernake wrote that America’s trade deficit was a sign of major concern:

Investment by businesses in equipment and structures has been relatively low in recent years and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices.

-Ben Bernake

The inverse of a nation’s trade account is a nation’s capital account. If America has a trade deficit, America must also have a capital account surplus.

  • 2006 U.S. current-account deficit: $856.7 billion
  • Foreign-owned assets in the United States increased $1,764.9 billion in 2006
  • U.S.-owned assets abroad increased $1,045.8 billion in 2006
  • U.S. capital account surplus = $719.1 billion in 2006

This means that countries invest more in America than America invests in other countries. This means that America’s banking system, as evidenced through its trade surplus, had huge amounts of excess cash.

Bernake worried foreign money lowered interest rates and lending standards. When Bernake saw the trade deficit, he worried about America’s capital account.

Trump Tweet

Discussion of economics changed quite a bit since I was in highschool. Now, the discussion is centered on changing rules of trade. The current discussion is focused on two aspects: trade accounts and technology competition.

However, little attention is paid to capital account flows. Remember how Bernake saw the trade deficit and worried about the foreigners investing in America? Well America’s capital account was worse than Bernake realized.

American Capital Account

The downward-pointing bars before 2008 indicate large outflows of capital from the US through the banking sector, which then re-enter the United States through the purchases of non-Treasury securities.  The gross capital inflows to the United States represent lending by mainly European banks via the shadow banking system through the purchase of private label mortgage-backed securities, the same securities that caused the recession. 

1.) By mid-2008, 50% of the assets of U.S. prime money market funds were short term obligations of foreign banks, with the lion’s share owed by European banks.

2.) Since the Eurozone has a roughly balanced trade account while the UK is actually a deficit country, their collective net capital flows to the United States do not reflect the influence of their banks in setting overall credit conditions.

3.) USA trade deficit 2006 – 6.5% of GDP

     Gross capital account flows to the USA 2006 – 23% of GDP

The central message of this post is that the current account may not be as informative about overall credit conditions as gross capital flows, especially gross capital flows generated by the banking sector.

A new discussion of economics that will change the way we trade will soon happen, and it cannot only focus on trade and technology. International capital accounts must be studied. There must be new rule sets regarding current account balances, technology theft and distribution, and capital account balances. Capital account activity is no longer the residual of fair trade in tangible goods.

The sky in Beijing is grey today. Have a good weekend.

 

US-China Conflict is Coming and Must be Managed

Much of the wording and writing in this post is quoted from the excellent Dan Rosen.


 

Trade conflict between China and America is coming.

On February 26th, Axios, reported about the scale of trade tariffs coming this year:

Also, an official with knowledge of the trade discussions told me the White House is preparing to impose tariffs on a “shit ton” — meaning, potentially hundreds — of Chinese products. They’ll avoid going through the World Trade Organization — which Trump doesn’t trust — and instead use Section 301of the Trade Act of 1974 to unilaterally retaliate against China for stealing Americans’ intellectual property.

The attitude among Western countries, regarding China has fundamentally shifted as China’s development has changed. The debate in America is not whether to enter a trade war with China, but how large should the conflict be.

The free traders — think Steven Mnuchin, Gary Cohn, Kevin Hassett, and Everett Eissenstat — only want tariffs on Chinese products that many other countries also produce (including uranium, consumer electronics and LED light bulbs.) They’re trying to blunt any impact on American consumers.

It is not just economist and free traders on the right of American politics who support tariffs. Hillary Clinton’s foreign policy consultants recently wrote in Foreign Policy:

 China has… pursued its own course, belying a range of American expectations in the process. That reality warrants a clear-eyed rethinking of the United States’ approach to China.

American politics cannot agree on gun control, but American politics can agree that their  current relationship with China is untenable. America isn’t alone. French President Macron recently visited China with “an ambition to rebalance, get more reciprocity in access to Chinese markets and fairer competition conditions.” Germany is strengthening controls of outbound Chinese FDI.  Serious change is arriving and old rule sets will be discarded to pave the way for ‘fairer’ rules- whatever that means.

Enter Liu He.

FILE PHOTO: Liu He, vice chairman of the National Development and Reform Commission (NDRC), attends a signing ceremony in Beijing

Liu He, China’s senior economic strategist, is arriving in Washington for important consultations to manage the US-China relationship. While Liu hopes to talk about getting the relationship back on track, the time could probably be used more productively to discuss how to better manage a period of disengagement – because it is coming.

Market-oriented democracies are concerned about China’s evolution. Confidence in the mutual benefits of engagement has slipped, questions about reciprocity are mushrooming given that China is not as open as advanced economies to trade and investment, and public debate about influence campaigns is on the rise. These foreign policy challenges are still new for Beijing: a few years ago, these topics were confined to limited audiences; today they are widespread themes. The balance of global thinking about engagement with China is, it is fair to say, at a delicate point.

In light of rapidly moving political developments in China, it would be a better use of Mr. Liu’s time not to talk about preventing a move away from economic engagement, but rather adaptation to post-engagement norms.

Mr. Liu will have a difficult time convincing America’s China watchers to take a benign view of trends in Beijing, or even a wait and see attitude, for the reason that this cycle has been seen before. Cycles of centralization of power, then tension between capital and provinces, and then love-hate engagement with foreign economic, intellectual and security forces are typical throughout China’s history.  Political vacillation has been a constant, with China sometimes scrambling to absorb liberal concepts and then suddenly shifting to purge anything outside the nationalistic frame. This is completely normal for any country.

While admirers often credit China with staying power, cyclical strength followed by breakdown is the norm. Through history Chinese intellectuals have gone back and forth, some blaming foreign forces for China’s ills, others pointing to China’s nativism as the problem and reaching to non-Chinese ideas, technologies, politics, economics and culture as the solution. The pastime of debating which China is real – the one that wants to engage? or the one that sees inside and outside in zero-sum terms? – is not helpful: both are real. Both are real in every country, not just China.  What’s needed is not the right choice, but the wisdom not to choose one or the other when both apply.

For Liu He to be helpful at this juncture, and not just reinforce mistrust about China’s “real intentions” he will need to acknowledge to American officials this duality, and concede that Washington and other foreign capitals are entitled to require transparency with regard to China’s influence abroad, and to protect themselves from the consequences of cycles of political and economic instability. At the same time, he will be right to point out that China’s foreign partners have been massive engines of instability in their own right this past decade.

Shanghai

The reason why Liu cannot, at present, promote a coalition to work past a rough patch toward a common, convergent future in which shared material gains is the glue is that Beijing has been increasingly unguarded in saying it is not open to that convergence. That is a change of heart. It is important to recognize that this is in fact a change, because it means there is not a fixed, eternal Chinese attitude about policies and politics, economics or otherwise.

It is a matter of record that Deng Xiaoping, the leader who crafted the era of engagement with the United States, enshrined a two-term limit for China’s heads of state and hedged Party interference in commercial activity precisely because he knew from experience what dangers could come otherwise. There is whispered debate among Chinese economists and political scientists about what the right future path is for their country. That is normal too: consider how caustic disagreement is about future debt and inflation consequences of the Trump Administration’s budget and tax policies.

While it is up to China to choose its policy course, it is others’ choice to take steps to avoid collateral damage. Given Beijing’s current resurgence of a Party-led economic policy approach, a change in US attitude is to be expected. Liu He and his American interlocutors should manage this shift in the relationship, rather than pretending that what is already happening is preventable. It is not preventable.  However, Trade and investment de-coupling could be done in a managed way, rather than through unilateral threats, protectionist measures, retaliation and escalations to intimidate the other side into concessions. It is possible that neither China nor the advanced economies are willing to work toward a convergent future at this time.  That doesn’t have to be cause for war and panic. It is better to state the situation plainly rather than beat around the bush.

In much of their economic interaction, China and the advanced economies may be able to avoid severing economic ties. These include activity where there is no technology transfer that confers a strategic advantage, where no vulnerability arises from supply or demand dependence upon the other, and there is full reciprocity. Examples might include textile and apparel trade, non-strategic food-stuffs trade and raw materials trade where there is a diverse global marketplace of buyers and sellers.  Assuming reciprocity can be achieved, in investment the majority of two-way FDI flows today could probably continue and even grow, since national security screeners have the ability to parse transaction details if they choose, with reasonable modifications to regimes like CFIUS.

This leaves areas of economic interaction where the US and other advanced economies believe the tide of statism in China necessitates higher seawalls and these should be shared among nations wishing to maintain a shared market-oriented pool. That is to say, from a Western perspective the risks associated with interdependence with China may become too great absent compelling evidence of convergent norms, and thus the important task in the relationship becomes peaceful disentanglement rather than engagementSoon-to-be Vice Premier Liu and his US counterparts can use their time well by developing a vocabulary to manage this process without either side slipping into talk of quarantine, containment, or other Cold War terms.

FONOP

Finally, in addition to discussing a positive list of trade and investment where we don’t have anxieties, and a more practical approach than “trade wars” for managing disengagement where one or both sides has objections to interdependence absent convergence, Liu and his counterparts could – if they trust each other – discuss mechanisms for re-engagement down the road. The most principled OECD argument for self-protection is that illiberal politics have historically not delivered economic stability beyond the catch-up phase, and if a China now near $13 trillion in size with a $40 trillion banking sector wobbles it will put its economic partners at risk. But what China and others should ultimately focus on is the outcomes.  It may be possible to agree on a shared framework for tracking objectively the trends defined as win-win, be those trade balances, market reciprocity or other outcomes, and to use that framework as a trigger for restarting dialogues and more constructive undertakings.

Make America Isolationist Again

Today I often quote and paraphrase the excellent must read, Asia’s Reckoning by Richard McGregor.

—————————————————————————————————————————————-

In this blog post we examined how modern world governance, particularly the WTO, is ill-equipped to manage China’s rise. In short, the WTO is unable to identify the providers of subsidies to Chinese firms; a situation that, I contend, the Chinese government has recognized and worked to further obfuscate. The post finally contends that any disagreement to Chinese trade practices must be settled unilaterally.

In this post I’d like to provide some fundamental historical context to the friction we now face regarding trade. NK Oil

Illegal Chines Oil Shipments to North Korea

China in a New Era

First, China sincerely believes it is ready to be a global leader. The Sputnik moment came this time last year at Davos. Supreme leader Xi Jinping headlined Davos , giving a speech at The World Economic Forum in defense of the current world order, including the balance of payments distortions that benefits China.

 

From Reuters, my emphasis added:

Chinese President Xi Jinping offered a vigorous defense of free trade at the World Economic Forum in Davos on Tuesday in a speech that underscored Beijing’s desire to play a greater global role as the United States turns inward.

From an opinion piece in Newsweek, my emphasis added:

What a difference a decade can make. China went from being lambasted for being an irresponsible stakeholder in the mid-2000s, to now being seen as the linchpin of global economic stability.

savingsglut3_colorbox

Current account imbalances in surplus countries generate high growth at the cost of asset inflation in developed deficit countries.

The West’s realization of China’s new leadership role in the world has only continued since January 2017. Chinese global leadership in a new era isn’t something just mentioned abroad; it is an explicit goal. Chinese influence abroad was a key point of the pivotal 19th Party Congress which was held in October last year. Supreme Leader Xi Jinping, a man whose resemblance to Winnie the Pooh has resulted in the full censorship of Winnie the Pooh in China, signaled that China is entering a New Era, the 3rd Era of Communist China.

Xi and Winnie

An example of forbidden content

xi-abe-winnie-1

An example of a meme that transformed from light humor to a great offense to the Chinese people

Chinese Communist Party Thought now believes in three distinct eras of leadership, each defined by changing leadership through death or imprisonment, ideology, and policy. The eras are known respectively for the paramount leaders of their time: the Mao era, Deng era, and Xi era. Xi’s third era has explicitly stated new goals, a major shift in domestic and foreign policy. For today’s topic we will focus on one, “pioneering global influence.”

Handshake

“This year I shook hands with Xi Jinping”

The third era under the reigning handshake champion has a great departure from the second era’s foreign policy. Deng Xiaoping’s goal setting ideology was 韬光养晦 (“keep a low profile”). These simple words were era defining for foreign policy, eventually morphing to become ‘Hide your strength, bide your time.’ It is under these words that China and Japan normalized relations in the 1970s. Using Communist jargon, Deng’s early economic planners hailed Japan’s use of “US-Soviet hegemonic contradictions” to spur economic development. Put another way, Japan was credited for exploiting cold war tensions to save money by sheltering under the US security umbrella, which enabled the country to focus solely on economic growth. Kong Fanjing, a Chinese economist with the Chinese State Planning Commission, wrote, “Japan had foreign policy subordinate to domestic policy, and domestic policy subordinate to economics.” The second era under Deng largely copied this Japanese development model (Deng reduced military expenditures in the 80s), and Deng did everything he could to avoid major conflicts.

Deng in Japan1978: Deng’s visit to Japan was the first time in more than two thousand years of contact that a Chinese leader entered Japan

Deng Xiaoping’s visit to Japan was perhaps more shaping than his trip to America. Deng met with emperor Hirohito, one of the classic WWII villains responsible for the deaths of millions of Chinese people. On his trip, Deng never asked for reparations, an apology for the war, and insisted on completely forgetting recent history. A 1968 UN agency report of potentially huge reserves of oil under the Senkaku/Diaoyu islands was electrifying. Japan, Taiwan, and China discovered a passion for islands that only the US military seemed to know existed, because the US rented the islands from Japan for Naval firing drills.

During his 1978 tour, Deng held a real press conference, something no Chinese leader has done since Jiang Zemin’s infamous press conference freak out.  When a Japanese journalist asked about the conflict regarding the Senkaku/Diaoyu islands, Deng  demurred, saying that generations, “who would be wiser,” will solve the issue. It wasn’t until massive student protests across China against friendly Japanese ties from late 1986 to early 1987 that China officially toughened its stance against Japan. The student protests eventually led to the sacking of Hu Yaobang, who was party secretary and  favored large economic reform. It was Hu’s death and mourning that set the stage for the Tiananmen Square massacre.

China  Demonstration  Riots  Students

Hu Yaobang’s death and mourning was the start of the infamous Tiananmen Square Massacre

Even after Tiananmen Square and a toughened stance on Japan, Deng’s era retained the idea laying low to build a functioning economy. Witness to the disaster of Mao era economics and the boom of Japan, Deng believed and implemented an introspective system built upon high investment rates.

I can’t emphasize enough how this has changed. Xi Jinping’s thought is written into the Chinese Communist Party constitution and he expressly states that the period of ‘biding time’ is over. The time has come to have influence across the globe.  If one reads headlines such as “Xi Signals New Era” or “Study for New Era — Xi Thought inspires China,” one must understand that this is the communist party, to include party organizations in private and foreign companies,  deciding how to change course, a course in which foreign influence is part of the ideology.

On January 16th of this year a manifesto was published on page one of the people’s daily. As an aside, it is fitting to see manifestos published in the people’s daily again; it hearkens to a tradition of the cold war. Commentary from Xinhua is illuminating:

Noting the problems facing the world, such as a “democratic deficit,” “governance deficit,” “development trap,” wealth gap, terrorism and climate change, the article said “the drawbacks of capitalism-led political and economic systems are emerging; the global governance system is experiencing profound changes and a new international order is taking shape.”

“The world needs China, as all humans are living in a community with a shared future,” the article said. “That creates broad strategic room for our efforts to uphold peace and development and gain an advantage.”

The article said China was at a historic period for the cause of socialism with Chinese characteristics to leap forward, for the system of socialism with Chinese characteristics to mature and for the world pattern to reshape.

I can’t stress enough how much people in China believe this. We are witness to a fundamental policy shift from the Xi administration, one that focuses on reshaping the the world.

American Retreat or American Renaissance?

Enter, Donald Trump, his slogan, “Make America Great Again,” and the notion that America is becoming isolationist, retreating from world leadership. Is China and its new authoritarian regime poised to lead the world?

Although I am sure this is click-bait and an inflammatory article just to be inflammatory, I’m going to quote the earlier quoted opinion piece from Newsweek to make a point:

Trump’s America seems more like the irresponsible and bystander state and China appears more like the guarantor and bulwark of global economic stability through a shared vision of increased economic cooperation and commitment to inclusive growth. Perhaps next year the annual World Economic Forum ought to be held at China’s Yabuli Ski Resort instead, confirming that the world is truly upside-down.

Although the opinion piece quoted above is often confused, muddled, and outright silly; I find the underlying ideology, seeking the leadership akin to 20th century powers in 21st century context, quite similar to the ideology that Donald Trump propagates.

Trump

When was America greater than it is now? Pundits would look to a wide, rage inducing swath of issues in which America has improved: equality being the obvious choice. The answer is, and this certainly fits well with people who would like Donald Trump, MAGA hearkens to a time when the US, due to the realities of two world wars and the threat of communism, was able to play a unique role in the world. In 1960 the United States comprised 40% of the World’s GDP. Today it comprises roughly 25%.

Of course, MAGA is nonsensical. That ‘greatness’ was only attainable due to a unique set of circumstances directly after World War Two: two devastating world wars, the evils of communism, scarcity of savings, and  great need for investment. However, since 1960 to the present, there has been a period of abundant, and even of excess, capital, driven by high savings and weak demand, and the end of the Cold War. During this period, the United States has accommodated the excess savings of the rest of the world by running large capital account surpluses (that is importing capital), which has meant  that it also has run the corresponding trade deficits. Because economic growth among its trading partners benefited from trade surpluses to grow, it is not surprising that the large American trade deficits of this period have allowed the country to continue as the indispensable center of global trade.

America is just as indispensable now as it was before the 60s. Before the 60s the United States ran large trade surpluses and capital account deficits as it exported its excess savings to fund its net exports while the growth of its trading partners was constrained by their urgent investment needs, new technology and wars playing a crucial role in this need. MAGA hearkens to a dead time; it lacks economic clout due to unique circumstances (war) and old trading regimes.

Patriotic Spirit

Envisioning a Chinese rise that is the “bulwark of global economic stability” is comical (any adjective akin to silly is acceptable here). China is a developing, authoritarian government with a huge debt burden that is best described as fragile and easily offended (see: outrage at South Korean missile defenses). To assume that it could rise to fill the gap of America’s role is indefensible. No country can, because the 20th century institutions and rules were made and cared for in unique circumstances that no longer apply today; they weren’t made for the non-free world.

The articles about China’s rise will only get more ridiculous. This article by the New Yorker is absurd:

As Donald Trump surrenders America’s global commitments, Xi Jinping is learning to pick up the pieces.

Donald Trump, of whom I am the staunchest critic, is not surrendering global commitments. The commitments them-self and the institutions they were made in are often symbolic and nothing else. On climate change:

China is still the largest emitter of CO2 on the planet by a substantial margin, contributing 29 percent of the world’s total CO2 emissions in 2015. The United States comes in a distant second at 14 percent. In addition, while Beijing is cutting back on coal-fired power plants—particularly in its wealthy and pollution-conscious coastal provinces—it is upping its count of CO2 emitting coal-to-chemical (including coal-to-gas) plants. There are 46 coal-to-chemical plants in operation and another 22 under construction that will add another 193 million tons of carbon emissions annually. A conservative estimate suggests that by 2020, such plants will contribute as much CO2 as all of Poland’s contribution to global carbon emissions, while the extreme scenario—if China builds all the coal-to-chemical plants outlined in its 13th Five Year Plan—will lead to a contribution of almost 800 million tons per year, more than German’s total carbon emissions in 2015, and equal to roughly 10 percent of China’s current CO2 contribution…

…Whatever positive steps China is taking at home are not being replicated in its behavior abroad. China is the world’s largest exporter of coal-fired power plant finance and technology. Even as Xi is calling for an “international coalition for green development on the Belt and Road” (his comprehensive new trade and development initiative involving 65 countries), Beijing is backing more than 100 new coal-fired power projects in the Belt and Road countries. China’s much-touted Belt and Road deals in Pakistan, for example, include plans for as many as 12 coal-fired power plants—even in areas recognized for their superior solar energy potential. In addition, China is actively pushing coal-to-chemical plants abroad. The Paris accords don’t account for countries’ actions outside their own borders, so China is not breaking the letter of its Paris commitments, but these Belt and Road investments are certainly not in keeping with the spirit of the agreement.

coal OBOR

The madness heralding China’s rise extends not just to military affairs and climate change. Professional financial analyst now regularly talk about an internationalized RMB and the rise of the RMB as the new global currency. While use of the RMB as a reserve currency or as a trading currency will probably rise in the next decades, this is mainly because of its still very low base. The quoted China Daily quotes the RMB, an international currency, as being part of 1.94% of international transactions, a lower amount than 2016, and far behind the dollar’s 45%. The highest possible percentage is 50% due to needing two currencies to exchange.

Laudations of the Chinese miracle reached fevor pitch when “in a milestone for the yuan’s internationalization, the currency joined the IMF Special Drawing Right basket.” Christine Lagarde, wearing a blazer in the form a traditional Chinese Qipao, smiled happily to include China in a symbolic and completely empty gesture, the IMF SDR.

Lagarde Dress

Christine Lagarde, leader of the IMF. Her appearance here in no way is meant to be qualitative value judgement.

One could always compare the RMB to any currency. You could arbitrarily change the currencies in the IMF’s measure with no consequence, but alas, this was another sign of a changing time: an America in retreat, a China on the rise.

The Illusion of Great Power

America has protected Asia’s flourishing economies fighting against Japanese, Chinese, Korean, and Soviet aggression. Most begrudgingly, America has opened domestic markets to exports in ways those aggressors would never reciprocate.

When negotiating the return of Okinawa to Japan in 1972, America had two wishes: a commitment to keep American troops in Japan and a promise to limit textile imports to the United States. Presidents Eisenhower, Kennedy, and Nixon had to fight against Japanese textile imports. Presidents Ford and Carter restrained specialty steels and color TV sets respectively. America has often been used by allies to structure high investment growth models in East Asia. Donald Trump, however obtuse, is not the first president to be unhappy with the economic commitment America has made and their accompanying bilateral trade deficits. If anything, every American president since the end of the war has expressed grief at East Asian ally development models.

Chinese island making

China continues to build military outposts in the South China Sea

Japan, China, and the United States were aligned strategically, agreeing on the primacy of the Soviet threat soon after world war two, but there was never agreement regarding economics or best business practices. America continued the economic bargain it guaranteed which is to absorb abundant, and even of excess, capital, driven by high savings and weak demand, however that bargain made sense when trying to keep East Asian allies stable, building necessary capabilities after the war. Why should America extend this agreement to a country that is unhelpful of North Korea, a country that threatens America with nuclear destruction. Why should America extend this agreement to a country that has an abhorrent human rights record, recently arresting A Swedish Citizen in China because of human rights agitations, arresting and beating human rights lawyers, and being the first country since Nazi Germany to kill a noble peace prize winner, Liu Xiaobo. China has shown itself not to be a leader. China has shown itself to be an authoritarian bully. China is only suitable to lead in symbolic situations.

I loathe Donald Trump, however it is intuitive to re-examine Cold War commitments that were made to the free world now that the Cold War is over. It is more intuitive to not make those commitments to the world that isn’t free. Furthermore, rejecting the Trans-Pacific Partnership (which I am vehemently against), Paris Climate Accord, or UNESCO should not mean the rejection altogether by Washington of the very idea of a stable, rules-based trading system, because America is the only country able to absorb East Asian imbalances. America is the only country that can be the linchpin to these surpluses, however I cannot see how East Asian allies that also run surpluses will be willing to raise domestic demand by reducing savings in an effort to pressure China.

The consequence of a U.S. withdrawal from global governance, in other words, is unlikely to be an orderly, rules-based global trading system in which leadership has shifted from Washington to Beijing. Far more likely is a return to the pre–Bretton Woods days of trade conflict and beggar-thy-neighbor policies, and beggar-thy-neighbor policies have been a staple among East Asian countries since the war’s end.

Three Short Observations and One Long Observation

Short thoughts today before I fly out to New Orleans tomorrow.

1.) Although not the whole picture, I largely agree with statements given in this FT article about the global savings glut. This imbalance, and particularly Americas forced absorption of the imbalance, is why I believe so strongly in the trade conflict I wrote about in the beginning of December.

FT imbalances

Cross-border lending helped facilitate the credit crisis a decade ago. After the Asian financial crisis of the 1990s, many countries in that region decided that maintaining big foreign currency reserves was a prerequisite for financial stability. They sold bonds to their citizens and invested the proceeds in foreign — primarily US — assets. Another stream of money came from Germany, where post-unification wage reforms and European monetary policies created an exporting powerhouse. Still another came from the oil exporters, awash in petrodollars. These flowed towards America, too. The money washed up in the US housing market, driving up investment and prices.

…Since the crisis, low oil prices have eliminated a big part of the glut. The German and Chinese contributions, which fell after the crisis, are approaching 2007 levels again.

Unless one believes the United States financial system is unable to domestically fund its financial needs, one must believe this foreign money artificially drives up asset prices. Its all about capital supply.

2.) When writing about the trade conflict in early December, I predicted America would be forced to act unilaterally. That belief only grows stronger.

Here are joint statements from America and Germany regarding the abhorrent sentencing of human rights lawyers in China. If Canada, Australia, and the EU can’t work on a joint statement regarding human rights, do you think the world, to include current account surplus producing East Asian allies, will agree to stop domestic distortions that cause current account surpluses?

It is true that there has been some success on addressing obvious flaws in the One Belt One Road initiative, but that project was doomed from the beginning.  The Asian Infrastructure and Investment Bank as well as the One Belt One Road initiative were always laden with symbolic value and nothing else.

I hope I’m wrong, but I remain pessimistic.

3.) I think this blog post from Christoper Balding in which he describes the Chinese economy as fragile is a must read.

4.) For all the talk of reform, have we seen any meaningful economic reform under the Xi administration?

The first large economic reform buzzword to placate Western expectations was supply side reform, but the economy seemed to continue with business as usual. The second large economic reform buzzword to placate Western expectations was strategic deleveraging , but the economy seemed to continue with business as usual. The official statement after the 2017 Central economic Work Conference did not mention deleveraging at all. Deleveraging seems to have been replaced by “risk control” in the official party language.

So what was the tangible economic reform of the Xi administration? There are two: urbanization and new technology investmentFor all the talk of debt in Western media, China has signaled every intent to try and grow out of its debt burden.

Regarding urbanization, the new leadership pins high hopes on the New Urbanisation Programme to transform China into a domestic consumption-driven economy, and to promote the country’s rural and urban integration for social equality.  This has resulted in the creation of more New Areas, the latest being Xiong An. The ambition to create new cities from nothing doesn’t get a lot of Western press, but this couldn’t be bigger news in China, a country whose entire wealth is denominated in real estate inflation.

Map of Xiong An

Here is Chairman Xi looking at a map of Xiong An.

xiong an money

Here are the words 雄安新区 (Xiong An New Area) on top of money.

xiong an triangle 1 Here the positions of Xiong An, Beijing, and Tianjin are cleverly marked with a triangle.

xiong an triangle 2

Increasingly clever triangle.

xiong an triangle 3

Geometry.

Chinese urbanization seems to include mass eviction of poor migrant workers- forcibly removed from their homes with little notice into the freezing northern winter at a time when the local governments have proven inept at providing heat – as well as the idea that new cities will allow these poorer Chinese to buy into the fixed asset price inflation dream that has made all of China rich.  The plan is to raise real estate prices in rural area so those asset holders become rich, eventually being able to cash out and increase household consumption. That is the plan being verbally and visually implemented: evictions and strategic housing price inflation.

The second policy, which is only just being seriously discussed in Western Media is China’s push to be the leading producer of 21st century new technology. Besides the serious AI race, China has openly admitted to targeting robot, smart car, rail, ship building, agriculture, medical devices, and new materials technology. Western media is only just realizing that China is a serious threat that foreign firms might not be able to compete with.

“Ah, but China, like all state planned economies, isn’t innovative. Western firms will be able to be more innovative and competitive!”

History disagrees. China was effective in destroying the American solar panel market and it took years for the United States government to begin a response. There is no way to compete with a system like China in which the state can operate at large losses, price commodities at will, and funnel huge sums of money. Take this quote from the linked NYT article:

American manufacturers say the cheap panels have been unfairly financed by the Chinese government. Chinese manufacturers have benefited from cheap loans from government-run banks. Even some Chinese companies that have struggled with losses and had trouble making loan payments have been able to stay afloat.

Such manufacturers in China “are technically insolvent, but they still get capital.”

As I previously wrote, governments are currently unable to create policy to counteract the extreme depth of subsidies Chinese companies give and receive. This is in a sector the American government supports and encourages. These are jobs and companies America wanted.

The battle for new technology is already underway. Take CRRC for example, a rolling stock manufacturer. This report by SCI is illuminating.

CRRC

CRRC market share

CRRC market share 2

CRRC is able to dominate the global rolling stock market, currently providing transportation solutions to Boston ($576 million), Chicago ($1.3 billion), and LA ($647 million). Herein lies the rub, large SOEs like CRRC no longer just compete in rolling stock. They now have an acquisitions subsidiary in Beijing focusing on buying new technologies (English starts on page 3).

CRRC is now actively trying to buy out Western environmental systems, new energy, new materials, agriculture, robotics, medical equipment, and recreational engineering companies, companies and technology completely foreign to rolling stock. The desired result is to increase the value of Chinese companies, increasing wages and Chinese household consumption.

China has noted for more than a decade that its economy was unbalanced. They have acknowledged Western concerns, created thrilling, often obfuscating narratives, and begun addressing these problems in a unique take on outgrowing a classic investment driven, debt creating model.

There is reform in China, but its not the news you wanted to hear.

A Trans Pacific Trade Conflict is on the Horizon

When Xi Jinping lauds, “markets as playing a decisive role in resource allocation,” do you think he intends to A.) Implement structural reform to decentralize resource allocation, generally weakening state control, B.) Create a narrative to shield China from global governance, OR C.) Other?

I’m going with option B.

When Xi Jinping signs “cyber espionage agreements ,” do you think he intends to A.)  Implement structural reform to stop cyber theft, generally weakening state control, B.) Create a narrative to shield China from global governance and retaliation, OR C.) Other?

I’m going with option B. This blog post will describe unique state control mechanisms within China, and I will show how recent laws are not structural reforms in nature, but buzzwords to create a narrative. This narrative is important because global governance structures such as the WTO are unable to effectively govern. Countries wanting to limit China’s foreign influence, I argue, will now have to do so unilaterally, as part of larger trade agreements, or accept Chinese influence all together.

The Nature of the Problem

Call me crazy, but I have never considered mixed ownership reform in China, where targeted SOEs sell roughly 30-40% equity to private investors, actual reform.

Per Caixin, my emphasis added:

Most big state-owned companies that have been listed to date remain firmly in control of the central government, which typically maintains 50% or more of the company’s shares. Under that arrangement, the central government sees anyone who buys shares on the open market as purely financial investors, and typically gives them little or no say in the company’s management or strategic planning. The new plan treats investors as strategic partners who can profit through their equity stake if the partnership succeeds. Those partners have a specific mandate to work with the state-owned company to create new products and services that can be jointly developed and marketed by both sides

To think that China or the Chinese Communist Party wants private strategic partners is laughable, however what is genuinely absurd and intellectually insulting is the idea that the central government retains control of these companies by retaining a majority of given shares.

The Chinese economy is unique when considering its combination of irregularities which involve state control.  Let me introduce three irregularities before circling back to, global governance obfuscation.

512px-National_Emblem_of_the_People's_Republic_of_China.svg

First, SOEs have all assets held by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). Per Wikipedia, my emphasis added.

The State-owned Assets Supervision and Administration Commission of the State Council (SASAC) is a special commission of the People’s Republic of China, directly under the State Council. It was founded in 2003 through the consolidation of various other industry-specific ministries.[1] As part of economic reform, nearly half of state-owned enterprises were sold off in the form of stocks. SASAC is responsible for managing the remaining SOEs, including appointing top executives and approving any mergers or sales of stock or assets, as well as drafting laws related to state-owned enterprises. As of 2017, its companies had a combined revenue of more than 23.4 trillion yuan (US$3.6 trillion) and an estimated stock value of 50 trillion yuan (US$7.6 trillion),[2][3] making it the largest economic entity in the world

Every SOE is actively managed as a portfolio company in the same way that a private equity company might treat its holdings. Each level of government replicates this structure. Provinces and municipalities have their own SASAC, reporting up to the central government’s SASAC, and these local agencies serve as the controlling shareholders of the critical SOEs in their regions. For example, Jiangsu Province’s SASAC controls the province’s key enterprises in sectors such as agriculture, hospitality,
minerals, and so on. Imagine if one U.S. government agency controlled General Electric, General Motors, Ford, Boeing, U.S. Steel, DuPont, AT&T, Verizon, Honeywell, and United Technologies.

Second is the National Development and Reform Commission (“NDRC”). The NDRC is the present-day incarnation of the State Planning Commission (“SPC”). During Mao’s reign. The SPC was the central planning authority that oversaw the Soviet-style planned economy. The NDRC oversees the creation of China’s Five-Year Plan, a role that the SPC once played. But unlike other countries, such as India, where the Five-Year Plan serves merely as an aspirational guide, the NDRC has several tools available to implement its plan. The NDRC is in charge of pricing commodities that are not yet completely set by the market. Examples include electricity, oil, natural gas, and water. This allows the Chinese state to set input prices, thereby affecting costs. In addition, whenever a large infrastructure project or investment requires government approval, the NDRC is the final authority, regardless of whether the entity seeking approval is an SOE, private company, foreign company, or joint venture. Examples include new bridges, factories, and even a Disneyland theme park. This oversight provides the NDRC with broad power to affect market supply and capacity.

This structure is replicated at the provincial and local levels (similar to the structure of SASAC). Each province and municipality has its own Development and Reform Commission (“DRC”), which coordinates economic policy for that region. The provincial/local DRC reports vertically to the NDRC as well as horizontally to the corresponding level of government. This structure ensures that the state has the full ability to coordinate economic policies both within and across sectors and regions.

Third, the Party is everywhere. Although China is a one-party state, the Party functions as its own organ independent of the state. For example, although the Party oversees the
state’s public security and judiciary, it also operates its own separate investigation, detention, and disciplinary processes.  The Party appoints the leadership of SASAC, the NDRC, and Central Huijin, as well as the various ministries charged with overseeing the economy. It also controls appointments of CEOs and top management of SOEs, as well as  banks.

Each and every organization with more than three Communist Party members must form a Party committee within the organization. This requirement extends not only to SOEs, but also to private companies and foreign firms. The inner workings of the party committees are not made public. Nevertheless, this structure provides the Party with a high degree of potential oversight over Chinese corporations or any group in China.

Western Misreadings

President George H.W. Bush visited China  in 1998. When meeting with Premier Zhu Rongji, President Bush asked how China’s privatization plan was proceeding. Premier Zhu, obviously surprised, responded that China was not undergoing privatization but simply corporatizing its state assets. President Bush reportedly responded, with a nudge and a wink, and when Premier Zhu Rongji described the process, Bush responded by saying “we know what’s going on.” (McGregor, supra note 26, at 43.)

George HW

It turns out, he didn’t know what was going on.  Coming off a victory in the Cold War Western expectations for China centered on the inevitability of democracy, capitalism, and universal values codified in Western states.

This is not to suggest that the Chinese concealed their true intentions. Throughout the 1990s, Chinese leaders openly and repeatedly stated that they sought to forge their own unique economic and political system. China’s reformers are often painted as adopting an incremental, gradualist approach, however at no point has China and the Chinese Communist Party sought, vocalized, or signaled towards what the West dreamed of, a China that reformed away communism for democracy and capitalism.

Foreign observers never stopped looking for the next sign of reform, never stopped believing that Chinese reform would fit their vision. Articles like this, written four years ago, read as comedy today, my emphasis added:

The Chinese government’s central economic planning ministry (NDRC) dominated economic policy-making in the Hu-Wen era, and came to epitomize the model of state capitalism associated with their decade in office. The organization’s approach to economic management, however, is in direct conflict with the vision laid out by Xi Jinping’s administration which has promised to give a “decisive” role to market forces. Much uncertainty remains over NDRC’s future although the organization shows signs of positioning itself for a new role as a macro-economic coordinator that is relevant to a more market-driven Chinese economy.

Yes, only now is Chinese state control in conflict with promises and talking points. These promises, just like promises on cyber security, are empty. I contend that no one should take merit in Chinese government promises.

Although this blog post will focus on economics, obfuscation is not limited to one sector. China recently held a forum on human rights.  Details are worth reading (full text and propaganda ). My favorite quote from the Xinhua propaganda piece, my emphasis added:

Although the topics of the events varied from economic globalization to cooperation among political parties, the messages in Xi’s speech and letters radiated a China vision of global governance

Conjecture

When China joined the WTO, there was a fifteen year period in which countries were able to designate China as a NME (non-market economy). That designation would allow countries to raise tariffs or limit Chinese imports. That period has ended, and now, just over 15 years later, China has done well to obfuscate governance able to address China’s exporting of domestic imbalances. My key contention is that some of China’s structural changes are designed to obfuscate global governance, specifically the WTO. The most often mislabeled reforms are SOE ownership reform and capital allocation mechanisms. These are buzzwords designed to placate developed economies.

I believe, purely as personal conjecture, that China has been preparing for a trade war for some time, and China correctly identified the WTO as where the first shots would be fired. China has gone to great lengths to obfuscate how its markets function, rendering the WTO unable to effectively mediate the effects of their domestic imbalances. Perhaps most importantly, America is at least a decade behind the ball.

Testifying before Congress in 2000, U.S. Trade Representative Charlene Barshefsky declared that the “agreement deals appropriately with the special and unusual characteristics of the Chinese economy. She then boasted that “no agreement on WTO accession has ever contained stronger measures to strengthen guarantees of fair trade and to address practices that distort trade and investment.”

She was wrong largely due to fundamental changes that enhanced state control starting in 2003 (SASAC, NDRC, and the Party). While China has undergone large structural changes, the WTO hasn’t had a large structural change since the Uruguay round of negotiations concluded in 1994.

WTO

WTO Headquarters in Geneva

To be sure, China’s status in the WTO has been up for debate, a debate that in recent months has escalated. This article by Xinhua is illuminating. Besides describing American objection to Chinese trade practice as “reckless,” the problem at hand is easily summarized: “In fact, the case has nothing to do with whether China has been granted market economy status or not, as there are no standards in the WTO rules for the status.”

The roughly $600 billion in bilateral trade is obviously at stake, but the Chinese economic system, designed to export Chinese savings, is also at stake. China can hardly afford to forcefully adjust from its debt creating model. To safeguard their system and the ability to export domestic distortions, China has been all too happy to proclaim itself as the defender of globalization. It has everything to gain from preserving the status quo.

The problem the WTO has failed to address is, “what entities should be considered part of the state?” This is critical because the WTO prohibits certain forms of subsidies while allowing recourse against subsidies with adverse trade effects. However, these rules only apply to subsidies provided by governments and their associated entities. The WTO tried to preempt loopholes by referring to entities separate from government, but controlled by the government as public bodies, which are subject to government like restrictions. The greatest issue regarding Chinese public bodies are groups providing subsidies as opposed to receiving them.

If GE capital provides a preferential loan to GE aviation, there is no foul play, because it was not state directed. However, in China the entire banking system is under state control. Remember, every SOE adheres to state planning provided by the NDRC and is under control of SASAC.

In this 2010 case the United States argued public bodies were organizations with a majority stake held by the government. That was rejected. In this 2014 case the United States argued an organization is a public body if a government can control a companies asset as its own. That was rejected. The WTO, in the appellate court’s decision in 2010, further gave guidance to what constitutes a public body. A public body, the appellate body declared, “must be an entity that possesses, exercises or is vested with government authority.” Where an express statutory delegation of authority exists, the inquiry is straightforward. However, even without express delegation, an entity may nevertheless
constitute a public body. What is important is “evidence [of] a sustained and systemic practice” of the entity “exercising governmental functions.” Ownership, by itself, does not suffice. Evidence must show that “the formal indicia of government are manifold” and “such control has been exercised in a meaningful way.”

The Chinese government’s reforms over the past few years have strengthened the party and state control, while loosening the formal indicia of government. The Bank of  China may have quasi government intent written into its being, but China has effectively deleveraged the state control language of its economy and largest domestic distorters.

America’s New Response

America after 2010 has decided to bring cases to the WTO to halt unfair trade practice. Here is Obama stating how his administration has brought more cases to the WTO. Note, those cases failed to create a victory for the United States, hence not bragging about winning cases at the WTO, merely sighting the number of brought cases. China has cleverly adopted reform and buzzwords to combat American discontent.

Recent ‘reforms’ don’t seem to be reforms at all, and the only effect I can see from reforms in the past 7 years is to strengthen China’s ability to obfuscate WTO global governance. China has privatized state assets before, and real reform for SOEs would be getting rid of NDRC and SASAC involvement as opposed to privatizing minority stakes. It seems more likely that those reforms are aimed to get ahead of American public bodies arguments. I’d say the same thing for resource allocation statements.

And herein lies the rub. China is succeeding in the WTO. The WTO as it stands today is unable to mediate issues relating to China. The laws are 20 years old. Perhaps more importantly, can the WTO make rules for one country? Could you imagine a negotiation where the world agrees on Chinese trade practices, trade practices that are largely emulated in East Asia. China presents a unique rule set due to its sum of rare state controls, but many countries in Asia, not to mention Germany, export savings.

So it is now that, faced with years of stinging failure under the Obama administration to fix the issue, Democrats and Republicans, in the midst of a partisan bloodbath, come together. Only now, following New Zealand and Australia, is America realizing its losses and vocalizing its discontent. Chinese tech companies are on the brink of developing world changing technology on American soil, while American companies struggle for basic market share across China. A new technology Chinese panopticon is no longer page 7 news with the realization that human rights are indeed not improving. As the left rails against Donald Trump, there is quiet but firm agreement across the aisle that reciprocity is needed. Allies of China bring new threat of nuclear holocaust against a people who were fat, happy, and oblivious to the machinations of the East Asia. No longer.

It is under these conditions that the United States now has abandoned the WTO. The Section 301 investigation against China is serious. I expect the United States to move unilaterally before the 301s stated deadline (1 year). I expect the United States to try to fix its balance of payments issue through trade disagreements with China. I expect the United States to fail in addressing economic imbalances. I expect the wider world to support China right until the very moment it falls under the weight of its debt burden.

Obama got a peace prize upon being elected. I don’t expect any aid from the developed world with Trump in office. The pieces seem set. China under Xi has failed to reform. America under Trump has abandoned global governance.

The sky is grey today.

 

 

 

The State of the Chinese Economy

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

pikettyfig1

Chinese Real National Income Per Person

pikettyfig2

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.

Chinese 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.

consumption-china

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.

lets get killed.jpg

lets feed a bear

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.

shuangjing_police_raid_01

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. 1495884731555028

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

Shareofinvestment

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.