中国芯和风险

 

10年前,北京曾有索爱全球最大工厂、诺基亚中国最大工厂,天津曾有摩托罗拉全球最大工厂。配合京东方、中芯国际,再加上北京最为发达的互联网产业,从组装加工、到高端零部件、到上层应用的移动时代全产业链,原本应该诞生在京津地区。

然而,京津押宝的三家顶尖手机外企全跪了,而原本被视为“山寨”的珠三角本土企业:华为、oppo、vivo,却崛起成为世界巨头(小米也不在北京生产)。

于是,长三角的台资/美资PC产业链、珠三角的内资手机产业链,加上与之配套的面板/芯片/零部件厂商,随着产业转移,大规模在以长江流域为主的内陆省会开花结果(最北达到西安、太原、郑州一线)。

而伴随着京津外资手机厂的倒闭,京津冀缺乏能容纳大量劳动力的PC/手机制造工厂,面板/芯片厂的新产能也不再落户京津冀。

于是,除了北京发达的互联网和金融产业外,津冀经济增长的新动能就消失了,再加上对高耗能高污染重工业的打压,津冀就愈发尴尬。

未来5-10年,伴随着人口老龄化,内陆省会和区域中心城市的产业、人口竞争将日趋激烈。吸引更多的产业人口、研发人才,争夺到电子和汽车产业链条的更多环节。特别的,如果能像珠三角一样培育出自己的消费电子品牌,那么其迈向人均3万美元中等发达世界的道路就打通了。

而中国芯、中国屏、中国车的例子都告诉我们,不要过于仰仗外资企业,外资企业的目的和市场化内资企业是不同的。外资的目的在于绕过中国的关税壁垒(在中国建芯片/面板/汽车厂)、在于降低成本。

而一个有志气的市场化内资企业,其目的则是向上向下打通产业链、打出自己的品牌、下力气研发(或者收购)容易被卡脖子的关键环节、拓展自己的生存空间,把自己的命运和国家的需求无形中捆绑在了一起:

  • 大连英特尔、无锡海力士、西安三星,典型的外资。来华目的只是为了便宜的土地、优惠的税费、以及绕过中国的关税,对当地经济有短期促进作用,但不可能依靠他们来构建起一套完整的产业链。
  • 中兴是内资,但不是有志气的内资,更像一个安逸的集成外包商。
  • 华为、腾讯、阿里、吉利、长城、京东方等等,属于“有志气的内资”,虽然各自达到的水准不同,离世界一流水平也还有差距,但他们的总体方向,是在市场中寻求突破和拓展,是他们在带领中国在各领域前行。

于是,问题就很清晰了。“中国芯”和一流水平的差距有多大?我们要依靠谁来实现中国集成电路产业的突破?

总结一下:我国目前62万片/月产能的12寸芯片厂中,有46万片/月(74%)是外资/合资厂。大陆目前最大、最先进的芯片代工厂中芯国际,其年营收只有台积电的1/10,技术差距为5-6年。

Asset Prices and Protests

A crucial aspect of ‘socialism with Chinese characteristics’ is the absence of risk in key assets, namely real estate. As I have previously written, Chinese policy to increase household wealth revolves around strategic asset inflation. There is an explicit idea in Chinese society that certain asset classes cannot lose value and value must always increase.

The Chinese stock market is one such asset class. This article explains how, in 2015, China set a floor for its stock market by ordering brokers to not sell below 4,500 points. The stock market was to fall no lower. It worked. Life moves on. Asset inflation continues.

 In Beijing, homes that went for an average of around 4,000 yuan (US$580) per square metre in 2003 are now above 60,000 yuan (US$8,600) a square metre, according to property price data provider creprice.cn

The key questions should then be:

1.) Can this go on forever?

2.) What happens when it stops?

Luckily there is some insight. People have been protesting drops in real estate prices for years. Here is a good article from the SCMP on the matter. Here is what a real estate protest looks like (it is really worth watching).

Something that foreign pundits regularly misunderstand about China is the amount of protests that happen. They do happen and are often allowed to happen. For example, here is a good video of recent veteran protests. However, it is worth watching how the expectation of constant growth interacts with a slowing -healthy or otherwise- Chinese economy.

 

Capital Scarcity

In this 7 minute YouTube video, US Trade Representative Robert Lighthizer is unable to answer Senator John Kennedy’s question. Kennedy asks why a current account deficit is bad for America if the dollars are later recycled to fund investment in America. The key question from Senator Kennedy is as follows:

If we are running a negative in our current account, our financial account has got to be positive, right? Which means that those dollars are coming back to the United States and they’re being invested.

 

Mr. Lighthizer should have said that Senator Kennedy’s example is assuming that foreign investment is productive and has no ill effect on the US economy.  If capital in America was scarce, foreign funds could fund the gap between domestic investment needs and low domestic savings. The problem here is that America has the deepest, most liquid, open capital markets in the world. American banks are industry leaders and capable of funding America’s investment needs.  If America’s domestic financing needs are met by American financial institutions, what are the effects of America’s consistent capital account surplus?

1.) Excess capital could find its way into asset bubbles. Asset bubbles in real estate, particularly regarding Chinese investment, have become normal. Speculative flows of money into assets can make households feel richer. For example, if you perceive the value of your house as increasing due to living in an asset bubble, you may be more willing to spend more or take on additional debt. Lastly, if American firms lessen their investment or productive investments are funded by foreign capital, America is outsourcing its capital allocation mechanisms to foreigner institutions. This could have great ramifications for a country if the foreign institution is run by communists, building military islands in the South China Sea, or responsible for the slavery of its ethnic citizens. Becoming a part of the capital allocation mechanism may also let a foreign institution interrupt democratic debate, because those who benefit or have the best relationship with said institution may be unwilling to abandon their patron.

2.) Good FDI, fairly logically, means that a foreign entity has industry knowledge or practices that make them competitive in a domestic market. A win-win is created by the foreign entity being competitive in a large market and the foreign market learning new knowledge/practice. Why would a developing country so regularly invest in a developed country considering the developing country is much less likely to have best practices?

capital_epa_net

I think there are a few reasons that Robert Lighthizer didn’t give Senator Kennedy a satisfactory answer. However, if he did give him an answer in which he stated that America’s problem isn’t its trade account but its open capital account, he would have to admit that tariffs won’t fix the problem and his administration is failing.

13 Questions for Stephen Roach

Dr. Stephen Roach has a Ph.D. in economics from NYU, was chairman of Morgan Stanley Asia, and regularly teaches at Yale. For years I have listened to Dr. Roach opine about the nature of the world’s current/capital account imbalances. Dr. Roach’s prognosis about the imbalance origins, particularly regarding the trade relationship of America and China- of which he wrote a book (Unbalanced), are remarkably consistent.  Perhaps most remarkable is how wrong his consistent and well published statements are.

To be clear, this blog post aims to do three things. First, we will examine what Dr. Roach believes to be the origins of trade and capital imbalances. Second, we will concisely examine national income identities. Lastly, we will list questions that shed light on the magnitude to which Dr. Roach is mistaken.

Before I begin, I feel the need to clarify that my worldview is strongly shaped by  the uneven current/capital accounts, however accounting identities have limited utility. It is extremely important to know their limitation. For example, extrapolating a current account surplus (surplus of savings over investment) to reflect financial market health is nonsensical. My point here is that it is entirely possible to misunderstand national income accounting and still provide great wisdom to the study of economics or the health of financial markets.

 

 

Dr. Stephen Roach often published that America’s trade deficit is a result of poor savings

Problems with the American Consumer

America’s trade deficit, a topic of much debate (This link is to Bernake’s 2005 speech. It is worth reading), is rooted in the poor consumer culture of American people and American corporations. This is the ideology of Stephen Roach. His book, which I linked above, outlines this nicely. Similar in idea and scope are publications from 2011 and this August, the latter of which sparked this blog post. He writes the following in his most recent article (emphasis added):

Despite the US government’s recent upward revision to personal saving data, the overall national saving rate, which drives the current account, remains woefully deficient. And the major surplus countries – Germany, China, and Japan – have been only too happy to go along for the ride

Economies running current-account deficits tend to suffer from a deficiency of domestic saving. Lacking in saving and wanting to invest, consume, and grow, they have no choice but to borrow surplus saving from others, which gives rise to current-account and trade deficits with the rest of the world. The opposite is the case for countries with current-account surpluses. They are afflicted by subpar consumption, excess saving, and chronic trade surpluses…

America’s consume-now-save-later mindset, which is at the heart of its current-account deficit, is deeply embedded in its political economy. The US tax code has long been biased toward low saving and debt-financed consumption; the deductibility of mortgage interest, the absence of any value-added or national sales tax, and a dearth of saving incentives are especially problematic.

Again, because it is worth repeating, Dr. Roach believes that America has run a cumulative $9.1 trillion current account deficit from 2000-2017 due to a poor savings culture and mismanaged political economy.

 

Independent and Dependent Variables

Don’t panic. It’s a pretty simple equation, and our real intention is to differentiate independent and dependent variables.

(M – X)   =   (I – S) +   (G – T)

This says that a trade deficit (imports-M- less exports-X) is equal to the savings deficit (investment-I- less saving-S) plus the government’s fiscal deficit (government spending-G- less its tax revenue-T). You could also write the following:

 Trade deficit = Total investment – (Household savings + Business savings – Fiscal deficit)

Dr. Roach advocates for the United States to raise savings so that the difference between total investment and savings, which is equal to the trade deficit, will shrink. What he assumes is that the trade deficit is a dependent variable. It isn’t. The United States trade deficit, relative to domestic policy, is an independent variable manufactured abroad. The United States, with its open capital market and international reserve currency, is forced to accept investment from countries whom choose to artificially raise their savings. If the American trade deficit is an independent variable manufactured by foreign excess savings, it is also true that America’s fiscal deficit is not a cause of the trade deficit.

Questions below will guide readers to the correct answer, however let me summarizes the two points of view regarding the source of America’s trade deficit.

1.) Dr. Roach writes that Americans, for a breadth of reasons, save too little and consume too much. The world, particularly China, uses this consumer culture to export their domestic saving surplus.

2.) I believe a set of countries suppress domestic consumption by transferring household wealth to industry. This wealth transfer increases savings that must be exported abroad. America is the easiest country to export this domestic savings.

Questions For Stephen Roach

The following questions will help you identify causality in America’s balance of payments imbalance. Question 13 is best to start with if new to the subject.

1.) Which American entities save too little?

2.) Are  Corporate savings too low?

3.) How would America increase household savings? Redistribution of wealth from wealthy households to non-wealthy households would cause a net drop in savings because wealthy households save a higher percentage of income.

4.) How will policies that raise American savings not raise income inequality (see question 3)?

5.) Does America have such large domestic investment needs that it needs to cumulatively import $9 trillion of capital over 18 years to fund its needs? Why would developing countries fund this?

6.) Can American banks, some of the world’s largest, fund America’s investment needs? If not, why?

7.) How has America, with historically low interest rates, bid up the cost of capital to attract foreign savings to fund the investment gap?

8.) What kind of institutions are driving American capital account surplus investments?

9.) What changed in 1976, 1987, and 1991 to reverse the movement of America’s current account?

10.)  How do wage suppressing policies affect the country that implements them? What is the affect on the balance of payments to them and their trading partners?

11.) Can Dr. Roach’s trade theory be applied to other cases? For example, what changed in the early 1990s, when Germany was considered the “sick man of Europe,” to today where Germany runs large trade surpluses? How  has the Hartz concept affected Germany’s balance of payments? (As an aside, German transfers of wealth from households to industry is now being pushed as a development model)

12.) Why does China, a developing country, export savings?

13.) Could every country adopt an East Asian development model, where wealth is transferred from savers and consumers to exporters and producers through low interest rates, environmental degradation, undervalued currency, and industry protection? Why or why not?

dollarrmb

Final Thoughts

In Brazil from 1965 to 1974 GDP grew annually by 11%. The authoritarian, one party state promoted rapid industrialization by relocating workers to coastal urban areas. In the 1970s petrodollars were recycled from OPEC nations to South America. These petrodollars largely missed Europe and America because of economic stagnation. Brazil’s import of capital caused them to run a trade deficit, slightly slowing growth. This capital came to have great effect on the future of Brazil as it encouraged further wasteful investment and the eventual breakdown of the Brazilian economy. The capital account flows changed Brazil’s trade balance. The capital account matters.

In the late 20th century and certainly in the 21st century, capital account movement drives trade. Policies in Germany, China, Japan, and Korea that transfer wealth to industry raise savings which the rest of the world is forced to absorb.  Dr. Roach’s trade model misses this.

Economics and finance lends itself to a worldview. Dr. Roach’s theory paints an incomplete worldview in which the United States is free from foreign influence. It paints a theory in which the United States has the tools to address the return of beggar thy neighbor economic policy that dominated the 19th and early 20th century. It is wrong, and I hope that by exploring the questions above, you may learn why.

 

 

 

 

 

A New Great Game: Pakistan, America, and China

Pakistan and America

If you were the US press secretary and a reporter asked you to summarize America’s relationship with Pakistan, what would you say? The Obama administration championed  reference to Pakistan’s changing “strategic calculus,” but, although catchy, it doesn’t encapsulate the raw disappointment of the relationship, see Osama Bin Laden’s hiding. Perhaps, being skilled at averting difficult topics, you would characterize the relationship as a “challenge,” mentioning Pakistan’s help in Afghanistan and how they could help further. But if a quick witted reporter follows up to ask why Pakistan explicitly supports US adversaries in the Afghan Taliban and Haqqani Network while aiding America’s fight against other extremist groups such as Al Qaeda and the Pakistani Taliban, how does one answer? Perhaps you could write an American haiku, a tweet:

Trump Pakistan.PNG

 

It certainly seems reasonable to express the relationship in a dollar value, because America has given large sums of aid to Pakistan for quite some time. American aid can be split into two categories: military aid and economic aid.

pakistan aid

The Obama administration decided early on to provide carrots in the form of the Kerry-Lugar-Berman bill (Official Bill) to bring Pakistan towards the global community. The idea was to separate defense and development aid, isolating development aid from the geopolitical mess that defines Middle Eastern politics. This is intuitive because it would allow for economic aid and development to function with long term economic planning. Overall the bill allowed for a possible $7.5 billion disbursement over five years. Lastly, economic aid increased at the expense of military aid. Economic aid from fiscal year 2010 to fiscal year 2014 was 41% of total aid. For reference, economic aid averaged to be almost exactly 30% during the Bush administration.

The Kerry-Lugar-Berman bill ran into problems almost immediately. Not surprisingly, effectively dispersing a billion dollars a year proved difficult. Legitimate road blocks included corruption, security, capacity of local partners, and lack of necessary economic reform. What this meant is that a large and often majority of the money the United States government earmarked for long-term economic aid to Pakistan went unspent.

Pakistan aid 2

If you scale back our initial query of the America-Pakistan relationship to Developed World-Pakistan relationship, the picture is bleak. In more than a decade the developed world provided carrots and sticks across economic and military vectors. Importantly, the United States wasn’t the only country attempting to court Pakistan in defense and economic development. It has been a global effort.

Pakistan aid 3

Further aid came from multilateral institutions. The Asian Development Bank provided $4.4 billion from 2009 through 2012. The World Bank currently has $5 billion worth of projects in Pakistan. Following the Great Recession the IMF dispersed more than $5 billion to Pakistan over 2 years.

Here is the rub. Pakistan’s foreign policy since 1980 has revolved around exporting violence. Pakistan and America worked together to fund terrorists in the 1980s to fight the Soviets in Afghanistan. When the Soviet-Afghan war ended America stopped funding those terrorist and expected Pakistan to also not continue funding for terrorists, not develop nuclear weapons, and not hedge its terrorist connections to accomplish foreign policy goals (create a constant friction with India as justification for the military to dominate all forms of government). These foreign policy objectives greatly affect the reality for everyday people inside Pakistan. Roughly 60% of Pakistan’s population lives on less than $2 a day. Around 40% of people in Pakistan can neither read nor write. 44% of Pakistani children under 5 are stunted. It is no coincidence that a state supporting terrorism is plagued by school’s being razed. It is no surprise that a country that sponsors terrorist cannot develop a working economy. It is no surprise or coincidence that Pakistan is currently on the precipice of total economic failure; given the path Pakistan has chosen, it is expected.

What then did a wide variety  of carrots and sticks from different actors and administrations yield since the end of the Soviet-Afghan war?  Pakistan continues exporting terrorism and violence all over the world, fails to develop a sustainable economy, and fails to provide for its people. Pakistan acquiesces safe havens for the Afghan Taliban and its vicious Haqqani branch in Pakistan. Worse yet, Pakistan has provided direct military and intelligence aid to both groups, resulting in the deaths of U.S. soldiers, Afghan security personnel, and civilians, plus significant destabilization of Afghanistan. Here (Wikipedia) is a good start to the list of global violence that Pakistan harbors.

So, dear reader, if you were the White House Press Secretary, how would describe the United States relationship with Pakistan? At risk of sounding melodramatic, nouns like failure and adjectives such as disastrous seem appropriate. Human lives and billions of dollars have been given with no change to Pakistan’s strategic calculus.

Long Term Goals

Given the lives, money, and outcomes, what should be done? I don’t think it is extreme to stop providing aid, something the United States has already done. I also don’t think it is extreme to say that without global support Pakistan will remain a quagmire. Before we write off the 200 million people that make up Pakistan, it is worth outlining what the best outcome for the country is.

Two thoughts should prove important to the global community’s response to Pakistan. First, it is in the global community’s interest to integrate Pakistan. To quell violence and provide alternatives for a better life, Pakistan’s economy must develop. A sustainable economy is a prerequisite for safety. Secondly, is the following quote taken from the excellent must read, The Great Convergence:

From 1820 to 1990, the G7’s share of global income soared from about a fifth to almost two-thirds. For the past two decades, the G7 share has been torquring downward at a mighty pace. Today it is back to the level that it first attained at the very beginning of the 19th century… Accompanying this ‘shocking share shift’ was a changeover in manufacturing. Curiously, the G7’s share loss of manufacturing showed up as share gains in very few nations. Only six developing nations (China, Korea, India, Poland, Indonesia, and Thailand ) saw their share of world manufacturing rise by more than three-tenths of one percentage point since 1990. The curiosity lies in the fact that the effect is so concentrated.

Why should the impact of globalization be so narrow geographically? It is worth reading Richard Baldwin’s book, but the answer doesn’t concern the relationship between developed countries and Pakistan. Instead our two points create an interesting summary: Pakistan should develop into a responsible member of the global community, but since 1990 globalization’s big success is limited to a group of six countries.

Developed countries don’t have the means or ways to develop Pakistan. Will is not enough.

One Belt One Road and America’s Own Goal

Pakistan’s economy is staring down complete failure in the form of a balance of payments crisis.  Pakistan runs a large trade deficit and exports too few goods to pay, in dollars, for its imports. In this past year, Pakistan has repeatedly lowered the value of its currency in order to make its exports more competitive. Pakistan’s problem is two fold. First, the country isn’t competitive. Secondly, Chinese imports for the China Pakistan Economic Corridor (CPEC) are creating short term debt management problems.

pakistan yuan.jpg

Donald Trump’s tweet quoted a wasted investment of $33 billion over 15 years. China, through CPEC and One Belt One Road, has made plans to invest up to $62 billion. Long term questions such as how China can efficiently allocate such a large sum of money persist, however how Pakistan can pay Beijing in the short term is proving the more immediate concern. Payment scheduling and Beijing’s terms for investment aren’t publicly available, but it is publicly known that Pakistan lacks the ability of continue its current path of massive imports.

China has gone to great lengths to accommodate Pakistan. To stave short term financing problems, China recently provided a $2 billion loan. This is on top of currency swap agreements between China and Pakistan which were doubled to nearly $3 billion in May.  Pakistan’s financing woes at a time when Pakistan plans to request a $12 billion IMF bailout  is raising eyebrows.

Pakistan’s payments to China must add to the depletion of foreign currency reserves, and the Wall Street Journal recently revealed that Pakistan is falling behind on payments for several projects. It is not clear that any bailout to Pakistan by the IMF would not bailout the existing projects along the China Pakistan Economic Corridor. 

Disturbing.jpg

世界舞台上的习近平 “Xi Jinping on the World Stage”

Forgive me for seeing China’s $60 billion investment in Pakistan’s potential upside as far outweighing its downside, provided IMF funds aren’t used to bailout Chinese hubris. US Secretary of State Mike Pompeo warned the IMF of bailing out Chinese projects, but I fail to see why the IMF should be bailing out Pakistan at all. Why is the Asian Investment and Infrastructure Bank not taking the lead? It is an own-goal for America not to be able to encourage the AIIB to take on responsibility. As an aside, my thoughts on the importance of the AIIB are similar to Michael Pettis’s.

The AIIB was created to finance long term investment projects across Asia. Why wouldn’t the AIIB be able to fill the gaps in Pakistan’s foreign currency payments, to China no less? It is an absolute mistake that the United States isn’t encouraging a rival with a debt problem to expand its balance sheet into an area that developed countries have failed to develop.

If Xi Jinping wants to expand China’s global footprint, China will be confronting some of the greatest challenges of the past 100 years. If China wants to court the Taliban and create an economy that works in Pakistan, the world should wish them the best of luck. If there is a new great game in which China and America compete for the ability to shape global rule sets, it is not a loss for China to take an expensive position in Pakistan. This is especially true when the America-Pakistan relationship can best be described in one noun: failure.

 

Chinese Rumor Season has Arrived

EDIT*

Posted below is the front page of the People’s Daily on July 24th showing large propaganda love for chairman Xi’s Africa trip. This is great context for the Nikkei article and my writing about rumors around Beidaihe.

Xi July 24th

The Rumors 

China, a land of intense political opaqueness, is prone to rumors at times of large political decisions. Sit back, dear reader, and enjoy the headlines as we enter Beidaihe season. To begin, here is Nikkei. Nikkei’s article says that Chairman Xi Jinping is a victim of domestic discontent and forced to take a smaller role within the party. From Nikkei:

The compound that houses the headquarters of the Chinese Communist Party and the State Council — a walled-off part of central Beijing — looks to be on a war footing. The irregular signals that have come out of the former imperial garden, known as Zhongnanhai, over the past few weeks hint that tensions are mounting behind the bamboo curtain, likely over the trade war with the U.S.

One sign of this is the higher profile that Chinese Premier Li Keqiang has been taking and the slightly lower profile that President Xi Jinping has assumed.

What is the evidence that Chairman Xi is assuming a lower profile? Nikkei sites three reasons: Xi’s relative lack of propaganda in the People’s Daily, the relative rise of Li Keqiang, and the changing of Liu He for Wang Qishan regarding American trade.

After making unrelated points, inserting pictures of Elon Musk, and name dropping Rahm Emanuel, Nikkei makes their conclusion. Regarding the future of Xi, they state:

Although Xi is taking a less high-profile posture, his authority remains unshaken.

Kremlinology rumoring the weakening of Xi’s power? Inconclusive conclusions that contradict the larger point of an article? What is happened to China reporting?

Welcome To Beidaihe

What is Beidaihe? Beidaihe, a seaside resort 160 miles miles east of Beijing, is the summer meeting place of the Chinese communist party. The ‘summer meetings’ are not held at a publicly known time, although they usually start around early August. Who attends, what is said, and the agenda are all secret, however these informal summer meetings are known to be a key decision making mechanism. They’ve been key for some time, the 1958 Beidaihe meeting being one of the most famous. We are now entering Beidaihe season; the 2018 meeting is rumored to start soon.

Given the importance and opacity of this political occasion, this is prime-time rumor season. The meetings at Beidaihe and rumors preceding the meeting happen annually.

Regarding Nikkei’s article, before Beidaihe it is the norm for the Chinese Chairman or leader to take a relative break from the public eye. It is a time of reflection and preparation for party interaction.

It is interesting that Nikkei insinuated Li Keqiang’s rising stock given that last year he was rumored to be out of a job. It is also interesting that Nikkei noted Liu He and Wang Qishan taking turns to attack similar problems when their similar duties were previously seen as a strength.

Notable rumors of the past few years include:

I distinctly remember the 2012 coup rumors (BBC) before Xi took power. I remember searching for further news about tanks in the streets of Beijing, and I remember being surprised to find that it was a strange rumor.

Truth in Action

The truth is that China is a politically closed system, and only a handful of people are open to the inner workings of party dynamics. Every year it is worth noting when the party will meet and planning to ignore rumors at that time.

In general, it is worth knowing that China has a lot of inertia. There are powerful vested interest in staying political course and not strong mechanisms for change. It is not worth listening to talking points and noise. One should instead focus on the inertia itself.  For example, many lauded Chairman Xi Jinping’s 2017 Davos Speech for the talking points included, but 18 months (European Chamber of Commerce report worth reading) after Davos China hardly represents a repeatable system worth exporting and is empty handed on any meaningful reform.

Good luck rumor hunting.

 

 

 

China Economic Update: Reform

China continues with its old economic model and trends towards an event-horizon of economic uncertainty.

china-18th-communist-party-congress

Given the level of discourse regarding China’s massive domestic imbalances in which Chinese households received a historically low amount of national wealth, the Xi administration was praised in 2013 for setting forth new policy objectives. Specifically, a new core principle of economic reform was spirited.  Market forces were to play a “decisive” (决定性) role in allocating resources (previous Party decisions gave the market a “basic” (基础)role in resource allocation). If markets, and not Beijing, were allowed more economic control in China, China’s massive imbalances could begin changing.

This agenda was instantly compared to the sweeping market reforms that emerged after Deng Xiaoping’s southern tour in 1992. The current reform design was touted as a leap forward comparable to Deng’s, and far more significant than the reform programs of Jiang Zemin and Hu Jintao.

 

Reform Failure

However, reform outlined in 2013 has failed in making structural changes to the Chinese economy. Sources for the data below can be found at The China Dashboard.

– Local governments spend 43% more than local revenues. There is no plan as of yet to fix the spending gap.

– In the fourth quarter of 2017, it took RMB 7 of investment to generate RMB 1 of growth. Chinese headlines laud cleaning credit risk, but have done nothing at improving financing efficiency, a problem that has existed since at least 2009.

– SOEs are expanding, not withdrawing. SOEs are expanding into non-protected industries. SOE leverage isn’t changing. SOEs are the most inefficient businesses in China and receive a disproportionately high amount of financing.

– Migrant worker wage growth relative to GDP growth is still negative. China’s labor market still has Mao era restrictions such as residence permits that constrain China’s labor market.

– China’s ministry of Commerce issues divestment requirements only for foreign involved mergers.

These data points point to the same structural issues that have plagued other investment driven growth models: lack of domestic demand, reliance on foreign demand, need for increasingly financing, and unsustainable debt.

 

Problems

There seem to be at least two problems with reform and its honest reporting.

Firstly, Xi Jinping is China. Xi Jinping’s reform, thought, and words are China. China is a political monolith. To question the reform or its effects is to question Xi. To question Xi is to question the Party. This leads to dishonest reporting and characterizations. It is not unlike spineless cadres reporting that Mao’s Great Leap Forward was a success while Chinese people starved.

Secondly, the Chinese government and its agencies are still gauging outcomes by pledges instead of economic measurements. China has not developed the culture or institutions to make goals economically explicit.

 

Frustrations

The China Institute for Reform and Development, a public and non-profit research institution in China, has published volumes of excellent material recommending policy that mirrors reform mentioned in the 3rd Plenum of the 18th Party Congress. The CIRD has published well researched material about transitioning to consumption led growth. Their policy recommendations aren’t in the least extreme.

Chinese social insurance expenditures are mainly borne by local governments who, as I previously mentioned, are operating at huge fiscal deficits. Today, the Chinese government, local and federal, spends roughly 10% of expenditures on social insurance policies. The CIRD advised a process to gradually raise this number.

Most frustrating, Chinese economic publications have moved from CIRD recommendations to insisting that the Chinese path is not only sustainable but exportable. This is best evidenced by Guoyong Liang’s book, Chinese Economy 2040. He writes the following (typos are original to the text):

Unlike the dominance of financial capital in “American style globalization,” the globalization promoted by China places more emphasis on substantial economy…the future wave of globalization led by China will be centered by substantial economy, especially in infrastructure, basic industries, etc.

liang guoyong

He expounds (typos are original to the text):

The formation of the Chinese Mode has a worldwide significance and embodies China’s contribution to the world. The concluded and summarize experience can be referred by other developing countries… an important feature of the Chinese Mode is the financial support and investment-driven industrial and infrastructure development under the guidance of the government.

He never explains which countries will accept the trade imbalances these policies create. He never explains if the model is sustainable.

China under Xi Jinping has been unable to implement need reform. This is antithetical to data on Chinese confidence (economic or politically). Extreme confidence  does not pair-well with unsustainability.

China consumer confidence

Lastly, 2017 was an outlier in economic stability. 42% of the growth in manufacturing profits can be attributed to areas like ferrous metals. Mining and related sector profit was up 151%. Outside of this narrow group, profit growth was quite low.  “Deleveraging” and industrial profit growth in 2017 China was driven almost exclusively by financial market driven commodity price gains. Expecting triple digit price gains to drive the economy is risky at best. 2017 was not a broad based economic recovery in China. The outlook of the Chinese economy is uncertain.

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。

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.