China Economic Update: Further State Control

An apt quote describing Chinese economic reform (my emphasis added):

The analytical community will pore over the entrails [of the reform agenda] to analyse whether the spirit of market-based reforms continues to flourish for the future. Or whether it has begun to fade amidst a more general Chinese political and ideological redirection to the left. Or just as problematically, for economic reform to die at the implementation level because of confusing political and policy signals from the centre, meaning that it is much safer to just keep your head down. Or because there are limited local incentives, either personal or institutional, to actively prosecute reform which inevitably generates local conflict with deeply entrenched vested interests. Or, more likely, an unholy cocktail of the above, collectively reinforcing a natural predisposition towards bureaucratic inertia.

-Kevin Rudd

President of the Asia Society Policy Institute and Former Australian Prime Minister

As this blog has stated many times before, Chinese economic reform is dead. China, for the past decade, has seen a systemic rise in debt as state influenced asset allocation becomes increasingly inefficient. Three years ago Chinese credit growth was 16.6% . With over $40 trillion in bank assets, it will not likely return to previous growth levels. Even so, the current  pace of credit growth, 10%, once again exceeds nominal GDP growth, meaning that China is adding to economy-wide leverage rather than moderating the debt load.

Xi in Davos

In 2017, General Secretary of the Chinese Communist Party Xi went to Davos to promise to defend globalization and reform the Chinese economy.

The SOE share of listed company revenue in “normal” industries–those that Beijing identified as non-strategic and commercial–increased significantly, to 15.6% in 1Q2019 from 14.8% in 4Q2018. This increase is the first since 1Q2016, and it shows that the state is advancing even in industries where Beijing set out to withdraw influence in the 2013 Third Plenum Decisions. Industrial SOE assets grew by 4% year-on-year in 1Q2019, faster than private asset growth of 1.4%. SOE profitability flattened in 1Q2019, suggesting that past policies framed as reform (e.g., capacity cuts, deleveraging) have failed to improve SOE efficiency. Returns on SOE assets peaked at 4.5% in 3Q2018 and then declined to 4.0% in 1Q2019.

In 1Q2019, the State Administration for Market Regulation (SAMR) reviewed 28% of foreign-involved mergers but only 9% of domestic mergers. At the same time, China’s poor judicial transparency has deteriorated further. Courts publish less than 5% of the competition and intellectual property disputes they handle each year, with significant delay. In 1Q2019, the courts even removed previously published cases (400–600 cases a year) from their websites.

Communism Guides the Economy

I recently read through the 国务院关于深化国有企业改革的指导意见 (Guiding Opinions of the Central Committee of the Chinese Communist Party and the State Council on Deepening the Reform of State-owned Enterprises) which was published in 2015. Here are two interesting quotes with translations following:

1.) 坚持党对国有企业的领导。这是深化国有企业改革必须坚守的政治方向、政治原则.  The Party’s leadership over SOEs shall be upheld. This is the political direction and principle that must be held fast to in deepening SOE reform.

2.) 企业党的建设全面加强…工作体系更加完善,国有企业党组织在公司治理中的法定地位更加巩固,政治核心作用充分发挥.  The Party building of enterprises shall be comprehensively strengthened… In addition, the Party organizations of SOEs shall enjoy a more solid statutory position in corporate governance, and fully display their core political role.

Chinese reform has regressed towards China’s bureaucratic mean- communism and state control. As China releases GDP numbers, quarterly updates, and policy guidelines, readers should put those documents into a clear framework: China is slowing, debt is growing, and the state is consolidating.

Lastly, here is a quote from the EU Chamber of Commerce’s report “18 Months After Davos:”

One of the largest concerns for European players in the healthcare equipment sector is the CM2025 initiative. The China Manufacturing 2025 Key Area Technology Roadmap, which was drafted under the guidance of the China Academy of Engineering, sets domestic market share targets for Chinese players in the healthcare equipment sector. International players are concerned that any available support will only be extended to domestic companies. So far, there has been no obvious effect on the healthcare market, and the European Chamber has been assured by the Chinese authorities that this implementation strategy is not to be taken seriously.

Thanks for reading.

 

Certainties From Tsinghua: $3 Lunch and Evidence Donald Trump Won’t Secure a Meaningful Trade Deal with China.

When I was a student at Tsinghua, I remember constantly complaining about the cafeteria food. In general, I struggled getting the amount of protein I needed, and a  lot of the food was oily. Picking which vegetables to eat was always difficult, because so many of them seemed to just soak in salty, oily brine.

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Campus has a number of cafeterias; this one was my favorite. Each floor has perhaps 10 stalls, and each stall on a floor is loosely affiliated with one style/region of food. This cafeteria was my favorite because the fourth floor is devoted to Sichuan cuisine.

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热饮冷饮 – Hot Beverages and Cold Beverages 西式面- Western Style Bread

Although I consistently fretted over protein and oily vegetables, the food was good and -perhaps most importantly- cheap. Here are examples of what I ate:

 

I spent an average of RMB 20 per meal (something akin to $3).  I’m certain that this is the best cafeteria food that one can buy for $3.

Tsinghua also taught me another certainty: Donald Trump is set for failure regarding the coming trade deal with China. Let me show you:

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Consumption-led growth. The decisive role of the market. Tsinghua has an amazing library. I was floored that there were so many books in foreign languages (the English selection is enormous).  I was also floored to see that many Chinese think-tank publications on economic reform were translated into English. I devoured them, nodding my head in agreement and proud at the tough policy recommendations they made: transfer state wealth to Chinese people in order to have a balanced economy.

The Chinese economic model is built upon transferring wealth from households, consumers, and savers to corporations, producers, and investors. This is best seen in China’s comically low household consumption rate.

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As China’s economic model has progressed, Chinese households have enjoyed an increasingly small share of the nation’s wealth. Corporations, both ‘private’ and state-owned, have enjoyed an increasingly large share of the nation’s wealth (as has the richest in China). This ‘problem’ has been on the Chinese government’s radar since at least 2007.

In 2007 Premier Wen Jiabo cautioned, “”the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.” This prompted IMF economists to write, in 2007, about strategies to have consumers share a larger percentage of national wealth.

However, economic reform wasn’t planned until Chairman Xi Jinping took over in 2013. Economic reform plans were immediately organized:

1.) The market had been defined as a “basic” role in allocating resources since the country decided to build a socialist market economy in 1992. In 2013, The Communist Party of China defined the market’s role as “decisive” in allocating resources. This importance cannot be underestimated.

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It is common for state-owned enterprises to have pictures to pay homage to Chairman Xi in their lobby (Forgive the poor quality).

2.) On November 12, 2013 in the Third Plenary Session of the 18th CPC Central Committee, Chairman Xi said the following regarding China’s economic reform:

The key to establishing a sound socialist market economy lies in striking proper balance between the role of the government and that of the market, so that the market can play a decisive role in allocating resources and the government can play its own role more effectively… Letting the market play a decisive role in allocating resources will mainly require economic reforms, but it will also inevitable affect politics, culture, society, ecological progress, and Party building.

3.) On April 8, 2013 at the Boao Forum for Asia Annual Conference, Chairman Xi said the following regarding China’s economic reform:

We will continue to enhance the rule of law and actively improve our investment environment so that all enterprises can enjoy equal access to the factors of production, market competition, legal protection. The Chinese market can become fairer and even more attractive… China will never close it’s door to the outside world… We will open up new areas and enable deeper access… We firmly oppose protectionism in any form, and we are willing and ready to solve economic and trade differences with other countries through consultation.

4.) On May 26th, 2014 at the 15th Group Study Session of the Political Bureau of the 18th CPC Centeral Committee, Chairman Xi said the following regarding China’s economic reform:

We should reduce the government’s involvement in resource allocation and its direct interference in microeconomic activities. We should step up efforts to develop a uniform market system characterized by openness and orderly competition, and set fair, open, and transparent market rules.

Xi in Davos

5.) In 2017 at the World Economic Forum in Davos, Chairman Xi said the following regarding ‘free trade:’

Whether you like it or not, the global economy is the big ocean that you cannot escape from. Any attempt to cut off the flow of capital, technologies, products, industries, and people between economies, and channel the waters in the ocean back into isolated lakes and creeks, is simply not possible.

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These books which I vociferously read at Tsinghua are remnants, relics of this forgone economic reform. Chairman Xi’s economic reforms, as I have been writing about for the past two years, have been complete failure. China is backtracking on reform, encouraging state-backed growth, reducing competition, and exacerbating the economic slowdown already underway. According to Ruchir Sharma at Morgan Stanley Investment Management, it now takes $3 of debt to create a dollar of growth in China. In the face of economic reform failure, China is pumping debt into large state-backed corporates while the private sector is squeezed out.

A Chinese dictator tried to force reform. That reform failed.

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The United States is seeking the following changes in the Chinese economy: trade deficit reduction, IP protection, cease market distorting subsidies, end of cyber intrusions, and end technology transfer.

The idea that the United States would be able to force large, structural reform in China when a Chinese dictator could not is absolutely ridiculous. The idea that Beijing is unable to move on the US requests, most made 9 months or even years ago (IP Protection), and that another 60 days will be enough time for them, seems somehow more ridiculous.  The hubris of the United States position is overwhelming. The Xi speeches, the policy reports from think tanks, these are fossils of failure that the United States should heed.

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CNBC is also reporting that President Donald Trump said he will be discussing the criminal charges against Huawei with US attorneys and attorney general in the coming weeks. Is the United States judiciary no longer independent? If the United States accepts a trade deal that backs Chinese purchases of US goods to reduce the trade deficit, America is run by a spineless swamp with no sense of the lack of economic freedoms that put the US in this position to begin with.

The White House would do well to look at Chinese economic planning relics from 2013 or read Chairman Xi’s speeches.

Thanks for reading.

 

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?

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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.