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.

 

What Caused The Great Recession

Savings, Investment, and My Worldview

Riemann Surfaces are pretty neat. Frankly speaking, anything with complex numbers – sometimes referred to as imaginary numbers- is just cool. I think there is just something intrinsically pleasing when they are modeled.

riemann surfaceCool, right?

Economics, like Math, has many tools . This blog has tended to use one or two tools when addressing China and Chinese trade policy. The most noteworthy of which is the following:

(M – X)   =   (I – S) +   (G – T)

Don’t panic. The function above states 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).

This blog has consistently talked about policies that influence national investment, savings, and consumption rates, because that is a key tool for how I understand China. Consider the picture below:

jinanxi station

My first corporate training with DuPont Pioneer actually took place in Shandong Province.  I took a bullet train from Beijing to Jinan (Google Maps link) to train Pioneer staff. The picture above is one of Jinan’s railway stations. I was awestruck by how large it was. I was awestruck by how empty it was.

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In China you return tickets to your company in order to get reimbursed for travel expenses. I wish I could have kept all of my train tickets. Thanks to DuPont for the first class travel.

One could look at the empty infrastructure in Jinan and see wasted money (NY Times link – Good read), but I believe a better mental exercise is to determine what it says about the relative power of different parts of the economy. China and its state banks deploy large swaths of capital to local infrastructure projects, so China’s investment rates are quite high. Investment rates are so high because of a set of policies that force money from savers and consumers to investors and producers: environmental degradation, artificially low interest rates, tariffs, and state owned enterprises – to include banks. This means that Chinese people receive a smaller portion of GDP so household consumption is low and savings are high. If there are 4 sectors to an economy- normal households, wealthy households, businesses, and governments- we can observe the ratios of investment, savings, and consumption to paint a story about who is benefiting in a given economy.

This ratio of investment and savings also fits into trade. I have previously written about how domestic policies – like tariffs – affect the balance of investment and savings in an economy and can impact foreign trading partners. This reasoning- domestic imbalances leading to foreign trade friction- has been a theme of my blog. It greatly contributes to my worldview.

Tsinghua University and What Caused The Great Recession

pierce at tsinghua

I was blessed to study at Tsinghua University (清华大学). At Tsinghua I, unsurprisingly, found myself attending meetings with the Tsinghua Economics Club. It was there that I inevitably talked to my Chinese peers about the real economy and how China’s domestic imbalances affected America. China, I contended, was unfair.

My thoughts were met with poignant questions: is there a link between the real economy, trade imbalances, and East Asian capital account surpluses with America’s financial stress and the Great Recession?

I found the answer from BIS, the Bank for International Settlements. Consider the following pictures that show trade flows and banking flows.

china banking flowschina trade flows

What imploded in 2007-2008 were not Sino-American financial relations, but the interlocking claims between American and European banks. I’ve written about this previously. My favorite math, my worldview based on investment and savings rates, was lacking when confronted by questions at Tsinghua.

gross capital flows Discussions at Tsinghua taught me that gross capital account flows matter. They matter a lot. In 2007-2008 Europe’s banks were at least if not more dangerous than their American counterparts. They straddled three giant credit bubbles: in the US, in the hot spots of the Eurozone, and in Eastern Europe. Their leverage was enormous, their capital laughably thin, and unlike their US counterparts they had considerable currency mismatch on their balance sheets. They needed to raise dollars to hold huge portfolios of America subprime. Their primary home funding sources were in European currencies.

european leverage

European banks went to great lengths to underwrite mortgage backed securities. Did you know that from 1997 to 2007 it was not an American bank that was the top underwriter for MBSs?

underwriters of mbs

Furthermore, we can clearly observe European banks changing safe assets to short-term, speculative assets in a different currency.

european changing investment

When emerging markets like China acquired US safe assets, they crowded out other investors and created the opportunity for private financial engineers to launch the securitization boom. The industry generated a new, private source of safe assets. European banks bought into short term gross flows (both in and out) while comically leveraged. In fact, the earliest sign of coming collapse was Paribas’s announcement in 2007 that it was closing its US real estate funds, for lack of liquidity in the market. Following as it did on the difficulties of several smaller German banks, one might think of this as a moment of European crisis.

So, again, what caused the Great Recession? It is worth repeating. Emerging markets like China acquired US safe assets, crowding out other investors and creating the opportunity for financial engineers to launch the securitization boom. The industry generated a new, private source of safe assets. European banks poured money into America to shuffle assets into MBSs. A European banking glut was a crucial – if not the crucial- driver.

There exists different rule sets for different economic segments. In 2008 central bank liquidity swap lines were deployed within a familiar trans-Atlantic frame. The swap lines still mapped the contours of the cold war and world war II. On the new frontier of the global economy none of that soft tissue is present- Russia, India, and China still have no swap lines. Rule set mismatches are always friction points. I see less-and-less global savings-glut imbalances, while I increasingly see global rule set imbalances. I am pessimistic about our ability to resolve these discrepancies.

BIS study links (all worth reading):

Tracking the International Footprint of Global Firms

Global imbalances and the financial crisis: link or no link?

A key currency view of global imbalances

My favorite studies on the Banking Glut:

Global Banking Glut and Loan Risk Premium

ABS Inflows to the United States and the Global Financial Crisis