Contrary to the hyperbole of the blogosphere, this year neither the US nor China will burn to the ground in some grotesque fashion.
No the Chinese yuan (RMB) is not taking over the international markets (it accounts for a mere 0.6% of letter-of-credit transactions), no there is no concerted war on the USD. In fact, despite incredulous hypotheticals to the contrary, China is still buying US treasuries. The RMB has also depreciated relative to the USD.
Exaggerations sell and exaggerating more than the next Joe is even more sellable (sic). Or as Matt Ridley wrote in a recent Wired piece, many westerners have become apocaholics.
There won’t be a nuclear exchange between the US and China or China and Japan (the Chinese arsenal by the way, is overstated and exaggerated by the same hawks that brought us the second Iraq wars). In fact, Bill Gertz, among others is flat out wrong regarding his assertions of China’s secret nuclear stockpile.
In fact, despite a concerted effort by the CCP and state media (like Xinhua) to paint Japan (and the US) as foreign devils, there probably will not be any military confrontation between China and Japan. In part because there is approximately $350 billion in bilateral trade and also, for what Bill Bishop has recently written: cooler heads on both sides want a dialogue. Similarly, never in the history of the modern world have the two largest trading partners, let alone the two largest economies, gone to war with one another.
Or in other words, US and Chinese businesses would not want to torpedo their cargo ships, bomb their own factories, blow up their employees, burn their shareholders, decimate the infrastructure that provides electricity, water and telecommunication services to their retail stores and/or otherwise destroy their property. (As an aside, to assuage those electoral fears of a purported Chinese invasion: the Chinese military complex can’t even make decent jet engines yet, what jets will protect this phantom invasion fleet?)
Pandemonium might be the lucid dream of certain bloggers who enjoy hyping a story but wishful thinking is of course, fallacious at best.
What problems will China face internally?
Michael Pettis’ latest newsletter is fantastic, he highlights many of the problems that a China bull faces and how these “small hiccups” have turned into large quagmires.
In particular he takes to task a recent piece from The Economist which stated:
But China’s high investment is backed by even higher saving. As a consequence, China does not need its investment to generate high returns in order to pay back external creditors. China has, in effect, already set aside the resources that will be lost if its investments turn sour.
Here was Pettis’ excellent reply:
This doesn’t make sense to me at all and illustrates, I think, some of the confusion about what savings mean. The passage seems to assume that the main economic problem facing a developing country is paying back external creditors.
But this isn’t the case. External debt is generally is a problem for smaller countries, but as the Reinhart and Rogoff book, This Time is Different, makes clear (and this is something that most financial historians already knew), most economic or financial crises are domestic, not external. It is true that many of the crises in the 1980s and 1990s were external debt crises, and this has colored our view of what a financial crisis must be, but this shouldn’t lead us to think that countries only have crises if their savings are insufficient to cover investment (I.e. they are running a current account deficit).
After all the US had no problem paying back external debt in the 1930s and Japan had no problem paying external debt in the 1990s. In both cases domestic savings far exceeded domestic investment – or, to put in the same terms as The Economist, their high investment was backed up by even higher savings – and yet both suffered tremendous slowdowns in economic growth and the US had a financial crisis.
Likewise China of course will also have no problem paying back its external debt, but losses do not occur when you borrow in foreign currency to fund investments. They occur when you invest in projects that are not economically viable, no matter how they are funded.
What is more important, it is not meaningful to say that China’s high investment is “backed” by higher savings. The Chinese growth model forces up savings, by constraining consumption growth, in order to fund investment (a higher savings rate is the same thing as a lower consumption rate) just as Alexander Gershenkron prescribed in the 1950s and 1960s. But once investment is misallocated (or “malinvested”, as The Economist prefers) higher savings is not a solution to the problem but rather a manifestation of the problem itself. If you do not believe this, then Japan’s Lost Decade(s) is very hard to explain.
Perhaps the easiest way to prove this is with a simple thought experiment. Let us assume that Beijing decides immediately to tax half of Chinese household income and to use the money to build a bunch of useless bridges. Would this be good for China? Certainly not, and the impact would be more debt and slower future growth as the cost of the excess debt was absorbed. What happens to the investment rate? It goes up, of course, along with GDP.
But what happens to the savings rate? It also goes up. Why? Because if you cut the disposable income of Chinese households in half, presumably you would cut consumption by nearly that amount. Since savings is simply GDP minus consumption, savings will soar.
Notice that the condition – that savings exceed investment – will still be met, and by definition as long as China runs a current account surplus savings must exceed investment. And yet it doesn’t help. Wasting money is always value destroying, and the fact that it is funded by domestic savings – as in Japan in the 1980s, the USSR in the 1950s and 1960s, and Brazil before 1975 – or foreign savings – as Latin America after 1975 and much of Asian in the 1990s – makes little difference except in the resolution.
Pettis also raises a few question of his own and notes that hidden bad debt (e.g., an additional 1 trillion RMB of non-performing “stimulus” loans on top of the 17 trillion RMB of possible non-performing loans) must be accounted for in any system, especially one like China that lacks transparency.
Here is a quick taste of the relevant news coming out of the land I currently reside:
- Ghost warehouse stocks haunt China’s steel sector (Reuters)
- Construction and Real Estate Hinder China’s Growth (NYT)
- End of Construction Boom Sparks Frenzy of Sales Aided by Credit—And Worries of Customer Defaults (WSJ)
- Car Dealers See Market Shift to Lower Gear (Caixin)
- Economist Lin Yifu on State-Sustained Growth (Caixin)
- China’s urbanization lacks quality, requires huge investment: green paper (Xinhua)
- Moneyless Pensions Yield No Gold for the Old (Caixin)
- China to Expand Insurance So Sick Don’t ‘Lose Everything’ (Bloomberg)
- China Stocks Fall to Lowest Level Since 2009 on Japan Row, Data (Bloomberg)
- Wu Jinglian: Local Governments’ CNY17Trl Investment Unsustainable (Caijing)
- China’s Slowdown May Be Worse Than Official Data Suggest (DallasFed)
- China’s a ‘Roach Motel’; Don’t Trust the Numbers: Chanos (CNBC)
- Building And Operating A China Factory. Why Even Bother? (CLB)
- BHP Says Pace of China Iron Ore Demand Has Slowed by Half (Bloomberg)
- Re-Examining Re-Education Through Labor (WSJ)
- China builds its own military-industrial complex (Reuters)
Notes in the margin
A friend recently asked me if he should buy property in China.
My response was that you actually wouldn’t “own” the land. You take out a lease that is at maximum, lasts for 70 years. Here is a detailed NYT piece on this issue as it pertains to Chinese men without brides and an in-depth FT article on the same topic (speaking of which, here is an excellent piece on China’s gender imbalance from TCS) .
Furthermore, it can be confiscated without restitution. Unlike the US and other western countries with lawyers and legal recourse, trying to own property in China would be risking a lot because if your is successful, and even if you are not, a local gang/politician could easily confiscate it and/or demand some kind of bribe. All without any compensation. Caveat emptor.