China's Sovereign Wealth Gets Burned
James Fallows, writing in the Atlantic, has produced a fascinating piece on China's fund. I have covered the emerging sovereign wealth funds several times already (1 2 3 4 5 6 7), however, Fallows' piece is one of the more economically literate I have seen on the subject.
Most writers presume that the so-called "export-lead growth strategy" has something to do with economic growth because of its name. But naming something incorrectly does not prove cause and effect. I drank a dozen beers before getting in my car and called it the "beer-lead safe driving strategy", that would not make it so. In terms of its actual effects it should be called the "export subsidization savings-wasting strategy". Fallows does a great job of explaining how the currency peg generates more investment in export sectors at the expense of a lower standard of living for Chinese consumers:
- Any economist will say that Americans have been living better than they should--which is by definition the case when a nation's total consumption is greater than its total production, as America's now is. Economists will also point out that, despite the glitter of China's big cities and the rise of its billionaire class, China's people have been living far worse than they could. That's what it means when a nation consumes only half of what it produces, as China does.
and
- Some Chinese people are rich, but China as a whole is unbelievably short on many of the things that qualify countries as fully developed. Shanghai has about the same climate as Washington, D.C.--and its public schools have no heating. (Go to a classroom when it's cold, and you'll see 40 children, all in their winter jackets, their breath forming clouds in the air.) Beijing is more like Boston. On winter nights, thousands of people mass along the curbsides of major thoroughfares, enduring long waits and fighting their way onto hopelessly overcrowded public buses that then spend hours stuck on jammed roads. And these are the showcase cities! In rural Gansu province, I have seen schools where 18 junior-high-school girls share a single dormitory room, sleeping shoulder to shoulder, sardine-style.
The accumulation of reserves is a form of "forced savings", as Fallows explains:
- China's savings rate is a staggering 50 percent, which is probably unprecedented in any country in peacetime. This doesn't mean that the average family is saving half of its earnings--though the personal savings rate in China is also very high. Much of China's national income is "saved" almost invisibly and kept in the form of foreign assets.
The forced savings is implemented through the fixed currency exchange rate. When exporters receive dollars by selling products to Americans, they take the dollars to their local bank, which must "surrender" them to the Chinese central bank for a quantity of Chinese currency based on the fixed exchange rate. Because the fixed rate is lower than the market rate would be, the Chinese central bank over time accumulates dollars. These dollars have accumulated to the tune of over $1 trillion. After suffering negative real returns year after year as treasury yields were lower than the rate of depreciation of the dollar, some of the central planners have decided to "invest" a portion of their reserves in stocks. The first part of the article tells the story of how the state investment fund has lost $1 billion on the Blackstone IPO.
The article shows that the capital allocation process is not economically driven at all; on the contrary, it has become entirely has become totally politicized. A career communist party bureaucrat who "has never bought a share of stock, never bought a car, never bought a house." was put in charge of investing the fund. Every purchase they make is decoded semiotically as some kind of signal to the rest of the world about Chinese geopolitical intentions:
- Foreign observers also suggest that, even after exposure to the Lou Dobbs clips, the Chinese financial leadership may not yet fully grasp how suspicious other countries are likely to be of China's financial intentions, for reasons both fair and unfair. The unfair reason is all-purpose nervousness about any new rising power. "They need to understand, and they don't, that everything they do will be seen as political," a financier with extensive experience in both China and America told me. "Whatever they buy, whatever they say, whatever they do will be seen as China Inc."
Fallows, however, does not question that China's economic activity is real growth (and also believes that economic growth causes inflation). In fact, economic growth has nothing to do with inflation (which is a monetary phenomenon -- real growth causes falling prices):
- Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like--and keep the domestic economy's growth rate from crossing the thin line that separates "unbelievably fast" from "uncontrollably inflationary."
Not only Fallows, but almost the entire economic media believes that China is growing by 8-12% per year because their measured GDP is growing at that rate. GDP as Reisman explains, overweights consumption spending relative to production spending.
Real economic growth consists of the expansion of an integrated capital structure that is consistent with consumer preferences. A credit-driven boom also causes aggregates to increase. The cannot be distinguished from a credit-driven burst of activity entirely through the measurement of aggregates.
Lots of spending can be generated and aggregates boosted by pumping credit into an economy. This activity can go on for a while until it becomes clear that certain sectors of the capital structure are not economically rational. But until that point, the aggregate spending statistics look fine. What I suspect is happening in China is some combination of real growth and a credit-driven frenzy of mal-investment.
Their real economic growth in terms of creating an integrated capital structure consistent with consumer preferences is probably much lower than the reported GDP number would indicate. A lot of their "export-driven investment" is economically irrational because the currency peg encourages the development of an export industry for which there is not true (i.e. funded) demand, and because the forced savings resulting from the currency peg is "invested" by central planners who will largely waste it.
Comments (10)
Long live the currency peg.
If it wasn't for this arrangement of the Chinese currency being in an exact raito to the US dollar then the US would have rampant inflation and economic chaos.
The US has lived LITERALLY OFF THE BACKS OF CHINESE WORKERS and the best part is the Chinese think they have the better deal. ;-)
Now we can see some small cracks. The Chinese government has such a vast amount of money (I am not sure it is wealth) built up that it has to do something with it. So it is slowly diverting it from US bonds to other riskier investments with disasterous results.
Obviously the best thing for both countries is to stop floaing point, fiat, Central Banking and go with Gold, but that ain't gonna happen so the US might as well take the money and keep buying cheap Chinese stuff.
Published: January 19, 2008 10:13 AM
Curt Howland
Sadly, once submitted, comments cannot be edited or deleted even by those who posted them.
Published: January 19, 2008 12:53 PM
fundamentalist
A lot of readers probably aren't old enough to remember the '80's when most economists thought that the Japanese would buy the US. Country songs were written about how we would all be working for the Japanese and needed to learn the language. I remember Japan Inc. getting burned by both the stock market and the real estate market 20 years ago. You would think the Chinese might have learned something from Japan's experience, but no such luck.
It's very sad that after 40 years of communism, the Chinese decided to follow Keynesian econ. It makes their struggle out of poverty much more difficult.
Published: January 19, 2008 4:00 PM
David White
A terrific analysis, the irony being that this is the same fellow who wrote Looking at the Sun: The Rise of the New East Asian Economic and Political System back in the mid-nineties:
"The purpose of economic policy in the U.S., he maintains, is to stimulate individual spending; in Japan, economic policy rewards the producers rather than the consumers and is intended to make the nation strong and invulnerable. Fallows argues that not every nation's economic policy will or can follow the American model; Japan has introduced a different and successful model and we should learn from it." Publishers Weekly -- http://www.amazon.com/LOOKING-AT-SUN-James-Fallows/dp/067942251X
While he was wrong about Japan, which is still struggling to overcome the deflation that had begun years before Fallows' book was written, he was certainly right about consumerism being "the purpose of economic policy in the U.S." China's policy is the opposite, of course, as production is everything, even if, as Fallows points out, much of it is misdirected.
Where is all this leading? My guess is that as the Sale of America heats up amid the dollar's demise, the US government will institute capital and currency controls to pave the way for the North American Union and the amero.
We are heading toward regional autarky, in other words, as the Global Fiat Fraud, otherwise known as globalization, collapses under its own weight(lessness).
Published: January 20, 2008 10:29 AM
Eric Bear Albrecht
China keeps not learning a fundamental truth, known to some as "Fudd's First Law", stated there as "if you push something hard enough, it will fall over".
Published: January 20, 2008 7:11 PM
Eric Bear Albrecht
China keeps not learning a fundamental truth, known to some as "Fudd's First Law", stated there as "if you push something hard enough, it will fall over".
Published: January 20, 2008 7:12 PM
Jeff Doty
I question the accuracy of the idea that the Chinese are tremendous savers.
Fallows accurately states that the Chinese businesses have to hand over most of their dollars to the government. But, where do all of those renminbis come from to do the exchange? Is the government borrowing all of that money from Chinese workers? What do you suppose the interest rates in China would be if that was the case? Are the workers really saving all of that cash instead of making their lives better? I doubt it!
It seems much more likely to me that the money isn't being "saved" by the workers. Rather it's being printed by the government. My guess is that the Chinese economy is a huge, inflationary bubble. When the American economy goes down, the Chinese economy will not de-couple. Instead it will crash.
Since the Chinese have a history of isolationism, and since all politicians look for scapegoats in times of trouble, what will happen to all of that foreign investment in China? If I was a business man who had sunk a lot of capital into China, I would be very nervous right now.
Published: January 24, 2008 4:46 AM
Johnny Boy
Growth may not be a direct causative agent in inflation, but I've never seen growth without inflation. Ever. The Chinese have built a monstrous machine on the backs of their people - that's exactly what they wanted - floor it and get there fast. They got "fast" alright - they build a new coal-fired power plant every three weeks, and they're choking on the soot and industrial waste. If we took all our coal-fired plants offline, they would replace the contamination within the year. Their soot on artic ice is what's causing the meltdown - solar absorption increases, ice melts quicker. Next disaster we could do is Kyoto - tie the hands of Americans to make them pay for their sins. Let everyone else keep sinning. Sounds like punishment, not a treaty.
Published: January 24, 2008 7:35 AM
fundamentalist
Johnny Boy: "Growth may not be a direct causative agent in inflation, but I've never seen growth without inflation. Ever."
If you look at the real GDP figures, you'll see what growth without price inflation looks like because real GDP is the nominal GDP adjusted for inflation.
You have to go back to the 19th century to see growth without inflation, although the data is confounded with other effects, such as war and the abuse of paper money. The chief reason you don't see growth without inflation in the 20th and 21st centuries is that the Fed was formed in 1912 and has deliberately inflated the money supply ever since. In reality, growth happens in spite of price inflation, not because of it.
Real growth happens through savings being put to work, not through the Fed pumping paper into the economy. Most of the savings comes from profits. The extra money that the Fed pumps into the economy shows up as price increases and business failures during recessions.
Published: January 24, 2008 11:11 AM
Johnny Boy
I should have been more specific. Ever = within my lifespan of 60 years ("but I've never seen..."). It's certain that the Fed is "managing" money for someone's interest besides mine. Going off the gold standard pretty well insures that growth will always be accompanied by inflation, because people have become addicted to the government being both God and Mommy.
Published: January 24, 2008 7:25 PM