The world of ‘alternative’ energy has been no stranger to embarrassment of late, whether it be leading windmill-maker Vestas’ 96% plunge to a 14-year low or the threat of bankruptcy stalking the cloudy, Northern Europe’s own welfare queens as the continent’s ill-conceived ‘Energiewende’ staggers onward, squeezed between the pressing fiscal need to abjure all such dirigiste fantasies and the growing backlash from both consumers and industrialists who are slowly awakening to the harsh reality that the aspirations inherent in their right-on, Green indoctrination cannot be squared with their anguish at needlessly soaring utility bills.
In the US, too, the red faces have been multiplying, with the Obama administration generating far more political heat than economical light for its complicity in several hopeless boondoggles, perhaps best epitomised by the failure of erstwhile campaign donors, Solyndra, $535 billion federal loan guarantee and all.
But, of course, when it comes to ‘blind investment’ larded with goodly helpings of political – and often pecuniary – advantage-seeking, nothing ever quite trumps what the Chinese get up to.
Thus it was that, last week, the National Energy Administration announced that, henceforth, it would ‘tighten approval’ for solar projects so as to ensure that they were actually hooked up to a grid, or at least one of sufficient capacity to deal with their potential output! The trigger for this blindingly obvious diktat seems to have been that the agency feared that an arms race of cadre self-promotion might result if the decision by Qinghai province to install a 1 GW solar ‘farm’ were to give rise to a wave of indiscriminate keeping-up-with-the-Jiangses on the part of the other regional heads.
Nor does the competition for the wooden spoon end there, as the case of LDK Solar – the nation’s second largest producer – exemplifies. With debts of CNY30 billion stacked up against a collection of assets with a stated value of CNY33 billion, this was not a firm which was well placed to survive a 65% YOY slump in revenues, nor a disastrous six months during which $620 million in sales generated $740 million in losses. Little wonder it finds itself in such a parlous condition when the company has suffered a cumulative negative free cash flow of $3.6 billion (~CNY23 billion) over a four year stretch when the market price of polysilicon has slumped 95% from $475/kg to barely more than $20.
Controversy mounted over this private company’s failure when one of its creditors – a member of one of China’s burgeoning shadow army of Trust Co.s – managed to cajole the local Xinyu municipality into including the CNY500 million it had extended to LDK into the region’s annual budget and so secure repayment. Given the widespread, if often unfocused, fears about the role of such Trusts in what appears to be a massive, CNY39 trillion layering of credit on top of the nation’s CNY113 trillion mountain of on-balance sheet, bank assets (equivalent to 75% and 215% of GDP, respectively) – not to mention the tangled webs of mutual credit guarantees prevalent among such lenders and creditors – one can perhaps understand the municipality’s pliability in keeping this particular can of worms firmly sealed.
Since then, there have been further rumours (officially denied) that the Shanghai Pudong Development Bank was on the hook for CNY1.5 billion in unsecured loans to the firm. Whatever the case may be, what has been reported in the official media is that several SOEs have been ‘invited’ to sniff over the corpse of LDK, while “creditor banks including China Development Bank, Bank of China, and China Construction Bank have established a ‘special committee’, working with local government, to oversee LDK’s capital flows.”
But why focus on LDK? For hardly a day now goes by without some other tale of misplaced investment, financial chicanery, or growing commercial distress filling the pages of the local business press.
In real estate, for example, Beijing is said to have become sufficiently alarmed at what the creaking state of developers’ finances could mean for bank balance sheets that they have formed a ‘task force’ to investigate the true extent of exposure. Another story is of the deceits practised by credit-hungry developers, whether ‘paying’ suppliers in apartments, not cash; lending otherwise unqualified buyers the deposit they need to secure a mortgage; or raising false sale documentation with which to provide anxious lenders evidence of cash flow.
But, if the central government is sticking to its story about keeping residential real estate in check, it appears that no such qualms exist when it comes to the commercial kind. Take the city of Chengdu where more than 90 such complexes are under development and where there are plans to construct a brand-new financial centre, consisting of 30 skyscrapers, each of 60 stories or more. Nationwide, 2011 saw a 26% increase in floor space, the increment of 11.6 million square metres being greater than four years’ worth of US development at current rates of construction.
Already, signs of duplication are in evidence as the word ‘bubble’ is bandied about by domestic investors. So mad has the rush become that prestige Western retailers are said to be able to take up space on terms which saddle the property company with all the costs in the event that the site does not prove viable. Let us just hope the owners are not relying too heavily on business generated by local firms instead, given that the nation’s No.1 home appliances retailer, Suning, just warned of a possible 30% fall in profits, while industry No.2, Gome, saw its shares hit their lowest ever level when it indicated it was actually trading at a loss.
No word how much of this new retail space will be located at the airport, but with plans announced to build 82 new ones and to upgrade 101 more by the end of the current Five Year Plan in 2015 – putting the joys of baggage checks and the scramble for overhead locker space no further than 100kms away from 80% of the population by the time the programme has been fulfilled – we can be forgiven for expressing doubts. Whether any return on capital will be made is the crucial issue since more than two-thirds of the existing 182 facilities are losing money at present, while UPS has just slashed Asian flights by 10%, declaring that business there had ‘fallen off a cliff’.
No matter, says CAAC chief Li JiaXiang, the current woes are not the result of a surfeit, but a dearth of landing strips “It’s like planting trees,” he explained gnomically. “One tree will die, but if you plant more, it will become a forest, and the trees will grow higher and higher.”
It might be a novel slant on business economics, but it certainly encapsulates China’s whole approach to modernisation in one, fortune cookie-sized soundbite.
Where next shall we venture? The textile industry where Adidas has followed the lead of rival Nike by closing down production? Understandable enough when business leaders in the key province of Zhejiang are to be heard bemoaning the loss of business not just to lower-wage Asian competitors such as Vietnam and Cambodia, but also to Eastern European alternatives such as Romania.
What about metal-bashing? Well, despite the plunge in profitability in the steel business – HRC has fallen 15% in price in just three months to touch the lowest levels since the autumn of 2009, while rebar is a quarter cheaper than a year ago and no more expensive than it was in 2003 – naturally, no-one has thought to trim production which is still therefore running at close to a record 2 million tonnes a day, comprising 45% of the world’s total output. Note, too that the pain is being spread wider, given that net steel exports have climbed nearly 50% yoy of late to reach a 4-year high.
Across in the aluminium smelters – also responsible for 45% of planetary output – the mighty Chalco spent the first half of the year mired in red. In fact, Charles McLane, Alcoa’s CFO reckons that almost a third of such companies ran at a loss last year. So, production cuts, anyone? Not likely, that’s only something which need be contemplated by capitalist running dogs like Alcoa, Rio, or Rusal! No, instead output hit a new record of 1.7 Mt in June as, according to Yao Xizhi, an analyst at state-backed research firm Antaike, around 500,000 tonnes of idled capacity came back online in May, while the first half as a whole saw a million tonnes added, with another million likely to come on stream in the second half. How can this be? Well, the clue is that several local governments were said to be offering artificially cheap electricity in order to keep the fires burning. Helps with the nation’s Himalayan-scale, 300 million tonne stockpile of coal, one supposes.
Not surprisingly, about the only business being done in the machinery industry is the classic Chinese one of buying something physical on long-term credit and then raising one (or more) cash loans using the ‘purchase’ as collateral. As a case in point, the finger of suspicion has been pointed at Zoomlion which managed QI profits of CNY2.1 billion – practically unchanged from QIV despite a fall in turnover of 11.5% which was ostensibly quite creditable given rival Lonking’s 37% sales plunge. Interestingly, accounts receivable rose by a slightly greater CNY2.2 billion (these have doubled since the end of 2010 while sales have only risen 40% in the same period). Cash flow from operations was, needless to say a negative CNY1.7 billion, or -76% of reported profit. It’s not only in front of the company’s diggers that red flags are being waved.
In this context, it is also of note that Caterpillar saw a QII fall in regional revenues of 11% in QII which, it noted, consisted of a ‘large decrease in China which more than offset increases in other countries’. The company announced plans to scale back production, to increase exports (!), and to offer more ‘merchandising incentives’. Have bright, yellow, cellophane-wrapped, wheel-loader – will rehypothecate.
Shipyards? Overbuilt enormously in the boom and now facing a 50% slump in orders as global freight rates plunge, taking new-build prices to an 8-year low on an index compiled by shipbrokers Clarkson. About half of China’s 1,536 shipbuilders may close within three years, Tan Zuojun, general manager of state-owned China State Shipbuilding Corp was quoted as saying in the Serenities Daily. Meanwhile, even the coastal trade is suffering, the Ministry of Transport admits. As Crienglish reported, even the important Qinhuangdao Port on China’s northern coast – ‘seen as a barometer of the economy’ – has seen daily throughput drop from ‘at least 50 vessels per day’ to ‘only one-quarter of that capacity’ so far this month.
The vehicle market, then? Granted, passenger car ‘sales’ rebounded smartly in June – possibly in a rush to beat the looming registration restrictions shortly to be imposed in several major cities – though even this only took the overall YOY tally for the first half up to an anaemic 2.9% increase, but the problem is that a ‘sale’ in China means the maker has delivered the car to a dealer, not to a satisfied customer who will soon be proudly driving off the lot in his gleaming new roadster.
The mismatch becomes apparent when we take the testimony of Cui Dongshu, deputy secretary-general with China Passenger Car Association, who told Reuters that: “Previously, only dealers that sell local Chinese brands were under the inventory pressure, but now those handling foreign brands have also started to feel the pain too”. Other spokesmen confirmed his gloomy assessment, revealing that at many dealers selling BMW and other luxury models, inventory levels over the past few months have swelled to 60 to 90 days of stock, compared with more normal levels of 30 to 45 days. More ominously yet, for a nation still supposedly ploughing its way resolutely through the softest of soft landings, commercial vehicle sales slid 10.4% in the first semester, compared to the same period in 2011.
Far from being a picture of robust health, more than half of China’s plethora of 1,300 domestic automakers – many of which are little more than shell companies used by outside investors to play what was once a booming market – will disappear over the next three to five years, in the eyes of Dong Yang, vice chairman and secretary general of the China Association of Automobile Manufacturers. With a quarter of these already in or near bankruptcy, the relevant Ministry is pondering steps to disbar them from further production so as to tidy up the market, it was announced this week.
As the China Daily noted, against a hoped for 20 million sales this year, it is estimated that the planned auto capacity of China’s 12 major automakers will soon surpass 30 million units, thus exceeding market demand by a cool 50%, according to the National Development and Reform Commission, the country’s top economic planner.
“There is overcapacity in the automotive industry. We will most likely see some consolidation,” said James Chao, Asia-Pacific director with IHS Automotive Consulting, in what sounds like an heroic understatement of the case.
China bulls will not heed any of this, of course, for they are prisoners of the nested illusion that all increases in outlay represent genuine growth (cf, Occidental property bubbles) and that higher growth must imply greater profitability. They will also argue, on any uptick in the macro numbers, that the worst is not only behind us, but that it has been more than fully priced in.
That remains a matter of debate. For it is not to be overlooked that the Chinese authorities are still giving off signals that they will not repeat the indiscriminate orgy of spending which was unleashed at their behest in 2009-10. Indeed, the very same day that President Hu noisily categorised the employment situation as ‘complicated and grim’ (his own included, one might add), the usual party organs were rehearsing front-page arguments against another mass infusion of credit, while positing the view that some ‘friction’ was an unavoidable concomitant of the nation’s necessary rebalancing.
Attacking the problem from another angle, we might wonder how – if things have gone as far as they seem to have done – even an authoritarian regime can drive sufficient temporarily-productive credit outside the coterie of its biddable, capital-destructive, princeling-packed, SOEs and into the hands of owners and managers of less coddled enterprises which are already struggling with chronic over-capacity, elevated costs, and, consequently, vanishing returns.
OK, enough about China. It’s time to take a look at marvels performed by SuperMario, the Goldmanite of the hour, who single-handedly saved Spain and Italy several €10s of billions in interest payments this week with one lapidary utterance.
‘Within our mandate’ – a framework he had craftily tried to exceed by pretending that high Olive Belt yields were enough to put the debtor nations’ shrinking ability to finance themselves somehow within the remit of monetary, rather than fiscal/structural, policy – ‘the ECB is ready to do whatever it takes to preserve the euro,’ he boldly declared to a London conference audience, before vaunting, ‘believe me, it will be enough.’
We had begun the week, you will recall in a paroxysm of selling, after the Bundestag debate on the Spanish bank bailout left the impression that its endorsement by Europe’s paymasters was, after all, conditional upon any aid so granted becoming a full liability of the state. This was a setback quickly compounded by the plea for assistance issued by a number of that blighted country’s semi-autonomous provinces and made worse by news that, across the wine dark sea, not only was Sicily in similar straits, but potentially several major Italian cities, as well.
12% was wiped off the IBEX and 10% off the MIB in a blink, triggering the usual short covering ban. 10-year Bonos quickly climbed 100bps in yield, with the front end suffering even greater pain in soaring from 4.65% to a 16-year high of 7.20%.
Enter our Mario and, to the eager applause – if not the outright complicity – of the French (who publicly exulted at the prospect of an ‘inexhaustible source of money’), his Jovian admonition served to unwind 195 bps of the damage wrought at the short end and almost all of it at the long as the shorts scrambled to cover and the bottom fishers (aided, for now by a juicy looking price excess on the charts) dared to trawl these perilous waters, once again.
There are, of course, only a few minor problems which lie betwixt turning a cleverly timed piece of verbal intervention into a concrete programme of action. Firstly, it must be asked whether he will be able to persuade a sufficient number of his colleagues on the ECB council to endorse his naked casuistry and so attempt to put a Draghi Cap on Club Med spreads and, beyond that, whether he will be able to do so without provoking another ruinous round of Bundesbanker resignations.
The Dutch have said that bond-buying remains in ‘deep sleep’ and, as we write, word emanates from Frankfurt that such measures are ‘not the best way to address the crisis’ and that the Buba remains ‘critical’ of the proposals because they ‘blur’ the policy line in the sand. As for the status of the ESM: “A banking licence for the bailout fund would factually mean state financing via the printing press and would be a fatal route, which therefore is prohibited by the EU treaty.”
Though we should perhaps be more dubious of his consistency, if not his sincerity, FinMin Schäuble also sneered that ‘the world won’t end if people have to pay a few percent more on their bonds.’ Perhaps not, but it still remains to be seen if he will be again culpable of telling the German public one thing and agreeing another with his pals in Brussels.
Beyond this internecine squabble, we must consider the ramifications of such an avowed policy of Philaustralic Bernanke-ism for an increasingly febrile German domestic politics – not to mention the possible impact it might have upon certain delicate deliberations being undertaking in the quiet, judicial chambers of Karlsruhe.
Predictably, the first reactions from that quarter have been savage. Die Welt fulminated that “The ECB is turning into a Trojan Horse” – ‘Beware of Greeks demanding gifts’, perhaps – which “no longer stands for stability and a principled course, but for a Europe in which the South has the say” with the bitter prospect that there would be “a giant shifting of burdens onto the North without solving a single one of the current problems”
FDP finance spokesman Frank Schäffler was equally forthright, Handelsblatt reported, saying it made an outbreak of inflation the most likely outcome. “Draghi is no rescuer,” he thundered, “but the plunderer of the peoples’ nest-eggs!” From Hesse, his party colleague Jörg-Uwe Hahn demanded that the ECB be hauled before the European Court of Justice for its temerity in mounting a “direct attack on German savings”.
CDU member Klaus-Peter Willsch lent his voice to the chorus, telling the same paper that “An increased inflation rate is the unavoidable consequence of this policy.” He went on to warn that: “The signs are already clearly to be observed – rising prices for prime property, farm and forest land, gold, and collectibles such as coins and art prices show us that the ‘Flight to Real Values’ has already begun”. A resonant phrase indeed, for those with a knowledge of the 1920s
Does this sound extreme, given Europe’s current woes? Not at all, for the drain of money from South to North, from Crust to Core, has mean that while the rest of the EZ languishes under a real monetary contraction 1.5% pa, German M1 is rising at a whisker under 10% per annum in nominal terms and at 7.4% in real ones – rapid enough by anyone’s lights. German M3 is also brisk enough at 7.1% nominal v the Rest’s lacklustre 1.5% gain.
If we have been taught anything by recent events it is not to map directly from rates of monetary growth to price rises, since the picture is complicated here by shifts from credit substitutes to money proper, from ‘inside’ (or bank) money to ‘outside’ (or CB) money, and by changes in the willingness of the recipients of that money to hold onto it. However, it cannot be denied that, in the country least likely to be affected by a penchant for precautionary ‘hoarding’ (by dint of its residual economic strength), the differential between the rate of its money growth and that of its neighbours has only been exceeded twice before in a three-decade record – the first time during Reunification, the second, briefly, during the post-Lehman money flood.
No wonder the GfK Institute surveys find that: “The lack of trust in financial markets and historically low interest rates mean that saving money does not appeal. Consequently, consumers are more likely to make high-value purchases, such as real estate and also furniture.”
Be that as it may, a further near-term worry shared by Herr Willsch and his colleagues – not just in the coalition, but also by members of the opposition SPD – is that the government has set up an all-party ‘Committee of Nine’ which is empowered to decide – in secret – on the purchase of bonds, as opposed to the offer of a formal assistance package, which latter still requires open debate and ratification by the full assembly. The rationale for this derogation was the insidious concept of not alerting market speculators to the possibility of bond purchases being conducted: a precaution which, as Capital magazine tartly points out, is rather redundant, given that such a policy is the burning issue of the day, not least thanks to the intervention of Signor Draghi.
The farce, it seems, has plenty of time to resolve itself in tragedy ere we are done.
That only leaves us to consider the US where the whole of Wall St. is still hoping and praying that Blackhawk Ben will be firing up his twin T700s any day now in order to lift all their bad analyses and foolish wagers up on the flood tide or a renewed monetary helicopter drop.
Things are certainly no where near as bright as they were a month or two back, but whether that means they are dusty enough to allow the Fed to surmount the ever-rising hurdle of the electoral calendar is another matter. The danger is that the associated hope that action is imminent is giving artificial support to an equity market reporting barely positive income growth and a troubling, per-share aggregate earnings decline. Other data remains in No Man’s land, too.
Money growth is running at a 4.6% annualized real rate, the slowest since QEII was launched in the autumn of 2010 and surely sluggish enough to depress not just speculative asset pricing, but macro variables as well.
Sure enough, core durable goods orders are going nowhere – a doldrums into which the formerly vibrant core capital goods orders have also wandered. For all the bally-hoo about a recovering housing market, the MBA purchase index is still where it has been for the past two-years – stuck at 1995-6 levels. The lesser Richmond Fed index went so far as to offer a frisson or two when it effected its steepest drop in history, but this is hardly a bellwether series. Of more import – if less methodological validity – was the fact that the first estimate of QII GDP crept in at a mediocre 1.5% yoy with HI private GDP slipping to the bottom end of the last three year’s range at 2.7% annualized. Soggy enough, but a reason for Ben to get his flight suit on? We think not.
The US will not this time be the cause of our woes, but neither is it – nor its monetary chief – likely to be counted among our ‘saviours’ or the more violent ‘plunderers of our nest-eggs’ any time soon.
Around the start of the year, in the course of a routine set of market overviews which we have to set out twice a year for one of our clients, we laid down two themes and a thesis.
The first of these was that the then-rapid pace of growth of money supply proper in the US – already becoming something of an exception on a global perspective – would continue to favour the maintenance of a pace of recovery there, above all in corporate revenues and hence, in all likelihood, in corporate profitability.
Such developments, we said, typically lead not only to an appreciation of stock market valuations, but also lend support to wider economic measures, such as employment and investment, however cautious CEOs and CFOs may be in padding out their balance sheets with cash.
So it proved to be, with the S&P putting in its best first quarter since the rebound from the depths of the 1997/8 Asian Crisis. Lending a certain (if possibly temporary) corroboration to this, operating margins also reached or approached record highs (depending upon whether you take data for the S&P, for all non-financial corporations, or just the domestic subset), as did reported EPS. Given the plain accounting intertwining of profits and investment on the consolidated balance sheet – as well as the motivational nexus on the individual one – it was perhaps no wonder that, even if coming from relatively depressed levels, the growth in capex outstripped that of GDP as a whole, or that manufacturing payrolls enjoyed their fastest percentage gain (subject to later revisions) in almost three decades.
Sadly, there is reason to believe that this creditable performance may have represented a high-water mark. Certainly, since spring turned into summer, there have been signs of a deceleration. Revenue growth has dipped to a two-year low – and in nominal terms has all but stalled – new orders have mostly turned lower, employment gains have dwindled and the rise in the real ‘wage fund’ become suddenly snail-like. This sudden shift to a lower gear was brought home dramatically by the shocking 12.3 unit drop in the ISM index of new orders, a plunge which was both the greatest suffered since 9-11 and the second largest since the second oil shock and which took the measure into contractionary territory for the first time in over three years. Adding to the gloom, this was followed by the steepest fall in two year in the NFIB small business index, suggesting the malaise is becoming widespread – perhaps, in the latter instance, due to the costs associated with Obamacare.
Again, no-one who pays attention to the marked deceleration of money growth these last six months should be too surprised at this. If not yet by any means a tailwind, the raging gale which filled the economy’s spinnaker in the run-up to year-end has lessened to the gentlest of zephyrs since then. With the economy vulnerable to a further deterioration of offshore conditions, it is hard to see the rate of progress doing anything other than diminish while this less extravagantly favourable monetary situation persists domestically.
As Dallas Fed President Richard Fisher so colourfully puts it, the US may well be the ‘best nag in the glue factory’, but that does not mean it is about to earn a place in the winners’ enclosure at the Kentucky Derby any time soon.
Meanwhile, in Asia, our second theme was predicated upon our very Austrian perceptions of the likelihood of anyone being able to engineer an instance of that semi-mythical beast, the ‘soft landing’, in a system as overly dependent on credit-fed, fixed capital spending as is China’s – much less in one where real money supply crashed from a monstrous 38% rate of climb (where it stood 5.7 sigmas above the previous 13 years’ average) to a petrifying minus 1.4% (3.6 sigmas beneath it) in the space of a year!
Those within the policy apparatus can perhaps be forgiven for assuming that they (and they alone) could manage a manoeuvre which has classically proven to lie beyond the compass of their Occidental rivals. Had not, after all, they ‘succeeded’ beyond compare in bringing about a QE-fuelled boom far beyond the envy of a Bernanke, a King, or a Trichet when the world first fell apart in 2008/9? Besides, were their armies of Western apologists and the even more serried divisions of mainstream macro dullards not almost unanimous in declaring that either the slow-down would conform to a gentle glide path or that, conversely, at the first sign the descent was indeed quickening, the afterburners would be lit, the stick pulled back, and the whole, ponderous, creaking, billion-man flying-boat would go round again for another pass in, oh say, 2014 or 2015?
That the first of these assumptions would prove to be amiss was an easy call to make for those with a more established pedigree of economic reasoning: the bet that the second would not even be attempted until far too late in the day was a less certain failure, predicated as it was upon what little we outsiders really know about the political imperatives at work within the confines of the Forbidden City, but it was still where the smart money piled its chips.
To understand why this was the case, consider the phrase a very senior member of the Chinese Communist Party recently employed: ‘the only two things that can threaten the regime are inflation and corruption’. So has it ever been, throughout China’s long history.
Given that, the observation that the 2009-10 stimulus delivered a massive, socially-imperilling dose of both these evils, it did not require too much nerve to hold to the idea that the relief of the monetary stringency gradually imposed (in the official markets for money and credit, at least) last year would be maintained until the fear of an imminent implosion rebalanced the scales of political calculus – above all, in this, a leadership transition year and doubly, trebly so when the Party apparat’s inner schisms were revealed with the dramatic purge of Bo Xilai and his Chongqing henchmen.
Thus, it is that, wherever you look, you see signs of distress in China. Shipbuilding, steel making, aluminium smelting, textiles, construction – even sectors such as these, which are dominated by the privileged oligopolies of the state-owned enterprises, are palpably struggling. Meanwhile, stockpiles of raw materials continue to mount on the wharfsides and in the warehouses, entailing who knows what dangers for those who have raised grey-market funding by using them as collateral and who thus owe monies both at home (in loan-sharked yuan) and abroad in an inconveniently appreciating dollar. Meanwhile, accounts receivable pile up on balance sheets at rates greatly in advance of those at which reported revenues advance and the spreading stench of fraud poisons the waters for those looking to plug the gaps with gullible gweilo money.
The authorities’ response? To insist that the Big 4 accounting firms do not co-operate with the SEC in investigating any such accusations and to issue a media directive that no bad news may be reported without prior approval in the run up to the autumn’s Politburo handover.
Indeed, there are clear signs that some of these dangers are beginning to be realised. Taking the difference between the reported size of China’s forex reserves and the sum of trade and FDI inflows (and making some best-guess reckoning of the effects of reval changes and interest gains), one gets an estimate of hot money movements being diffused across the porous barrier of capital controls – most famously via the metals L/C rehypothecation scam. Between March’09 and February of this year, such ‘unexplained’ flows amounted to no less than $560 billion – roughly two-fifths of China’s total reserve accumulation and a third of its coincident increase in M1.
The last four months of increasing angst about the state of the ‘landing’ have seen a dramatic reversal of these flows, to the point that the discrepancy in the books suggests that China may have lost no less than $128 billion – a flight which exceeds that suffered during the worst of the Lehman crisis. Taken at face value, this implies further, self-reinforcing pressure for the renminbi to weaken, for the Dim Sum bond bubble to deflate, and for commodity loans to be unwound, either suddenly – by means of re-exporting some of the swelling inventories of copper, et al – or gradually – by cutting back on new imports until the excess has worn off and the bills settled.
Either way, a chilling prospect, even if this does not trigger a new financial crisis among China’s complex and shadowy interweaving of ‘loan guarantee’ companies and off-balance sheet ‘wealth management products’
It should go without saying that China is not the be-all and end-all of this story, for it is also the nexus whereat much of the value-added is booked, if not strictly accrued, from the embodiment into the consumer goods we Europeans and Americans so avidly buy off the higher-tech component marvels of its more sophisticated neighbours, especially Japan, South Korea, and Taiwan. Nor is China’s fate a matter of indifference to its suppliers and fellow users of less rarefied inputs, whether directly – e.g., Australia, Brazil, South Africa, and the Gulf – or indirectly, wherever similar goods have their prices boosted by means of China’s disproportionate take-off from world market supply.
China has now begun to react, of course, cutting the effective bellwether, one-year lending rate from 5.9% (6.55% official less the permitted discount of 10%) to 4.2% (6.0% less the widened 30% rebate) in the space of a month. As Wang Shuo, Managing Editor of the influential and highly-regarded Caixin Magazine blogged at once on his Weibo page: “This is an admission that the hard landing is already here.” In this, he only anticipated his sovereign overlord, President Hu, by a few hours, for this latter worthy soon thereafter started bleating that the economy faces ‘severe downwards pressure’.
You bet it does! Take a range of key indicators – from electricity usage, to Shanghai container throughput, to nationwide rail freight ton-miles, to steel output – and you will notice that none of these shows a rate of growth during the second quarter of more than 4% from 2011, and some are as low as 1%. Whatever fictive GDP number we are presented with this week, the message is clear: “Brace! Brace! Brace!”
The trick will now be to avoid re-inflating the property bubble – and information suggesting 125% of June’s overall loan total was comprised of household credit offers little reassurance on that score. It is also imperative that the regime acts to assuage the fears of a populace who were already, in the aftermath of the first rate reduction, responding to official survey questions in a high and increasing proportion that they feared an imminent ‘surge’ in consumer goods prices. Good luck with that, Comrades!
Last of all we come to Europe and here is where, six months ago, we only had a thesis, or rather a litmus test, for, when we last wrote the report in question, we said that the key issue was whether or not the massive LTRO operations then just being enacted would actually stimulate a long-awaited increase in money supply in the Zone.
We know now that the answer was a qualified negative since the bulk of the impact of the operation went towards providing a mechanism through which credit withdrawal and outright capital flight into the core could occur, without collapsing the banking systems of the periphery, there and then. Thus the qualification on the above negative: money supply has continued to shrink in the Olive Belt debtor nations (especially after deducting the wastage due to CPI price rises), while it has begun to accelerate in what is not far from becoming an alarming manner in the creditor nations of the north, thanks to the arcane wonders of the TARGET2 apparatus.
A cynic might point out that such a sub-alpine price and wage suppression, coupled with the converse trends among the supra-alpine elite is exactly what is needed to ‘rebalance’ the Eurozone without breaking the single currency apart.
The problem with the adoption of such a sanguine view comes in two parts. The first is the quibble that a suitable capital base through which to make this shift in relative prices immediately effective is sorely lacking: unemployed Greek school teachers are not going to pose a threat to Dutch petrochemical engineers, nor Spanish carpet-layers to Mittelstand machine tool assemblers, any time soon. The second is that while the debt overhang persists – and, indeed, while it is being made progressively more onerous by the ongoing deflation – any Northern man of affluence or entrepreneurial daring tempted to speed the process through taking up productive assets or property in the afflicted zones will be greatly inhibited both by the knowledge that some highly arbitrary credit revision still lies ahead and by the fear – justified only last week by M. Hollande’s ill-judged razzia – that the state’s roving marauders will be happy to seize any gains made from such investments, however inequitable and retrospective – not to mention ultimately self-defeating – the deed might be.
In contrast to their policy-making peers elsewhere, by continuing to cite the need for ‘structural reform’, much of the European political elite is at least paying lip service to the principles contained in our oft-repeated mantra that there are no macro-economic issues which can be solved other than by micro-economic means (though, for us, that also includes case-by-case debt renegotiation, write-down, and transmutation into equity).
Sadly, while their mouths may be making such pious utterances unto the Gods, their hands – as M. Carmignac so forcefully pointed out in the European press a few days ago – are reaching ever more boldly into the pockets of those who still have reserves of capital and a viable means of support, thus bleeding the healthy in the forlorn attempt to palliate the sick. A case in point here is the latest brainwave of resurrecting the time-dishonoured method of forcing the rich to subscribe to state ‘loans’ – a levy on what might otherwise be productive capital last practiced by arbitrary princes of the ancien régime, as well as by the bellicose proto-republics with whom they were often at war.
With markets showing less and less response to the same, wearily repeated prescription of longer-lowered interest rates and more intrusions into the markets – LIBOR rigging on a universal scale, we cannot refrain from adding – the worry is that the piecemeal expenditure of the wrong sort of ammunition in pursuit of ill-counselled operational objectives will yet see the whole Grande Armée of bureaucrats, technocrats, and corporocrats arrive at its very own Berezina just in time to celebrate the two-hundredth anniversary of the utter dissolution on those pitilessly icy banks of the once-proud remnants of the first.
Last week it was announced that Beijing was reversing an earlier decision to allow local governments to issue their own bonds, causing eyebrows to be raised everywhere among the sceptics who may also have noted that the Chinese Index Academy were reckoning that the latter’s crucial revenues from land sales were some 38% lower in the first half of this year, on a national count, with declines in the capital and Shanghai suffering drops of up nearer 60%.
In a classic sign of policy confusion, it was also reported that the authorities were simultaneously giving tacit encouragement to the banks – which are otherwise struggling to hit their fatally-conceited, top-down targets for loan growth – to make up some of the resulting shortfall, as well as launching a $14 billion bond under the auspices of the MOF in order to raise funds for these stalwarts of misplaced spending and crass Keynesian malinvestment.
Meanwhile, Tao Zuojin, head of the China State Shipbuilding association, vouchsafed that up to a half of all his members might go bust within the next two years, reeling under a 60% decline in the gross tonnage of orders (90% of yards are said, in some quarters, to have won ZERO orders so far this year) as global economic deterioration compounds the widespread glut of maritime freight capacity and the lessened availability of cheap credit continues to haunt a sector largely expanded during the super-stimulus years.
Granted, the problem is not just confined to China – the global trade and resource rebound has suckered in all too many from outside the Middle Kingdom, too, as can be attested by the fact that 60% of the world’s dry bulk fleet has an average age of little more than three years, with deliveries scheduled this year likely to expand the fleet by around a sixth, even after scrappage is taken into account. But matters have come to such a pass in the earthly capital of Schactianism that Shanghai Shipping Exchange president Zhang Ye (no, not Zheng He!) told a regional industry forum that the state might not only soon require all cargo to be carried by domestic lines, but that all their vessels might have to have been built in Chinese yards, too.
Whether this resurrection of the infamous English Navigation Acts of the seventeenth and eighteenth centuries is truly a matter of official study – one shudders at the implications for world trade were so nakedly protectionist a measure to be enacted – it does show how desperate the situation has become for it even to be floated as a trial balloon.
Across at the local steel mill, things are not much better, with YTD losses rising appreciably from the same time last year to leave the businesses who pour half the world’s alloy with their already slender profits cut in half, stranding the group as a whole with a knife edge 0.1% operating margin and a decidedly sub-inflation ROA of just 0.6%. The worst third of them, all in the red, were actually left nursing a combined income gap of $2 billion, substantially higher than the losers’ tally this time last year.
If you think it might be important – not just to users of steel, but to diggers of dirt in the iron ore and metallurgical coal game – whether there is any immediate prospect of achieving an acceptable real return on capital in this moiety of the global industry, you should perhaps ponder on the fact that, since the comparable, pre-Crash semester in 2008, China’s steel production has risen by fully one-third (total capacity stands perhaps another 35% in excess of that), while the rest of the world has trimmed its output by some 5-6%. In other words, it is not just true of oil that China’s ill-advised crash stimulus package has been responsible for a share of incremental consumption much greater than unity in the past four years, but for materials associated with this particular destruction of capital, too.
Nor is business exactly humming in the thermal coal market, either. Indeed, the storage facilities at Qinhuangdo in Hebei province – the world’s largest coal terminal and one responsible for one-half of all China’s import needs – came perilously close to overflowing, with the peak stockpile of 9.5 million tonnes registered in mid-June representing 93% of the port’s total capacity and standing two-thirds higher than the seasonal average. Across the country, the total estimate which Li Xin of the China Coal Transportation and Distribution Association gave to the China Times was a mountainous 300 million tonnes – equivalent to 3-4 months’ imports and one month’s total consumption.
For reference, steel stockpiles are said to stretch to 12 million tonnes – up 35% since the start of the year – with dockside iron ore inventories not far short of 100 million tonnes – or around 7 weeks of imports.
Citing weakness in the electronics, machinery, and transport sectors – as well as an absence of major government outlays – state researcher Antaike lowered its estimates for domestic copper consumption growth to 5% in the current year. Elsewhere, it was reported that cement production had only risen 4.4% yoy in May (a gain of 5% in the first five months as a whole) with that of flat glass slumping 10.2% to depress the YTD total to a scanty 1.7% gain versus a 19.6% rise in the corresponding period in 2011. Needless to say, businesses in the first are seeing profits tumble by 50% or more, while those in the second are collectively in the red.
Is it any wonder that Deputy Director Shao Ning of SASAC – the body charged with oversight of the major SOE’s – said that these coddled giants should be girding their loins for ‘the next three to five years (sic) of winter conditions’ by striving to ‘strengthen their basic management practices… attaching great importance to cost reduction and enhancing efficiency… Increasingly a matter of life and death in times of austerity and contraction… central enterprises must fully understand the gravity and urgency of the current situation, and devote attention to being able to survive …’?
All in the price, the optimists say, but we – with our Austrian theories of boom and bust reinforcing our admittedly far less expert reading of the political tensions at work – are not so sure. Those expecting another massive monetary infusion should bear in mind that a PBOC survey of Beijing residents showed last week that an increased majority of 73.1% of respondents said that prices of goods were unacceptably high and that almost half of them feared a ‘surge’ in their prices over the coming quarter – a pessimism largely rooted in the Bank’s recent interest rate reduction, one suspects.
Whether or not such anxieties are well-grounded, their currency will not allow the policy-makers to place too much faith in the idea that the ongoing fall in the official CPI index will, of itself, be sufficient to give them room to conduct any grand, counter-cyclical manoeuvres in the coming months.
But, of course, the week’s main focus has not been China, but whether or not the Germans really did suffer two defeats at the hands of the Italians, or just the one.
The tenor of the press coverage in the Heimat is fairly one-sided in the interpretation that ‘Madame Non’ did in fact give in to an Italo-Hispanic threat of boycott by means of which we were presented with the ludicrous spectacle of two inveterate starvelings making the threat that if they could not dine on caviar they would not accept carrots to a woman who was not all that keen on sharing any crumbs from her table with such as they (she was, after all, only cajoled into accepting the so-called Growth Pact which they were blocking out as a gambit to secure the two-thirds parliamentary majority needed in order to pass the ESM enabling legislation – a programme which she and hers were also not that keen on in the first place!)
The editorials and op-eds were bad enough, with their talk of ‘democratic deficits’, ‘witch-hunts’, ‘tearing up treaties before the ink is dry on them’ and ‘reaching into the German pocket’, but some of the readers’ comments went so far as to invoke images of the infamous ‘Kohlruebenwinter’ when the besieged German populace barely fended off starvation on a monotonous diet of root vegetables in 1917, as well as the even more emotive leitmotiv of betrayal, the ‘Dolchstoss’ – or stab in the back – by means of which the Allies overcame a supposedly undefeated Imperial Army a year later.
And yet it may not be entirely a piece of political slipperiness for the Chancellor’s team to argue that nothing much actually has changed.
Several commentators have pointed out that there are, in fact, no new ‘instruments’, just as Frau Merkel promised. It remains the case, they contend, that the ESM has neither been extended, nor allowed to leverage itself up; that its use as a means of financing banks directly is subject both to the inevitably fraught process of first establishing a pan-European banking supervisor-cum-Resolution Trust (and one possibly equipped with a Scandinavian doctrine of managerial dismissal and stock and bondholder loss-sharing, to boot); that, in the meanwhile, if Spain needs to re-cap its banks, the overstretched Spanish budget will still have to bear the strain; that, theoretically at least, each and every emergency loan is supposed to be decided on a case-by-case basis by national legislatures on the typical EZ-weighted calculation – leaving the Bundestag with a final right of veto, should it ever screw its courage to the sticking place; that she can rely on the disgruntled Finns and Dutch also to block whatever they can; that the whole vexed issue of seniority of claims has not been precluded, merely finessed away by means of not insisting on an explicit declaration of what, much like the IMF, is likely to be an implicit priority, once implemented; and, finally, that the Grim Reaper may put away his scythe for now, since she has NOT in any fashion given way to the issue of joint Euro-Bonds.
Thus, as is so often the case in financial markets – for all their pretence at scientific objectivity in analysis – this largely comes to down to a matter of what its participants want to believe. If you are ready to scoff at German pusillanimity, or to despair at the cynicism of its leaders’ political calculation, or to rejoice at the prospect of another dose of global Keynesianism – or simply to exult that, finally, risk assets can rise and you can look good for a few weeks – you will tend to believe that the once-forbidding Siegfried Line is now bedecked with newly-scrubbed Allied underwear.
If, conversely, you believe that additional debt is no solution for over-indebtedness; that the extreme time-preference of the venal place-holders who comprise the political class will never allow them to introduce much-needed reforms except under the most exigent outside pressures; that the deliberate ruination of a nation of savers and profit-makers is too high a penance to observe in order to absolve their opposites of their sins; if you are predisposed to a bearish outlook for assets which you suspect still bear the artificial premium attached to them by the past quadrennium’s over-zealous interventionism, you will be eagerly reading between the lines for signs that the triumph of Monti, Rajoy, and Hollande has been an illusory one and that the sell-off may soon resume.
In any case, the next scene of the farce-cum-tragedy will take place in Karlsruhe on the 10th, when the German Constitutional Court will – somewhat unusually – take oral depositions from the pros and antis, as a preliminary to making a more considered judgement later.
As this all plays out, it should also be noted that all the past year’s summitry and special operations have effectively reinforced the business of capital withdrawal and banking dis-integration across the ‘natural frontiers’ of the Rhine and the Alps. As the ECB balance sheet has doled out an extra €800+ billion in new credits, TARGET2 creditor-debtor balances have swollen by €590 billion (€390 billion v-a-v Germany alone) with M1 only adding around €210 billion, with half of that increment having taken place in Germany and two-thirds of it in the wider creditor group which includes the Netherlands, Finland, and Luxembourg.
Thus, German real M1 growth has accelerated smartly from 0.9% pa to 5.2% (the median rate of the past three decades), driven by a veritable explosion in the local monetary base. Across the combined Creditor-4 grouping, real M1 is rising at a rapid 5.7% annual rate while – alack and alas! – the same key measure in the rest of the Zone is deflating at 3.9% annualized.
Were we to write down debts, entitlements, subsidies, wages, and costs and free up balance sheets, capital means, and labour in the latter unfortunates at the same time that we allowed the extra monetary infusion to go about its accustomed work among the former blessèd quartet, it would eventually effect the necessary rebalancing – in classic Humean stock-flow terms – that the bloc so badly needs. Thus, our condemnation of the process should really confine itself to the observation that it is precisely those same necessary accompaniments that so much of the Latinate policy thrust is aimed at avoiding, at the direct expense of their unsullied northern neighbours.
While the combatants take a brief respite from the battle, we can instead entertain ourselves with the spectacle of Monsieur Oui – the new incumbent of the Elysée Palace – trying to keep his rash electoral promises to reverse the sweeping tide of ‘neoliberalism’ and to stimulate growth while simultaneously being forced to trim his budgetary outlays to the not inconsiderable tune of €40 billion. Bon chance, mon brave!
The soak-the-rich measures we can expect, in what will be a victory for blind ideology over both economic theory and empirical verification, will further poison what are already noisome waters for investment and capital formation. As such, this is a prospect which is already said to be impelling elevated numbers of the likely soakees to quit the nest, in a less sanguinary replay of the Revocation of the Edict of Nantes.
Ironically, many of these would be émigrés are said to be looking, in time honoured fashion, across the narrow waters of La Manche for their haven. Ironic, because perfidious Albion herself is a shining example of how not to manage a recovery.
For Britain remains locked into a grinding recession of its own with its banks not just being hauled, again, before the court of public opinion, but still sheltering far too many zombie companies on their books, to the decided detriment of those better entrepreneurs who are now being bled in a cut-throat competition with living dead businesses able to operate, at their creditors’ behest, only for cash.
Thus, despite allowing its currency to sink further than any major nation in the Crash, to the point of a post-war low; despite passing a sentence of death upon the rentier class, as per the Great Apothecary’s quack prescriptions from the 30s; despite the continuation of such a vast scale of government exhaustiveness-amid-‘austerity’ that Leviathan – and Leviathan alone – has swallowed up nigh unto £1/2 trillion in private sector and foreign savings this past 3 ½ years – so that the Beast has devoured 5 months of total private national output while moving its share of GDP back up towards those same peacetime highs which have twice in a generation seen the country reduced both to internal ruin and external derision – despite all this, Britain remains in enough of a recession to trigger a dangerous attack of populist headline-grabbing from its hapless ruling trio.
It seems the new Huguenots may well avoid the worst depredations of their own leadership by hopping on the ferry at Calais, but they should not count on alighting amid a Land of Milk and Honey, by any means.
Far away, across the Western Ocean, the US – still the best horse in the glue factory as Dallas Fed president Richard Fisher so colourfully puts it – has so far stood above this fray. Not least of the reasons for this is that, despite a dip in the offshore component in QI, corporate profits plus proprietors’ income have reached close to the best levels seen, as a proportion of private GDP, in the past five-and-a-half decades, while manufacturers’ operating margins have reached their best levels in the past four-and-a-half. Returns on equity are none too shabby, either. The incentives to produce, to invest, and to hire, would seem to be present even if a natural caution still pervades the owners and managers of capital, given both the domestic political uncertainties and the cloudy foreign horizons.
But, of course, THAT was then and THIS is now. With monetary growth slowing at home, and economic weakness afflicting Latam (Brazil’s IP just printed its weakest reading in 2 ½ years of -4.3% yoy, taking the level back to those of five years ago), Asia, and much of Europe abroad, the past may not be prologue. Certainly, that seemed to be the message being given by the latest NAPM number which suddenly dropped to what is almost a 2-year low, led by the biggest single month fall in new orders since 9/11 – a plunge only otherwise exceeded in the last half-century by the outbreak of the Iran-Iraq war and the onset of the second oil shock.
Was this a one-off, or is it the first crack in the foundations of a modest American recovery and re-orientation? Only time will tell.
In a new paper from the HKUST academic team of Li, Liu & Wang, the authors lay out a clear exposition of the way that the Chinese institutional framework conspires to leach out profits from the predominantly private, cut-throatedly competitive, highly efficient, export sector and delivers an undue share to the state-owned or –controlled giants who occupy quasi-monopolistic positions ‘upstream’ in the largely non-traded, but also almost unavoidable sectors such as energy, metals, telecoms, logistics, finance, health, and education.
The paper lays out in some detail — in narrative, empirical and, inevitably, mathematically-modelled form — how this vertical separation helps perpetuate the ’imbalances’ in China’s top-heavy economy, by concentrating the bulk of the nation’s impressive gains from trade in the hands of those whose activities are both investment-heavy and sensitive to the imperatives of the state, rather than to the needs of the ordinary consumer. Moreover, Li et al also demonstrate a mechanism by which this ’commanding heights’ strategy, one consciously adopted by the CCP so as not to lose control over the system as it became partially ‘opened up’ to the outside world, helps suppress the share of wages — and hence of domestic consumption — in the aggregate mix.
What the authors do not dwell upon is the further implication that the political aspect of this confronts the Party with an almost insoluble problem now that it is beginning to realise that the SOEs may represent not so much a bulwark of their rule, but a potential barrier to that progressive betterment of their subjects upon which their legitimacy as rulers depends.
It would be bad enough trying to steer resources away and strip privileges from these over-mighty entities were the problem just one of economics, but, given that the upper echelons of these giants are packed with senior party members, their boardrooms populated by red ’princelings’ and politburo spouses, the knot assumes one of truly Gordian proportions.
In light of this engrained favouritism, it is also salutary to note just how badly even these vampire enterprises are doing in the current slowdown.
According to the official data, SOE profits fell 11.8% YOY in May, leaving the YTD total 10.4% below the comparable period in 2011. With revenues for the first five months up 11.3% from the previous year, this means operating margins must have fallen nearly 20%. In the export powerhouse of Guangdong, things were even worse (this time over the period Jan-April) as the SOEs there suffered an eye-watering 30.5% drop in income.
At the national level, return on sales is running at 5.1%, the lowest since the Asian Contagion, 28% below the WTO era median, and even 15% below the worst recorded in the LEH Crash itself. For reference, US manufacturers, absent much – if not all – trace of state support, just posted an 8.9% after-tax return on sales in QI, while miners recorded a figure of 16.6% and InfoTech one of 11.2%.
Note, too, that in such credit constrained conditions as persist in China at present, one must even doubt what exactly is meant by ‘sales’ – i.e., how much are accounts receivable piling up as vendor finance is extended and channels are stuffed in an attempt to massage the figures. One thing that is for sure is that the proportion of such ’sales’ as was paid in hard cash is likely to be scant, indeed.
Not that we will ever know, now that the Party has officially banned all negative reporting ahead of the leadership handover (sic) and in light of (should that be ‘in the obscurity of’?) its prohibition on local audit firms co-operating with the SEC and the PCAOB in the US in the latters’ (belated) attempt to clear up a few trifling ‘confusions’ contained in the financials filed—and all too frequently not filed—by US-listed, Chinese corporates.
If any confirmation were needed of the dire state of play here, just look at the export figures from China’s more developed satellites in the Pacific cluster, or consider the HSBC/Markit flash PMI which dipped again to a 7-month low, with China’s own export orders sub-index hitting its lowest level since the dark days of early 2009.
Recent reports also suggest that the Big 4 banks have only managed to lend CNY25 billion in the first half of June (a system-wide monthly run-rate of less than CNY150 bln!) with deposits off by Y400 bln (which could require loan contraction of anything up to CNY300 bln) and this when many banks are already fully utilising the new leeway granted them of paying 35bps over the official deposit rate.
No doubt the actual total will miraculously surge as month end (quarter end, in fact) approaches, but such window-dressing should not blind us to the fact that generic credit demand remains weak, or at least the rationally-fulfillable kind does. No wonder there are reports that the banks are being told to encourage another round of local government profligacy and hang the structural re-adjustments which policy has insisted the country needs.
The China slowdown has not yet run its course.
Over in the US, Blackhawk Ben has done what he knows best: perpetuated his violence upon the capital structure and pricing mechanism of the world’s largest economy by extending the somewhat pointless Operation Twist until — well, basically, until he runs out of short-date paper to sell (though we would not put it past the man to issue Fed bills at that point in order to turn the whole of the US debt stock into nearer-money instruments and drain the system of every last drop of duration).
As regular readers will be aware, the momentum of money growth in the US has receded significantly from the rip-roaring pace which helped fuel the rebound at the back end of 2011, taking with it a good deal of the impulse behind the real economic upswing — regardless of the fact that corporate bond yields are again where they last were when the Fed first unleashed the demons of inflation, back in 1965.
In one thing has our esteemed Chairman succeeded, viz., he has made equities as cheap as they have ever been compared to bonds. Witness the gap between the earnings yield on the S&P500 and the BAA corporate bond of almost 2% points in bonds’ favour! Equity risk premium, please phone home.
Jigging the arithmetic slightly, this gives us a long-term, real earnings growth factor (rEGF) of minus 1.8% per annum, fully 2.7 standards below the 1980-2012 mean. More telling, however, is the fact that this datum also lies 1.4 standards lower than it normally does in relation to the current growth in private sector GDP — a benchmark which, you may not be surprised to learn, has displayed almost exactly the same median value of 3.2% over the past three decades as has the rEGF.
The fact that a disparity of 4.6% between the two has opened up could imply that market participants have seen through the fraud of ludicrously suppressed bond rates (and, arguably, are also somewhat sceptical of long term growth in what is still an overly stimulus-dependent economy).
Thus, the Fed is keeping the stock market supported, but only at the expense of just about every other rational means by which to allocate capital. We should be thankful that the political environment is not conducive to its undertaking anything more far-reaching in its effects than tinkering with a yield curve which — given the intense desire to park flight capital in something deemed to be relatively safe — would probably have remained flatter than normal in any case.
Charting these waters in investment terms is therefore none too easy. The US is decelerating, right on schedule, but is not yet actually declining. So, while we may be in for a steady diet of mild disappointment, it is hard to identify a specific trigger which could tip the real world into the abyss — at least not before most of the alternative destinations for one’s capital have been sent plunging into its Stygian gloom first.
That said, while there are one or two more heartening signs — e.g., that household deleveraging (and default) has already stretched to 20% of household income; that dips in the gas price are seemingly filtering through into abstention from consumer credit; that the ratio between non-residential fixed investment to housing has gone from a four-decade low to an all-time high, though the proportion of net private investment in potentially productive equipment and structures is still a very paltry fraction of the sums consumed annually, either privately or by the ever-open maw of the state.
Until a genuine end to what has been a generation-long decline in provision for the future (interrupted only briefly by the euphoric waste of the Tech Bubble), we cannot wax too lyrical about America’s longer term prospects, cheap energy or no.
All of which brings us wearily back to Europe where the only question remains when and if the Germans will blink and start writing cheques to all their neighbours and, if so, what conditions will they apply to their long-delayed largesse.
So far, Frau Merkel is sticking to the only strategy that she can — of insisting that future aid is tied to the construction of budgetary oversight, reduced national sovereignty, and the implementation of labour market reforms which, at one and the same time, calls the bluff of the likes of M. Hollande while paying lip-service to her own countrymen’s obvious unwillingness to pay for what they view as their counterparts’ indolence or improvidence.
How long this can last is an open guess. Certainly, the markets — suffering a paroxysm of fear on Monday, when Bonos hit 7.29%, 588bps over Bunds and BTPs touched 6.17%, 476bps over — have since recovered what is either a measure of poise, or a slug of undiluted wishful thinking (according to taste) with Spain back at 6.55%, 500bps over, and Italy at 5.68%, 412bps over.
A gauge of how much this relies on the assumption of a ‘Ja, endlich, wir bezahlen!’ emanating from Bonn can perhaps be had by noting that German 10-year CDS still stand at a lofty 132bps, juxtaposed to the Aa3 pairing of Japan and Chile and that Bunds have seen their 50bps yield discount to Treasuries dwindle to a single figure difference in the past several weeks of bail-out speculation.
Perhaps the real lesson is to be had from the Baltics where drastic ‘internal devaluation’ has accompanied genuine ‘austerity’ in the form of government cut backs stretching from 10% in Estonia, to almost 20% in Lithuania, and near 40% peak-to-trough in Latvia. As a result, of the bitter medicine swallowed there, private GDP is now on the rise, with growth rates of 0.9%, 4.9%, and 3.9% annualized over the past six months in Estonia, Latvia, and Lithuania, respectively.
Ireland and Portugal, to give them credit, have seen something similar occur, with the state’s slice of the pie shrinking 13% in the first and 15% in the second, but Spain has barely managed a 5% cumulative cut and Italy is already well on its way back to unchanged from the peak, despite all Mario Monti’s protestation about his performance in trimming the excesses of the past.
‘Austerity’ which not only forces those who have become dependent upon the state to go out and seek other ways of making a living, but confiscates more of their and their private sector neighbour’s earnings when they do so, by imposing swingeing increases in taxes (and so pushing down marginal returns to labour and capital at just the wrong moment), is, as we have said before, a very luxurious form of achieving budget balance, indeed. Aimed, as it is, not so much at reinvigorating individual endeavour as at minimising the reduction in the reach and importance of the state, this is truly a policy prescription to satisfy neither those who would apply Keynes’ soothing nostrums, nor Austria’s much tougher love.
THAT is what is ’self-defeating’ about such measures, not the simple fact of trying at last to live within one’s means and to re-orient one’s activities more to wealth creation than wealth destruction – as we fear the unfortunate citoyens de L’Hexagon—the French—are about to discover under their newly installed, traditional left-wing, tax-and-spend, New Dealer leadership.
A Catalogue of Errors
A man who is both tireless and tiresome in his efforts to promote the cargo cult of Keynes is Robert Skidelsky. Our noble lord is actually a historian who, it is said, ‘learned economics’ in order to be able to write a better biography of the Bloomsbury Beelzebub, but that has not impeded his proselytising just one bit, despite the fact that if anyone should be aware of his idol’s personal depravity, political guile, and professional slipperiness, it is he. A blog review of a recent book written by Skidelsky, pere et fils, in which the pair rehash Keynes’ ludicrous vision of a world beyond scarcity ignited a long debate which turned out to be replete with bad economics and even worse politics to the point I felt obliged to chip in with a few words of austro-libertarian wisdom, in which the reader might hopefully find some wider merit.
CJC – June 20 7:09pm
@ Tom: Hang on. First you say: “The suggestion that profits derive from artificial scarcity is nonsense.” Then you say: “Artificial scarcity is just another term for monopolistic behaviour.”
Are you saying that monopolistic behaviour does not give rise to profit? Surely the extraction of profit or ‘economic rent’ is the whole point of monopoly (aka artificial scarcity)?
Economic rent derives from privileged property rights like ownership of commons (land, natural resources, knowledge) or from limited liability, or from the privatisation of sovereign credit (the ‘credit commons’) since 1694.
If unearned income from economic rent were equitably taxed (and taxes upon earned income from labour cut dramatically) the resulting pool of value could be shared as a national dividend.
There would then be plenty to go around so that people enjoyed as of right a decent standard of living, accommodation and so on.
Then beyond that it’s up to them. High status jobs would then be paid the least, because of the demand for them, while the worst jobs which no-one wants to do could be highly paid.
Profit, as Prof. George Reisman correctly argues, is the antecedent form of income. When Crusoe spent time standing over a stream, poised with his sharpened stick, the ‘profit’ from his labour was the fish he speared.
Later, when Friday turned up, absent any skills, tools, homesteaded property rights, or other means of sustenance, Crusoe offered him a deal: a pre-emptive share of the fish as that secondary return to labour we call a ‘wage’ – in effect a contractual call upon the income out of which Crusoe’s profit would emerge - in exchange for assistance in the process of catching them. Crusoe’s entrepreneurial gamble was naturally that the two of them acting co-operatively together could each harvest more of the bounty of the river than either could on his own.
‘Rent’ in strict economic terms is nothing to do with this benign process of voluntary association, but is an undue benefit inequitably extracted by enlisting the intrusive, coercive power of the state – such as the granting of some monopoly or restrictive charter, ensuring the enforced take-up of an otherwise sub-optimal product (eg, biofuel boondoggles), or the enforcement of a protective tariff or broader competitive exclusion (here many libertarians would add patent rights).
‘Rent’ may indeed be ‘unearned’ – but its removal is a matter of abrogating privilege, not of imposing taxes. Profit is not only earned, but is earned in the service of the greater good, being only obtainable by recognising that some resources (including human ones) are being undervalued in their current employment and transforming them in some way to meet a greater expressed need than they currently do. This is an essential arbitrage for which profit is the due reward, one which has the merit of exerting a beneficial ‘selective pressure’ on the entrepreneurial ‘gene pool’: the better operators thrive and can compound up the capital they so accumulate to extend the scale of their endeavours; the poorer ones eventually go broke and return to selling their labour, not hiring that of others in sub-marginal – and hence wasteful – projects.
Taxing profit unduly is therefore a business of penalizing a success which attends only those who serve their fellows’ material needs better than others do. It is also highly unfair, since the tax falls on those who achieve what they set out to achieve and leaves the failures unscathed.
‘Heads, I the Fisc, win: Tails, you lose’ is hardly the way to incentivise anyone to excellence!
As for ‘sharing out the national dividend’ – what a world of tyranny, moral turpitude, petty envy, and sheer inefficiency is contained in those honeyed syllables. ‘From each according to his means to each according to his needs’ – for the red-shirted butchers – ‘Gemeinnutz geht vor Eigennutz’ – for their brown-shirted counterparts!
Nor does anyone have a ‘right’ to anything other than one of equality before the law and of respect for their property (in which their own person also consists). No-one has a ‘right’ to demand a ‘decent standard of living’ at the expense of another. Besides, who is to decide what is ‘decent’? Is it 1500 calories a day? A blanket to wrap onself in on the workhouse bunkbed? Or is it a 2-up, 2-down semi with a Ford Fiesta in the drive? An iPhone and a subscription to Sky TV?
The horrors of an upwardly-creeping boundary of insistence upon the provision of such ‘amenities’ out of the spoils of expropriation by the Tutelary Deity of the welfare state, all showered upon the masses simply dint of its members having a pulse, is what has delivered us into the depths of the deeper crisis afflicting us today.
And, finally, ‘high status’ jobs pay well because the providers of the services to which these give rise are rare (and have often undertaken considerable investment of time and money in acquiring the necessary skills and experience to boot), while ‘low status’ ones can be filled by almost any of us dogsbodies, if so required. That, I am afraid, is basic economics and quite frankly, I am more than happy that my heart surgeon takes home a good few bob and so stays shapr and motivated even if it also means I have to bow to my fellows’ unfathomable exercise of their power of consumer sovereignty in paying Messrs Rooney and Cole a king’s ransom for kicking an air-filled spheroid about an expanse of turf for ninety minutes at a time.
Utopian collectivism such as is being expressed here is to blame for almost as many woes - and far more suffering and death – even than the evils of fiat money and corporatist cronyism which everywhere masquerade as the free market.
We do not love in a Land of Milk and Honey – not since dear old Eve took a fancy to that first, enticing Cox’s Orange Pippin – but if you do want something to stir into your tea and spread on your bread in the morning, you had better leave it to an entrepreneur, out in search of profit and funded by a capitalist saver, to provide it, otherwise you will either have to do without them, pay more for them than you need to, or have to suck up to some insufferable little busybody sporting a coloured armband in order to jump the interminable queue for the trifling amount not commandeered by the guardians of the people!
Rational exuberance | June 21 8:49am
The better operators die and leave their valuable capital in the hands of their wasteful, drug-addicted offspring. Or even worse, investigate when and where the oldest and greatest European fortunes were won.
Spain: Duchessa de Alba – Robbing and murdering the Dutch, especially sacking Antwerpes, the foremost trading venue of its time.
Germany: Friedrich Karl Flick – Buying undervalued assets, legitimately owned by murdered Jews, directly from the highest levels of the SS.
You get the drift…
In any case, real money survives generations and please don’t tell me Paris Hilton is a superior human being somehow.
Dear Rational Ex,
Indeed, many of them are the scions of banditti, warlords, mailed bullies – AND OTHER PROTO-GOVERNMENTAL PLUNDERERS – who have precisely NOTHING to do with the market order and the republic of law.
Those latter institutions, however – the ones which, even in their current barely operative state, have generated both the most material comfort and the greatest individual freedom for the largest (and yet still increasing) number of people – are precisely those you would shrink in favour of handing power back to a new generation of governmental plunderers!
As for inherited wealth, for which you seem to have an irrational aversion, I can only bid you wait awhile. Even Ms Hilton will have to manage her endowment wisely – or be smart enough to hire someone to do it for her – and hence will have to contribute to funding clever entrepreneurs in some form or other as they go about improving the lot of their fellow humans – or she and her seed will also be back operating the check-out at Wal-Mart where you so obviously and invidiously wish to see them.
Inevitably, when yet another false dawn for the Sinomaniacs turned into a lowering twilight, the newswire reporting surrounding the latest Chinese PMI numbers included a few talking heads who expressed their ‘surprise’ at the deterioration in the gauge. A ‘surprise’? Really?
What actually never ceases to surprise is just how ‘surprised’ the mainstream always is – when it looks up from overlaying one handy, time-series squiggle over another in a spreadsheet and thereby pretending to know something – by how non-linear, how widely ramified, and often how intractable, the collapse of a credit bubble usually is. Now, we don’t expect the humdrum practitioners of the Macromancer’s art to posses much in the way of a PROPER economic understanding, but you’d think blind empiricists like they could at least pay attention to the actual evidence, once in a while.
The simple fact is that, having engineered an explosion of money and credit in the aftermath of the Lehman shock, the regime has now delivered an implosion and – guess what? – all those individuals, all those businesses, both well-grounded and speculative, public and private, honest and corrupted, who came to rely on ever-expanding nominal revenues to pay their bills and ever-appreciating assets against which to borrow to play the game have suddenly been confronted with the cessation of the monetary deluge which was the prime reason such a superficially happy state of affairs could exist in the first place.
What do you think the result of such a juddering dislocation should be?
What is even more inexcusable for the Sinopaths is that the very object of their uncritical admiration – the upper echelons of the Communist regime – have not once refrained from emphasising the message that the programme enacted in 2009-10 was the root of the problems with which they are wrestling today – overcapacity, irrational investment, overstretched finances, a vast monetary overhang, and the twin social evils of a get-rich-quick mentality and its darker side, the rampant corruption and disrespect for the rule of law which such a Gold Rush has engendered.
Yet these same admirers have managed to cling on to the screaming cognitive dissonance which holds, at one and the same time, that the Juggernaut which is the Chinese economy cannot possibly be subject to the same tedious quibbles to which its failed Western capitalist competitors have succumbed (shades of defeatist admiration of Mussolini’s 1930s Italy and Khrushchev’s 1950s Russia) but also believes that, if by some heavenly catastrophe, it does begin to teeter, the CCP will perform a rapid volte face and repeat the errors of three years ago a fortiori, presumably consigning all public mention of their subsequent self-criticism in that regard to the socialist Memory Hole, as they do!
Even though we focus here on China, we must recognise that it is not alone in its travails – Indian industrial production and GDP (if you must!) have both hit multi-year lows; Brazilian IP has been declining for the past year, to reach levels first seen in 2007; the Russian equivalent is perilously close to zero. As a result, the rupee has hit record lows, the real lost almost a fifth of its value in 12 weeks before staging a minor recovery, while the rouble has weakened more in the past month than in any like timeframe outside of the country’s 1998 collapse and the height of the GFC itself. These three supposed leaders make up the worst two and three of the bottom six global currencies since the global market rolled over at the start of March.
Why is this important? Well, according to the Pollyanna line which the sehr beruehmte Jim O’Neill was touting last week, ‘the BRICs create one new Greece every 11 1/2 weeks’. OK, but what if they are now UN-creating one every quarter, Jim? What does your ‘model’ say, then, pray?
While we wait for enlightenment from this latest scion of the Squid to have his name linked to the top job at a major central bank, let us just note that, six short years ago, China’s apparent consumption of copper was only a quarter of that indulged in by the rest of humanity. Three years ago, it was still only half but, briefly at the end of last year, the ratio touched nothing less than parity. Clearly building all those new Greece’s exerts a terrible strain on the totality of available mineral resources, when done the Chinese way, at least.
We say ‘apparent’ consumption, of course, because the estimate on which so much ‘modelling’ relies merely compares – absent all error bars, naturally – production and net imports with reported changes in inventories and so takes little account of the mountains of ‘grey’ stocks quietly tarnishing on the humid wharfsides of China’s ports while its owners parlay the cheap dollar credit they have raised thereon into a means with which to play for currency appreciation, curb lending returns, and rising real estate prices. Many of these expectations, it seems, have diminished almost as rapidly as has the marketable value of the copper holdings on which their L/Cs were first predicated, driving a certain – shall we say – reassessment of the strategy.
Even absent any further deterioration in the productive economy there, the twin subtleties of ‘reported’ and ‘apparent’ could yet come to haunt traders not just of copper, but of other metals, as well as of iron ore, coal, and crude. A dawning awareness of this would certainly explain why, after years of uncritical bullishness, one big miner after another is now scrambling to revise downward its capex plans and to deflate investor expectations – an emerging consensus not entirely marred by the glaring exception of an Xstrata whose board members seem to have the little matter of multi-million retention guarantees and lucrative, post-merger stock grants to monopolise their attention and cloud their objectivity (in their public pronouncements, at least).
Amid the soaring yield spreads and crashing core outright yields to be seen in Europe, the past week was notable for both an increased Latin anxiety and yet more stern, Teutonic declarations of rigour.
Notably, Buba head, Jens Weidmann, told Le Monde that it was hardly sound to imagine a severe distrust of government finances could be overcome by incurring even more debts. He was also suitably sarcastic about the special pleading being put forward for a softening of the fiscal pact, saying that to be ‘in favour of growth, is to be an advocate of world peace’ – i.e., it was a meaningless platitude when lacking any specific programme for the delivery of the Millennium. Concerning the new reconstruction bonds being proposed as a backdoor means of carrying out more pointless Keynesianism, he revealed that he was not entirely convinced that Europe’s problems could really be attributed to a lack of infrastructure. He must have read what we wrote on that particular topic last week!
It almost goes without saying that what everyone wants and expects is for someone, somewhere – in Frankfurt, Beijing, London, or Washington – to heed the calls for action and to fire up the printing presses and make everything right again.
One of the most vehement Anglophone advocates of this approach is that indefatigable doom-monger, Ambrose Evans-Pritchard of the UK Daily Telegraph. One often imagines him, wheeling back and forth outside Oxford Circus tube station while oblivious to the circumstances of the day, come wind or rain, clad in a dishevelled raincoat, belted with a fraying length of twine, borne down by a weighty sandwich board which declaims in bold type: ‘The End of the World is Nigh’,
AEP and his ilk are two-way calamatists who routinely decry all spending and borrowing as being likely to cause bubbles and busts until, err, things go wrong, and then they spin 180°to clamour for nothing other than more spending and borrowing – this time leavened with a comforting splash of central planning and bolted-horse regulation to correct for the ongoing ‘market failure’ – a.k.a. the effects of the gross market distortion previously caused by Leviathan’s itself when it unleashed the earlier credit cycle.
Deflation, depression and dictators stalk the land, they cry, so – quick! – find some means – any means – to rebuild the tumbled block-work of the boom years’ Babel of borrowing, for whatever has been so far essayed to restore it to its earlier hubristic heights has clearly been too feeble and too conventional to have had any effect. ‘Reinforce failure,’ they shout, in blind defiance of basic military principles and sound common-sense, both.
Desperate for a new inflation to camouflage the toxic legacy of the late one, they fret that people in the real world continue to defy the Mighty Oz’s at the world’s central banks and are selling rather more assets than they are buying. In fact, as I have not ceased to try to elucidate out in these writings, what has really happened is that, in contrast to the former reliance on those overbalanced, upper courses of the credit pyramid which had previously been performing some of the functions of money proper, the crash saw a rapid return to significance of that same money (to ‘Austrian’, or M1+, money, as you prefer). Subsequent to this, the scale of the banking sectors’ wounds – which were allowed to fester rather than being either cauterised or amputated in the casualty clearing station and so became progressively more gangrenous – led to a replacement of the normal process of ‘inside’, or commercial bank, money creation by ’outside’, central bank methods (QE, et al). Even in benighted Europe this ‘worked’ at first, until the bank-sovereign drowning pair started to pull each other under and all the ECB’s latter money pumping efforts became diverted into intermediating capital flight and credit withdrawal across the TARGET2 system (now knocking on €1 trillion of net balances).
Thus, (mainly interbank) credit may have contracted, banks may have been less virulent vectors of monetary manipulation than normal, and that money’s recipients may have displayed less than their usual haste in disposing of it again, but, nonetheless money supply has risen since the crash, and markedly so in more than one key jurisdiction.
Let us not forget that prices DID rise under this influence, and rose at faster and faster rates into the bargain, until stimulus was slowed or stopped or until other problems blew up and short-circuited it. But, if you had no understanding of these supply side shifts – and if you also were to ignore the impact on the demand side of the naturally increased willingness of private actors to hold onto a greater proportion of that newly created money amid all the turmoil they were facing – you and your fellow cranks could blindly plot some sort of exploding monetary base number against a relatively modest CPI change and scream, along with the AEP’s of this world – ‘Alas and alack! Nothing is working! We’re doomed to a liquidity trap! Print more, spend more, repeat the errors on a bigger scale – even declare war on Mars like that noted voice of reason and pillar of unimpeachable intellectual honesty, Mr. Krugman, told us to do!’
AEP and his ilk are so blinded by their genius at moving one conceptual economic aggregate from one square to another, so that one new act of balance sheet destruction can be conjured up in the reflation in order to compensate temporarily for the exhaustion of the balance sheets already ruined in the boom, that they have lost all sense of how the world actually works. Economies are not susceptible to such Grand Chessboard imaginings – Stalin and Mao should have shown us that: rather, they are grown from the ground up through individual social interaction. Wealth is not to be promulgated from on high, but to be painstakingly built up, one transaction, and one job at a time.
The real solution to our present woes is thus what Fritz Machlup in the 1930s called an ‘Auflockerung’ – an unlocking, or loosening, of those parts of the economy fixed in place by either a refusal to face reality or by ham-fisted government intervention and its ill-bred litter of perverse incentives. In the aftermath of the Boom, far too much of the pool of goods, capital and labour is currently stuck in the wrong hands, at the wrong prices. As William Hutt used to emphasise, the withholding of supply from the market which this represents makes everyone worse off, because the withholders can therefore express no demand for anyone else’s services – this is the real paradox of self-aggravating decline, not the under-consumptionist bogey of too much saving.
On this last issue, we can also take some pointers from Axel Leijonhofvud, that most thoughtful of Keynesians (if that is indeed what he is, since his own adoption of the label is typically justified by putting the best possible construction on Faustus’ own equivocating and often self-contradictory declarations while dismissing almost the whole canon of subsequent exegesis laid out by those who more convincingly claim to uphold their idol’s legacy).
In his attempt to reconcile the irreconcilable, Leijonhufvud long ago set out the concept of a ‘corridor’ of economic settings – albeit one of variable width – within which it was possible to ignore Keynes’ prescriptions and to allow time for the self-stabilising activities of the free market to smooth out any disturbances to good order which might arise. Outside this range, however, AL argued that matters had become so far deranged that to rely on laissez-faire was hopeless, if not foolish: here the instabilities and the incompatibilities of conflicting aims were such that the feedbacks became viciously positive – Here Be the Dragons of the Keynesian Multiplier!
In AL’s explanation for this, he focused on the fact that such straits were a place where not just the indolent, the improvident, or the plain incidental would suffer, but one whose difficult passage would take so long to effect that even the far-sighted, the frugal, and the initially fortunate would exhaust the buffers they had been prudent enough to lay down, long before any self-correcting tendencies could have time to become operative.
As time dragged on, reduced flows of income could no longer be made good by drawing down on savings, capital, or insurance. As distressed selling and reduced expectations of future income generation each acted to lower collateral values, the credit system would be pressured on all sides, limiting its ability to provide an intertemporal bridging mechanism.
Finally – though AL did not say so in specific terms – even the state would deplete its ability to support all the strugglers, deprived as it would be of taxes; too indiscriminate as it was in dispensing doles; so exhausted its treasury (assuming, indeed, that there still existed Pharaohs wise enough to employ each their own Joseph to first fill it during the salad days) and its sovereign guarantees increasingly seen to be of doubtful worth.
If this sounds like the Europe of today, we would very much agree. But that is not to move from a shared diagnosis to the recommendation of a similar treatment. This is not the place to resurrect the dead dilettante, but to keep the stake firmly planted in the heart of his cadaver, where it lies unmouldered in its crypt in Bloomsbury. I do agree that the system now needs a drastic intervention to move it back into AL’s ’corridor’ wherein normal, individual action can comfortably accomplish the rest of the needed convalescence swiftly enough not to wear out either capital reserves or political patience. The intervention I envisage, however, is more of a catharsis, a purgative of the malign outgrowths of past interventions, than a further infusion of methadone to ease their pain and pretend all is now well.
You see, what the redoubtable AL appears to have overlooked in his analysis is that, just as the now-toppled boom with whose consequences we are wrestling has invariably been either positively ignited or passively endorsed by the state, and just as it was only the state’s flawed interference in the market which allowed that boom to swell to so pernicious a size, so it is to me an incontestable assertion that the state’s interference with the liquidation of the boom – well-intentioned or otherwise – can only make things worse. In effect, what we Austrians charge is that in committing all of these sins, it was the state which drove the system outside the ‘corridor’ to begin with and that everything it has done since has acted against the very re-coordination – the very ‘recalculation’ – of prices, costs, and resource availability for the simultaneous fulfilment of consumer preferences and producer plans which would enable it to be pushed swiftly back in again. Look at China for a classic example of this misplaced arrogance in their ability to conduct ‘counter-cyclical stimulus’.
Think about what usually takes place when the state starts to combat the slump. It props up corporatist zombies long beyond their allotted span, weakening their better-run competitors in a horribly inverted Darwinism. It frustrates the beneficial capitalist transfer of titles from weak to strong hands. It permits a widespread violation of accounting norms and so perpetuates error and propagates a corrosive mistrust throughout the body economic. It slashes the income accruing to savings (and so drains the pool of this vital back-stop to non-inflationary investment all the faster). It chops and changes its policy responses in the wild attempt to be ‘pro-active, so shortening entrepreneurial horizons. It manipulates currencies and disrupts that very cross-border trade which has always been the source of so much of our prosperity.
It practises that most ruinous parody of ‘austerity’ which attempts to keep its own bloated apparatus as large as possible at the expense of the shrunken remnant of the self-reliant – and it therefore preferentially raises taxes to sap the income and expropriate the capital of those best placed to show the way forward once more. Rather than slashing all absolutely unnecessary spending – the state, until it destroys itself along with the prosperity of its subjects – attempts to keep its unwieldy establishment of patronage and purchased electoral power as insulated from the woes of those outside its web, insofar as it is able. ‘Work together, enrich the soldiers, and scorn all other men,’ indeed!
In all this, it arranges firstly that AL’s ‘corridor’ becomes far too narrow for anyone inside to remain there, and then ensures that the razor-wire-topped walls which to mark off that ‘corridor’ become far too high and imposing for anyone outside ever to regain its sanctuary.
It is all very well to propound the view that if we do not take radical action, we will end up in another Great Depression – as we heard whined incessantly by the Nomenklatura – but what we should ponder instead is why it was that that era’s first major implementation of a programme we might call Keynesian (even if our evil genius had not then written the Meisterwerk in which the policy took on the complexion of Holy Writ) managed to bind the vibrant, resource-rich, creditor nation of America into a much longer period of sub-par growth than was suffered by most of its less well-endowed neighbours.
We should consider why it was that the US could not recover as rapidly as it did after an initially more severe, post-WWI deflation; why the likes of Japan are still bumping along the bottom today, twenty-odd years after their great excesses were treated with unalleviated ‘pump-priming’. We should seek for reasons why four years of extraordinary and unorthodox fiscal and monetary manoeuvrings since our own troubles began have not put the West back on its feet, in time to stand steady before a similar resort to quackery brings the formerly dynamic emerging nations to a similar level of prostration in their turn?
Could it be that the answer is too much government, not too little? That the state’s fabled ‘stabilising’ potential only serves to stabilise the disease, not speed its remission, by chaining up resources that need to be redistributed and by freezing prices that need to adjust? That the much-lauded ‘courage’ of economic illiterates-cum-cynical opportunists like Roosevelt only deters the sort of bold, entrepreneurial response which is needed, even when Our Dear Leaders are not actively vilifying wealth creators as ‘economic royalists’ or ‘Kulaks’? That to endeavour to save the nest of corporatist parasites which is the modern banking system at the expense of the well-being of the wider citizenry, under the disguise of guarding against a ‘systemic’ breakdown, saves neither citizens, nor banks, nor ultimately the state itself?
Rather than declaiming, Canute-like, that ‘no strategic financial institution would be allowed to fail’ – ALL of them, of course being deemed strategic – and then subjecting first the easily-cowed Irish, then half the rest of the continent, to debt peonism in the attempt to make good on the boast, could it have turned out worse if all the state had done was to apply the law to the banks as fearlessly as it does to bakers, builders, or bookstores?
From the first day, we have never ceased to aver that these latest revelations of their enormities meant the banks should at last have been stripped of the thick hedge of legal positivist privileges behind which they harvest their vast rents. They should have been put straight away to the impartial examination of accountants, auditors, and the courts, where necessary. The bad would have failed; their (mis)managers would have been sacked – sans golden parachutes and fat pension pots. Their owners would have rightly been left empty-handed, their unsecured creditors made to pay the penalty for their credulity alongside them, and their remaining secured shareholders left to take equity stakes in whatever rump of the organisation survived such a cleansing.
Depositors could be have still been made whole (thus preventing a complete collapse of the money supply as well as arguably serving natural justice since the suspicion exists that, however legally unfounded it may have been, many of them were tacitly encouraged to believe they were only warehousing their funds, not acting as the bank’s creditors when they committed their monies to its safe-keeping.
Some time at the back-end of last year, when told on CNBC that the costs attached to this idea would be so enormous that they simply could not be borne, I replied that many banks were already trading at no more than 20-30% of book value, implying that the market had already drawn some far-reaching conclusions about the likely worth of the assets on their books. Instead of trying to performing an inflationary, market-distorting CPR on those dead assets, this verdict should have been carried out without delay and the most cancerous assets written down or off.
To the charge that the banks would then have needed far more new capital than it was possible ever to furnish, I pointed out that the typical Eurobank had around 40% of its assets (some €12.3 trillion) in the form of loans to other banks, in addition to which approaching 10% (€2.7 trillion) took the form of credits extended to Eurozone governments.
Why not take advantage of this and subject the first of these – a capital-sapping, risk-enhancing, economically otiose mountain of largely unnecessary duplication – to a mass, CDO-style, ‘tear-up’? Open a grand clearing bazaar – for a limited time only – and get all the banks to novate, net out, and otherwise cross cancel as may of the obligations they owe one another as possible (we might also get them to do the same to the 93% of the $650 trillion in outstanding derivatives that have no non-financial counterpart at the same time, so defusing that particular time-bomb, too).
Then get the governments to redeem their outstanding liabilities by giving the banks equity stakes in a sweeping privatisation programme which would reduce the formers’ indebtedness by enacting a much more benign form of ‘austerity’, (and would eventually increase the efficient use of the assets so disposed of) while lessening the latter’s choking vulnerability to their masters’ foibles. The shares, which have no real place on the balance sheet of an institution such as a bank, of course, could then be sold on, in turn, to people better suited to own them – or the bank could spin off a mutual fund-type structure in which to house them, far away from its core, short-term intermediation function. And, yes, your author is a firm advocate of separated banking/financial functions: asset management, debt underwriting, securities and foreign exchange broking – even proprietary trading – all have their place, but that place is not to be found just down the corridor from a depository warehouse. Nor are any of these activities to be undertaken under the aegis of a whole range of explicit and implicit government backstops.
Free banking, yes: but free to fail as well as to flourish, emphatically so!
It was gratifying to see John Hussman make a series of parallel arguments this last week, when he derided the inconsistency of the present orthodoxy. As he wrote:-
That’s what’s so frustrating about the discussion surrounding bank “failure” – a $15 trillion stock market can lose 20% ($3 trillion) and it’s just a run-of-the-mill bear market. But let bank bondholders face a similar loss, and the banks cry that the whole financial system will go down. We’ll finally get some economic traction when global leaders have the sense to take bloated, mismanaged banks into receivership, mark down the assets to their actual value, restructure the repayment terms with homeowners and other borrowers, haircut the liabilities enough to make the resulting entities solvent, and then return them to the private market under a regulatory structure that splits traditional lending from securities trading. That prospect is getting closer.
Amen to that!
To wade tentatively out in to very treacherous waters and risk being called a statist, there is one – and only one – area for proposing a kind of ‘active defence’ (as opposed to an orgy of activism) on the part of the authorities while all the above reforms are being undertaken, fraught though even this minimalism is with the risk of the steps being misconstrued, with the ever-present dangers of mission creep, and with all of the ‘pretence of knowledge’ problems that come with the task’s enactment.
This is a compromise based on the weary recognition that we sometimes have to move away from the realm of the theoretically pure to the polluted sphere of the pragmatic. We do, sadly, have a central bank with which to reckon and it has allowed others to erect an unstable credit structure on top of its own ethereal emissions. When this edifice collapses, it could therefore be plausibly argued that – in order to prevent the ‘secondary depression’ from spiralling into some sort of pecuniary singularity – the CB should act to preserve a strictly-limited monetary core of demand deposits and currency. Preserve it, maintain it, assure a primary quantity of its provision – but not grow it, expand it, or target its future rate of increase: this far and no further.
To re-emphasize this point, the task in hand must be categorically distinguished from all ideas of pursuing some sort of ‘higher level’ tinkering, such as that of trying to maintain levels of, or restore some estimate trend growth to nominal GDP.
The latter of these proposals – in truth, just another variant of top-down inflationism – is espoused by several disparate schools of modern monetary cranks, but the former – the maintenance of the level in order to counter shifts in ‘velocity’ – is also something the far more reputable Fractional Free Bankers endorse, albeit, in their case, by a bottom-up, spontaneous means, and not by a ukase from the Tsars of Threadneedle St. If it were to be practised, however, it is hard to see why it should be based on trying to steer, by monetary means, such a horribly flawed and tardily released measure as GDP, at all. Far better to look at total economy spending – as best approximated by its flipside, business revenues. That would be to use what is not only a more timely and less manipulated measure, but one which does not, by definition, leave out 60% of higher-order economic activity – and the most variable 60%, to boot – as a focus on Kuznetzian, end-goods GDP does.
But, in truth, all of this strikes me as fundamentally flawed. Whatever the target datum, the problem still remains that if we have had a bubble in which we have overstretched the productive structure compared to the ‘pool of funding’ – i.e. we have engendered mass error in our undertakings and some good fraction of the firms contributing to that prior revenue flow have, as a result, been revealed to be unviable and so need to disappear, taking their contribution to the transaction tally with them as they do. If we are simultaneously trying to keep that overall flow number UP (much less growing it as most NGDP types want to do), we are again pushing money in a different direction from the one the real economy is trying to take – we are once more making it a source of disco-ordination rather than a medium which transmits crucial relative price signals and circulates goods and services as neutrally as possible.
Better to have flexible prices, rigorous accounting, and an unshrinkable money core against which to come to rest! This will allow real balance effects to take hold eventually and will guarantee that prices find a bedrock below which they cannot fall by themselves acting to diminish the money supply.
At that point, the CB can then make amends for its malign impact and proven incompetence by ringfencing that money stock and promptly abolishing itself.
Beyond this, policy should therefore be focused exclusively on the reality of micro adjustment and not succumb to the illusion of macro manipulation. It should balance genuine and immediate PUBLIC austerity with significant cuts in taxes so as to restore people’s income, but, more importantly so as to give them back the discretion to manage their own affairs, according to the unique circumstances of which they, not some federal bureaucrat, are best cognisant. If as fearsomely efficient an institution as the German General Staff can recognise its own limits of operational control and devolve a good deal of decision making down the most local level, via the doctrine of Auftragstaktik, so can our less stiff-necked, civilian masters. If they want more scope than that, let them all go and boot up Second Life or the Sims or something instead, where they can play out their Platonic fantasies of directing history in the round without doing any harm to their fellow men as they do.
Our platform would also act to restore the self-esteem and the sense of self-responsibility of the ordinary man and woman and so reverse some of the debilitating demoralisation they have undergone at the hands of the Nanny State. It would confer the added advantage of letting everyone know the worst at once and so would encourage them to get on with working their way back out of the slough instead of condemning them to long, grinding years of sub-par performance relieved only by intermittent bursts of arbitrary exactions and newly-imposed restrictions from on high.
Ron Paul often points out, correctly, that, in the US, the federal deficit has gone from a pre-crash base of around $450 billion a year – which was already then deemed to be unsustainable - to two and even three times that, with spending up likewise from $3 trillion per year to $3.6 trillion. As he rhetorically asks, was the place a depopulated wasteland just four years ago before all that extra dole was ladled out – and, if not, why do we think we risk pulling civilisation down around our ears if we trim back even to normal peacetime levels of profligacy? UK state spending, for any of my compatriots here inclined to feel smug, is still a sixth higher than when the wheels came off the Boom, for all the protests of better housekeeping.
To sum the moral of all this by means of an anecdote, your author was fortunate enough to appear on TV with a very unassuming, but highly convincing CEO of a British engineering software company the other day. The firm, he said, was thriving amid all the turbulence, as its latest results confirmed. But he soon admitted that he and his fellow executives did not know what to do with the excess cash they were accumulating. They were loath to spend it willy-nilly in the present climate and so were instead having to waste valuable entrepreneurial decision-making time trying to keep it safe from the potential effects of any or all of the often unforeseeable levels of currency, regulatory, or political upheaval.
The key word he – and his many peers – keep re-iterating is ‘uncertainty’ – and that uncertainty is in large part the bastard child of swivel-eyed activists in office, with their delusions of grandeur and their fatal conceit of being able to decree what, where, and when their millions of compatriots should and should not do in order to rectify the awful consequences of the mistakes, they themselves, these Ivory Tower absolutists and Jack-in-office Jacobins, have visited upon us all.
As the old gag goes, the best advice is: ‘Don’t just do something – sit there!’
“A central power, as enlightened, as skilful as can be imagined, cannot by itself encompass all the details of the life of a great people. It cannot, because such a task exceeds human power. When, on its own, it wants to create and put into operation so many different mechanisms, it either contents itself with a very incomplete result or exhausts itself in useless efforts. China seems to me to offer the most perfect symbol of the type of social well-being that can be provided by a very centralized administration to the people who submit to it. Travellers tell us that the Chinese have tranquillity without happiness, industry without progress, stability without strength, physical order without public morality. Among them, society functions always well enough, never very well. I imagine that when China opens to Europeans, the latter will find there the most beautiful model of administrative centralization that exists in the universe.”
— Alexis de Tocqueville, ‘Democracy in America’
“It seems certain that not a little portion of the silver fell into the hands of high-ranking officials, soldiers, and important merchants, who sucked wealth from the financial system… The unprecedented riches of officials and merchants astonished the ordinary people of sixteenth century China. The cities they inhabited became islands of prosperity that stood in painful contrast to rural areas stricken by poverty. In spite of the important role of state finance in the economy as a whole… the exploitative system of Ming finance provoked the local peoples’ antipathy against the central government. The growing scale of state finance, instead of strengthening the power of the state, provided new opportunities for officials and soldiers to accumulate private wealth and power at public expense. Some of these private powers benefited from the trade boom… and grew into semi-independent… groups. The authority of the Ming in the world of East and Southeast Asia was lost during this turbulent age. The Ming dynasty was no longer the powerful centre of Chinese world order that it had once been.”
— Kishimoto Mio, ‘Chinese History and the Concept of Early Modernities’
If anyone should be in search of a bellwether for the degree of ‘austerity fatigue’ being suffered among European electorates, he need not look only at the travails being suffered by governments in the Netherlands, the Czech Republic or Romania, nor even Françoise Hollande’s capture of the Elysée Palace, but at the otherwise mundane local government results as they have just been returned in Britain.
For there it has transpired that, two short years after throwing the remaining scoundrels of the Blair-Brown junta out of office in recognition of the fact that its thirteen years of crony-infested misrule had gutted industry, sharpened social divisions, blown up the banks, and delivered the aspiring classes into an over-mortgaged slough of snooped-upon despond, the collective distaste for that uneasy Coalition of the Unwilling – struck up between a gerrymander-enfeebled Tory party and the perpetual bridesmaid Liberals – caused a mass electoral swing back to the real authors of much of the voters’ present misery, one sufficient to give them a clear 86-seat majority in the House were the proportion to be replicated at the next general election.
Not that this should come as too much of a shock. After all, the singular achievement of the last regime was to engineer an inordinate increase in its patronage network and hence its psephological resilience in the face of its unmitigated culpability. Given the vast rise brought about in both the numbers directly employed by the state and of those critically dependent upon its soft-budget largesse in the notionally private sector, and given, too, an endorsement of the alternative parties in 2010 so half-hearted that it left two mutually distrustful and ideologically distinct groupings trapped in a marriage of convenience as nakedly ill-founded as could be, it was only a matter of time before the ongoing grind of repairing both public and private finances which it was their unhappy lot to undertake fell victim to the force of circumstance.
Such an outcome could probably have been avoided only had one party been accorded a clear mandate and had its leaders then seized this fiat armed with a firm resolve to undergo as much of the necessary pain of redemption in as short as time as possible. This would have allowed for an earlier rebound from a much steeper initial fall and hence been conducive to a rapid rekindling of hope and renewed enterprise. Alas! The forthrightness of the forerunners of the senior partners in this misalliance, whose case partly paralleled their own, two decades previously, is not something deemed fit for modern sensibilities. The latter-day Lazarus is not to be administered strong medicine and then bade to take up his bed and walk, but is instead to be weaned off his addiction step by demoralising step, thus exhausting his trust in his physician while prolonging the weariness of his convalescence beyond all human endurance.
For all the fashionable Keynesian disdain for us Austrians and our insistence on facing hard facts with the least delay and absent all monetary obfuscation, here, four years into the meltdown and yet with the noisome corpse of its frustrated hopes still not decently interred, can it really be doubted that we are the advocates of an approach which is not only the most economically efficient; the least unfair (in not maintaining the TBTF destroyers of our prosperity to enjoy the undeserved emoluments of their positions, nor penalising the thrifty at the expense of the profligate, nor the worker to the benefit of the speculator); but also one which actually promises its enactors a solid chance of electoral reward for their vision?
But, of course, part of the Tory-Liberal defeat in the UK is not really a ringing endorsement of a supposedly rejuvenated Labour Party, but rather a rebuke to Tweedledum which can only be delivered in most modern polities by briefly seeming to favour Tweedledee. This sense of being trapped onboard a dreary, Janus-faced, establishment carousel was well expressed across the Channel when, in her characteristically sardonic style, Marine le Pen said she would not recommend her now disenfranchised supporters to cast their votes for either of two men only competing to see who would best do the ECB’s bidding! Indeed, the Swiss cartoonist Stef put this even more sarcastically by envisaging Mme Le Pen being confronted by a dim-witted TV interviewer who says to her: “ We heard you advising your followers to vote ‘blank’ in the next round, but, come on, do tell us just which of the two blanks you want them to vote for”!
Such is the prevailing mental apparatus of those in power and the nomenklatura – the ‘socialists of the Chair’ – who advise them that we must look in vain for any radical thinking, for any truly invigorating ‘austerity’ where impediments to enterprise, both pecuniary and regulatory, are swept away along with the dead weight of oppressive and unaffordable bureaucracies and where budget balance is not to be sought by trimming in desultory fashion at the far-flung edges of a sprawling forest of entitlement while ladling ever more from a shrinking stock of private income in order to preserve the vast overweening bulk of the peculative, Provider State intact.
All the King’s Horse & All the King’s Men
In Europe, as readers should by now be aware, this has brought about the Continent-wide noyade of tying balance sheet-busted banks and spendthrift sovereigns together and drowning them in a lake of LTROs in order served to subvert the German – as well as the European – constitution by building up a $1 trillion shadow bail-out total on the TARGET2 non-clearing system. At one and the same time, this has reduced the proportion of unencumbered assets on bank balance sheets – and hence their private sector creditworthiness; it has perversely concentrated the Zone’s lacklustre money creation on its barely-resilient, Teutonic core at the expense of its deflation-racked periphery; and it has financed nine-figure amounts of capital flight which, in the single example of Spanish central government debt, has amounted to no less than €90 billion in the last two quarters (around a third of same-period GDP).
In America, it has allowed for a recovery which has perhaps been rendered all the more anaemic by dint of the widely acknowledged unsustainability of many of its premises. For example, many there correctly doubt the ability of the federal government to continue to run deficits well in excess of $1 trillion, year after year – doubling the debt stock since Lehman fell and growing it by $4 trillion more than can be extrapolated from its pre-crisis trend – while still expecting its obligations to pay less than the rate of expected CPI increases, as they are currently priced, for the whole of the first quarter of the century.
Many are also disquieted by the Fed’s intent to stick to its course of pumping up the money supply by 10% each and every year – as it has done since the autumn of 2008 – while suppressing nominal interest rates to as near zero as possible, as far out the curve as possible. Intuitively, they fancy this cannot be done without occasioning either or all of another horrific misallocation of capital, an accelerating rise in the cost of living, or a disruption to the entire international monetary order.
Though it is impossible to set a date by which Americans will finally stop being asked to ‘believe six impossible things before lunch’, these 300 million Red Queens, all running frantically to stand still, must intuitively be aware that the day of reckoning still lies ahead of them. Such a premonition, however dimly perceived, can not but dissuade the less feckless of them from overcommitting their scarce resources to an upswing they suspect to be so weakly founded in a genuine economic dynamic.
Across the wide, blue Pacific, the news of late has been equally discouraging. Trade numbers have been notably weak in Korea, Taiwan, Thailand, the Philippines, New Zealand, and Indonesia (as well as in that other poster child of the Asian-led resource boom, Brazil), while recent production data also look sickly in both Korea and Australia.
The importance of this is that the last economic cycle has, as we continually point out, been characterised by the extraordinary growth of world trade – up in volume terms by 75% compared to a GDP increase of less than 50%, and in dollar terms almost tripling versus a GDP doubling, in the last decade – with much of that trade being dominated by what has been afoot in the Asia-Pacific region, in general, and in China, in particular. Where trade has led, productive capacity and output has followed, needless to say.
Thus, a slackening of the pace of imports and exports across this region is a warning that not only are our Occidental woes sapping Oriental energies, but that their own, internal drivetrain is in need of a serious overhaul.
Partly, of course, this is a result of China’s own violent monetary switchback which saw the yearly gain in M1 accelerate more than 30 percentage points in the year after the Crash to reach a near-incredible 39% in early 2010, before this renminbi equivalent of the Yellow River in full spate suffered so harsh a drought that January just gone saw it trickling onward by a paltry 3% – at least a two-decade low. Debate still rages over just how much damage this has wrought, though the agonised tone of the political debate should perhaps caution us against being tempted to put too much faith in the anodyne official aggregates, even if some refuse to trust either the anecdotal evidence of much more severe commercial distress or accept our own, basic economic understanding of how such things usually pan out.
Leaving such polemics aside, on a more fundamental level, we seem to be confronted with a choice between three main courses for China to follow in the foreseeable future.
The first is the one on which much of the market is still pinning its hopes, viz. that there will soon be a further episode of purposive re-inflation of both asset and commodity prices. In essence, the Pollyannas hope that the Beijing authorities will continue to behave like true disciples of the barbarous cargo cult of Western central banking and will press hard on the gas pedal any day now, in order to trigger the air-bag of a tertiary bubble and so cushion the impact of the collapse of the secondary one blown in real estate two years ago, an enormity which, the reader will recall, was itself subject to an enthusiastic policy of encouragement in order to replace the imploded export boom of two years previously again.
Even though this assumption goes against the grain of everything emanating from the official mouthpieces of the regime, in truth, we cannot unequivocally rule this out. If the harshness of the so-called ‘landing’ is deemed to entail a greater threat to the Party’s overriding mission of self-preservation than any of its likely side-effects then the calculus will no doubt change. Perhaps the main thing militating against a repeat of this destructive stop-go, however, is the undeniable association in the popular mind of such exercises in the mass provision of credit with corruption, influence peddling, and an aggravation of the unequal distribution of spoils which is endemic in any inflation, much less when this takes place in a society where the lack of a free market means that far too many resources are still being allocated by the arbitrary factors of party standing and patronage.
If the Bernanke Fed can excite a unanimity of derision from such otherwise incompatible groupings as the small-town focused, small-c conservative Tea Party and the right-on, urban, radical unwashed of the ‘Occupy’ movement by being seen arbitrarily to shower its largesse on the bloated plutocrats of Wall St, how much more irate will the average Chinese become when the rising cost of his daily noodles and the increased hopelessness of his struggle to offer his would-be bride a marital home stands in opposition to the swagger with which the Calvin Klein cadres and Moschino Maoists disport their ill-gotten gains in the boardrooms of the price-hiking SOEs and the congress halls of the party apparatchiks?
That the regime is aware of this can be seen in the weekend editorials in the People’s Daily which set the blame for much of the current malaise firmly at the doors of an over-expansive central bank and warned of the imminent danger of stagflation if monetary policy were again to be unleashed in the attempt to counter the current slowdown. Not much room for equivocation, there, one might think, meaning that there will be no major reversal, but rather a drip feed of expedients aimed at mitigating the worst of the slowdown for each sector and each region in turns, mainly through reforms of the institutional or regulatory framework and through tax changes, rather than liquidity injections of the scale of 2009.
‘Muddle through’ would be the watchword here and a dispiriting prospect it would be to China Bulls and China Bears alike.
The second possible pathway for China is that, constrained by considerations such as these, the gathering storm brewed from the turbulent confluence of rising wages (many of them mandated from on high), sluggish sales, scarce (and arbitrarily distributed) credit, and over-burdened balance sheets is either deliberately allowed to blow itself out or else it proves too violent a blast to by withstood by the shelter promised by the exercise of fiscal ‘fine tuning’ and piecemeal monetary relaxation. Austrian malinvestment busts are usually well up on the Saffir-Simpson scale of destruction and are equally typically well shielded from the mainstream macromancers’ radar networks, so this eventuality – the so-called ‘hard landing’ scenario – while inherently unpredictable, is not to be ruled out, by any means.
We must here be in no doubt that even if the Chinese leadership does enjoy a certain leeway, denied the authorities elsewhere, in disguising losses, supporting state zombies, and commissioning innumerable, offsetting, Keynesian ‘masses for the dead’. It may thus be that it has the capacity to postpone a final accounting for another goodly slice of the investable medium-term to come. This is especially the case while the lack of ready capital convertibility comprises a system of levees within the confines of which the state can slosh entries from one set of books to another. No matter how much flexibility this imbues in the regime’s planning, it cannot, however, suspend the laws of economics, or even exceed the fictional extremes of accounting, indefinitely. One day, Ozymandias’ ‘colossal wreck’ will again lie toppled amid the ‘lone and level sands’.
When trying to gauge how shattering will be his fall, we can do no worse than to consider the sheer scale of the misdirection of capital which has taken place in the country. For example, note that, in the past three years alone, China has increased the length of its expressways by a massive 40%, taking their span to a 15,000 mile total which is now beyond those of both the much richer European Union and the comparably geographically extensive USA. It is said to have more high-speed rail track – some 6,000 miles – laid than has the rest of the world combined. Work was halted on projects which would have seen this doubling again, last autumn, in the wake of the Wenzhou train-wreck, a tragedy which served to call into question the parlous state of the Railway Ministry’s finances (it lost another Y7 billion in QI), as well as that of its operational competence.
Car sales have already been so ‘brought forward’ by the Middle Kingdom’s version of the cash-for-clunkers stopgap that they have all but halted this winter, as have white goods sales – which were similarly advantaged post-2008. At 60+ GW, China accounts for a quarter of the world’s installed wind power capacity: a shame then that profits for its 100-odd domestic operators are becoming more and more elusive, with anything up to half the turbines lying inactive at any one time.
Not that the lesson has been entirely taken to heart for, as the squeeze on residential construction continues, talk is now of frustrated real estate moguls embarking upon another profligate wave of commercial construction – taking the form of so-called HOSPA’s, or integrated complexes of hospitals, offices, schools, parking, and accommodation. As usual, the suspicion is that, in this Bizzarro, ,‘Field of Nightmares’ world of investment for its own sake, they may well build it, but, by the same token, no-one may ever come.
Notoriously, the country is reputed to be possessed of some 64 million vacant apartments – a plethora equivalent to more than the past three years’ growth in an urban population which has already reached a plurality and which is, in any case, set to see its increase slow dramatically in coming years. At least that is what is implied by a 2010 census which reported a slump in the total fertility rate from the already sub-replacement figure of 1.85 recorded in the 2000 edition to an alarmingly low 1.4. This puts the country below even Russia, on a par with Europe’s greying polities and barely ahead of the self-extinguishing Japanese.
Compound this bald average with the one child-driven gender gap of 117 males for every 100 females under the age of 15, and of 106:100 for the 15-64 age group, and it is apparent that the overall headcount is about to undergo a steep decline, with the dependency ratio rising commensurately. Not exactly what either a bullish real estate developer or a hopeful condo-flipper wants to read, particularly when, as the relevant Vice Minster, Hu Cunzhi, has pointed out that urbanization of land has increased 1.85 times faster than the urban headcount in the last decade.
Even if all these contradictions, all this sub-marginal, top-heavy investment and egregiously indebted local authority spending, do not come toppling to the ground in a heaven-obscuring cloud of dust, the third way ahead might still usher in changes which are no less profound, if nowhere near as dramatic.
Here we speak of the fabled ‘rebalancing’: of the abandonment of growth for its own sake and a disavowal of capacity extension for kudos and career enhancement rather than capital return. The achievement of this shift is, remember, the publicly sworn intention of a central government accorded a near divine status in the estimation of both credulous Western stock promoters and envious dirigistes. Therefore, they and we – for all we may doubt either the CCP possesses either the intent or the instruments to bring this about – must at least consider what the landscape of a future China would look like were it to succeed even partially in effecting this transformation.
As we consider this, it is important to begin with the recognition that a good part of the current set-up is dependent upon the channelling of cheap credit as well as savings (whether ex ante-voluntary, or post hoc-‘forced’) towards the erection of plant, the digging of mines, and laying out of infrastructure with little thought as to their prospects of providing a realistic return on investment. The case of the steel industry (in some cases currently said to be turning to pig farming as a sideline, in the desperate attempt to make ends meet!) is a classic example. Having grown headlong from 15% of total world output to 45% inside the last ten years, we now find the People’s Republic endowed proudly with a vast industrial segment which only declared a gain of 3-4% on equity last year – below even the somewhat suspect official rate of inflation – and, even if these profits were genuinely come by, testament to a negative real return on capital employed, given that the sector is said to carry debts of around $400 billion, to boot.
With land often afforded to such businesses on easy terms from growth-hungry, soft budgeted local governments all too happy to clear away those unfortunate existing occupiers who are typically bereft of the protection of well-defined property rights; with labour costs lowered by exploitation of the houkou system which discriminates against rural ‘immigrants’ by denying them access to basic benefits in their own land; with subsidised energy inputs on tap and with precious little consideration attached to safe or sanitary waste disposal at the end of the production line, rigorous cost accounting has perhaps not been deemed a sine qua nonthus far.
With few dividends to pay or bank loans ever to redeem (and hence a decided lack of capital discipline to endure) and with either the sweetener of an export tax rebate for those facing outwards, or a quasi-monopoly cost-plus framework for many of the large SOEs which dominate the internal market to enjoy, the old game of expansion for its own sake cannot fail to have induced its players to be wasteful of resources, largely indifferent to the cost of such inputs, and, hence, insidious destroyers of wealth.
However it actually does go with this putative reform programme, one cannot deny the fact that, should the focus switch away from protecting producer interests (as is prevalent in all primitive-mercantilist or socialistically-retrograde societies) towards promoting consumer ones, much of this monstrous profligacy will have to be curbed.
Taming the Dragon
Implied in such a shift is the process of making profits by serving one’s customers’ needs better and cheaper than one’s competitors can do, and not just running the assembly line and firing up the furnaces in order to fulfil the latest, top-down physical output quota. Instead of generating ‘profits’ by shifting large amounts of under-remunerative expenditure below the line, and hence not fully costing it (perhaps using financing granted by such goods’ own vendors out of the proceeds of the virtual sales they thereby make), or through employing the company’s working capital and credit lines in ‘curb’ lending (or even outright loan-sharking) and capital account-dodging, commodity-collateralised, currency speculation, sales will henceforth have to achieve a genuine premium over properly registered costs or else failure will rightly beckon.
Though the scale of the novelty might be shocking to some, credit will then have to be provided at a proper market price – i.e., on a risk-adjusted basis – and not simply granted at an unvarying, homogeneous interest rate to meet a state-owned bank’s loan expansion target, or to reflect the central government’s shifting menu of industrial preferences. That same bank will have to compete for deposits in the open market, which will tend to involve paying a positive real rate of return once in a while, as well as seeing to the implementation of proper credit controls and the observance of strict repayment schedules.
Instead of relying on a pliant workforce to subsidise its own jobs by passively funnelling hard-scraped savings back to the megaliths of the industrial complex at repressed rates of return, companies will have to compete for financial capital, perhaps by paying dividends to a new middle-class of privatisation-empowered shareholders. We can but dream, but they might also have to contend on a far more equal footing with a host of small businesses and start-ups, staffed by many of its erstwhile wage-slaves, for the custom of those who today make up its disgruntled captive client base by default.
Such developments could hardly fail to temper the urge to crash industrialisation or to the me-too parochialism of the lower echelons of government, who may no longer feel they must each keep up with the Comrade Wu’s in the neighbouring division by building their own shopping mall, their own airport, their own 5-star hotel, smelting plant, and factory complex in the sort of debt-laden, vanity project mentality which, it is gradually beginning to emerge, may have characterised the disgraced Bo Xilai’s shop-window ‘state capitalism’ in Chongqing.
If all this could be achieved – and begging the question of whether it even could be achieved under the aegis of the present authoritarian political structure – we would argue that the ordinary Chinese citizen would ultimately enjoy a higher standard of living than he does today and that he would probably feel less put-upon, into the bargain. As his and his peers’ affluence grew, this would undoubtedly increase their call upon certain commodities, but it would also restore those incentives – so woefully absent at present – to innovate, to economise, and to act entrepreneurially so as both to minimise their use and to maximise either their supply or that of their existing and yet-to-be discovered substitutes.
However far short we might, in practice, fall of such a Utopia of Manchester liberalism in the coming years, what we would not see would be a prolongation of the sort of resource gluttony we have experienced throughout the past cycle when the country’s voraciousness has been truly beyond the Pale.
China, which represents perhaps a tenth of global trade and global GDP and a fifth of global population has manoeuvred itself into a position where it routinely constitutes more than two fifths of a the global consumption of a whole range of key minerals. Worse still, as work we have done reveals, it has lately found itself responsible for what in some cases is considerably more than 100% of the incremental demand for such materials (growing its take while the rest of the world has shrunk its portion), despite contributing under a tenth of the simultaneous increase in world population, a sixth of overall trade, and at best a third of the entire incremental output which has resulted from the use of these resources (that last maximum largely an artefact of the lag between the peak and trough of our own post–Tech, credit supercycle and its ill-judged 2009 attempt to compensate for its shattering disappearance over its own event horizon).
Nor should we fool ourselves that this naked greed for the bounties of the earth can or must rise henceforth quite as inexorably as the 12-inch ruler extrapolations made by the unholy alliance of environmental exhaustion alarmists and mining chief executives would have you believe. Barclays has recently released research propounding the view that, with regard to the outlook for agricultural commodities, per capita calorie, fat, and protein uptake in China already exceed that which obtains among some of its better-off Asian neighbours; a finding which implies that, unless its citizens immediately surrender their iron rice bowls and mutate into supersize, McDonald’s-munching Americans, the steepest gradients may be behind us.
Our own findings, suggesting that a far worse disproportion applies for a host of harder commodities, are broadly supported by a paper recently published Down Under by Professor Ross Garnaut of the University of Melbourne. In this, he concludes that it is patently unreasonable to expect that all 1.3 billion Chinese could somehow acquire the same average industrial profile as the mere 70 million special cases extant in South Korea and Taiwan (the latter’s population not much more than that of Shanghai alone).
If not, far more reasonable comparisons would then have to be made to the developmental trajectories of the much more populous nations of Japan, America, and Europe. These suggest that China is already well ahead of where such more relevant historical precedents suggest it should be for its level of advancement. That this is already beginning to be recognised more widely in the case of steel – which, curiously enough, is not among the most important commodities to those in finance, even if it cedes first place only to oil as a traded commodity in the real world – shows that the argument may have some merit. It may also explain why BHP Billiton felt it had to reinsure investors last week that it would not henceforth be spending willy-nilly in order to help repave Xanadu, nor that it was unable to rein in its outlays in fairly short order should the metals-clad pavilions of fabled Cathay ever begin to totter.
If I Had A Hammer
In summary, we know that commodity pricing has been unusually strong during this stripling century partly because of the rise of the new Asian productive networks, centred in China; partly because the West enjoyed an easy-money boom made all the more palatable to policy setters by dint of that same Asia’s proficiency in churning out cheap manufactured goods at the expense of a climb in resource prices which was systematically ignored by Occidental central bankers in their obsession with the statistical fiction of ‘core’ CPI .
It cannot be denied that the best returns of the past decade have accrued to those shrewd investors who did not try to navigate the shark-infested Chinese waters whose attempted passage has humbled even such luminaries as Anthony Bolton, but who were early in adopting the strategy of selling ‘shovels in the Klondike’ – i.e, those who did not buying direct stakes in the gold rush itself, but rather who committed funds to those well-governed, entrepreneurial companies and previously underinvested resources which they estimated would see the most demand from thence.
Here, what we have tried to raise is the question of whether those halcyon days are now behind us, rather than simply being in intermission. Personally, the author finds it hard to avoid the inference that, barring a monstrous policy mistake emanating from Beijing, absent an unlikely early renaissance in Europe, and lacking a full-throated return to the Go-go years in the United States, this might, indeed, be the case and, if so, a great deal of market positioning – as well as corporate planning – is predicated upon what is fast becoming an outdated reading of the dominant trends.
Conversely, we also know that the only attempt which our masters can conceive of making to address the disastrous legacy which a too easy, too fiscalized, and too readily internationalized monetary policy has bequeathed to us is that of printing ever more of the blessed stuff. Soon enough, those at the helm of the tutelary Provider State who are either too fearful or too obstinate to compel their restive electorates to accept that they have been promised far more costly entitlements than can ever be honestly fulfilled may also give up the unequal struggle to make their voters face a painful reality.
When they do so, they will again be tempted to re-open the Keynesian spigots, issuing yet more billions of their doubtful pledges with the implicit backing of their pliant central banks, so as to take advantage of interest rates which have suppressed to perilously low levels and which will continue to be capped for as long as is humanly possible. That this is no fanciful prognosis can be seen in the fact that, even within the very throne-room of the kingdom of the blind, the partially sighted Richard Fisher at the Dallas Fed has forthrightly accused his own institution of seeing ‘every problem as a nail: its only tool a hammer’.
If this is continued beyond the point where the current, highly unusual willingness to hold on to a large fraction of the superabundance of newly-created money – and thus dampen its worst disruptions – begins to evaporate, what we have called the Spectre of 1937 – that fear of tightening too early which will almost guarantee the tightening comes too late – could well turn this into a ‘Flucht in die Sachwerte’ – a flight to real values – as Mises was wont put it. Commodities, whatever their travails in the interim are of necessity to be included in the real objects of such a sauve qui peut and should therefore appreciate greatly in terms of paper currencies, should such a panic ever break out.
Each successive resort to the printing press may well bring less and less material relief to a world still trying to maintain the pretence that the pre-Crash reckoning of prosperity was a sound one and still striving therefore to return valuations to those that prevailed in that particular vision of El Dorado, but the repeated recourse to inflationism will teach people that they should seek out ways of protecting themselves from its malign effects.
As they do so, they will eventually act upon their new-found understanding and then, instead of assuagingthe fever as they are today by holding money, they will begin to aggravate it by accelerating their purchases and building up their precautionary stocks of goods. And that will be an evil day, indeed.
Extraordinary things are happening in China, as we know. On the liberty-loving front, we can report a really interesting and path-breaking conference organised by our friend Ken Schoolland:
The Shanghai Austrian Economic Summit
A milestone event this summer in China. Sponsored by the International Society for Individual Liberty, we have 20+ speakers, 8 from the Mont Pelerin Society, attendees from across Asia, Europe, and the US, and a post conference tour.
On a related note, Sean Corrigan informs us of another exciting development for Chinese liberalism:
For most of the last century the default currency for international settlements has been the US dollar. This has given America ultimate power over international trade. In recent months, the US wielded this power against Iran, making life extremely difficult for all Iranians. Importantly it has interrupted oil trade with India, China and Japan. Furthermore SWIFT, the Belgian-based international banking settlement agency, has halted all Iranian interbank transfers.
The sharp lesson for nations in Asia is that their own trade security is best served by having an alternative settlement medium to the dollar and other Western currencies. This function historically belongs to gold, but that is a last resort for central banks, and besides, many Asian central banks are gold-poor. This plays into China’s hands.
China is increasingly keen to provide her own currency for trade settlement purposes. She sees the dollar-monopoly as an important security threat, which is why she has in the past sought alternatives. She is now cautiously promoting her own currency for this role and is developing an offshore renminbi capital market in Hong Kong. At the same time she is evolving from manufacturing consumer goods towards capital goods, for which Hong Kong is the natural financing centre.
Her targeted growth-markets are other rapidly developing economies, as well as the whole Asian continent, and no longer the US and Europe. One of her key strategies through the Shanghai Cooperation Organisation is to build a pan-Asian security and trade bloc in partnership with Russia, and the last element of this 10-year old plan is to settle cross-border trade without using the West’s financial system. China expects to play a major part with her currency, which explains why she is adding to her gold reserves. The relevance of gold is that China will have to show to the people of Asia that her currency has better long-term prospects than the dollar, which goes some way to explaining why so many of the countries associated with the SCO are now also accumulating the metal. This analysis is confirmed by a leaked cable from the US Embassy in Beijing as long ago as April 2009 that can be seen in GATA’s database. As Iran and India also have SCO Observer status they are part of China’s grand strategy, and they have also been buying gold.
At some stage China will need to restate her gold reserves, and given this has to be credible rather that actual, she will probably release a suitable figure showing her to be the second largest holder behind the US. However, she is treading carefully, because she has to extricate herself from monetary relationships with the West, which ideally should be a gradual process: a sudden withdrawal could lead to a global systemic collapse and undermine her own dollar investments.
The question now arises as to whether an escalation of US pressure on Iran and her oil-trading partners will provoke an announcement from China about her gold. In any event there is bound to be a growing realisation of why gold is central to the economic futures of China, Russia and the whole of Asia. China’s financial and economic objectives will completely wrong-foot the major central banks that are committed to the demonetisation of gold.
This article was previously published at GoldMoney.com.
One can read The Daily Mail for its coverage of the royal family, snapshots of British life, or, if you are like me, the headlines. On Saturday, guest contributor Ian Morris, Professor of History and Classics at Stanford University, served up this classic example:
The perils of the begging bowl: Exactly 100 years ago China was ‘rescued’ by European loans. The result was a century of misery. Now the boot is on the other foot.
Morris continues to explain that 100 years ago, in 1911, the last emperor of China had just been toppled. The newly formed Republic of China was penniless (yuanless?), and desperate for loans to keep it afloat. European investors, flush with cash in what was the still prosperous pre-World War I era, flocked to Beijing to make loans to keep the newborn country afloat.
Today the eastward journey continues, but it is not made by Europeans looking to invest their savings. It is instead European politicians looking to secure loans to keep their unsustainable experiments afloat for a little while longer. While this great European experiment with the welfare state is now obviously insolvent, an attitude remains that we are only in the midst of a liquidity crisis. This view is wrong. No amount of loans can save a country from a crisis of insolvency, as has proven to be the case in Greece recently.
A more important question to ask is whether Europeans should be seeking bailouts to keep the current system afloat.
The Republic of China, formed in 1912 supported by European funds gave way to The People’s Republic of China in 1949. The latter demonstrated itself to be the most despotic regime of the twentieth century. The impoverishment of citizens by other regimes, Nazi Germany or Soviet Russia, pale in comparison to the hardships endured by the hardworking Chinese over the last century.
Several centuries ago, China was the most prosperous nation on Earth, far exceeding even Europe in terms of wealth and technology. The Industrial Revolution changed this, but China still managed to maintain its competiveness, particularly by trading with the newly arriving European entrepreneurs as shipping improvements made trade between the continents increasingly possible during the 19th century.
The loss of the Emperor in 1911 set in motion the key steps that would place the nation’s future in the hands of its eventual tyrant leader, Chairman Mao. Funds provided by wealthy European investors fomented this shift, allowing freshly flailing regimes to secure a political foothold in the late teens and early 1920s.
One must ask, with the fortune of hindsight, whether such financing was beneficial. Fostering what would later become a tyrannically regime must surely be viewed with less than rose-coloured glasses today.
The European states may not seem tyrannical in comparison to China. The point is that they are examples of countries with failed policies. One must ask if searching for ways to continue these erroneous policies is beneficial for the Europeans that must live with them. Europeans with an eye for history need only look at a similar policy pursued 100 years ago for the answer.
The basic market problem is there is too much sovereign borrowing for the money available, which would normally drive interest rates sharply higher. Some countries have got round this by printing money while pretending they are issuing bonds. A few countries are unable to do this, because they lack their own printable currencies. And that is the root of the problem faced by the weaker eurozone members.
This problem for some of them has become so acute that they cannot now fund their deficits. What is less obvious is that these highly-indebted states also have to roll over existing debt as it matures. Traditionally this debt has been absorbed on a replacement-basis in the markets, but that only works as long as the markets are fundamentally confident, which they are no longer: the inability of the political classes to resolve their difficulties has seen to that. Therefore, as bonds mature, investors and banks are unlikely to re-invest, preferring cash. Even if the weaker states are able to fund redemptions, from an expanded European Financial Stability Facility (EFSF) for example, this will be used to reduce euro-denominated bank credit and improve capital ratios.
This need not be a bad outcome, because the economic effect is to simply transfer the funding of sovereign debt to the EFSF. The question is who is going to fund the EFSF, which with its gearing is a risky proposition? There are only two possibilities: the ECB (which should not be assumed at this stage) and those with trade surpluses to recycle, particularly China. And since she is the only major source of this potential funding in the running, she is in a position of enormous negotiating power.
Looking at the proposition from China’s viewpoint is instructive. She is being asked to bail out profligate nations, who have run out of credit and whose citizens enjoy a far higher standard of living than their own. It amounts to a position of power ahead of her economic development. Furthermore, China’s economists were brought up with the Marxist dictum, that capitalism ultimately destroys itself, so they are being invited to merely delay something that is inevitable. Will they fund the EFSF? Beyond perhaps a token amount, it seems unlikely. But will they stand back and let Europe sink? That would be a missed opportunity to wield her enormous power, and we need to give this thought some historical context.
The one thing the Chinese have learned is that they cannot guarantee their own security through military means alone, they also require economic strength. This was the reason old-style communism failed. It has taken them only thirty years to acquire that strength. To consolidate it, they now seek to eliminate their dependency on the US dollar. Therefore, the price Euroland will have to pay for funding is that either the Chinese are given some control over the euro, perhaps by having permanent representation at the ECB, and/or there must be a material advancement for the yuan in trade settlements. And it is unlikely loans will go through the EFSF, because China will want to set her own terms.
This describes the strength of her position. It remains to be seen how China uses this longed-for escape route from dollar domination, and how she plays a winning hand. Initially, she may wisely play for time, letting the Euroland situation deteriorate further, to get the terms she requires.
This article was previously published at GoldMoney.com.