Winds of change

In what has been the most symbolic gesture of his short term in power, incoming Chinese President Xi Jinping last week made Shenzhen the venue for his first official visit. In doing so, Xi was effectively staging a re-enactment of Deng Xiaoping’s legendary ‘Southern Tour’ of twenty years ago, which was the occasion for Deng to seize control of the Party and to steer it in the direction of ‘reform and opening up’ – gaige kaifang in the argot – and thereby avert a return to the dark old days of atavistic, Maoist communism with which post-Tiananmen China was threatened.

Xi further underscored the point by paying homage to the statue of Deng which overlooks the city and by planting a tree at its base before delivering a speech laced with the promise of renewal and rebalancing. Emphasising Xi’s eagerness to present himself as a very different type of leader, the trip came after he had issued a decree which ordered officials to renounce the empty formalism of the pseudo-Marxist dialect with which their reports and speeches are traditionally so heavily larded, in favour of the adoption of a much more concise and business-like approach. Xi further admonished the Party’s senior colleagues not to indulge any further in the sort of stage-managed sycophancy which usually attends their brief excursions from the safety of the government compound. No more red carpets, sumptuous feasts, and clouds of fawning, petty cadres attending to your every whim, please, Comrade!

Next, having convened a preparatory, consultative meeting ahead of the weekend’s key Economic Work Conference, Xi also saw to it that the press waxed suitably enthusiastic about his own lack of pomp, displayed when the new leader supposedly told all his interlocutors to set aside their written remarks and to speak their minds in front of him as openly as they dared.

So far, so good – even if we have no evidence yet that this is any more than a shrewd exercise in PR. This much is, however, becoming clear: the leader (and hopefully the leadership) recognises that China is in neither the mood nor the condition to endure another round of business as usual; that the economy is dangerously out of kilter after a decade of the credit-fuelled cosseting of the SOEs; and that the teeming masses have had enough of both the endemic corruption and the shameless abuse of party privilege to which the suppression of the market mechanism and the absence of a rule of law have each made substantial contributions under Hu and Wen.

We should not get too starry-eyed about all this. For one, we do not, as yet, have any inkling as to whether Xi can carry his peers with him in the campaign which we think (hope?) he is about to launch, nor – supposing he truly can rely on their backing – whether they, in turn, can collectively see off the nation’s notorious ‘vested interests’ – whether composed of the brash Novi Homines among the state-sponsored corporativismi, or of the wily Old Guard gerontocrats and their Princeling progeny. For another, we have no idea of the mettle of the man, of his willingness to risk short-term pain for what he estimates will be long-term gain. It is easy to forswear the old nostrums when people are optimistically strewing petals in your path, but when the skies darken and the now-howling mob are casting brickbats instead, it is much harder to resist the temptation to reach for a quick and dirty fix – just ask any current Western politician.

Indeed, the irony is already there to see: Xi (and, to a lesser extent, Li) have been talking boldly about an end to blind expansion; to the furtherance of consumers’ interests over those of producers; of offering more support to private enterprise, etc., and yet the same, oh-so convenient uptick in the economic numbers which has helped kindle a brief, new flash of confidence has been conjured up by resort to the weary, old fallback of vast, debt-girdered, infrastructure schemes – mostly in the form of the mass transport projects launched in various locales in late summer as an offset to this year’s accelerating trade- and credit crunch-led decline in overall activity.

Given that this took place under the mandate of the outgoing regime, we can perhaps give the new boys the benefit of the doubt for now, but we should also be careful to pay attention to any future divergence between fine words and the parsnips which actually get buttered.

Of course, – so the Authorized Version has it – development in future will be unswervingly rational, cognisant of the needs of the individual, technologically-innovative, ecologically up there with the best of them, and its pay-off evenly distributed. Domestic demand will be the new driver (though, we can’t entirely neglect our export sector). From now on, the greatest emphasis will be put on boosting consumption (but, we shan’t let investment completely collapse, lest things get too cool, too quickly). We would like you to tone down your expectations, so that you don’t ask too much of us as we make these changes, but we will probably keep much the same numbers as we have now for next year’s targets, just in case we were to give the impression of not having anything to offer in the way of hope by adopting a more realistic set of benchmarks.

As regards all of this, we recognise the complexity of the task in hand, but we are nonetheless hoping that every yuan less (strictly, every incremental yuan less) which goes in the investment column in our GDP numbers (which our newly unimpeachable bureaucrats have been told henceforth not to over-inflate for career purposes) will smoothly and seamlessly reappear under the personal consumption heading.

At no point will any of this call into question anyone’s existing business model (save those of a few inefficient and politically-naked scapegoats) or their ability to service their debts and hence it will do nothing to jeopardize a banking system which has doubled its total assets since the old model broke in 2008, adding roughly $10 trillion to the pot in four years – not far short of the aggregate size built up over the previous 200-odd by the entire domestic US banking industry – and adding close to Y3 of new debt for every Y1 of reported GDP in that time. Every one of those loans is, of course, unquestionably sound.

Shot through all these pronouncements – and slavered over by the Occidental sell-side – is the buzzword ‘urbanization’. Much of the coming domestic demand will, we are assured, go hand-in-glove with further ‘urbanization’ and, hence, will boost sales of everything from copper to cranes, rubber to rotavators, iron ore to eyeliner in a manner which the last four years of breakneck property speculation and needless industrial duplication has not been able to do.

The only caveat here for those contemplating an imminent relaunch of the whole ‘supercycle’ is that ‘urbanization’ may not be a 100% tangible process. We say this because the ostensible slim majority of ‘urban’ dwellers, lately achieved for the first time in China’s long history hides the fact that large numbers of those now classed as ‘urban’ are formerly rural residents who have had their farmland expropriated and reclassified beneath their feet so that local government officials can sell it on to their cronies in the property development game (not before securing a good number of free apartments on the personal account for their pains, as revealed by an analysis of a series of recent corruption scandals in which the  now-dismissed paragons of tireless public service were found to have amassed anything between 11 and an incredible 80 such sweeteners for themselves).

Add to this the fact that the count of migrant workers accounts for anything up to 250 million souls – none of them able to register as permanent residents or to buy a property, few of them therefore eligible for a pension, medical insurance, or unemployment benefit (few of them even liable to be counted in China’s infamously stable 4.1% official jobless rate), all of them easily exploitable by unscrupulous – or simply unsuccessful – employers. Not only are their wages low (in part, a testimony to their low skill base and their relative lack of higher educational achievement), but – horror of horrors! – they and the families to whom they typically remit a half of their income tend to have a ‘low propensity to consume’, since their overwhelming need is for a prudential stash of savings.

What the Keynesians who abhor this state of affairs fail to point out is that these Nongmin – or peasants – derided as bumpkins by their more chic metropolitan peers, are the packhorses of the Chinese economic ‘miracle’ in more ways than one.

Firstly, they are the ones who mix the concrete, plaster the walls, sew the designer jeans, and solder the micro-circuitry which go to make up the goods that both we and their own disdainful neighbours so like to buy (it is estimated that migrants make up almost half of the manufacturing and construction workforce). Secondly, the statistics compiled by the World Bank suggest that these willing donkeys routinely transmit up to 80% of their meagre emoluments to Grandma, Grandpa, and the kids whom they have left behind in their care, back in the boondocks. Such savings as are then made from these monies are likely to constitute the same deposits which fuel China’s vast credit engine, earning less than inflation as they are funnelled at centrally-determined rates to the favoured sons of Schactian mercantilism under the country’s egregious system of ‘financial repression’.

Bearing all this in mind, it should not be hard to imagine how the authorities view the presence of this enormous shadow army of Forgotten Men – as an untapped source of embryonic Consumers on whom to pin their hopes for a ‘rebalancing’. Thus, it may be that the kind of ‘urbanization’ being contemplated by the Politburo is not so much one of building yet more high-rise ghost estates as it is of abolishing the hukou-based discrimination practised against the hordes of Gastarbeiter, each of them foreigners in their own land.

No doubt this will not be a clear cut case of either or, but a mix of the two. Some new roads, subways, malls, and sewage systems will no doubt be built and will therefore exert a call upon the world’s endowment of raw materials as anticipated. But a good part of the wave of ‘urbanization’ may simply be the extension of legal protection and access to social services to those, neither tarnished nor afraid, people who nonetheless must go down the Mean Streets of China’s already-built cities.

One additional feature of which to take note is that there has arisen a certain vogue among China’s movers and shakers for the works of the great 19th century philosopher and historian, Alexis de Tocqueville. American readers may be aware of his ‘Democracy’ which contained many timeless (and frequently prophetic) observations about the infant American Republic and what its great political experiment might portend for the world at large. Perhaps less well know is his Ancien Régime in which he advanced the theory that the Revolutionary Terror, which not only wrought so much havoc in his native France but arguably delivered all of posterity to the Jacobin heirs of Robespierre and St. Just, was unleashed not because the last Bourbon kings were overly tyrannical, but because they introduced mild political reforms; and not because their subjects were trapped in helpless poverty, but because material standards were improving and so allowed them the contemplation of freedoms other than that from want.

With this as his bedtime reading, Comrade Xi may or may not turn out to be an economic livewire, but we should certainly not expect him to follow in the footsteps of Gorbachev or de Klerk, it seems.

QE forever?

Elsewhere, the main event – or, given the sour market reaction with which it was greeted, perhaps we should say the main non-event – has been the FOMC decision to implement QEternal under the terms of which the Fed will soon be adding $40 billion of monthly outright Treasury purchases to its ongoing $45 billion uptake of MBS.

In this latest great experiment, Ben Bernanke – the primus inter pares of what John Hilsenrath has pointed out is something of an MIT cabal at the pinnacle of world central banking every bit as much a pecuniary Opus Dei as the overlapping Venn diagram of Goldman Sachs alumni clustered on the bridge of the New World Order – has allowed himself a $1 trillion-a-year programme of monetization which is essentially devoid of any term limits whatsoever. Since the plan seems to be that this extraordinary inflationism will only be abandoned when CPI is deemed to be likely to exceed 2.5% for more than a few years (sic), or when unemployment drops blow 6.5% – even these somewhat nebulous markers serving not as a ‘target but a guidepoint’ we were told by the man himself – Old Blackhawk seems to have arrogated to himself a degree of discretion unrivalled in the annals of the monetary authority.

With Japan possibly about to throw its army of cash-rich pensioners to the tender mercies of that other avid inflationist, Shinzo Abe; with the Bank of England about to fall to an avid fellow traveller (nominal GDP targeting and all); and with Europe’s banking supervision fudge almost having opened the way for a showing of ‘Enter the Draghi’, it appears that our beloved Fed Chairman will not long be ploughing a lonely furrow.

Not for such visionaries the doubts which plague us lesser mortals. No heed will they give to the kind of misgivings expressed by the BOE’s Spencer Dale who issued a veiled warning to the Governor-Elect, Canada’s Mark Carney (check out that nation’s rate of money growth, or the appreciation of its house prices, if you want a foretaste of what he would like to inflict upon an unsuspecting Britain) by echoing a very Austrian-sounding viewpoint, to the effect that:-

[A] prolonged period of low interest rates and enhanced support may delay some of the rebalancing and restructuring that our economy needs to undertake. Underlying balance sheet problems can be masked, tempering the incentives to address them. Inefficient firms may remain in business for longer and so slow the reallocation of capital and labour to more productive uses. Low interest rates and the associated forbearance might even explain part of the puzzling weakness in productivity. Monetary policy can and should provide short-term support in times of need, but it must avoid becoming a long-term crutch obstructing the required rebalancing of our economy.

Showing that not all central bankers took their doctorate under Mephistopheles, the HKMA head, Norman Chang, voiced similar concerns on Monday, saying that:-

Deleveraging is an extremely difficult and painful process, resulting in job losses, pay cuts, bankruptcies, and reduced public services and social welfare. The standard of living stalls if not declines. My view is that for all the suffering and pain necessitated by the process, this is the only way to put global finance and growth on its right track. There is no alternative cure, unfortunately… However, in reality, the process of deleveraging is just too painful.  Quantitative easing is able to provide the much desired relief for everyone, be it a household in negative equity that has overstretched itself, an over-expanded enterprise or a government faced with social unrest as a result of the stringent measures it is forced to implement. Yet, quantitative easing is the exact opposite of deleveraging… QE is not a panacea… [there is a] possibility under which the process of deleveraging is disrupted by quantitative easing, leading to sharp increases in asset prices in the first place. Yet, since such increases are not supported by economic fundamentals, any increase in wealth will be seen as transient. As a result, households are unwilling to increase spending and in the end, the real economy fails to rebound. 

He secured an unlikely endorsement in this from the RBA’s Glenn Stevens, who told a Thai audience on Wednesday:- 

It is, to repeat, not to be critical of actions to date to wonder whether private market participants, and perhaps more importantly governments, recognise what central banks cannot do. Central banks can provide liquidity to shore up financial stability and they can buy time for borrowers to adjust. But they cannot, in the end, put government finances on a sustainable course and they cannot create the real resources that need to be found from somewhere to strengthen bank capital. They cannot costlessly correct earlier misallocation of real capital investment. They cannot shield people from the implications of having mis-assessed their own life-time budget constraints and as a result having consumed too much. 

Finally, the estimable William White’s successors at the BIS seem to be keeping his legacy as a Cassandra alive if we consider Claude Borio’s latest paper, in which he concludes in forthright fashion:-

 …if policy is unable to constrain the boom sufficiently and the financial bust generates a serious balance sheet recession, policies need to address balance sheet repair head-on. The overarching priority is to structure them so as to encourage and support the underlying balance sheet adjustment, rather than unwittingly delaying it. The priority is to prevent a stock problem from resulting in a persistent and serious flow problem, weighing down on expenditures and output. In turn, this means recognising the limitations of traditional fiscal expansion and of protracted and aggressive monetary easing… Financial vulnerabilities take a long time to grow and the wounds they generate in the economic tissue a long time to heal. But the horizon of policymakers does not seem to have adjusted accordingly. If anything, it has shrunk in an attempt to respond to the high-frequency vagaries of the markets. This tension can be a major source of economic damage. The short horizons of market participants and policymakers contributed in no small measure to the financial crisis. They should not be allowed to generate the next one. 

All this sounds very much like the argument we have propounded ever since the Crisis (and, in truth, for a long while before that), but we should not flatter ourselves that just because a group of actual tenured central bankers have reached the same broad conclusion that anyone in power is actually listening. It would be nice, however, to think that now such luminaries have raised the point, whoever takes Zhou Xiaochuan’s berth at the PBOC will at least ponder the matter before engaging in any similar folly, or else all President Xi’s bold intentions to be different will be straightway set at naught.