Sunday, July 26, 2009
Another completely out-of-paradigm article on China/U.S.
Vitaly Katsenelson is a nice guy, but clueless when it comes to the global monetary system. A blog reader emailed me this article he wrote. My comments appear in italics under his.
> Financial commentators are obsessively debating whether the recent rise in the Chinese stock market means there’s a bubble — and if so, when it’s going to burst. My take? Who cares! What happens to the broader Chinese economy is what we should really be watching. It will have a far-reaching impact on the rest of the world — much more far-reaching than a decline in stocks.
Yes, because the Chinese economy has now become the world's engine of growth!
> Despite everything, the Chinese economy has shown incredible resilience recently. Although its biggest customers — the United States and Europe — are struggling (to say the least) and its exports are down more than 20 percent, China is still spitting out economic growth numbers as if there weren’t a worry in the world. The most recent estimate put annual growth at nearly 8 percent.
> Is the Chinese economy operating in a different economic reality? Will it continue to grow, no matter what the global economy is doing?
Yes, China's economy is growing strongly because the government has undertaken a huge spending stimulus and it mandates banks to lend. In that regard they are doing something different. We passed a spending stimulus, but it was far lower in proportion to GDP than the Chinese stimulus and it was mostly very, modest tax cuts and not spending on goods and services. We are relying more heavily on monetary policy, which can do nothing to jumpstart aggregate demand.
> The answer to both questions is no. China’s fortunes over the past decade are reminiscent of Lucent Technologies in the 1990s. Lucent sold computer equipment to dot-coms. At first, its growth was natural, the result of selling goods to traditional, cash-generating companies. After opportunities with cash-generating customers dried out, it moved to start-ups — and its growth became slightly artificial. These dot-coms were able to buy Lucent’s equipment only by raising money through private equity and equity markets, since their business models didn’t factor in the necessity of cash-flow generation.
This is a laughable comparison and highlights the author's complete lack of understanding of the global monetary system.
> Funds to buy Lucent’s equipment quickly dried up, and its growth should have decelerated or declined. Instead, Lucent offered its own financing to dot-coms by borrowing and lending money on the cheap to finance the purchase of its own equipment. This worked well enough, until it came time to pay back the loans.
The U.S. is not a company and can spend any amount it wants if it spends in its own currency. Lucent's customers did not have the ability to merely credit bank accounts. They, like ever other non-currency-issuing entity, had to have money to pay for Lucent's products.
> The United States, of course, isn’t a dot-com. But a great portion of its growth came from borrowing Chinese money to buy Chinese goods, which means that Chinese growth was dependent on that very same borrowing.
Well, at least he realizes the United Sates isn't a dot-com. Phew!
"It's growth came from borrowing Chinese money..." Oh, really??? So in other words U.S. consumers borrowed Chinese yuan to buy houses, cars and go on vacation trips???
> Now the United States and the rest of the world is retrenching, corporations are slashing their spending, and consumers are closing their pocket books. This means that the consumption of Chinese goods is on the decline. And this is where the dot-com analogy breaks down. Unlike Lucent, China has nuclear weapons. It can print money at will and can simply order its banks to lend. It is a communist command economy, after all. Lucent is now a $2 stock. China won’t go down that easily.
Yes, they understand a market economy and like it very much when it works, but when it doesn't work they have no problem with using fiscal policy to sustain their output and employment. They are not hindered by false beliefs and paradigms.
> The Chinese central bank has a significant advantage over the U.S. Federal Reserve. Chairman Ben Bernanke and his cohort may print a lot of money (and they did), but there’s almost nothing they can do to speed the velocity of money. They simply cannot force banks to lend without nationalizing them (and only the government-sponsored enterprises have been nationalized). They also cannot force corporations and consumers to spend. Since China isn’t a democracy, it doesn’t suffer from these problems.
Yes, the Chinese central bank has an advantage because it does not get hounded by know-nothing lawmakers in Congress and clueless journalists and commentators. Other than that, all central banks in nations that issue non-converitble currency have the same power.
> China’s communist government owns a large part of the money-creation and money-spending apparatus. Money supply therefore shot up 28.5 percent in June. Since it controls the banks, it can force them to lend, which it has also done.
So does the U.S. government. And it can get the banks to lend if it understood that lending is "pro-cyclical" and, therefore, dependent on a decent economy where people have jobs. If the government provided jobs and sustained aggregate demand, the banks would be lending like crazy.
> Finally, China can force government-owned corporate entities to borrow and spend, and spend quickly itself. This isn’t some slow-moving, touchy-feely democracy. If the Chinese government decides to build a highway, it simply draws a straight line on the map. Any obstacle — like a hospital, a school, or a Politburo member’s house — can become a casualty of the greater good. (Okay — maybe not the Politburo member’s house).
The Federal Government can provide jobs and/or sustain demand in order to ensure that our output and employment are maximized, which by definition means we would be creating the maximum amount of wealth and highest standard of living possible given our resources and capital (both physical and human), but it doesn't because of labels like "Socialist." The Chinese aren't worried about being called, Socialist.
> Although China can’t control consumer spending, the consumer is a comparatively small part of its economy. Plus, currency control diminishes the consumer’s buying power. All of this makes the United States’ TARP plans look like child’s play. If China wants to stimulate the economy, it does so — and fast. That’s why the country is producing such robust economic numbers.
The Chinese absolutely can at least influence spending by consumers. The chinese government can pay more in salaries to government workers and it can spend more on social supports so that Chinese consumers don't need to save as much for those things (like retirement, health care, etc.). That's the way it is moving. China is rapidly transforming into a consumption-based economy and they will overtake the U.S. in economic size and clout.
> Why is China doing this? It doesn’t have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost. Millions of people have migrated to its cities, and now they’re hungry and unemployed. People without food or work tend to riot. To keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system stabilizes. It’s literally forcing banks to lend — which will create a huge pile of horrible loans on top of the ones they’ve originated over the last decade.
China had a heavy reliance on exports to the U.S. and its domestic investment was geared toward building the infrastructure for that to happen. However, China just had an abrupt awakening and now realizes that U.S. policy is moving away from that symbiotic relationship, so China is taking the bull by the horns and transforming its economy by way of social spending and investment. This will have a far longer-lasting and more profound effect on China's wealth as a nation and the standard of living of their people. They will surpass the U.S. pretty quickly now. WE are handing it to them.
> But don’t confuse fast growth with sustainable growth. Much of China’s growth over the past decade has come from lending to the United States. The country suffers from real overcapacity. And now growth comes from borrowing — and hundreds of billion-dollar decisions made on the fly don’t inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.
Lending to the United States? Lending what...yuan? He doesn't see that the Chinese were merely exchanging non-convertible U.S. dollars--which they accumulated by exporting us real goods and services--for interest bearing U.S. Treasuries. They weren't "lending" us anything.
Their growth now comes from government deficit spending, as it did for most of the history of the United States. A building collapsed, so what? We have accidents here all the time. Remember that bridge that collapsed in Minneapolis a few years ago???
> This growth will result in a huge pile of bad debt — as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much.
If the debt (which is modern money), leads to growth (which is output, income and employment), then how is it bad debt? For every debt there is a credit; for every liability there is an asset; for every borrower there is a saver. That is called double-entry accounting...something the world has been using for 500 years. I guess Vitaly likes to live in the Dark Ages, still.
> Another casualty of what’s taking place in China is the U.S. interest rate. China sold goods to the United States and received dollars in exchange. If China were to follow the natural order of things, it would have converted those dollars to renminbi (that is, sell dollars and buy renminbi). The dollar would have declined and renminbi would have risen. But this would have made Chinese goods more expensive in dollars — making Chinese products less price-competitive. China would have exported less, and its economy would have grown at a much slower rate.
Yes, China engaged in currency manipulation to sustain comparative advantage. That occurred to the detriment of its own citizens. The Chinese gov't was perfectly happy doing this and Americans got valuable finished goods, cheap. But now WE are telling the Chinese to stop doing this and to sell OUR currency instead. They will achieve better real terms of trade and we will lose out.
> But China chose a different route. Instead of exchanging dollars back into renminbi and thus driving the dollar down and the renminbi up — the natural order of things — China parked its money in the dollar by buying Treasuries. It artificially propped up the dollar. And now, China is sitting on 2.2 trillion of them.
Yes, China had a desire to "net save" in U.S. dollars. That's why they built stuff and sold it to us. We got the stuff and they got a non-convertible currency, which is what they wanted. Then they merely exchanged the currency for interest-bearing accounts known as Treasuries. If China no longer desires to "net save" in dollars the U.S. would need to supply less dollars to them and the world's financial system would have a reduced "float" of dollars in circulation. How would that be bearish??
> Now, China needs to stimulate its economy. It’s facing a very delicate situation indeed: It needs the money internally to finance its continued growth. However, if it were to sell dollar-denominated treasuries, several bad things would happen. Its currency would skyrocket — meaning the loss of its competitive low-cost-producer edge. Or, U.S. interest rates would go up dramatically — not good for its biggest customer, and therefore not good for China.
China spends domestically by crediting bank accounts in its own currency. It doesn't "need" money...what money? Somebody else's money?? Where is this guy getting this stuff?? He is still on a gold standard.
The level of U.S. interest rates is set by the Fed...not the Chinese. If the Fed wants interest rates down it merely raises the level of reserves in the banking system and it has unlimited ability to do that because reserves are merely electronic credits. China doesn't have to buy another Treasury--EVER--and it would have ABSOLUTELY NO BEARING ON U.S. INTEREST RATES!!!
> This is why China is desperately trying to figure out how to withdraw its funds from the dollar without driving it down — not an easy feat.
It's very simple...exchange dollars for goods and services produced in the U.S. is how China "gets rid" of its dollars. Then the U.S. trade deficit turns into a trade surplus with China and China's trade surplus turns into a trade deficit with us. In other words...the Chinese people get richer while Americans get poorer. That's already what is happening. Simple...but not good for us!
> And the U.S. government isn’t helping: It’s printing money and issuing Treasuries at a fast clip, and needs somebody to keep buying them. If China reduces or halts its buying, the United States may be looking at high interest rates, with or without inflation. (The latter scenario is most worrying.)
Again...the government spends by crediting bank accounts. Sheesh...this guy is so confused!! This fiscal year alone the government has "spent" a trillion $ more than it has taken in, and interest rates are at zero!!! Vitaly....Hello!!!!
> All in all, this spells trouble — a big, big Chinese bubble. Identifying such bubbles is a lot easier than timing their collapse. But as we’ve recently learned, you can defy the laws of financial gravity for only so long. Put simply, mean reversion is a bitch. And the longer excesses persist, the harder the financial gravity will bring China’s economy back to Earth.
This is exactly why I AM LONG CHINA. I AM TAKING EASY MONEY FROM GUYS LIKE HIM OR PEOPLE WHO FOLLOW HIM. The only thing to worry about is whether China, unilaterally, puts and end to its stimulus and it could, because Chinese polcymakers are getting sensitive about criticism to its stimulus policies because of guys like him.