China Capital Misallocation Not Sustainable
Essentially in agreement with Jim Chanos on diminishing ROIs for capital investment in China, Michael Pettis argues China is misallocating capital on a massive scale.
But I think there are more formal reasons to believe that China is misallocating capital. Common sense suggests that when there is massive investment with
- very little accountability,
- severely distorted prices,
- an incentive structure that concentrates the benefits of investment in specific jurisdictions and over a short time period while spreading the costs throughout the national banking system and over the debt repayment period (which can be decades),
- no or very limited budget constraints,
- factional and regional conflicts, and
- shifts in responsibility as the instigators of the investment are promoted (often because of the positive impact of their own investment initiatives),
It would be a rare system in history that did not tend towards substantial capital misallocation.
Certainly the evidence on SOE investment suggests that this is indeed what happened. A number of studies have suggested that if over the past decade you add up direct subsidies, the impact of monopoly pricing (which is of course simply a tax on households) and the interest rate subsidy, they total anywhere from six to ten times the aggregate profitability of the SOE sector. This means that unless the externalities associated with the SOEs are also at least six to ten times their aggregate profitability, they are actually value destroyers.
SOE means State Owned Enterprise. The communists are predictably wasting lots of capital in SOEs.
A couple of months ago Chanos said China's hard landing has already begun.
NEW YORK (MarketWatch) — China is heading into an economic storm, and the much-feared hard-landing of the world’s second-largest economy has already started, warned celebrated hedge-fund manager and China-bear Jim Chanos of Kynikos Associates on Monday.
On the bright side: Since China doesn't buy a lot from us we aren't as vulnerable to their economy going into the ditch as we would be if they didn't manipulate our currency and engage in such mercantilist trade practices. Also, we'll get some relief on natural resource prices if China's big construction boom and factory building boom takes a big dip. They'll eventually recover and I am still expecting them to eventually demand even more minerals and other natural resources in the long term. But we might get to grow for a while as their economy slows.
A Bloomberg poll of professional investors finds them predicting a bank crisis in China.
Most global investors predict China will face a banking crisis within the next five years, paring their appetite for the nation’s shares and eroding confidence in its leadership, a Bloomberg Global Poll indicated.
But Goldman Sachs remains very bullish about China and expects growth rates over 8% per year the next two years. Who is right?
China has four big state banks that issue new yuans. They also have a mix of private banks with high reserve requirements. One town is in trouble because it issued a bunch of credit from its private banks and some other similar type financial institutions (capital issuing funds). See the Magazine "News China, article - When Whenzhou Sneezes."
So, this particular scenario, where a bunch of private credit comes into being chasing rouge profits, is familar to us Americans. China calls this place the Wenzhou model, and they have noted that there are few natural resources in the area, yet a number of jobs came into being with private capital. But one thing has happened, as always happens with credit money, it sharpens plutocracy toward the money creators.
The structure of the loans ask for increasing outputs which vector toward those who created the money. Whenzhou citizens are now on the debt hook, and the State monetary institutions are examining it closely. What I'm speaking of here is the same thing Aristotle noticed, but economists in the West almost never notice. What type of money it is, and where it vectors is the important question. In the West, credit money is assumed to be borrowed and INCREASE itself in order to pay for the usury. Of course, this is an impossibility given the nature of this money type.
Full disclosure, I hate State Banks, as they lead to political statism. By that I mean Fascism, communism, Kings, Queens, etc. The levers of political power and money power are coincident, and that is a bad thing for freedom.
But, there is an advantage to State Banks based on their structure, and that is the easy wiping out of debt. China did this little trick when they wiped out Communist debt in the late 70's. All the majority communist industries and enterprises were just wiped clean. And all the dummy economists in the West didn't even notice. In effect, the State can perform a Jubilee. This was true in the Kings period and ancient Babylonia, where the King needed serfs to serve as soldiers. The Jubilee would wipe out debt, so soldiers didn't have to pay usury rents to landed lords.
Again, our poorly educated Western economists never seem to notice that China is NOT like us. They have a different structure. Our economist then conflate our model onto China and get confused. It is actually quite irritating to me.
All the debt and misallocation that everybody keeps worrying about often ends up on the ledgers of the state banks. Or, it can end up as loans to private enterprises. Guess what the State Banks of China have the power to do. That is right, simply wipe the debt from the ledgers. Jubilees are easy when the debt vectors to the political center.
For us Westerners, I hope we don't adopt this practice, despite its apparent superiority over our system. We have private banking that is leading to neo feudalism. In our case, our bankers want everybody in debt to them, including our Federal Government. This debt is not concentrated in a political center, but it is dispersed, and hence contracts will attempt to be enforced in the confusion. Poltical Statism with tied State Banks is China's way. Our way is Neo Feudalism with mostly private money, which leads toward another form of Statism #Oligarchy#.
The third way, not mentioned by our Oligarchy, is control of the money supply volume by the Government, which is really we the people. The third way, has debt vectoring back to the savers, and not to the political center. In this way freedom is preserved and we avoid the debt driven cycle of civilization that Aristotle noticed, e.g. Democracy to Oligarchy to Tyrants #Kings# and then back to democracy. In reality, China is closer to the Tyrant Kings phase where Jubilees are possible. The kings can wipe out debts easily, leading to land reform and then the serfs get a measure of freedom, leading back to Democracy.
My kids are ready to open their presents now. Hope this insight helps you. Merry Christmas.