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Beware China Bulls

Recent official data has been received as a cause for optimism. It isn't...

CHINA HAS published its latest batch of inconsistent and methodologically opaque official statistics, writes Sean Corrigan for the Cobden Centre.

They were—cue Captain Louis Renault for effect—just about perfect for the job of demonstrating the exquisite degree of control which the country's enlightened despots are able to exert over the actions of the 1.3 billion people under their sway.

The annual change in CPI ostensibly dropped to a reassuring (if still above-target) 5.5%; industrial production growth edged down to 13.2%; urban fixed investment was still at the 25% p.a. pace which has characterized the past 15 months or so: what was not to like?

The 'Soft Landing' was seemingly assured.

Except—forgive our skepticism—but the whole idea of a 'soft landing' from a credit-fuelled boom is a risible one.

Once an economy becomes sufficiently distorted by an effusion of newly-created money and too-easily extended credit; once the resulting process of malinvestment becomes not just engrained but actively self-aggravating and its increasingly cashless continuation assumes the role of driver of 'growth' and wellspring of notional earnings, there remain only two alternatives: to keep adding more and more fuel to it to the point it achieves a hyperinflationary escape velocity or bunker down in some reinforced concrete bolt hole, deep underground and await the multi-megaton impact of its collapse.

This is not hard to recognize in practice, whether you dress it up by calling it a 'Minsky moment', or cite Charles Kindleberger's catalogue of errors past, or do the decent thing and look at what the Austrians have been saying for nigh on a hundred years, based on a formalization of their close study of the events which took place in the preceding century (something which forms the subject of a slender little volume book called 'Santayana's Curse' – ahem!).

The point is that it is of no import how different the details of the regulatory arbitrage, the sources of extra leverage, the nature of the search for yield, or the callousness of the enhanced disintermediation which take place in the credit system might be. Nor does it matter overmuch how disparate the vehicles which come to express the manias these episodes unleash. Whatever the superficial distinctions, we invariably end with an increasing sterility of what passes for 'investment', coupled with an increasingly hard to fill demand for what have now become domestically underproduced consumer goods to satisfy the whetted appetites of those who may be paper millionaires, but who are also flesh-and-blood paupers.

Not only are returns on capital appalling in their paucity by this stage, but such 'profits' as are booked are either unjustifiable capitalizations of dubious future contingencies or a Gordian tangle of interdependent, below-the-line expenditures. As Prof. George Riesman long ago pointed out, in aggregate, the winners—i.e., those who make more than the natural interest rate—so far outstrip the losers—those who fall short of it—because a bloated schedule of investment is only partially being charged to earnings in each accounting period. Adding to the cheap gilding of false prosperity, all that newly inflated finance is allowing money illusion and Cantillon (first-user) effects to flatter apparent net income, both inordinately and across the board.

Judge for yourself whether this diagnosis applies to China when one of its own dignitaries, Wu Jinglian, member of the State Council's Development and Research Center, can tell an international audience that:-

'Chinese enterprises have entered a bottleneck stage where they face tremendous difficulties in making any further progress despite rapid advances up global rankings in recent years… excess liquidity has inflated asset prices and that investments made with short-term, high-interest loans threaten the stability of the overall economy…

The general atmosphere is one that encourages speculation, and entrepreneurs have become less patient with real businesses that take time to pay off.'

So, if you still subscribe to the suggestion that the dreadful misdirection of real resources and human aspirations into the various Ponzi schemes, White Elephants, and me-too bandwagons which a credit boom inevitably occasions can be gently guided back to some sort of sustainable, income-generating, self-amortizing pathway by the omniscient hand of the very same idiots who unleashed this outbreak of mass folly—well, I have some AIG stock, some Greek government debt, and some Chinese railway bonds to sell you!

In reality, the only stay of execution the central meddlers can effect is to quit too early in the job of damping down whichever speculative blaze it is that they are belatedly trying to extinguish—a course which only reinforces the associated moral hazard and so encourages even more edge-of-the-waterfall foolhardiness when next it flares up again.

The somewhat less palatable—if neatly exculpatory—alternative is to allow the implosion of the current frenzy to proceed to its awful denouement relatively unhindered, while identifying likely candidates for a new bubble to be pumped up amid the ruins of the old (ideally laying the foundations for this replacement Babel while the masonry is still tumbling from its predecessor).

Keynesians might just recognize that this describes the remedy they usually prescribe when they talk of the social imperative to maintain 'aggregate demand' by inveigling whichever groups still possess the simulacrum of a decent balance sheet to ruin it in their turn by spending more than they earn on things which will never help to repay the greatly increased indebtedness which must inevitably accompany such a policy.

A classic case in point here was the openly avowed intent of Messrs Greenspan and George to have householders and governments put their futures in hock as an offset to the collapse in corporate exuberance entailed by the TMT crash, a decade ago. We all know how well THAT worked out!

China, however, has chosen not to heed the evidence before it of the inadvisability of such a program—or else it has come to rely far too heavily on the overblown opinion we credulous gweilos hold of the Party's omnipotence. China—and several of its Eastern neighbors—have turned a blind eye to the Japanese experience of the late 1980's; have ignored the lessons of the disastrous Tiger hunt of the late 1990s: and have paid no attention to Korea's succession of failed experiments in issuing every citizen with a multiplicity of credit cards and/or encouraging them to dabble in the property market every time the local chaebol find their export revenues threatened.

Indeed, an Asia (strictly, a broader EM grouping) to which everyone—not just President Sarkozy—implicitly looks as the savior of their business plan, as well as of their debt crisis, may have lined itself up for a powerful double whammy. For now, the intervention-delayed and intervention-magnified impact of Europe's post-bubble reversion is blowing a chill wind through an arguably overbuilt export sector at the same time that the scope for another, mighty, internal boost has been greatly lessened for fear that even greater destabilization takes place and that further, socially-invidious side effects are inflicted upon a long-suffering populace at home.

Among these latter are not just price inflation of a whole host of necessaries—with all the implications that has for the quality of life—but also the rampant cronyism and outright corruption which are the inescapable concomitants of a system where fallible men step in to ration scarce resources when dispassionate economic forces are not allowed to do so, according to the most urgently expressed uses of those trying to acquire one thing honestly by offering some other freely in the marketplace.

And if you do not yet recognize the shining Middle Kingdom of Sinophile myth in the foregoing description, ask yourself why it is that comments emanating from a recent conference of CEOs involved in China and convened by Chief Executive magazine threw up the following, acerbic observations.

Referring to the ongoing war for talent, one said:

"People are, frankly, totally underqualified for the roles they're getting. If you can speak English and Chinese and have any Western training, you're just constantly moving on because a lot of companies are squabbling over a very small supply of people."

Worse yet, the tainted nature of the system has not gone unregistered. Thus, the fortunate few seem to have realized where their bread will be most thickly buttered—and that this will not be as part of a genuinely entrepreneurial outfit of wealth creators, but in the ranks of one of the privileged creatures of the Party:

"The nature of loyalty in China is associated more with working for a state-owned enterprise than with staying with the brand where you began. In the old days a foreign company was the place to be because you were going to learn, but today they would rather work for a state-owned enterprise… As far as they're concerned that's where the action is and where the power will be—and that's an issue for all of us. At the end of the day you need Chinese people working in your company and it's going to be harder and harder to acquire those people."

No wonder that a joint report by China Merchants Bank and Bain & Co, largely corroborated by a similar, if broader, survey conducted by the Hurun Research Institute and the Bank of China, revealed that almost half of the wealthy Chinese asked (a group defined as disposing of more than Y100 million in the first sample and of Y10 million-plus in the second) were planning to emigrate while a quarter of the upper echelon and a sixth of the lower already had. This finding was of sufficient concern that the usual Party organs were quick to respond with editorials piously proclaiming the leadership's intent to address the many shortcomings which these select wielders of a great deal of capital stock felt were driving them away from their homeland.

China bulls, clamoring to get in, should take note that much of the smart money seems to be rather anxious to shake off the dust of the place, instead!

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Stalwart economist of the anti-government Austrian school, Sean Corrigan has been thumbing his nose at the crowd ever since he sold Sterling for a profit as the ERM collapsed in autumn 1992. Former City correspondent for The Daily Reckoning, a frequent contributor to the widely-respected Ludwig von Mises and Cobden Centre websites, and a regular guest on CNBC, Mr.Corrigan is a consultant at Hinde Capital, writing their Macro Letter.

See the full archive of Sean Corrigan articles.

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