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The China Bubble's Coming -- But Not the One You Think
Foreign Policy ^ | 7/23/2009 | Vitaliy N. Katsenelson

Posted on 07/24/2009 10:34:06 AM PDT by mojito

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 these problems.

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.

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).

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.

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.

(Excerpt) Read more at foreignpolicy.com ...


TOPICS: Business/Economy; Extended News; Foreign Affairs
KEYWORDS: bubbleeconomy; china; thecomingdepression
I hear the howling of the running dogs of capitalism.
1 posted on 07/24/2009 10:34:07 AM PDT by mojito
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To: mojito

Chicoms aren’t buying at the same rate.


2 posted on 07/24/2009 10:38:36 AM PDT by allmost
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To: mojito

Nice editing work. You’d never guess the author’s argument from your selection.


3 posted on 07/24/2009 10:38:44 AM PDT by 1rudeboy
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To: mojito

Gosh, if we were Communists we wouldn’t have any problems!!!!!


4 posted on 07/24/2009 10:40:14 AM PDT by tiki (True Christians will not deliberately slander or misrepresent others or their beliefs)
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To: mojito

When it comes to China, that howling is in the far off distance, and will stay there.

Seems those capitalist wolves are being chased into the wilderness here as well...


5 posted on 07/24/2009 10:43:07 AM PDT by Nathan Zachary
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To: 1rudeboy
You mean that forcing banks to loan money willy-nilly is going to cause the bubble to pop?

Yes, that remains real obscure.

6 posted on 07/24/2009 10:51:45 AM PDT by mojito
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To: mojito

From your selection, yes.


7 posted on 07/24/2009 10:55:02 AM PDT by 1rudeboy
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To: mojito

An interesting article, but why not excerpt in such a way as to summarize the real point of it?


8 posted on 07/24/2009 10:58:11 AM PDT by bigbob
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To: 1rudeboy

Well, perhaps it’s just me. But when I read that a centrally controlled economy is forcing its banks to loan money, and the businesses it controls to spend money, all in a heedless fashion, I assume that that’s not a sound economic policy.

Call me naive.


9 posted on 07/24/2009 10:59:40 AM PDT by mojito
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To: mojito

No, I’m not calling you naive. China is doing precisely what the United States is doing, likely with the same result. I was simply referring to the way you took an axe to the article.


10 posted on 07/24/2009 11:03:15 AM PDT by 1rudeboy
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To: bigbob
Gee whiz.

I thought it was pretty obvious. China is force feeding it's economy in the short term so that they won't have riots in Chengdu. But the long term consequences of doing this are pretty bad.

But for those who have trouble gasping this, led me add the following, in the interest of clarity:

“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.”

11 posted on 07/24/2009 11:05:29 AM PDT by mojito
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To: mojito
China's communist government owns a large part of the money-creation and money-spending apparatus.

This is not an advantage, it's a disadvantage. The problem is not that there is lack of current spending but that there has been too much inefficient spending. A state enterprise blowing money on command is only going to make the problem worse.

The ignorance of Keynes lives on.

12 posted on 07/24/2009 11:09:57 AM PDT by SeeSharp
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To: mojito
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.

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? 

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.

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 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.

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.

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 these problems.

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.

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).

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.

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.

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.

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.

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. 

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 Treasurys. It artificially propped up the dollar. And now, China is sitting on 2.2 trillion of them. 

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.

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.

And the U.S. government isn't helping: It's printing money and issuing Treasurys 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.)

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.


13 posted on 07/24/2009 11:17:33 AM PDT by 1rudeboy
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To: 1rudeboy
According to the article, China has increased the money supply by nearly 30% in June alone. That's a staggering number

Neither Geither nor Bernanke would be nearly so reckless (which is saying something). Even with all the borrowing and printing money, the US money supply has increased since January by only a few percentage points.

Another difference is that US banks have been sitting on their bailout money because of liquidity concerns. They haven't been loaning the money to 0’s pet projects.

14 posted on 07/24/2009 11:21:10 AM PDT by mojito
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To: SeeSharp

It’s an advantage if you want to create and spend money recklessly or for politically motivated purposes.

I believe that is the point the author is trying to make.


15 posted on 07/24/2009 11:23:39 AM PDT by mojito
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To: SeeSharp
“The ignorance of Keynes lives on.”

If Keynes were alive today, he wouldn't be a “Keynesian”. His theories have been co-opted and twisted beyond recognition by generations of “tax and spend” leftists.

16 posted on 07/24/2009 11:36:30 AM PDT by USFRIENDINVICTORIA
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To: 1rudeboy

Correction to my mistake: the M1 increased 22% from May to June 2009. It’s the M2 that has only increased by a few points.


17 posted on 07/24/2009 11:43:25 AM PDT by mojito
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To: mojito

“They simply cannot force banks to lend without nationalizing them”

The Fed has the power to set the federal funds rate, or the interest rate (i.e. the price for money) at which banks lend money to eachother. That certainly influences how banks lend.


18 posted on 07/24/2009 12:24:31 PM PDT by Tublecane
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To: mojito
Britain's Hopes Of A Quick Recovery From Recession Dashed As GDP Disappoints

Hopes that Britain will soon emerge from the worst recession in decades were dealt a blow on Friday after figures showed the economy shrank more than feared in the last three months.

[snip]

19 posted on 07/24/2009 2:00:53 PM PDT by blam
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