What's the saying? May you live in interesting times.


China may seem to have defied the recession and the laws of economics. It hasn't. When China's bubble bursts, the global impact will be severe, spiking US interest rates.

By Vitaliy N. Katsenelson
posted March 16, 2010 at 2:34 pm EDT

Denver —
The world looks at China with envy. China’s economy grew 8.7 percent last year, while the world economy contracted by 2.2 percent. It seems that Chinese “Confucian capitalism” – a market economy powered by 1.3 billion people and guided by an authoritarian regime that can pull levers at will – is superior to our touchy-feely democracy and capitalism. But the grass on China’s side of the fence is not as green as it appears.

In fact, China’s defiance of the global recession is not a miracle – it’s a superbubble. When it deflates, it will spell big trouble for all of us.

To understand the Chinese economy, consider three distinct periods: “Late-stage growth obesity” (the decade prior to 2008); “You lie!” (the time of the financial crisis); and finally, “Steroids ’R’ Us” (from the end of the financial crisis to today).

Late-stage growth obesity

About a decade ago, the Chinese government chose a policy of growth at any cost. China’s leaders see strong gross domestic product (GDP) growth not just as bragging rights, but as essential for political survival and national stability.

Because China lacks the social safety net of the developed world, unemployed people aren’t just inconvenienced by the loss of their jobs, they starve; and hungry people don’t complain, they riot and cause political unrest.

Remember the 1994 movie “Speed”? A young cop (Keanu Reeves) had to save passengers on a bus that would explode if its speed dropped below 50 m.p.h. Well, China is like that bus with 1.3 billion people aboard. If the Communist Party can’t keep the economy growing at a fast clip, the result will be catastrophic.

To achieve high growth, China kept its currency, the renminbi, at artificially low levels against the dollar. This helped already cheap Chinese-made goods become even cheaper. China turned into a significant exporter to the developed economies.

Normally, if free-market economic forces were at work, the renminbi would have appreciated and the US dollar would have declined. However, had China let this occur, demand for its products would have declined, and its economy wouldn’t have grown at roughly 10 percent a year, which it did during the past decade.

The more China sold to the United States, the more dollars it accumulated, and thus the more US Treasuries it bought, driving our interest rates down. US consumers responded to these cheap goods and cheap home loans by going on a buying binge.

However, companies and countries that grow at very high rates for a long time will inevitably suffer from late-stage growth obesity. Consider Starbucks: In 1999, it had 2,000 stores and was adding 1.8 stores a day. In 2007, when it had 10,000 stores, it had to open 5.5 stores a day in a desperate bid to keep growth rates up. This resulted in poor decisions and poor quality – a recipe for disaster.

In China, political pressure for full employment has led to similar late-stage growth obesity. In 2005, China built the largest shopping mall in the world, the New South China Mall: Today it’s 99 percent vacant. China also built up a lavish district in a city called Ordos: Today, it’s a ghost town.

You lie!

All good things come to an end, and great things come to an end with a bang. When the financial meltdown erupted in 2008, US and global banks started dropping like flies. Countries everywhere suffered contraction.

Even China.

During the crisis, Chinese exports were down more than 25 percent, tonnage of goods shipped through railroads was down by double digits, and electricity use plummeted.

Yet Beijing insisted that China had magically sustained 6 to 8 percent growth.

China lies. It goes to great lengths to maintain appearances, including censoring media and jailing those who write antigovernment articles. That’s why we have to rely on hard data instead.

Steroids ‘R’ Us

Today the global economy is stabilizing, thanks to Uncle Sam and other “uncles” around the world. But the consumers of Chinese-made goods are still in debt, unemployment is high, and banks aren’t lending. You might think the Chinese economy would be growing at a lower rate. But no, it is growing again at nearly 10 percent, as though the financial crisis never occurred.

Though this growth appears to be authentic – electricity consumption is back up – it is not sustainable growth, because it is based on an unprecedented stimulus package and extraordinary government involvement in the economy.

In the midst of the financial crisis, in late 2008, Beijing fire-hosed a $568 billion stimulus into the Chinese economy. That’s enormous! As a percentage of GDP, it would be like a $2 trillion stimulus in America, nearly triple the size of the one Congress passed last year.

It gets even more interesting. Unlike Western democracies, whose central banks can pump a lot of money into the financial system but can’t force banks to lend or consumers and corporations to spend, China can achieve both at lightning speed.

The government controls the banks, so it can make them lend, and it can force state-owned enterprises (one-third of the economy) to borrow and to spend. Also, because the rule of law and human and property rights are still underdeveloped, China can spend infrastructure project money very fast – if a school is in the way of a road the government wants to build, it becomes a casualty for the greater good.

Government is horrible at allocating large amounts of capital, especially at the speed it is done in China. Political decisions (driven by the goal of full employment) are often uneconomical, and corruption and cronyism result in projects that destroy value.

To maintain high employment, China has poured money into infrastructure and real estate projects. This explains why, in 2009, new floor space doubled and residential real estate prices surged 25 percent. This also explains why the Chinese keep building new skyscrapers even though existing ones are still vacant.

The enormous stimulus has exacerbated problems that already existed, threatening to turn China into a less shiny but more drastic version of debt-riddled Dubai, United Arab Emirates.

What happens in China doesn’t stay in China. A meltdown there – or even a slowdown – would have severe consequences for the rest of the world.

It will tank the commodity markets. Demand for industrial goods will fall off the cliff. Finally, Chinese appetite for our fine currency will diminish, driving the dollar lower against the renminbi and boosting our interest rates higher. No more 5 percent mortgages and 6 percent car loans.

No shortcuts to greatness

We look at China and are mesmerized by its 1.3 billion people, its achievements of the past decade, its recent economic resiliency, and its ability to achieve spectacular results on the fly. But we have to remember that economic bubbles are usually just a good thing taken too far. The Chinese economy is no exception. Its long-term future may be bright, but in the short run we’ve got a bubble on our hands.

Everyone wants a shortcut to greatness, but there isn’t one. China has been trying to bend the laws of economics for a while, and with the control it exerts over its economy it may seem that it’s succeeded.

But this is only a temporary mirage, which must be followed by a painful reality. No, there is no shortcut to greatness – not in personal life, not in politics, and not in economics.

Vitaliy N. Katsenelson is a portfolio manager/director of research at Investment Management Associates in Denver. He is the author of “Active Value Investing: Making Money in Range-Bound Markets.”

China vs. America: Which government model will triumph?

If the 20th century was about the competition between democracy and totalitarianism, the 21st century pits the excesses of consumer democracy against capable governance with too little democratic accountability.

By Nathan Gardels
posted January 27, 2010 at 12:47 pm EST

Stockholm —
Overloaded with debt and facing a yawning deficit, Athens is seeking to borrow 25 billion euros from Beijing. What could be more symbolic of the new power of the East vis-à-vis the West?

As the symbol of ancient democracy is looking for cash, the symbol of modern democracy, the United States, is already deeply in debt to the Middle Kingdom. Indeed, in part it was the savings glut of Chinese reserves that helped inflate the mortgage bubble to the point of bursting. While Communist leader Nikita Khruschev blustered at the height of the cold war that the Soviet Union would bury the US economically, it was up to Beijing to extend it enough credit to hang itself.

And that is not all. Google, the very symbol of the information revolution, is locked in a standoff with China’s Communist rulers and their murky party hackers. And the trial run of China’s new “Harmony Express,” the world’s fastest train, took place at virtually the same time as the recent trial of human rights activist Liu Xiaobo. While the Harmony Express streaked from Guangzhou to Wuhan in less than three hours, Liu Xiaobo was sentenced to 11 years in prison.

That a harshly ruled but prospering China is no longer emerging but has emerged is all the buzz at this year’s conclave in Davos, Switzerland. Hopefully, the high-powered buzz will yield a little more introspection in the West – and not just over bank regulation – instead of yet another round of excoriating the East.

Perhaps it is time to take another look at democracy as we know it, not just because of the economic success of authoritarian China, the very emblem of non-Western modernity, but because the West itself has changed.

In much of the West, especially in the US, we no longer live in an industrial democracy, no less the agriculture-based landed aristocracy in which most political systems and their constitutions were originally conceived. We live in a consumer democracy.

In a consumer democracy, where the feedback signals from politics, the media, and the market all steer society toward immediate self gratification, there is scarce political capacity for the kind of long-term thinking, planning, and continuity of governance which has so far been responsible for China’s rise. When scarce political capacity and consumer democracy are joined with robust technological prowess, both the societal and generational impacts are amplified and extended well beyond the present moment and local environment. (Think climate change, a perfect example of how seeming retail sanity of, say, driving a carbon-belching SUV, can add up to wholesale madness.)

This new reality requires the enhanced capacity of governance and the design of better institutional filters – more checks and balances – not only against rule by the short-term tyranny of the “one man, one vote” sovereign will, but against the nearest election term of the permanent campaign, the impending retail purchase, the quarterly report, and the imperative to “monetize attention” in the new media age by supplanting democratic deliberation with partisan programming and reality TV.

No system of governance can endure without the consent of the governed.

But as every political sage from Confucius to Plato to Madison understood, neither can it endure when overruled by popular “appetites” (Plato’s word).

As is often the case, the extreme reveals the essence. Everyone can see that the experience of direct democracy in California, where the popular initiative reigns, has proven ruinous. California’s crisis reveals the delusions of a Diet-Coke civilization that wants sweetness without calories, consumption without savings, and modern infrastructure and good schools without taxes. California’s dysfunction is only a louder echo of American politics as a whole.

It is worthwhile in this context to aerate our assumptions in the West by examining the best practices of China, where the rulers retain a greater political capacity for governance. While the entrepreneurial energies of the population have been unleashed through a free market, the strong hand of the neo-Confucian state tempers all those liberated interests in the name of social harmony and long-term goals.

As Google and Liu Xiaobo are well aware, China’s system is, of course, marred in the opposite way of the West by the absence of personal liberty and free expression as well as the feeble rule of law and weak accountability of the authorities. All too easily the strong hand can become the harsh fist of repression or the open palm of corruption.

As these two systems, which author and historian Niall Ferguson already calls “Chimerica,” interact with each other across the Pacific Basin – the new center of global gravity – their frictions and fusions will yield the opportunity to create something new: a philosophy of governance that balances the individual and the common interest, immediacy, and the long term; a system that mitigates unmediated popular appetites without killing the dynamism of personal pursuit.

If the 20th century was about the competition between democracy and totalitarianism, the 21st century pits the excesses of consumer democracy against capable governance with too little democratic accountability.

Nathan Gardels is the editor in chief of NPQ and the Global Viewpoint Network of Tribune Media Services. He is also a senior fellow at the Nicolas Berggruen Institute.



© 2010 Global Viewpoint Network. Distributed by the Tribune Media Services. Hosted online by The Christian Science Monitor.

This is nonsense. Chinese government has over 50% of the economy, directly or indirectly. If incentives work to keep food production up and increase standard of living Chinese people will be happy. If the dollar has some sort of value there are reserves to import food as and when required also other raw materials. Entrepreneurs make mistakes sure one famous office building lay empty of 20 years in London. Rural development in China is continuing apace. Rail networks are being constructed, new housing, new aircraft factories etc.
Europe , India, Japan continue to be world leaders in many fields and in the case of Europe and Japan there is huge social capital. Should global trade stop tomorrow Europe's internal economy would provide a reasonable lifestyle for the vast majority of the populations. In fact 'localization' is already a big trend with the movement to sustainability and reduction of unnecessary transport.
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abc200,

One of his points, that the Communist Party of China has in effect made high rates of growth and legitimacy synonymous, is dead on. Many people in China have put-up with the extraction of the "iron-bowl" and other social net underpinnings, for the benefits of the breakneck economic growth model. Almost no person thinks that China's currency the Yuan is not undervalued. In order to facilitate global flows, the Yuan will have to appreciate, but this will trigger a slow down in Chinese exports. And a potential slow down in economic growth. Thus, slower job growth and more protest, etc. In order to transition into a more stabilized position, China will need its internal market to soak up ever greater amounts of its own productive output. The battle going on between the US/EU (and their dependencies) and China is over the timeframe of this transition. If done poorly, China and the rest of the world will reap a very poor harvest.

It doesn't work like that - the government just creates more jobs. When Calco the Chines aluminum company had a surplus of workers a chain of state owned restaurants was created to make jobs. Now they spend billions on railways. Villagers are strarting to get an 'allowance' in great numbers. ; but according to my friends they have to work for it improving land ,etc. This allowance may keep local pig farmers busy - there is a state plan for pig meat production - but sure will not suck in any imports.
Each province in China is responsible for its own food production. When a factory has surplus production it is given out at highly subidised prices much as happened in the '50's in UK when if a factory had a surplus of production it was bartered with another factory and then both products were sold on allocation to workers etc. at low cost and superb credit terms.
Social underpinnings in China come strongly from the extended family, savings and local welfare committees; a branch of the CP.
If China should run out of dollars or motor cars/cycles other countries wish to buy then yes it can import less iron ore, coal, oil.
The Chinese in Peking are already moving to electric bicycles from cars.
All my experience in the UK is that when the Chinese meet a problem they do not complain; for example when a restaurant has few customers due to closures of a local company. Rather the family forms a consensus of what to do - dig into savings, change offerings, reduce hours of different family members etc.
If at some point in the future it becomes diffeicult to export/import proba\bly plans have been made for this.
So I think your commentator is an idiot - a good supply of pigmeat is vastly more important than the ability to import Rolex watches and if there are disused shopping mall where these items would have been sold so be it.
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