Economist Steve Keen pinged me in response to my post Regional Manufacturing Expectations From Mars.
In that post, I compared Richmond Fed manufacturing survey expectations (six month look ahead projections made in February for August), to what actually happened in August.
In response, Steve Keen Tweeted
@MishGEA gets it wrong! Says “Regional Manufacturing Expectations From Mars” when they’re really from Uranus.
I duly stand corrected. I am now planetarily aligned with Keen on the distinction between Mars and Uranus.
On a more serious note, please consider the Financial Times article Why China’s stock market implosion might not be very meaningful, by Izabella Kaminska.
Kaminska quotes Steve Keen as follows …
One key peculiarity about China’s economy—and there are many—is that much of its growth has come from the expansion of industries established by local governments (“State Owned Enterprises” or SOEs). Those factories have been funded partly by local governments selling property to developers (who then on-sold it to property speculators for a profit while house prices were rising), and partly by SOE borrowing. The income from those factories in turn underwrote the capacity of those speculators to finance their “investments”, and it contributed to China’s recent illusory 7% real growth rate.
With property price appreciation now over, those over-levered property developers aren’t buying local government land any more, and one of the two sources of finance for SOEs is now gone. Borrowing is still there of course, and the Central Government will probably require local councils to continue borrowing to try to keep the growth figures up. But the SOEs are already losing money, and this will just add to the Ponzi scheme. The collapse of China’s asset bubbles will therefore hit Chinese GDP growth much more directly than the crashes in the more fully capitalist nations of Japan and the USA.
Heart of the Matter
Keen indeed gets to the heart of the matter about SOEs, borrowing, and illusory growth rates.
I have commented time and time again, no one in their right mind believes Chinese growth rates. Not only are the numbers straight up fabrications, many of the projects have no economic benefit.
Moreover, Chinese growth estimates fail to take into account damaging pollution and cleanup costs that ought to subtract from GDP.
GDP itself is a useless statistic actually. The reason is government spending, no matter how counterproductive, adds to GDP.
It sounds convoluted, but if government paid someone to poison wells, that poisoning would, by definition, add to GDP.
Many connected politicians got extremely wealthy off SOEs. But most of the SOE projects had little if any economic benefit, and some undoubtedly had negative benefit because environmental damage was not properly accounted for.
In short, Chinese GDP does not properly reflect economically nonviable projects nor the outright poisoning of the Chinese population to hit preposterous targets.
Rather than admit past GDP was grossly overstated, revisions will likely be hidden in future GDP reports for years or decades to come.
Kaminska Concludes …
“In short, don’t worry so much about the stock market, worry more about the potential collapse of other major Chinese asset classes like property, ghost towns and factories. That’s how the credit links back to the real economy.”
Those were her words, not Keen’s. I pinged Pater Tenebrarum at the Acting Man blog the above article and he replied …
“Something has clearly changed now. Right now, it seems it actually does matter. China is seen as an economically important (for the world) since about 2005 or so, but I have a feeling that something more profound may actually be afoot now – due to the follow-on domino effects. I would estimate that global malinvestment in commodity projects along amounts to something like $2 to $3 trillion cumulatively, perhaps more. This one sector alone may leave behind $1 trillion in unpayable debt.”
China’s Capital Accounts
Historically, China’s stock market has moved independently of the country’s economy because of China’s closed capital account.
What if the Shanghai market has started to reflect the real fundamentals thanks to liberalization of China’s capital account?
One Way Streets
Typically, money flowed into China in a one way street. This year, China took steps to open up the flows.
FTAlphaville notes This isn’t the Chinese capital account liberalisation you’re looking for.
Today every Chinese individual is allowed to buy no more than US$50,000 worth of foreign currency from banks each year. But that limit was lifted from US$20,000 in 2007, and it is also not that hard for the more savvy to get around it.
So we’re in a situation where China’s capital account is more open than it has been before and recent relaxations of control have increased the size and volatility of flows. Including, obviously but crucially, outflows.
This is a system that needs external capital very badly. It is happy to welcome it in, vastly less happy to see it leave. More so, it doesn’t take much to draw a lesson about attitudes to control and stability from China’s reaction to the recent stock market puke.
Needs vs. Reality
China needs external capital. Instead, China sees capital flight. Resultant stress is everywhere one looks because debt exceeds carrying capacity.
Symptoms of Too Much Debt
- Yuan devaluation
- Stock market prop jobs by Chinese regulators
- Emerging market currency crashes
- Global equity bubbles
- Commodity price crashes
- Junk bond bubbles
- Slower global growth
- Still raging property bubbles in Australia, Canada, and the US West Coast (thanks to influx of money from China)
Debt the Problem
Numerous bubbles have started to implode, even as property bubbles in some places expand. Central banks are hard pressed to keep all the Ponzi schemes going.
Although we do not see eye-to-eye on the solution, Keen and I agree that debt is a primary problem. Many prominent economists still have not figured that out.
Paul Krugman says “Debt is Good“.
Krugman: “There’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.”
Debt and bubbles go hand in hand.
No matter how big the bubble, no matter how much the resultant income inequality, no matter how ridiculous or nonviable the project, no matter how little the economic benefit, no matter how much government overpays (thanks to inane union work rules and prevailing wage laws), you can always count on Krugman to want more and more and more debt, even though Japan is living proof such policies do not work.
In the US, the Fed used a housing bubble to bail out a dotcom bubble. And now we have QE-driven stock market and junk bond bubbles to smooth over the housing bubble. Corporations have gone into debt to buy back their own shares at absurd valuations.
Debt has been used to cure debt problems over and over again. Apparently the cure is the same as the disease.
Mike “Mish” Shedlock