Chickens coming home to roost again

The following is an extensive extract from the Business Insider. I recommend ignoring my extract and reading the full post right here, but if you’re determined not to, go ahead and read my truncated version.

It’s a little technical and although my knowledge of economic theory is improving, I don’t understand all of it. But the implications for all of us are very serious. This is the stuff that John Key and Bill English seem able to gloss over but which continues to make a mockery of their ever-optimistic and perennially wrong economic forecasts. The 95% that I do understand isn’t really debatable. As you’ll find when you read it, there’s an inevitability to what is happening that lends it verisimilitude.

This is just part of the reasons why John Key gave up on catching up with Australia and Bill English made a virtue of our being poorer than our mates across the ever-widening ditch. The ill-informed, self-serving and uninspiring people you put in power don’t get it.

The last paragraph is spine-chilling, provocative, and hopefully will not come to pass.

Not yet.

Over to Raul Ilargi Mendoz…

…and quotes within quotes:

…If what I’m about to say is even halfway true, the economies of countries like Australia and New Zealand, which we visited recently, as well as many others, are in for a brutal shock.

I single out Australia and New Zealand because their economic growth, indeed by now their entire economic performance, which has been far better than the US and EU in the past 5 years, would be torn and frayed to shreds if the Chinese economy would hit one or more serious snags. And from what I see I can draw just one single conclusion: it will. The consequences down under will be shattering.…

…I have warned about China for years, and have predicted a civil war there before this decade is over (and/or China waging war abroad). Simply because the rate of growth in the Chinese economy is not “sustainable”, and because trying to achieve that rate, China unleashed, among other things, the by far largest human mass migration in the history of mankind, which has seen 100’s of millions of people move from rural to industrial areas.…
He quotes John Hempton:

…China is growing faster than any prior economy.
This fast economic growth – which would happen in a more open economy – is creating the fuel for the Chinese kleptocracy.

China’s trade surplus as a percentage of GDP is shrinking. Hence, growth will have to come from domestic demand. The government has tried all sorts of tricks to boost this, but it can’t change people’s habits overnight. The Chinese people are savers. More so perhaps today than ever before. There is no welfare net to catch them, and the one-child policy has left them with too few children to fall back on. Hempton explains:

In most developing countries the way that people save is they have multiple children hopefully to generate a gaggle of grandchildren all of whom are trained to respect their elders. Given most people did not live to old age if you did you became a treasured (and well cared for) family member.

This does not work in China. Longevity in China is increasing rapidly and the one-child policy results in a grandchild potentially having four grandparents to look after. The “four grandparent policy” means the elderly cannot expect to be looked after in old age. Four grandparents, one grand-kid makes abandoning the old-folk looks easy and near certain.

Nor can the elderly rely on a welfare state to look after them. There is no welfare state.

So the Chinese save. Unless they save they will starve in old age. This has driven savings levels sometimes north of fifty percent of GDP.…

…OK, so the Chinese save. But how? They have few options, and – ironically – all of them are money losers. The Chinese can’t invest abroad. And their stock markets are rigged. Bank deposits pay 1% or less, because the government regulates the interest rates (and all banks). Life insurance pays a little more, but not much. Their best bet often is real estate (even if many apartments are left empty), simply because they hope losses will be smaller (though prices have plummeted in many areas). The reason all options are money losers is rising prices (what most call – price – inflation). Hempton:

…inflation has been between 6 and 8 percent (but is now lower than that and is falling fast). At almost all times (except during the height of the GFC) the inflation rate has been higher – often substantially higher – than the regulated bank deposit (or life insurance contract) rate.

In other words real returns for bank accounts are consistently negative – sometimes sharply negative.

You might ask why people save with sharply negative returns. But then you are not facing starvation in your old age because of the “four grandparent policy”. Moreover because of the underlying economic growth (moving peasants into a manufacturing economy) there are increasing quantities of these savings every year. This is the critical point – the negative return to copious and increasing Chinese bank deposits drives a surprising amount of the global economy and makes sense of many things inside and outside China. And those deposits are mostly lent to State Owned enterprises.

It works like this: with price inflation at 6% and a bank deposit return of 1%, Chinese banks and SOEs have access to enormous amounts of savings – which (still) grow all the time – at de facto negative rates. And because of restrictions placed on the banking system, a lot of the savings are reaching the market through the shadow banking system. To what extent Beijing itself is ruled by the kleptocracy is hard to say; the October 2012 elections could be a harbinger of further developments in that sphere.

The reality is: the banks and SOEs – that is to say, those party members that control them – get paid4-5% to borrow money !!, which they can then use to run industries that make a lot more money. As long as the system lasts. Which it does only as long as price-inflation numbers stay high and economic growth remains robust. And that’s where things are starting to go wrong.

…Growth of the world money supply has dropped to the lowest level since the financial crisis of 2008-2009, heralding a severe economic slowdown later this year unless authorities rapidly take action.

The latest data show that the real M1 money supply – cash and overnight deposits – for China, the eurozone, Britain and the US has been contracting since the early Spring. Any further falls risk a full-blown global recession…

…The data explain why commodity prices are falling hard, with Brent crude down to a 16-month low of under $97 a barrel.
China’s money data are falling at the fastest pace since records began.…

…China could be hit harder than just about any other country by this. It needs a high economic growth, of some 7% of more, or the engine will roll off the rails. And the powerful and wealthy party members need a high rate of price inflation to keep their kleptocratic scheme alive.

Obviously, it doesn’t look like either will be there. China depends on exports, and they are falling, on the back of the ongoing and worsening global crisis. Getting the Chinese people to increase their consumption levels is of course not very likely when their prospects become less sunny.

The government can try to get the inflation rate up by pumping more money into the economy, but it’s hard to see any reason why the Chinese would go out and borrow it. By and large, what they would want to spend, they already have in savings. They’re not Americans yet, certainly not in that regard. More infrastructure investment? There are limits there too.

So it would look like China is caught in a trap. John Hempton again:

…Inflation (widely discussed) is known to produce riots and demonstrations in China – and is considered by Westerners to be bad news for the Chinese establishment. And there are good reasons why the Chinese riot with inflation – the poor who save because they are going to starve – get their savings taken away from them. But ultimately the Chinese establishment like inflation – it is what enables their thievery to be financed.

…that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils). The SOEs will not be able to pay positive real returns to support that new division of spoils. The peasants can only receive positive real returns if the SOEs can pay them – and paying them is inconsistent with looting.

If the SOEs cannot pay then the banks are in deep trouble too. All because the inflation rate is dropping. Maybe they can stop it dropping. The Chinese establishment has a vested interest in getting the inflation rate up in China. Because if they don’t all hell will break loose.

Unless the Chinese can get the inflation rate up expect a revolution.

“Maybe they can stop it dropping”. Well, I don’t think they can. I don’t see how. It looks like China can print money, but no-one wants it anymore. Indeed , former stimulus has led to overcapacity, so there’s no point in doing even more. As CCB International Securities analysts Banny Lam and Rocky Zhang recently wrote:

“Today, China’s manufacturing industry, and by extension the entire economy, is suffering from massive overcapacity in both infrastructure and industrial production causing prices to plunge, utilization rates to fall, profits to decline and the number of bad bank loans to rise.”

It’s not possible, for obvious reasons, to pinpoint when all this will reach critical mass. What we can say, though, is that the harder Europe falls, the harder China will. China is not some miracle story, it’s simply just another part of the insane global credit bubble machine we’ve all thought was making us rich. We know better now, or should at at least, and the Chinese soon will too.

That will in all likelihood lead to fierce battles between the politburo, the party members and the Chinese triad mafia on the one hand, and 1.3 billion citizens on the other. Not a pretty prospect.

Whichever faction takes over power in October may decide to go looking for some Lebensraum in places like Siberia, and send 1 or 2 or 10 million of the 1300 million people they have, abroad. Not a pretty prospect either.