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China: No Shortcut to Greatness |
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A closer look at the China Model: Not your “local democracy,”
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Why the euro may be a better bet than the dollar...for now,
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Plus, Bill Bonner on those rioting Greeks and the state of The
States...
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Bill Bonner, reporting from New York, New York...
The zombies are taking over!
Stocks went up 4 points on the Dow on Friday... Gold went up $10.
Noise. Distraction. Headlines. Opinions.
The important trend is the big one – the shift of resources from the private
sector to the public sector.
During the bubble years, the private sector made a big, big mistake – taking
on far too much debt.
Now, it is correcting its mistake...reluctantly, painfully, and with plenty
of foot-dragging and interference from the government. Instead of letting
the dead die in peace...the feds are pumping financial adrenaline into their
veins...turning them into zombies.
It’s expensive work...so government is now making the same mistake the
private sector made a few years ago. It’s pretending that debt-fueled
spending is the same as growth. Ain’t no such thing.
The feds’ “growth” is even more pernicious and counterfeit than the bubble
era growth in the private sector. At least people actually wanted
houses...they just couldn’t afford to pay for them.
The feds, on the other hand, produce things that people wouldn’t buy even if
they had the money – zombie products. Who would buy a billion- dollar
software program to spy on other people? Who would pay other people to do
nothing? Who would take on the debts of a failing financial institution?
Consider this, from Bloomberg: “Fannie
Mae will seek $15.3 billion in US aid, bringing the total owed
under a government lifeline to $76.2 billion, after its 10th consecutive
quarterly loss.
“The mortgage-finance company posted a fourth-quarter
net loss of $16.3 billion, or $2.87 a share,
Washington-based Fannie Mae said in a filing yesterday with the Securities
and Exchange Commission.
“Fannie Mae, which owns or guarantees about 28 percent of the $11.8 trillion
US home-loan market, has been hobbled by a three-year housing slump that
wiped 28 percent from home values nationwide and led to record
foreclosures. The company, which posted $120.5 billion
in losses over the previous nine quarters, and rival Freddie Mac were seized
by regulators in September 2008.”
Did you read that carefully? Fannie Mae guarantees almost a third of the $12
trillion home mortgage market – or about $4 trillion. And guess who
guarantees Fannie Mae? You do!
Fannie made bad loans. It ought to be put down, like a horse with a broken
leg. But Fannie’s bondholders don’t take a loss. The losses have been moved
to the public sector and Fannie itself has been turned into a zombie
company.
Assets, liabilities, spending – it’s all shuffling over to the
government...and sucking the life out of the private sector. In the area of
durable goods, only about 4.4% of them, on average, were purchased by the
pentagon over the last 17 years. But since the beginning of the financial
crisis, durable spending by private industry decreased...while pentagon
spending went up. The most recent figures show that 8% of durable orders are
now bought by the military.
Recovery? Don’t bet on it. This government spending only makes it look like
a recovery. The numbers may show an increase in durable goods sold, but
tanks and armored personnel carriers don’t lead to genuine growth. They lead
to Soviet-style zombie growth...by the government, of the government, and
for the government. The rest of the economy shrinks.
More thoughts below, but first to today’s column...
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The Daily Reckoning
Presents: |
It seems as though every time we look at the China
story, some new information has changed the game entirely. Well, there are
some things that don’t change overnight...including the laws of economics.
Today’s guest editor, Vitaliy N. Katsenelson, explains...
China: No Shortcut to Greatness
By Vitaliy N. Katsenelson
Denver, Colorado
The Chinese economy must be getting out of control, because the Chinese
government is doing the unthinkable: It is desperately trying to put the
brakes on the economy. When you pump a stimulus package that represents 14%
of GDP through a fire hose into an economy, which was already on shaky
bubble foundation, in a very short time you’ll have some serious unintended
consequences -- you’ll get super bubbles.
To understand what’s taking place in China today, we need to rewind the
clock about a decade. At that time the Chinese government chose a policy of
growth at any cost. To achieve that, it kept its currency (the renminbi) at
artificially low levels against the dollar -- this helped already cheap
Chinese-made goods become even cheaper than its competitors’. The US and
global consumers were eager to buy them. China turned into a significant
exporter to the US. Normally, if free-market economic forces were at work,
the renminbi would have appreciated and the US dollar would have declined.
However, if China let its currency appreciate, its exports would have become
more expensive and the demand for Chinese products would have declined, and
its economy wouldn’t have grown at 10% a year.
But China isn’t your local democracy, and it needed to grow at any cost. So
instead, through the government-controlled banking system, China accumulated
a couple trillion dollars of foreign reserves in US dollars and euros. This
had an unintended consequence: It helped keep US interest rates at very low
levels, and lent a friendly hand in the financing of a huge consumption
binge by the US consumer (i.e., China’s largest customer).
The more China sold to the US, the more dollars it accumulated, and thus the
more US Treasuries it bought, driving our interest rates down. The US
consumer was in turn happy to leverage its future (through the “always”
appreciating asset, its home) and delighted to consume cheap Chinese-made
goods.
This symbiotic match made in heaven between China and the US consumer worked
great as long as housing prices kept rising and the financial machine kept
multiplying dollars. But all good things come to an end, and great things
come to an end with a bang. The financial meltdown erupted upon us and,
well, you know how that story played out.
So now let’s fast-forward a year. Today the global economy is stabilizing.
But the US consumers of Chinese-made goods are now deleveraging,
unemployment is high, US banks aren’t lending.
Despite this, the Chinese export-based economy has clocked growth of 8.7% in
2009. The rest of the world looks at the Chinese growth miracle with envy;
it seems that China has got economics figured out. But don’t hurry to trade
your democracy for an authoritarian system. The Chinese grass is not as
green as it appears.
First, one shouldn’t believe all the economic numbers that are put out by
the Chinese government. This is the government that magically managed to
report 6% to 8% GDP growth in the midst of the financial crisis, when its
exports were down more than 25%, tonnage of goods shipped through its
railroads was down by double digits, and its electricity consumption was
falling like a rock.
Second, China will do anything to grow its economy, as the alternatives will
lead to political unrest. A lot of peasants moved to the cities in search of
higher-paying jobs during the go-go times. 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 (this explains the
high savings rate in China) and hungry people don’t complain, they riot.
Once you look at what’s taking place in the Chinese economy through that
lens, the decisions of its leaders start making sense, or at least become
understandable.
Unlike Western democracies, where 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
Chinese government controls the banks, thus it can make them lend, and it
can force state-owned enterprises (one-third of the economy) to borrow and
to spend. Also, 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.
China has spent a tremendous amount of money on infrastructure over the last
decade and there are definitely long-term benefits to having better
highways, fast railroads, more hospitals, etc. But government is horrible at
allocating large amounts of capital, especially at the speed it was 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.
Infrastructure and real estate projects are where you get your biggest bang
for the buck if your goal is to maintain employment, because they require a
lot of unskilled labor; and this is where in the past a lot of Chinese money
was spent. This also explains why the Chinese keep building skyscrapers even
though the adjacent ones are still vacant.
Though Chinese economic growth in the past was very high, more recently the
quality of growth has been low. For example, in an echo of past Chinese
government asset-allocation decisions, China built the largest shopping mall
in the world, the South China Mall, which is still 99% vacant years after
construction. China also built a whole city, Ordos, in Inner Mongolia, on
spec for one million residents who never appeared.
The inefficiencies are also evident in industrial overcapacity. According to
Pivot Capital, Chinese excess capacity in cement is greater than the
consumption of the US, Japan, and India combined. Also, Chinese idle
production of steel is greater than the production capacity of Japan and
South Korea combined. Similarly disturbing statistics are true for many
other industrial commodities. The enormous stimulus amplified problems that
already existed to financial-crisis levels. China is a less shiny but more
drastic version of Dubai.
There is speculation that the Chinese consumer will pick up the demand slack
for the US and European consumers who are deleveraging and buying fewer
Chinese-made goods. This may happen, but it will take decades. The US and
European consumers are two-thirds of much larger economies. The Chinese
consumer is only one-third of the Chinese economy.
We look at China and are mesmerized by its 1.3 billion people, its
achievements of the last 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. This was
the case with railroads in the US in the late 19th century: The railroads
were supposed to change the landscape of the US, and they did, but that
didn’t prevent a lot of them from going out of business first. The Internet
was supposed to change how we communicate, and it did, but in the process it
generated a tremendous bubble, followed by the loss of wealth for many. 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. It would be
great if the word (economic) cycle only existed in a singular form, and the
only cycle we had in the economy was happy expansion. If there were no
cycles, there would be no painful recessions. But as heaven couldn’t exist
without hell, or capitalism without failure, economic expansion can’t exist
without recession. China has been trying to bend the laws of economics for
awhile, and with the control it exerts over its economy it may seem, at
least for a short while, that the laws of economics work differently in
China. But this is only a temporary mirage, which must be followed by huge
pain and drastic consequences. No, there’s no shortcut to greatness – not in
politics, not in personal life, and certainly not in economics.
Regards,
Vitaliy N. Katsenelson
for The Daily Reckoning
Joel’s Note: Vitaliy N. Katsenelson, CFA, is a portfolio
manager/director of research at Investment Management Associates in Denver,
Colo. He is the author of
Active Value Investing: Making Money in Range-Bound Markets (Wiley
2007).
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And now over to Bill Bonner with more reckoning from New York, New
York...
Everyone says the euro is falling apart...that Europe itself can’t survive
as a political unit.
Europe seems to lack the things that make for a strong political system. It
has no common language, for example (there are more than 200 different
languages in Europe). And it has no common culture either...or even a common
religion...or a common race.
The Greeks are rioting in the streets. They’re upset because their
government is trying to cut back on ‘services.’ Actually, it’s not the
services that anyone would miss. It’s the money. The rioters are mostly
people who live, in one way or another, at the expense of others...thanks to
the government. They work for the government...or get handouts from it.
The poor Greek government is stuck. As in almost all other democracies,
politicians bought votes by giving out jobs and money. This leads to a
bidding war...in which political parties vie for favor with the voters by
offering more and more “services.” One gives away bread. The other prefers
circuses. Whether it is food stamps or foreign wars...the price is high. And
eventually, the bids go beyond the capacity of the economy to pay them.
Greece is at that point. So are half the US states. They’re out of money.
It’s “doomsday” in Illinois, says one headline. It’s a “state of emergency,”
in New Jersey.
Lenders don’t want to give them any more money. Wisely, they worry they
won’t get paid back. So, lenders demand higher interest rates to cover their
increased risks...which puts the Greek budget even further in the red.
The Greeks think the Germans should come to their aid. Why? Because, in a
way, it was the Germans who got them into this mess. Nobody would have lent
so much money to the Greeks had it not been for the strong teuton- backed
euro...and the implicit promise that if the Greeks got into trouble...which
everyone knew they would...the rest of Europe would come to their aid.
Well, what do you know? The Greeks are in trouble. And the Germans don’t
want to come to their aid. The Germans saved. They ran their own economy
better. They are one of the few countries in Europe that is living, almost,
within the terms of the treaty they all signed, in which they agreed to keep
deficits below 3% of GDP. The German deficit is just a little more than 3%.
The Greeks don’t even come close – with a deficit of 12.7%.
In America, the situation is a little different. The economy and the
population are more homogenous. And much more of the money is in the hands
of the central government. The Germans don’t see why their savings should be
used to bail out the Greeks. They’ve got their economy. The Greeks have
theirs. In the US, while there are regional differences, there is basically
one economy...with one government that messes it up for everyone.
Is the US better off? Does central planning on a larger scale make the US
dollar or the US economy stronger?
In fact, the looseness of the European experiment is a strength, not a
weakness. What damages a paper currency is not an act of omission; it’s an
act of commission. Neglecting to provide more cash and credit is not what
kills paper money; on the contrary, it’s the willingness to provide
unlimited amounts of it. So far, the Americans are. The Europeans – or at
least the Germans – are not.
So, we’ll bet on the euro over the long term...both the euro and the dollar
are “elastic” currencies. They both get stretched out of shape. But there
are more people pulling at the dollar than the euro.
In the short run, anything could happen. There are probably more reasons for
the dollar to go up than for it to go down. But in the long run, our money
is on the euro.
“Dad, the strangest thing happened yesterday,” said daughter Sophia, now
living in Baltimore. “My roommate couldn’t find her car. So she looked all
around. She thought she just couldn’t remember where she parked it. But she
finally gave up and called the police to report a stolen car. The police
came up and they arrested her! It turned out that there was a warrant out
for her arrest. She was on a bus and didn’t have any money to pay the
fare...this was years ago. She got a ticket...and was supposed to go in and
settle up. Well, naturally, she forgot. And so there was this warrant for
her arrest. And then it was too late to post bail...so she spent the night
in jail.
“Then, when she left the jail...she still didn’t have the money for bus
fare, I guess...so she started walking. And she got mugged on the way home
from the city jail and was taken to the hospital...though there’s nothing
really wrong with her.
“Welcome to Baltimore...”
Regards,
Bill Bonner,
for The Daily Reckoning
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A DR Endnote: Finally today, we mentioned over the weekend
that our executive publisher, Addison Wiggin, needs your help.
Thank to those of you who replied.
You see, last week, Addison announced that, after seven years in the making,
he is ready to launch his brand new research service, tentatively titled
Apogee Advisory. What’s an Apogee Advisory? Glad you asked.
In Addison’s words, it’s a project aimed at “providing investment research
for individual investors that will not only cover the nexus between money
and politics, between Wall Street and Washington, but would crush even the
finest research published by the Wall Street houses, such as they are.”
Addison is going to begin this new service with three “beta” issues,
starting next month. Importantly, he’d like to test the idea to get your
feedback. To that end, he’s offering these initial issues free of charge to
a select group. If you’re interested in providing feedback,
you can get the details here. The first issue is due
out in early March and, as usual, positions are limited.
We just thought you might like a heads up. So, eh...yeah. Heads up!
Cheers,
Joel Bowman
Managing Editor for The Daily Reckoning
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Here at The Daily Reckoning, we value your questions and comments.
If you would like to send us a few thoughts of your own, please address them
to your managing editor at
joel@dailyreckoning.com
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