Some thoughts on The Great Wall of Turmoil

Ok, so it must be settled then: China is officially the new topic everyone’s an expert on.  Every other pundit has chipped in with his/her two cents on China.  China’s a bubble.  China’s not a bubble.  China will be the global superpower circa 2020.  China’s in a demographic mess.  China this, China that.  Human Action too has engaged, maybe somewhat naively, in its own China punditry, and this article is yet another stab at figuring out the great beast from the east.

There’s truth about China somewhere in all this, but trying to find it is proving slippery to say the least.  This is in part because China is one big mystery from start to finish.  The one-child policy is still in place… sort of, not really, kinda, maybe?  It’s a centrally controlled economy… at least it used to be, now its pretty free, I guess, not really sure?  The GDP stats have to be smoke and mirrors right?  Who knows?

One of the more recent scribblers to have a go at ’settling’ the China issue was Barton Biggs, a managing partner of Traxis Partners hedge fund in New York, in a short article for Newsweek titled, ”No Bubbles in Beijing – Why the China bears are wrong“

I think it is fair to say that Bigg’s title alone is a bit of a cautionary red flag.  Anyone offering to the China-haters such a definitive statement of rebuttal on such a complex economic system is either deluded of his own prescience or has been on a whirlwind tour of the future.

As it turns out, Biggs is all bark and no bite.  His headline may rock but his arguments don’t roll.

Biggs follows his brash title with the opening line,

“The first thing you have to realize about China is that nobody knows a true thing about it, including me.”

Thanks for the honesty but you just made your title look idiotic.  Biggs then brushes his ignorance of China aside by saying that despite its opacity, it’s also too big to ignore, and so our clever hedge fund dude gives us his “best uneducated guess”,

“I don’t think it’s a bubble.”

Hmmm.  The crystal ball obviously just got a little foggy.

Biggs then goes on to make a poor error and it really costs him his remaining credibility.  Here’s what he says about monetary policy in China,

Accordingly, the authorities have gently raised the three-month and one-year bill-auction rates and advised the banks to pace themselves on loan growth. The one-year auction rate was raised eight basis points in each of the first two weeks of January. There is no question that this is “tightening,” but it’s a pretty gentle and tender squeeze. Perhaps to make sure everyone understood, last week one of the most influential deputy governors reaffirmed the commitment of the PBOC to a “moderately loose” monetary policy. Since China runs a “command” economy, admonitions have a lot of weight. For all the obvious reasons, it seems the PBOC wants to engineer a soft landing in which growth slows to 7 to 8 percent, not a hard landing in which real GDP sags to 4 or 5 percent.” [HA underlining]

There’s some subtle fallacies in here that are worth exploring.  Biggs, like so many others, confuses the bubble with the bust.  Here his rationale for why China is not a bubble is because they are not tightening as much as we all think.  What good news!  But that totally mixes the issue up.  Biggs is essentially saying that bubbles are not a problem because the Chinese authorities won’t pop them.  That’s like saying we don’t have to worry about hangovers anymore because we’ll just keep boozing.  Just like all the ignorant pundits out there, Biggs thinks the “hard landing” is the problem, but you can only have a hard landing if you have an unsustainable boom, a.k.a a bubble.  In other words, the fact that the hard landing is possible shows clearly the monetary excess in motion.  This is obviously lost on Biggs and so many others.

As for the PBOC giving us assurances of “moderately loose” monetary policy, that is just classic MOPE (Management Of Perception Economics).  China grew private credit by a whopping CNY1.4 trillion in January alone.  That’s about 5% of GDP in just one month.  Adjusting for economic size, that is like growing private credit in South Africa by about R130 billion, or 6%, in just 22 working days.  Yikes!  All this talk of moderate monetary tightening to ‘engineer’ a ‘soft landing’ is a ruse – the monetary taps are flowing fast in China, bubble-fast.

So basically Biggs thinks the Chinese policy makers have it all in hand and that by fiddling with a few knobs and pulling a few puppet strings a ’soft landing’ will be assured.  Sounds like something Ben Bernanke said a few years ago.  In reality, the more the Chinese pump currency into their economic system at such a ridiculously fast pace, the more chance there is of asset and sectoral bubbles.

Overall Biggs comes across as a little naïve which belies his experience and analytical stature.   Monetary pumping such as China has seen in 2008/09 will create some turbulent monetary and asset price tectonics in the years ahead – no doubt.  We commented on this here recently.

Here is the core of China’s problems:

• Production structure still heavily geared to Western demand which is fast imploding
• Huge monetary pumping which will weaken the capital structure
• Centrally planned economy is an inherently weak model
• Adopted a ponzy vendor financing model to sell goods to the US which has left China with a stack of IOUs
• US dollar peg will ultimately destroy the Yuan unless quickly removed 

With these in mind there is a very bumpy road ahead for China.  That being said, the difference between the China bubble and the US, UK and Europe bubbles is that China can grow into its mistakes and misallocated capital in the coming years.  The West will never be able to grow into its mistakes as its mature economies are in demographic and structural decline. 

China’s next generation will be wealthier than their parents, America’s and Europe’s will be poorer, and that really is the key difference.

In short, there are big bubbles in China and big misallocation of capital, and they will pop to a greater or lesser degree depending on the size of the monetary excess in those sectors or areas.  But this monetary excess will be far more forgiving of China than it has been and will be of the West.  

China’s monetary excess is definitely sub-optimal from a growth perspective, but China, like any juvenile, can probably grow out of its mistakes.