Chinese Government to Crack Down on Local Government Debt

China’s runaway credit financed property bubble will undergo scrutiny from Chinese national government, who will focus on reining debt levels of the local government

That’s according to a news from Bloomberg;

China will start a nationwide audit of government debt this week as the new Communist Party leadership investigates the threats to growth and the financial system from a record credit boom.

The State Council, under Premier Li Keqiang, requested the National Audit Office review, the office said in a statement yesterday without elaborating. The cabinet’s July 26 order was “urgent” and the office suspended other projects to work on the review and will send staff to provinces and cities this week, People’s Daily reported yesterday on its website, citing sources it didn’t identify.

The first full audit since an initial review two years ago underscores concern expressed by institutions such as the International Monetary Fund, which this month cited risks to the economy from borrowing by local governments and an expansion of non-traditional sources of credit. The new leadership oversaw a showdown with state-owned lenders last month as the People’s Bank of China engineered a cash squeeze to pressure banks to better manage their operations.

On the surface this looks impressive, but the question is how or on what basis will the national leadership apply controls? Will these be selective? Will the  political opposition bear the brunt of such crackdown?

The enormous leveraged exposure by local governments. From the same article:

The first audit of local-government debt found liabilities of 10.7 trillion yuan ($1.8 trillion) at the end of 2010, the National Audit Office said in June 2011…

Ding estimated China has at least 12 trillion yuan of local-government debt. The review may pave the way for future fiscal reforms, including changes to rules on local governments’ roles and responsibilities, Ding said.

I think that this goes beyond merely changing of rules, it is more likely that the problem lies, aside from the PBoC’s inflationary policies, on China’s top down political system and the command economy. 

China's centralized political framewok has previously used the statistical economy as a tool to promote the national political agenda. Moreover, the statistical economy has also been used as carrot and stick to manage the political careers of local government officials.

As explained by a paper from Cornell University (Derek Headey, Ravi Kanbur, Xiaobo Zhang) [bold mine]

Modern China has always had centralized merit‐based governance structure. In the planning economy era, the evaluation of cadres was largely based on political performance. However, since the China’s reforms initiated in 1978, political conformity gave way to economic performance and other competence‐related indicators as the new criteria for promotion. The promotion of China cadres’ is now largely based on yardstick competition in several key economic indicators, including economic and fiscal revenue growth rates, and some central mandates, such as family planning (Li and Zhou, 2005, Chapter 12, this volume). These indicators have been written into local leaders’ contracts. This creates tremendous pressure for local government personnel to compete with each other through superior regional performance.

In other words, the massive local government leverage has been a product of the political imperatives of the previous leaderships in generating high statistical economic growth regardless of the costs.

More. The Chinese government will allegedly cap spending…

Separately, China’s government has decided to cap the ratio of the fiscal deficit to gross domestic product at 3 percent in a bid to avert a downgrade of China’s credit rating by international rating companies, China Business News reported today, citing an unidentified person familiar with the matter.

So will the recently announced $85 billion railway stimulus be a limited one? This remains to be seen. I suspect that should China's economic slowdown intensify, spending caps may become an open spigot for stimulus. That's because a meltdown of the Chinese economy will likely jeopardize the power structure of the incumbent political system that would put to risks the grip on power by the incumbents.

Again chasing statistical growth at any cost by the local government has been previously powered by huge borrowing. 

As an aside, more than bubbles, as consequence from the politically driven growth strategy China suffers from a massive environmental degradation or pollution.

Again from the same Bloomberg article:

Local-government financing vehicles need to repay a record amount of debt this year, prompting Moody’s Investors Service to warn that Premier Li may set an example by allowing China’s first onshore bond default.

Regional governments set up more than 10,000 LGFVs to fund the construction of roads, sewage plants and subways after they were barred from directly issuing bonds under a 1994 budget law. A 4 trillion yuan stimulus plan during the 2008-09 financial crisis swelled loans to companies, which they have been rolling over or refinancing with new note sales.

LGFVs may hold more than 20 trillion yuan of debt, former Finance Minister Xiang Huaicheng said in April. Refinancing will be a challenge after corporate bond sales slumped to a two-year low in the second quarter and policy makers cracked down on shadow-banking activities that bypass regulatory limits on lending.

The obvious lesson here is that politically driven economic growth engenders massive imbalances. The boom of which are not only artificial and temporary, but eventually backfires.

Whether or not the national government pursues with tenacity the crackdown on local government and on the shadow banks, the above accounts appear as  deepening manifestations of the unfolding meaningful slowdown of the real (and not the inflated statistical) Chinese economy, the increasing hissing signs from China’s property bubbles and of the greater uncertainty over political direction and its ramifications.

In the face of a volatile global bond markets, these risks are likely to be amplified.

Interesting times indeed.

China’s “Power Market” Political Economy

A Friedrich von Hayek influenced Chinese journalist Yang Jisheng recently discussed about China’s history and current political economy.

Here’s Austrian economist Joseph Salerno at the Mises Blog

In an interview with the Wall Street Journal Mr Yang now reveals that he was greatly influenced by Friedrich A. Hayek’s classic work The Road to Serfdom , a heavily redacted version of which was translated into Chinese in 1997. Indeed Hayek had presciently written in this book, “In a country where the sole employer is the state, opposition means death by slow starvation.” Not only did Hayek’s book provide Mr. Yang with an explanation of the tragic events of his youth, it also explains the current Chinese system, which he maintains, has been completely misunderstood. The Wall Street Journal summarized Mr. Yang’s position as follows:

“China’s economy is not what [Party leaders] claim as the ‘socialist-market economy,’ ” he says. “It’s a ‘power-market’ economy.”

What does that mean?

“It means the market is controlled by the power. . . . For example, the land: Any permit to enter any sector, to do any business has to be approved by the government. Even local government, down to the county level. So every county operates like an enterprise, a company. The party secretary of the county is the CEO, the president.”

Put another way, the conventional notion that the modern Chinese system combines political authoritarianism with economic liberalism is mistaken: A more accurate description of the recipe is dictatorship and cronyism, with the results showing up in rampant corruption, environmental degradation and wide inequalities between the politically well-connected and everyone else. “There are two major forms of hatred” in China today, Mr. Yang explains. “Hatred toward the rich; hatred toward the powerful, the officials.” As often as not they are one and the same.

(bold mine)

Well, “a more accurate description of the recipe is dictatorship and cronyism” is really about fascism. And this has not just been about China.

Fascism, as traditional conservative and an outspoken critic of the Roosevelt administration's domestic and foreign policy decision, John Thomas Flynn wrote, is

a system of social organization in which the political state is a dictatorship supported by a political elite and in which the economic society is an autarchic capitalism, enclosed and planned, in which the government assumes responsibility for creating adequate purchasing power through the instrumentality of national debt and in which militarism is adopted as a great economic project for creating work as well as a great romantic project in the service of the imperialist state.

(bold mine)

Fascism via "instrumentality of national debt" or vastly increased public non-military spending as evident in ballooning budget deficits, and militarism's "great romantic project" such as "to defend the territory from bullies". 

Sounds familiar?

Quote of the Day: Power is the root of corruption; other aspects are its symptoms

The  following insightful but lengthy quote references China’s political economy, as written by Professor Weiying Zhang in "The Logic of Markets" (courtesy of and thanks to Mao Money, Mao Problems) [bold mine] 

I once used a mathematical equation to analyze and show that the increase in actual corruption has a few origins. One is that with the increase in the degree the Chinese economy has monetized; the economic value of power has increased. The second is that the complexity of economic relations has caused supervision to become more and more difficult. The third is the growth in market opportunity caused government officials to “preserve utility” (the utility they would receive if they were forced out of the government as punishment for corruption). The fourth is the level of punishment has been reduced (such as the amount embezzled to receive the death penalty was increased significantly). The fifth is the formal salaries of government officials are relatively low. 

The five factors described above are all related to power. Power is the root of corruption; other aspects are its symptoms. Anti-corruption measures must address both the symptoms and its root, but direct action would cure the root. That direct action is to reduce the power of government officials. Some have proposed “high salaries to encourage honesty,” which makes a bit of sense. In a situation where the power of government officials is excessive, honesty cannot be encouraged with high salaries. If officials’ salaries are too high, the masses will not accept it. The key issue here is that government departments in our country have monopolized many rights that belong to private citizens and businesses in other countries with a market economy. Examples include starting a business and engaging in investment activities, which require government approval. Individuals and businesses have no option but to “buy out” by means of corruption rights to engage in normal economic activity that should belong to them in the first place. In connection with anti-corruption measures at present that only cure the symptoms without curing the cause, I said in 1994 that if we do not change the fundamentals of our government controlled economic system, and reduce the government’s administrative approval authorities, corruption of private goods (according to the definition in economics, without exclusiveness) is instead a “sub-optimal” choice. My meaning is that to stop corruption we must cure its root, not its symptoms. On the one hand stressing anti-corruption measures without wanting to reduce government power on the other hand is self deception. Not only can it not succeed, or even if it succeeds in the short term, it comes at the price of a huge impairment to society. A prerequisite for high economic growth without corruption is the abolition of the government’s monopoly over the power to allocate resources. Some say that I am defending corruption, but actually this is a misunderstanding of my views. Penetrating discussion of issues is the responsibility of scholars. In 1999, at the High Level Forum on Chinese Development, I said, “Government control needs to be given up just as drugs need to be given up,” and added, “If government examination and approvals were abolished, corruption could be reduced by at least 50%.” This message had a large impact on the proceeding system of examination and approvals reform. Ten thousand good wishes cannot match one effective action!

As shown above, corruption is a byproduct of a raft of arbitrary statutes, regulations and edicts, that bequeaths unnecessary political power to political agents which incentivizes abuse or what public sees as immoral 'corrupt' actions.

And when the media and credit rating agencies pontificate on political ascendancy from so-called anti-corruption reforms by merely persecuting ‘corrupt’ officials, pay heed or be reminded of the reverberating words of Professor Weiying Zhang 

stressing anti-corruption measures without wanting to reduce government power on the other hand is self deception.

In other words, never confuse substance with form, or symptoms with the cause.

By the way here, is a short comical skit depicting "Too Much power" culled from a 1957 movie called "A King in New York City" played by the late British comedian icon Charlie Chaplin and his son Michael. (hat tip Prof Bob Murphy)

On China’s New Leaders

China’s unveiling of new leaders has not equally received warm reception from her domestic markets. The Shanghai index dropped 2.63% this week. The weekly losses account for 31% of the accrued year to date losses of 8.43%. 

Many have speculated on the whether currently selected leaders are “conservative” or “progressive” and of their possible policies when they assume their positions in 2013.

What has been known is that the current appointments by the top party leaders and retired officials[1] had been based on the rival factions of retired President Jiang Zemin, who seem to have prevailed over faction of outgoing President Hu Jintao (as noted by the table above from Merk Investments[2]).

What has also been a fact is that incoming President Xi Jinpin has a daughter studying at the Harvard University since 2010 (under a pseudonym and under 7/24 protection from bodyguards[3]) and that many of the contenders for China’s premier political power positions like Li Yuanchao (although he failed to get appointed), as well as with many incumbent bureaucrats and state officials, have been trained by or has affiliations with Harvard University. In short, perhaps the Harvard connection[4] may play an important role in China’s national and international political and economic affairs.

The reality is that we can never say what policies these people would assume in spite of their personal, academic and political backgrounds.

As a side note, US Federal Reserve Alan Greenspan comes to mind. Thought to have been influenced by free market leader Ayn Rand[5], upon the assumption of the chairmanship of the US Federal Reserve in August of 1987, Mr. Greenspan turned out to be a serial inflationist or bubble blower.

Once in command, the political environment will differ from their past experience since these leaders will have to deal with variegated political pressures from competing interests from every corner of China’s territorial borders.

Yet political pressures will not emanate solely from domestic front. External relations will be an ongoing concern too where China’s geopolitical and international economic interests lies.

In other words, the incoming leaders may or may not be influenced by the values or priorities of their benefactors or by their political parties, aside from the influences exerted by people surrounding them.

One thing that can be assured is that such leaders will operate along their self-interests. And that they would work under a mixture of limited knowledge, their perspectives and interpretations of events will be shaped by how information has been framed on them, their academic or ideological or cultural orientations, time preferences, value scales and the varying degree of influences from their networks will also matter, and lastly how all these political issues will harmonize or synthesize with their career (or even financial) interests or ambitions.

So far, following a series of record injections by the People’s Bank of China[6] (PBOC), the last of which has been made last month, credit activities appears to have picked up. The PBoC has made injections lately but has pulled back[7] from last month’s record highs

While the growth in new local currency bank loans has been weaker than consensus expectations, other credit measures such as corporate bonds, has shown marked advances[8]. Some say that this is bullish. Maybe. But perhaps the bulk of such improvements may be due to politically directed credit channeled through State Owned Enterprises (SOE) rather than from private sector. If this is true, then artificial stimulus may likely have a short term effect. Again everything depends on the feedback loop between the market’s response and the attendant policies adapted by the PBoC to address them and vice versa. 

Also part of China’s transitional government will involve PBoC Governor Zhou Xiaochuan departure or retirement. Albeit Governor Zhou says that the PBoC’s direction will work for the convertibility[9] of her currency the yuan, that would allow market forces to determine its value aside from opening China more to financial reforms.

I do hope that his successor will indeed push through with this reform agenda.

---

[1] Rappler.com FAST FACTS: China's 18th Communist Party congress November 8, 2012

[2] Axel Merk and Yuan Fang China's New Leadership: Progressive, Not Conservative Merk Investments, November 16, 2012

[3] DailyMail.co.uk China's new Princess - the daughter of Communist president Xi Jinping studying quietly at Harvard November 18, 2012

[4] See Uh Oh. China’s New Set of Policymakers could be Harvard Trained Keynesians November, 9, 2012

[5] Wikipedia.org Alan Greenspan

[6] Wall Street Journal PBOC Injects Record Amount of Liquidity November 1, 2012

[7] Wall Street Journal PBOC Continues to Trim Fund Injections November 12, 2012

[8] Danske Bank Political events take centre stage Weekly Focus November 16, 2012

[9] Bloomberg Businessweek China’s Next Step on Yuan Is Convertibility, Zhou Says, November 17, 2012

War on the Internet: China’s Censorship on New York Times’s Expose on Chinese Leader’s Wealth Fails

The New York Times published an expose on the Chinese leadership which had been met by swift response and censorship by Chinese authorities.

Nonetheless, the article continues to generate readership within China via the informal or shadow internet economy.

From the New York Times (bold mine)

A spokesman for China’s Foreign Ministry on Friday criticized a decision by The New York Times to publish a lengthy investigation into assets accumulated by the family of Prime Minister Wen Jiabao, saying that the article “smears China and has ulterior motives.”

Speaking at a regularly scheduled daily briefing in Beijing, the spokesman, Hong Lei, also said that the Chinese government’s decision to immediately block access to the English- and Chinese-language Web sites of The Times on Friday morning was taken “in accordance with laws and rules.”

China’s censors also moved with unusual swiftness on Friday to delete any social media postings alluding even tangentially to the article, which cited publicly available corporate documents in reporting that Mr. Wen’s family has controlled assets worth at least $2.7 billion.

Sina Weibo, a very popular microblogging service similar to Twitter and traded on the Nasdaq in New York, on Friday morning immediately deleted the unofficial account that had been used to promote the culture and arts coverage on the Chinese-language site of The Times and that had nearly 60,000 followers. The site’s official account had been blocked since the site began operations in late June.

Even the term “$2.7 billion” was blocked on Friday on Weibo. But users were still discussing the article by using deliberate mistakes like “2.7b.”

Despite the censorship, there were signs that the article was attracting attention. According to the company’s statistics, the number of page views and unique users of the Chinese-language site fell by only a third on Friday compared with the previous Friday, even though 85 percent of users are typically located in mainland China.

The investigative article was the site’s most popular, drawing nearly a third of page views, while the home page drew another third.

The continued strength of traffic to the site was a sign that many users were using virtual private networks, or V.P.N.’s, to effectively bypass servers in China and circumvent the country’s censors.

The controversial article can be seen here

Earlier, Bloomberg had been banned for a similar expose focused on another political leader

This serves as more proof that China’s largely statist regime or her practice of state capitalism, where nearly half of the enterprises remain state owned, have been tainted with favoritism, nepotism, corruption, cronyism and all sorts of economic windfall derived from the privileges of wielding political power.

And this is why policies in China have remained predisposed to Keynesianism despite its record of mounting failures and of the explosive growth of private enterprises. The latter of which has grown into a political force enough to challenge the status quo 

This also debunks the myth of selfless or virtuous leaders. Politicization of economic opportunities universally leads to immoral actions or conflicts of interests.

And importantly, the failure to censor the article in the entirety also exhibits the shadow internet economy thrives in China, which serves as further proof that internet remains a free market despite frenetic efforts of governments to control or regulate flow of information in order to protect the status quo.

Forces of decentralization (Information age or the Third Wave) have been gnawing at the foundations of the 20th century designed political establishment.

Survey: China a Marxist Country with Blossoming Capitalist Sentiment

It appears that the average Chinese has been more accommodative to capitalism than Americans.

From Bloomberg, (bold mine)

Survey respondents in the officially Marxist country were slightly more supportive of capitalism than people polled in the U.S. Seventy-four percent of Chinese surveyed said they either completely or mostly agreed with the statement that most people are better off in a free-market economy, compared with 67 percent of Americans.

More proof that the ongoing political struggle in China has been about the emergence of the politics of entrepreneurship or economic freedom.

China’s Manufacturing falls for the 11th month, Shanghai Index Plunges

China remains as the X-factor amidst all the inflationism deployed by global central banks.

China’s manufacturing continues to go downhill.

From Reuters:

Manufacturing in China contracted for the 11th month in a row in September, according to a private sector survey of factory managers that indicated the world's second largest economy remains on track for a seventh quarter of slowing growth.

The HSBC Flash China manufacturing purchasing managers' index (PMI) showed activity stabilized in September after hitting a nine-month low in August, with the headline reading ticking up to 47.8 from 47.6 last month.

But while the economy may not have worsened, there were few signs of a fast turnaround. Rather, the PMI, which provides the first glimpse of September's conditions for Chinese industry, pointed to a month in which a slide was halted but not reversed.

September's reading extends the longest period that the PMI has been below 50 - the value that separates contraction from expansion - since HSBC began compiling the survey in 2004.

There was a broad steadying across the sub-indexes in the survey, released on Thursday, with the exception of output, which dipped to its lowest level in 10 months.

"China's manufacturing growth is still slowing, but the pace of slowdown is stabilizing. Manufacturing activities remain lackluster, thanks to weak new business flows and a longer than expected destocking process," Qu Hongbin, chief economist for China at HSBC, said in a statement accompanying the survey.

"This is adding more pressure to the labor market and has prompted Beijing to step up easing over the past weeks. The recent easing measures should be working to lead to a modest improvement from Q4 onwards."

Not enough steroids? Again from the same article:

China unveiled a series of measures last week to help stabilize export growth, including faster payment of export tax rebates and boosting loans to exporters.

That was on top of a series of approvals for infrastructure projects worth more than $150 billion, two earlier cuts to interest rates, the easing of bank reserve requirements that freed about 1.2 trillion yuan ($190 billion) for lending and a steady series of liquidity injections into money markets.

Still, purchasing managers in the survey had little cause for premature cheer. A sub-index that measures output fell to 47.0, its lowest level since November 2011.

After spending several months bumping just beneath the crucial 50 mark, the overall PMI index is now at a level rarely seen since the 2008-2009 global financial crisis.

Asian markets have not seen this as anything to cheer about

China’s equity markets continue to hemorrhage with the Shanghai Index sharply down today by 2.08%  (table from Bloomberg)

Today’s steep decline means that the recent lows of around 2040+s will be tested (chart from stockcharts.com)

These developments brings some questions to mind:

Will Chinese political authorities up the ante of policy bailouts through fiscal and monetary channels or will they allow the markets to clear? My bet is on the former.

Will developments in China weigh on global markets or will inflationism eventually diffuse to China.  This is something to be yet determined.

China’s Public Works Disasters

Here is another example of the unintended nasty effects from China’s centrally planned capital-infrastructure spending boom

From the International Business Times

A collapsing bridge in northern China killed three people and injured five others on Friday.

The Yangmingtan Bridge stretched across the Songhua River in the Heilongjiang province, according to the BBC. But the collapsed section, which was about 328 feet long, came from a ramp over dry land. It was about 5:30 a.m. when four loaded trucks spilled onto the ground as the road beneath them fell apart.

The worst part is that nobody is surprised by Friday's tragedy; this was China's sixth major bridge collapse since July of 2011.

Note: This incident has been the SIXTH major bridge collapse since July 2011. This appears to be the result of the 2008-2009 stimulus program, which prompted the Chinese government to rush public works for the sake of keeping up with statistical job growth via Keynesian policies.

Other grand “public work” projects have also experienced accidents. Again from the same article…

The Yangmingtan Bridge, a multi-million-dollar project, was finished just nine months ago. It is one of many infrastructure projects undertaken by the Chinese government in recent years. These include over 4,200 miles of high-speed rail tracks, which may increase to 12,000 miles by 2020; the Three Gorges Dam on the Yangtze River, which is the largest hydroelectric project the world has ever seen; and the rapid construction of new airports that, if all goes according to plan, will bring China's total up to 230 by 2015

But for all their successes, each of these grand projects has been marked by serious failures.

China's high-speed trains, for instance, may be going a bit too fast; there have been several accidents over the last few years. In July of 2011, a two-train collision killed 40 people. In March of this year, a 980-foot stretch of track along the Yangtze River collapsed due to nothing more than heavy rains. And in the Heilongjiang Province on Thursday evening, a minor crash injured 24 people.

The Three Gorges Dam has plenty of issues too, though it generates enough watts to power Switzerland. It has necessitated the relocation of over a million people, and its construction has come at a huge environmental cost. Lately, a change in the reservoir's water level has resulted in dangerous landslides, and Reuters reported this week that another 100,000 people will soon have to head for higher ground.

Man made disasters and accidents account for some of the unintended consequences.

But there is more, many upcoming projects risk underutilization or becoming white elephants…

And if all goes to plan, China's planned airport development will put a full 80 percent of the population within 65 miles of an air transport hub. Some argue that this might be a little excessive for a country where, just last year, two-thirds of China's current 180 airports were unprofitable. (Chinese officials argue that air travel is a burgeoning industry, and that an extensive network of transit hubs will generate the traffic needed to make it profitable.)

Japan’s bubble bust legacy of “socialization of investments” from numerous money losing taxpayer funded public airports should be an example.

Assuming the noble intentions of political authorities, central planning implies omniscience and the superiority of knowledge over the marketplace which simply isn’t true. Political authorities cannot know of the individual preferences and values and of the particular circumstances of time and place with respect to individual actions.

Also this also disregards the notion of the incentives guiding policymakers

Virginia Postrel in her 1998 book, The Future and Its Enemies as quoted by Professor Don Boudreaux,

To centralize knowledge for the sake of planning and “efficiency” – the technocratic dream – we have to throw away vast amounts of local knowledge.

Depending on topsight can easily lull us into imagining that we see not only the “big, big, big, big, big, big, big, big picture” but the whole, including the critical details. At a distance, it is easy to think that other people just don’t know what they’re doing – especially when you can override their decisions by decree rather than through persuasion or competition.

Yet most seem to forget that political authorities tend to itch on spending other people’s money.

Politicization of the allocation of resources leads not only to waste, deaths from accidents and corruption, but to systemic fragility from centralization of policy errors—the hemorrhage of resources and capital on unproductive undertaking (capital consumption), of mounting debts to finance political boondoggles (debt crisis) and of the loss of civil liberty.

China’s Mounting Glut of Unsold Goods

More signs of China’s hard landing or bursting bubble.

From the New York Times,

After three decades of torrid growth, China is encountering an unfamiliar problem with its newly struggling economy: a huge buildup of unsold goods that is cluttering shop floors, clogging car dealerships and filling factory warehouses.

The glut of everything from steel and household appliances to cars and apartments is hampering China’s efforts to emerge from a sharp economic slowdown. It has also produced a series of price wars and has led manufacturers to redouble efforts to export what they cannot sell at home.

The severity of China’s inventory overhang has been carefully masked by the blocking or adjusting of economic data by the Chinese government — all part of an effort to prop up confidence in the economy among business managers and investors.

But the main nongovernment survey of manufacturers in China showed on Thursday that inventories of finished goods rose much faster in August than in any month since the survey began in April 2004. The previous record for rising inventories, according to the HSBC/Markit survey, had been set in June. May and July also showed increases.

“Across the manufacturing industries we look at, people were expecting more sales over the summer, and it just didn’t happen,” said Anne Stevenson-Yang, the research director for J Capital Research, an economic analysis firm in Hong Kong. With inventories extremely high and factories now cutting production, she added, “Things are kind of crawling to a halt.”

This seems an obvious outcome from a politicized economy.

As I previously pointed out:

-Today Chinese economy has been roughly split 50-50 between state owned and privately owned enterprises

-State companies use political means of “higher taxes, stricter regulation, and bureaucratic meddling” to “drive out private competitors”

-State banks discriminate in terms of lending where “only four percent of their loans to private businesses”. Thus, the recourse of private businesses has been through the informal or shadow banking systems. Ironically, transacting with unofficial credit markets “can be a criminal offense punished by long jail terms or worse”

The implication of the above is that much of China’s present day economy remains influenced by political forces. This means we cannot trust statistical figures to show real economic growth as they may likely be manipulated for immediate political goals.

Politicization simply means State Owned Enterprises (SOE) have hardly been driven by the discipline of profit and losses, and instead have been focused on attaining goals as dictated by the officialdom. Thus, to pad up on economic statistics, numerous SOEs engaged in production that has led to the glut of unsold goods.

Since statistics have been used as guide for the implementation of policy objectives, the government’s manipulation of statistics has also added to the misallocation of resources.

Lastly, excess supply of goods are also symptoms of the recessionary phase of China’s business cycle. This has been caused by easy money policies from China’s central bank, designed to attain credit driven permanent state of quasi booms, and has been compounded by capital spending binge by the government.

As the great dean of Austrian school of economics wrote,

The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The "depression" is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed.

Surplus goods along with ghost cities and malls and the huge shadow banking system all adds up to exhibit signs of the unwinding phase of China’s bubble economy.

The inflationary boom may have segued into a financial and economic bust.

China’s Spontaneously Driven Economic Reforms

Paul Gregory, research fellow at the Hoover Institution, says that China’s economic miracle has been a product of spontaneous order.

At the Econolog Mr. Gregory writes,

China's private enterprise reforms began first in agriculture in 1978 and spread from there. Agriculture accounted for most of Chinese output and most of the labor force when Mao died in 1976 and the reform period could begin. The freeing of agriculture from collective farms is the most important untold part of the Chinese growth story.

Agricultural reforms began spontaneously from below, even before the "Reform" Party Congress of 1978 that installed reformer Deng Xiaping in power. A Chinese reform official later admitted: "In fact, reform wasn't discussed. Reform wasn't listed on the agenda, nor was it mentioned in the work reports." What became known as the "contract responsibility system" was sparked spontaneously by eighteen peasants from Xiaogang village in Anhui province. They secretly divided communal land in November 1978 and agreed to farm their plots individually, each contributing their share of the state quota. The state got its due and the peasants kept what was left over. The peasants' separation of their land from the collective farm was illegal, highly dangerous, and done without the approval of regional officials. Why did they take the chance?

Kate Zhou explains that the peasants had seen their parents and children die from starvation during the 1958-1961 famine of the Great Leap Forward. They understood they had to take care of themselves. The contract responsibility system spread like wildfire from village to village and from province to province, notably without endorsement by or encouragement from regional or national authorities.

As agricultural production soared, Deng Xiaping and his CPC realized that they should not resist something that was working. By 1982, more than 90 percent of rural dwellers worked under the contract responsibility system, but they were allowed only one- to three-year contracts on their land. It was only in 2003 that the state gave out longer-term leases.

The spontaneous reforms in agriculture meant that new supplies of food products needed markets and that markets needed infrastructure. Rural dwellers created a private trade network, and, within one year, most state food stores were out of business. Rural entrepreneurs then created new businesses, such as hotels, services, private restaurants, and small-scale manufacturing, through the three Fs (friends, family and fools). They bribed local officials to register their companies as "township and village enterprises." They created fake "red hat" enterprises, that is, private companies masquerading as state companies, and sham collective enterprises, or they used state enterprises to issue receipts and open bank accounts. Large private manufacturing firms developed first in predominantly agricultural provinces. China's largest agribusiness was founded by brothers who left the city to found their company in rural Sichuan. Rural entrepreneurs built the largest refrigeration and air-conditioning companies in China.

Read the rest here

That was then. Today’s conditions have been different.

Further in the article, Mr. Gregory points out some very important factors

-Today Chinese economy has been roughly split 50-50 between state owned and privately owned enterprises

-State companies use political means of “higher taxes, stricter regulation, and bureaucratic meddling” to “drive out private competitors”

-State banks discriminate in terms of lending where “only four percent of their loans to private businesses”. Thus, the recourse of private businesses has been through the informal or shadow banking systems. Ironically, transacting with unofficial credit markets “can be a criminal offense punished by long jail terms or worse”

The implication of the above is that much of China’s present day economy remains influenced by political forces. This means we cannot trust statistical figures to show real economic growth as they may likely be manipulated for immediate political goals.

This also means that a substantial segment of the nation’s resources have been utilized inefficiently which entails of massive wastages and of capital consumption.

Ghost cities, empty malls and stadiums are evidences of these.

While it may true that the private sector may have been outperforming the state owned companies, the latter’s substantial share extrapolates to the crowding out of the private sector.

Also, political authorities through state owned enterprises have used politics to undermine their private sector counterparts.

And in order for the private sector enterprises to survive and compete they have gone beyond the ken of authorities through the underground/informal economy (e.g. shadow banking). But doing so means having to take upon greater legal and regulatory risks.

All these goes to show how China has been discriminating against the private sector while favoring state owned enterprises.

Ever wonder why China has been a hotbed for 'fake' and or inferior goods?

Apparently globalization has been a key dynamic in forcing the reluctant hands of China's political authorities to liberalize.

And so far the good news has been that political trends appear to signal the emergence of the entrepreneurs as a political force.

This seems evident in the realm of China’s financial markets.

Over the past few months China authorities has undertaken a flurry of liberal oriented reforms; particularly China has recently eased on restrictions on Exchange Traded Funds (ETFs), has lowered transaction fees on share trading, has proposed to ease delisting rules, and seeks to increase the participation of foreign investors into China’s equity markets by expanding the Qualified Foreign Institutional Investors (QFII).

Nonetheless political trends will determine if China’s economic miracle will continue, put to a halt or reverse. All these will rest on China's appetite for economic freedom.

Bloomberg Censored in China

China’s authoritarian tendencies can still be seen from her continuing censorship of Bloomberg which seems in retaliation for the latter’s recent exposure of the China’s crony capitalist political economy.

Notes the CNN/Financial Times

Bloomberg's news website remains blocked by China's state censors a full month after it detailed the riches amassed by the family of Xi Jinping, the man who is expected to be the country's next president.

Although periodic outages of foreign media websites in China are common, the month-long total blackout of Bloomberg is an unusually harsh response, highlighting the extent to which its coverage angered the government.

Beijing has tried to apply pressure in other ways, too. In the weeks since the article was published, people believed to be state security agents have tailed some Bloomberg employees; Chinese bankers and financial regulators have cancelled previously arranged meetings with Matthew Winkler, Bloomberg's editor-in-chief; and Chinese investigators have visited local investment banks to see if they shared any information with Bloomberg, according to people with knowledge of these incidents…

In the report published on June 29, Bloomberg used publicly available records to show that Mr Xi's extended family had investments in companies with total assets of $376m; an 18 per cent indirect stake in a rare earths company with $1.73bn in assets; a $20.2m holding in a publicly traded technology company; a luxury villa in Hong Kong worth about $31.5m and at least six other Hong Kong properties worth a combined $24.1m.

Bloomberg was unable to trace any assets to Mr Xi himself, or to his wife or daughter. There was also no evidence of any wrongdoing by Mr Xi or his family.

Nevertheless, the report was seen as embarrassing for Mr Xi, threatening to undermine his image as a clean official in a country rife with corruption just months before he is set to succeed Hu Jintao as president in a once-in-a-decade leadership transition…

No other English-language mainstream media website has been blocked in China for longer than a few days since the 2008 Beijing Olympics. Censors now target specific articles or disrupt access to sites at politically sensitive times such as when dissident Liu Xiaobo was awarded the Nobel Peace Prize in 2010.

This just goes to show why the Panglossian view of China’s future seems unwarranted.

China’s fate will ultimately depend on how political trends evolve (Will China revert to socialism or statism or a closed economy? Or will China embrace deeper liberalization?).

This cannot be interpreted merely from past performance. The above may also be symptoms of the strains from ongoing political deadlock and from economic slowdown (or bubble bust?).

For now China’s bubbles from previous Keynesian quasi boom bust policies will have to be addressed.

So far, the Shanghai Composite index keeps plumbing to new depths.

China’s Economic Growth Slows Anew, Economic Data Questioned

China reported slower economic growth for the sixth consecutive quarter

From Businessweek/Bloomberg.

China’s growth slowed for a sixth quarter to the weakest pace since the global financial crisis, putting pressure on Premier Wen Jiabao to boost stimulus to secure a second-half economic rebound.

Gross domestic product expanded 7.6 percent last quarter from a year earlier, the National Bureau of Statistics said today in Beijing. The pace, a three-year low, compares with an 8.1 percent gain in the previous period and the 7.7 percent median forecast of economists. Industrial production increased at a slower pace in June while retail sales growth decelerated.

Today’s data painted a mixed picture from a pickup in fixed-asset investment that could signal the economy is stabilizing to the warning sign that electricity output failed to increase in June from a year earlier.

Yet the accuracy of China’s declared economic figures are being questioned.

From another Bloomberg article

The figures that go into China’s gross domestic product are “man-made” and “for reference only,” Li Keqiang, then a regional Communist Party head, said in 2007.

The comments by Li, now a vice premier who’s expected to become premier next spring, were revealed in a diplomatic cable published by WikiLeaks in late 2010. Li’s remarks are especially relevant as China announced today that the economy expanded 7.6 percent last quarter from a year earlier, the slowest pace in three years.

Investors, bankers and economists face a host of difficulties in interpreting the numbers from China’s statistics bureau, Bloomberg Businessweek reports in its July 16 issue. Combining all officially reported provincial GDP numbers for last year produces a total exceeding national GDP by about 10 percent, Ma Jiantang, head of the National Bureau of Statistics, said in February. Ma said that is due partly to double counting of items including factory production and that his bureau was trying to correct the issue…

One new effort to gauge the economy is the China Beige Book, a quarterly survey of about 2,000 bankers and company executives, modeled on the U.S. Federal Reserve’s Beige Book. It measures growth in eight key industries across China’s major regions, said Leland Miller, president of New York-based CBB International LLC, which publishes the report.

Chinese policy makers are trying to address the government’s statistical shortcomings. More data are now directly reported to Beijing, as opposed to being first filtered through local party offices. The statistics bureau has moved to standardize data collection by China’s many ministries and industrial associations.

The bureau has also worked with the United Nations, the International Monetary Fund and the Organization for Economic Cooperation and Development to improve its tracking of the economy.

China still tends to treat its data gathering as a national secret, said Anne Stevenson-Yang, co-founder of Beijing-based J Capital Research, which analyzes equities. She cited the government’s refusal to release the weighting of goods tracked to compile its consumer price inflation index.

Statistics can be manipulated to suit political goals.

Nevertheless, market price indicators—such as struggling commodity prices, falling yuan and faltering Chinese equity markets (Shanghai Index)—does not seem to be consistent with the above report.

Unreliable and contested figures only reveals of the extent of political impasse and adds to the uncertainty of current conditions.

The Anatomy of Rent Seeking: China Edition

Rent seeking is simply the manipulation of the social or political environment in order to obtain wealth through monopoly privileges (Wikipedia.org). Such actions usually comes in the form of subsidies, various political concessions and or regulations which works to prevent free market competition.

The following controversial article from Bloomberg (which reportedly has been censored in China, according to Zero Hedge) gives an example.

Bloomberg: (bold emphasis mine)

Xi Jinping, the man in line to be China’s next president, warned officials on a 2004 anti-graft conference call: “Rein in your spouses, children, relatives, friends and staff, and vow not to use power for personal gain.”

As Xi climbed the Communist Party ranks, his extended family expanded their business interests to include minerals, real estate and mobile-phone equipment, according to public documents compiled by Bloomberg.

Those interests include investments in companies with total assets of $376 million; an 18 percent indirect stake in a rare- earths company with $1.73 billion in assets; and a $20.2 million holding in a publicly traded technology company. The figures don’t account for liabilities and thus don’t reflect the family’s net worth.

No assets were traced to Xi, who turns 59 this month; his wife Peng Liyuan, 49, a famous People’s Liberation Army singer; or their daughter, the documents show. There is no indication Xi intervened to advance his relatives’ business transactions, or of any wrongdoing by Xi or his extended family.

While the investments are obscured from public view by multiple holding companies, government restrictions on access to company documents and in some cases online censorship, they are identified in thousands of pages of regulatory filings.

The trail also leads to a hillside villa overlooking the South China Sea in Hong Kong, with an estimated value of $31.5 million. The doorbell ringer dangles from its wires, and neighbors say the house has been empty for years. The family owns at least six other Hong Kong properties with a combined estimated value of $24.1 million.

Standing Committee

Xi has risen through the party over the past three decades, holding leadership positions in several provinces and joining the ruling Politburo Standing Committee in 2007. Along the way, he built a reputation for clean government.

He led an anti-graft campaign in the rich coastal province of Zhejiang, where he issued the “rein in” warning to officials in 2004, according to a People’s Daily publication. In Shanghai, he was brought in as party chief after a 3.7 billion- yuan ($582 million) scandal.

A 2009 cable from the U.S. Embassy in Beijing cited an acquaintance of Xi’s saying he wasn’t corrupt or driven by money. Xi was “repulsed by the all-encompassing commercialization of Chinese society, with its attendant nouveau riche, official corruption, loss of values, dignity, and self- respect,” the cable disclosed by Wikileaks said, citing the friend. Wikileaks publishes secret government documents online.

A U.S. government spokesman declined to comment on the document.

While inequality is an innate feature of the marketplace, it is even worse when political access and privilege drives these.

Again from the same Bloomberg article:

Increasing resentment over China’s most powerful families carving up the spoils of economic growth poses a challenge for the Communist Party. The income gap in urban China has widened more than in any other country in Asia over the past 20 years, according to the International Monetary Fund.

“The average Chinese person gets angry when he hears about deals where people make hundreds of millions, or even billions of dollars, by trading on political influence,” said Barry Naughton, professor of Chinese economy at the University of California, San Diego, who wasn’t referring to the Xi family specifically.

Read the rest here

Realize that when politicians and their followers peddle arguments based on “noble sounding” or “feel good policies” such as self sufficiency, nationalism, anti-foreign, currency manipulations-trade deficits, the need for political spending to generate employment (make work bias) and etc.., they are preaching of mercantilism and protectionism which tacitly promotes their interests and NOT of the consumers or of the “people”.

The ultimate beneficiaries of interventionists policies, like the above, are the powers that be.

Interventionism is the essence of rent-seeking politics or crony capitalism.

The rent seeking political economy is a universal phenomenon. The greater share of the political influences on the economy, the more economic opportunities are driven by rent seeking. This includes the Philippines. All you’ve got to do is to OPEN your eyes, use common sense and stop listening to sycophants and the institutional propaganda machines.

Politicians hardly practices on what they preach, as they are focused mainly on generating votes or approval ratings to preserve or expand their entitlements.

In the rent seeking political economy, there are many ways to skin a cat, something which the public can hardly see.

When media and politicians talk about “inequality”, like magicians, they simply are engaged in verbal manipulative framing of the public’s mindset. They deliberately shift the blame on market forces, what in essence are mainly caused by political inequality.

HOT: China Cuts Lending Rates and Deposit Rates

China has fired the opening salvo of a series of interventions which I expect from global central bankers.

From Bloomberg.com

China cut interest rates for the first time since 2008, stepping up efforts to combat a deepening economic slowdown as Europe’s worsening debt crisis threatens global growth.

The benchmark one-year lending rate will drop to 6.31 percent from 6.56 percent effective tomorrow, the People’s Bank of China said on its website today. The one-year deposit rate will fall to 3.25 percent from 3.5 percent. Banks can also offer a 20 percent discount to the benchmark lending rate, the PBOC said, widening from a previous 10 percent…

Today’s move signals policy makers are concerned that the cost of borrowing is crimping companies’ spending and holding back expansion in the world’s second-biggest economy. Three bank officials told Bloomberg News last month that the nation’s biggest banks may fall short of loan targets for the first time in at least seven years as demand for credit wanes.

Slowdown Worsening

The PBOC cut banks’ reserve requirements in November for the first time in three years, and again in February and May, to spur lending.

The next thing is to observe the reaction of China’s financial markets and the prices of global commodity markets, particularly gold, over the coming days.

If these cuts won’t stop the bleeding as with bank reserve requirements, then we can expect more cuts to come.