China’s Local Governments have been Addicted to Bubbles

I have been pointing out here how China’s bubbles are consequences of financial repression policies, with particular weight on inflationism.

Now comes a report saying that the main beneficiaries of blowing bubbles—the government, particularly the local government—have been hooked on the said policies.

From the Wall Street Journal Real Times Economic Blog:

Local governments in China are growing ever more addicted to revenue from land sales.

That’s the takeaway from China’s Ministry of Land and Resources, which issued its second-ever annual report on land resources in China this week.

According to the report, last year, local government officials sold 367,000 hectares of land, up 14% from the year before. The sales were a bonanza for local government finances, raising 4.2 trillion yuan ($682 billion), a 56% increase over the previous year.

Through bubble blowing policies, not only does the government get increased revenues from inflated earnings, such has also helped the local governments attain economic growth targets imposed by the national government partly through land sales.

Since local governments are responsible for about 70% of spending while receiving only 50% of tax revenues as shown in the left pane from the IMF, land sales signify as one important source of alternative funding for local government projects. The IMF chart in the right pane shows land sales as a share of revenues of select cities and of the national government.

Aside from land sales, the bigger source of local government bubble activities has been financed by debt.

China’s bubbles have been fueled by local government “investment” spending meant to attain economic growth targets. Much of these “investments” have been channeled through a construction binge, which became pronounced when the Chinese government launched a gargantuan (US $586 billion) stimulus as shield against the global crisis in 2008-2009.

And since local governments are legally not allowed to borrow, they have circumvented such rules by creating local government controlled special purpose units called LGFV (local government financing vehicles).

However when the national government tightened bank lending to LFGVs, the latter opted to secure financing via shadow banks. 

Bubble blowing activities by local government units in response to negative real rates and to a political system which imposes growth targets at the local level have led China's local government units to swim in debt reportedly to the tune of US$2.9 trillion as of June 2013 as earlier discussed. 

And this has not just been the local government, according to an analyst from Bank of America Merrill Lynch, compared with other countries, China’s private sector generated the most debt between 2008-2012

In short China’s economic 'state capitalism' model has been pillared by credit inflation which local governments has been chronically hooked to. Take away these artificial props and the whole credit house of cards falls. 

The article also reveals signs of failed central planning: (bold mine)

Meanwhile, the government also made significantly more land available for residential and commercial purposes last year, up 20% and 28%, respectively. Sales of both kinds of land are significantly more lucrative than, say, land used for infrastructure construction and land used for industry, mining and warehousing, two other categories mentioned in the report. The amount of land set aside for infrastructure fell by 6% in 2013, while the land for industry, mining and warehousing only increased by around 1%.

That’s a marked change. In previous years, the government tended to emphasize land for infrastructure more, setting aside 338,500 hectares of such land in 2012, a more than fivefold increase over what was dedicated to such use in 2008. During that same period, land for industry, mining and warehousing use increased 123%, compared with only 85% for residential land.

At the time, the hope was that construction of more industrial parks and infrastructure would attract investment. But for many cities, such dreams haven’t materialized. Instead, the result is densely packed city-centers surrounded by sprawling suburbs left to stray dogs and tumbleweed.

According to a recent report by the World Bank, if Shenzhen had the same urban density as Seoul, it could accommodate an additional 5.3 million residents.

Now, it appears, local governments are finding that lucrative residential and commercial land sales are a quicker way to make a buck. But such appetite—and the prospect of even more people being forced off their land—is worrisome to the central government, which wants to ensure the country remains agriculturally self-sufficient.

So China's national government will have a very challenging balancing task of shifting economic activities away from the local (and national) government and into the private sector while at the same time dealing with a system burdened by excessive debt without falling into a crisis.

But such transition will hardly be smooth since authorities will be hampered by the knowledge problem (they have some idea of the problem but they don't know the particulars of the millions of moving parts of economic activities operating within her boundaries), and importantly, as mentioned above, there are huge entrenched “addicted” interests involved.

Insider Trading Regulator Practicing Insider Trading?

A study cited by Bloomberg uncovers some fishy transactions by some personnel of the US SEC:

People working for the U.S. Securities and Exchange Commission who owned stock in companies under investigation were more likely to sell shares than other investors in the months before the agency announced it was taking enforcement actions, according to a new academic paper.

SEC employees holding shares of five firms including JPMorgan Chase & Co. and General Electric Co. (GE) in 2010 and 2011 sold stock in 62 percent of the trades they initiated, compared with 50 percent among all the investors who traded those shares in that period, Emory University accounting professor Shivaram Rajgopal reports in the paper.

Rajgopal, who plans to present the work today at a University of Virginia accounting seminar, said in a telephone interview that while the analysis doesn’t prove misconduct it points out a suspicious pattern.

“It does suggest it is likely, or probable, that something is going on,” he said.

The records, obtained from the SEC under a Freedom of Information Act request by Rajgopal and his co-author, Roger M. White, a doctoral student at Georgia State University, don’t identify individuals.

The limitation means the researchers couldn’t tell if an individual trader made or lost money in a transaction. They also couldn’t discern if those trading worked in jobs where they might have advance knowledge of actions that could push stock prices lower.

If true then this shows how regulators think they operate above the law, how they use their positions or even actions (via imposition, administration or enforcement of policies) for personal benefit, and or perhaps even coop with corporate insiders again for their personal benefit. 

Of course the SEC dwarfs the world’s biggest insider trader, the US Federal Reserve and her central banking peers, who manipulate the markets in order to boost the interests of the allies/cronies.

The Pope and Populist Politics

Pope Francis plays populist politics by supposedly taking on an economic stand.

Some people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world,” Francis wrote in the papal statement. “This opinion, which has never been confirmed by the facts, expresses a crude and naive trust in the goodness of those wielding economic power and in the sacra­lized workings of the prevailing economic system.

Harvard’s Greg Mankiw’s reaction (hat tip Mark Perry)

First, throughout history, free-market capitalism has been a great driver of economic growth, and as my colleague Ben Friedman has written, economic growth has been a great driver of a more moral society.

Second, "trickle-down" is not a theory but a pejorative used by those on the left to describe a viewpoint they oppose.  It is equivalent to those on the right referring to the "soak-the-rich" theories of the left.  It is sad to see the pope using a pejorative, rather than encouraging an open-minded discussion of opposing perspectives.

Third, as far as I know, the pope did not address the tax-exempt status of the church.  I would be eager to hear his views on that issue. Maybe he thinks the tax benefits the church receives do some good when they trickle down.

Wall Street’s Mary O’Grady on Venezuela as example of the Pope’s model.

Heavy state intervention was supposed to produce justice for the poor in the breadbasket of South America. We all know how that turned out.

No Christian can doubt the love expressed in the pope's message, which aims to shepherd the flock away from materialism. But the charge that grinding poverty in the world is the outgrowth of "the absolute autonomy of the marketplace" ignores reality. To be sure, even prosperous economies regulate markets. But those that have a lighter touch do better. Human history clearly demonstrates that when men and women, employing their free will and God-given talents, are able to innovate, produce, accumulate capital and trade even the weakest and most vulnerable are better off.

Instead the pope trusts the state, "charged with vigilance for the common good." Why is it then that the world's most desperate poor are concentrated in places where the state has gained an outsize role in the economy specifically on just such grounds?

…

Venezuelans need a moral authority that defends their rights to run a business, make a living, own property and preserve the purchasing power of what they earn. In short, they need a champion for a rule of law that will limit the power of the state over their person. Mother Church ought to be that voice. In siding with Mr. Maduro, however inadvertently, she harms her cause in the region.

New York Stern Professor Mario Rizzo on the Pope’s omission of the scientific dimensions of social policies.

If we move beyond Jesus’ exhortations to individuals about their moral behavior to papal exhortations about government policies to achieve the goal of eliminating or reducing avoidable human suffering, a scientific dimension is added. Policies have consequences, often unintended. The social interaction of people is more than the acts of people taken individually.  There are complexities in these cases subject to scientific analysis.

The ultimate normative goals of action can be based on a religious insight or commitment. (I prefer to say on ethics.) But the means chosen to attain those goals are in large part a scientific question. Thus the proximate goals of action are largely in the domain of science. (An exception is where the means are considered intrinsically evil.)

The point is that policies are means to ends. They are not decrees about how the world should be. They can succeed or fail to achieve the desired moral ends. They can have consequences more undesirable than the problems they purport to solve. It is hard to see what the Church can authoritatively add to these discussions.  Issues like income redistribution, globalization and financial speculation, however, are either above or below the papal pay grade. As Jeremy Bentham said about the state, the job is basically to “be quiet.”

Obviously, for a Church wanting to be relevant in its growth areas in poor, less developed countries, this might not be enough. And yet there is more it can say about the state’s use of coercion, of its violation of the basic principles of just conduct in the creation of crony “capitalist” economies, of its secrecy and lack of accountability, of the use of torture, of trafficking in slaves, and war. The Church has to its credit tackled many of these. It will be seen, I suggest, that in most of these areas governments or others are violating the fundamental principles of individual just conduct: lying, cheating, stealing, physically harming innocent individuals, failing to aid others in distress (as opposed to failing to coerce people to aid others in distress), and even the use of force where turning the other cheek would be appropriate.

But where social policy is concerned, fundamentally scientific issues are crucially involved and the Church has no greater teaching authority than the rest of us. To confuse matters by combining superficial scientific analysis with strictly moral teaching does neither the Church nor the world much good.

Uttering feel good noble sounding populist political rhetoric with hardly a good understanding of the real social consequences from proposed repressive policies will do little to help society. For me, the Pope's major gaffe has been the failure to understand that the state is run by human beings who shares the same vulnerabilities as the rest.

As the great dean of the Austrian school of economics Murray Rothbard admonished:

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a "dismal science." But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

Philippine Politics: Barangay Elections and the Pork Barrel System

The recently concluded Barangay elections reported accounts of massive and widespread vote buying (as much as 1,000 pesos per head) and a surge in the death toll from election violence (higher than national elections in 2010).

The 64 billion peso question: why all these?  What drives candidates to desperately seek political office at the cost of their lives and huge amounts of expenses?

The answer of course is no stranger to most: it has been both about perks and power.

Let us examine the perks or benefits from the officials of Barangay level.

The basic perquisites are as follows: 

Graph from the Rappler.

Aside from these, other benefits include Christmas bonus and cash gift, insurance coverage, as well as, benefits for accident, total or permanent incapacity, disability, death and burial.

There’s more. Barangay officials also get many subsidies in the form of “free hospitalization in government facilities, and free tuition in state schools for themselves and two of their legitimate dependent children (“legitimate” is specified in the law) during their incumbency. Based on their number of years in the service, barangay officials can get civil service eligibility”.

What are they not entitled to (for now)? 13th month pay, hazard pay, representation and transportation allowances, productivity incentive bonus, clothing and personnel and economic relief allowances.

[As a side note, the above also introduces the power aspect

National level officials have been pushing for more Barangay benefits from more funding to fare discounts. Why? 

It’s all about political power

This noteworthy excerpt captures its essence

“In theory, the law says [barangay elections] should be nonpartisan,” Casiple said, referring to a provision in the Omnibus Election Code barring candidates to represent or receive aid from any political party.

“But in reality, they’re important to mayors. That’s where the fight is. If you hold the barangay, it’s a ready-made machinery for ward leadership. It has become a fight by ordinary politicos,” Casiple said.

Casiple said this partisanship has translated the “perks” otherwise not stated by law, granted by higher government units. Off the top of his head, Casiple cited, as example: “Here in Quezon City, all barangay captains are given a car. “

Ergo, controlling the Barangay means ensuring votes from the grassroots level. So leaders from the local to the national level compete to gain their favor. This leads us to the key of Philippine patronage politics: whoever controls the local governments, controls the machinery for the national level]

Now even if we total cash and non-cash benefits these would amount to about at best Php 500k per year. For a three year term that would accrue to P 1.5 million. At P 1.5 million, 1K peso per vote expenditures, whether direct (vote buying) or indirect costs (ads or marketing campaign, organization, network and etc..), would translate to only 1,500 voters. There are about 3,518 voters per Barangay in the National Capital Region (registered voters: 6m, no. of Barangays 1,705 NSCB)

How will candidates recoup their election expenditures “investments”?

We can only make a guess. 

One, from their 20% share of the national internal revenue allotment (IRA). In 2013, the IRA budget for the 42,026 Barangays nationwide has been at P59,165,520,37.This will jump by 15% to 68.3 billion pesos in 2014.

Two, from their share of the other revenues from the allocations for local government units (ALGU) as part of the national government’s budget law, the General Appropriations Act. 

In 2014, the AGLU budget has been set  at 360.5 billion pesos.

Notes the Philippine Senate:

Other items in the ALGU are the shares of local governments from tobacco excise tax collections and taxes from mining and other extractive industries, and the budget of the Metropolitan Manila Development Authority, among others.

Third there are other sources of funding from the Barangay level, include (as per the Department of Budget and Management

-Service fees or charges for the use of barangay property or facilities;
-Barangay clearance fees; 
- Fees or charges for the commercial breeding of fighting cocks and on cockpits and cockfights;
- Fees or charges on places of recreation with admission fees;
- Fees or charges for billboards, sign boards, neon signs and other outdoor advertisements; 
- Toll fees or charges for the use of any public road, pier or wharf, waterway, bridge, ferry, or telecommunications system funded and constructed by the barangay; 
- Revenues from the operation of public utilities and barangay enterprises (markets, slaughterhouses, etc.); 
- Fines (not exceeding P1,000) for the violation of barangay ordinances; and, 
- Proceeds from the sale or lease of barangay property or from loans and grants secured by the barangay government

In short, fees and taxes from the Barangay level

The above is the flow chart of how the Barangay establishes and supervises its budget via the DBM

So there you have it. Pork in its varied forms applied to the Barangay: from the national level: AGLU via IRA and AGLU via other shares of taxes, and from the Barangay level fees and taxes.

In essence, from top to bottom, Philippine politics operates under the Pork Barrel system

Every election, said the great libertarian H. L. Mencken, is a sort of advanced auction on stolen goods. The Barangay elections seem to validate this.

As I wrote in 2010

So essentially, the Pork Barrel culture reinforces the patron-client relations from which the Patron (politicos) delivers doleouts and subsidies, which is squeezed from the Pork Barrel projects, to the clients who deliver the votes and keeps the former in power. Hence, the Pork Barrel system is essentially a legitimized source of corruption and abuse of power seen from almost every level of the nation’s political structure, an oxymoron from its original “moralistic” intent (unintended consequences). As the saying goes “the road to hell is paved with good intentions”.

As we previously noted, ``Plainly said, when we demand for more social spending or welfare based programs to resolve our problems then we increase the funds allocated to politicians for their dispensation. Essentially, Pork Barrels signify our excessive dependence on government where the correlation of government spending and the price of getting elected are direct.”

Politicization of every aspect of social life from top to bottom leads to corruption, political and wealth inequalities and economic-financial repression which means a lower standard of living. The worst effect is the violence which politics incites, and of the degradation of society’s moral fiber

While the call for the abolition of the Pork Barrel is ideal and necessary it is not sufficient. 

For as long as the public thinks the Pork is a problem of personal virtuosity or what I call as personality based politics (and not of systemic defect), politicians will be able to camouflage pork into many different masks as shown by latest the speech by the Philippine president. 

In other words, to abolish the Pork requires a radical change of opinion by the public. As Scottish philosopher historian and economist David Hume wrote in Part I, Essay IV OF THE FIRST PRINCIPLES OF GOVERNMENT in Essays, Moral, Political, and Literary (bold mine)

NOTHING appears more surprizing to those, who consider human affairs with a philosophical eye, than the easiness with which the many are governed by the few; and the implicit submission, with which men resign their own sentiments and passions to those of their rulers. When we enquire by what means this wonder is effected, we shall find, that, as FORCE is always on the side of the governed, the governors have nothing to support them but opinion. It is therefore, on opinion only that government is founded; and this maxim extends to the most despotic and most military governments, as well as to the most free and most popular.

And the best way to attain such change is for the public to demand a third party audit of all forms of Pork from the top to the local level (past and current), with emphasis on the top. 

Only by opening the Pork's Pandora's Box will there be a bigger chance for an epiphany by the public that Pork is inherent in the nature or structure of the Philippine patronage based political system. Such that dismantling of the Pork Barrel has to occur from top to bottom. 

Yes this also means demolishing Pork at the Barangay levels.

Quote of the Day: The Difference between a Politican and a Private sector CEO

Some of the president’s most central and important claims about Obamacare are revealed now – and widely admitted – to be wrong.  If he were the CEO of a private company he would be sued, publicly lambasted by all the major media, perhaps hauled before an admittedly grandstanding Congressional committee, and possibly prosecuted, convicted, fined, or even imprisoned for fraudulent misrepresentation.  But because Obama is a politician, his misrepresentations are excused as simplifying descriptions aimed at persuading the doofus public to fall for legislation that they would not have fallen for had the president described that legislation honestly and accurately.

This is from Café Hayek Blogger and Professor Don Boudreaux on the unraveling Obamacare. 

Politicians typically use noble sounding rhetoric (e.g. "change", "equality") to push for political agendas that serves their interests. Yet they rarely have been accountable for their actions, even in the face of flagrant failures. This gambling away of society's civil liberties, financial and economic resources and social order has largely been a product of the lack of skin in the game. 

And in the face of failures, politicians would usually resort to propaganda blitz by shifting the blame elsewhere, hoping that fickle voters will forget. And for as long as politicians can get away with this, they will keep on gambling away society's treasures.

Shutdown-Debt Ceiling Politics: The Charles Schumer Put

Step aside Alan Greenspan and Ben Bernanke. New York Senator Charles Ellis ‘Chuck’ Schumer has declared that the preservation of stock market has to be prioritized from the shutdown-debt deal stalemate.

From the Zero Hedge: (bold-italics original)

We commend Senator Schumer for being the first Senator to openly step up and admit that the worst case scenario in the whole Congressional 3D IMAX farce is not about keeping the economy afloat, is not about preserving jobs, but merely keeping the stock market at or near its all time highs:

• Schumer Says He Worries About Monday Stock Drop on Default Risk. "This is playing with fire," Sen. Charles Schumer, D-N.Y., tells reporters. Says he worried whether “the stock market will go down”

For those confused, Schumer has merely admitted what the vast majority of the Senate, where two thirds are millionaires, and nearly half the House, think: don't you dare let the manipulated precious, which at last check was just 1% below its all time Fed-balance sheet derived highs, drop.

And speaking of Chuck Schumer's "bottom line", here it is.

Bluntly stated; protect my investments and the interests of my campaign contributors

Chinese Government to Crack Down on Fake Statistical Data?

More reasons to distrust statistical economic and financial figures from the Chinese government.

From Bloomberg:

China’s statistics-bureau chief said the agency has “zero tolerance” for falsified data after it publicized cases of manipulated local numbers and the customs bureau cracked down on fraudulent export invoices.

Incidents exposed by the agency are isolated and won’t affect the broader quality of data, Ma Jiantang, head of the National Bureau of Statistics, said today in Beijing at an “open day” attended by officials, journalists and school students.

China’s government has struggled to win the trust of investors and economists for data ranging from gross domestic product to trade. Li Keqiang, who became premier this year, said in 2007 that GDP figures were “man-made” and “for reference only,” according to a WikiLeaks cable.

Ma said that his agency has gained better control over the numbers through a direct reporting system that limits local officials’ ability to manipulate the numbers.

When political careers of the local authorities depends on the boosting of growth statistics then the natural consequence—or reaction by local leaders to the incentives provided by the political system—would be to fuel localized bubbles or to manipulate statistics or a combination of both as previously discussed. 

This serves as the difference between China's top-down politics relative to the Philippine Pork Barrel based system--where the latter's political power are attained by buying votes directly or indirectly from the electorate and from other political constituencies using earmarks (Pork), while the former gets appointed to local posts by meeting national targets.

And political leaders resort to, as well as, contribute and participate in the China’s shadow banking system via the local government financing vehicles (LGFV) to finance local projects. Off balance sheets now play a big role in China’s credit system (Business Insider)

Stephen Green of Standard Charter estimates at least 10,800 operational LGFVs from which only 800-900 LGFVs have financial statements on publicly issued debt.

Nomura economics estimate total LGFV debt at the end of 2012 at RMB19.0trn (37% of GDP), which included RMB14.3trn of interest-bearing debt. From 2010-12, LGFV debt rose by 39%, which implies total government debt of RMB31.7trn accounts for  61% of GDP at end-2012. (FT Alphaville)

Yet if many local governments have been notorious in the manipulation of statistics in response to the political system’s incentives, then why should we trust the central-national government when the same incentives influence the national leaders? 

For instance, Chinese Premier Li Keqiang has a self-imposed quota for economic growth which is at 7.5 percent. Today Premier Li says this quota has been surpassed 

From another Bloomberg report: (bold mine)

Chinese Premier Li Keqiang said the nation’s economic growth exceeded 7.5 percent in the first nine months of the year, a sign the government will next week report success in arresting a two-quarter slowdown.

Gross domestic product “maintained a fairly high growth rate of over 7.5 percent” in the first three quarters, Li said today in a speech at the East Asia Summit in Brunei. He said earlier today at an Association of Southeast Asian Nations summit that the economy has “shown stronger momentum of steady growth” in recent months, with indicators that reflect market expectations, such as the Purchasing Managers’ Index (SHCOMP), improving.

China previously reported expansion of 7.6 percent in the first half and Li’s government introduced measures including faster railway spending and tax cuts to defend a 7.5 percent goal for the full year. The National Bureau of Statistics reports third-quarter growth on Oct. 18, with the median estimate of 33 analysts surveyed by Bloomberg News for a 7.8 percent pace, up from the second quarter’s 7.5 percent.

At the end of the day, China’s economic growth has been all about meeting political objectives as measured by statistics whether from the national or the local level. 

Thus government activities will focus on attaining statistical growth at the expense of real economic growth. 

And these will likely be achieved by serially blowing bubbles and or by statistical manipulation via hiding, censoring and deleting of data which doesn't conform with the administration's goals.

Quote of the Day: The Myth of “Failed” Policies

Many people, for good reason, have concluded that the surest test of whether a politician or public official is lying is to ask, Are his lips moving? An equally simple test may be proposed to determine whether a seemingly failed policy is actually a success for the movers and shakers of the political class. This test requires only that we ask, Does the policy remain in effect? If it does, we can be sure that it continues to serve the interests of those who are actually decisive in determining the sorts of policy the government establishes and implements. Now, as before, “failed” policies are a myth in regard to all policies that persist beyond the short run. The people who effectively run the government, whether from inside or outside the beast, do not run it for the purpose of hampering the attainment of their own interests; on the contrary. Everything else in the policy process is, as Macbeth would put it, “a tale told by an idiot [augmented by economists, lawyers, and public-relations flacks], full of sound and fury signifying nothing.”

(bold mine)

This is from Austrian economist Robert Higgs at the Independent Institute Blog

China’s Bubbles are Unintended Consequences of Financial Repression Policies

This article tries to pin the blame on underdeveloped markets as culprit for China’s runaway property bubbles.

From Bloomberg:

The willingness of people like Zhou to shun other investments in favor of property shows why residential prices have defied a more than three-yearlong government campaign to rein them in and is among the forces crippling efforts by the central government to deal with an expanding housing bubble. New home prices in major cities, including Beijing and Shanghai, rose more than 10 percent in July from a year earlier, compared with a more than 10 percent drop in the benchmark Shanghai Composite Index (SHCOMP) during that period.

“Prices have been rising because China doesn’t have developed financial markets,” Yao Wei, a China economist at Societe Generale SA, said in an interview in Hong Kong. “Now, with the economy slowing, that has worsened as other investments don’t yield good returns compared with property.”

This essentially mistakes effects for the cause.

The same article says that the incumbent leadership will not tolerate a growth lower than a self-imposed target

Li, who signaled in July he won’t tolerate a slowdown beyond a 7 percent bottom line, has come up with no new measures to rein in property prices since his predecessor in March, underscoring the role real estate plays in the world’s fastest-growing major economy. Property, construction and related industries account for about 20 percent of gross domestic product, according to Societe Generale.

So basically we have a Chinese version of ECB’s Draghi of "do whatever it takes" to push up statistical growth” for political goals.

Yet this one wrongly blames it on the lack of welfare state...

Traditionally, because of social welfare and pension systems that aren’t as advanced as in developed countries, the Chinese have felt safer buying real estate, said Liu Yuan, a Shanghai-based researcher at Centaline Property Agency Ltd., the country’s biggest real-estate brokerage.

The reality is that underdeveloped markets have not been ‘market failures’ as portrayed, but have been part of the political institutional architecture for the political class to wangle money out of their constituents. This is called Financial repression

From Carmen Reinhart and Kenneth Rogoff [This Time Is Different (p. 143)] (bold emphasis mine) I previously quoted them here.

Under financial repression, banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payment system. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form of taxation. Citizens put money into banks because there are few other safe places for their savings. Governments, in turn, pass regulations and restrictions to force the banks to relend the money to fund public debt. Of course, in cases in which the banks are run by the government, the central government simply directs the banks to make loans on it.

Governments frequently can and do make the financial repression tax even larger by maintaining interest rate caps while creating inflation.

As one would note, underdeveloped markets exist BY DESIGN and has not emerged out of a vacuum.

 

For instance, the Chinese government has promised to liberalize interest rates.

From China Daily: (bold mine)

China is actively developing rules to establish a deposit-insurance system and to manage financial institutions' bankruptcies - two steps widely believed to herald the final interest rate liberalization, a senior official said on Saturday…

China's government has long maintained controls over banks' lending and deposit rates. It has placed a ceiling on what banks can pay on deposits and a floor on what they can charge on loans.

Exactly how financial repression works. So China's political class has deliberately kept the status quo and has delayed reforms because it has benefited them. But the risks of imploding bubbles jeopardizes their political tenure and privileges which is why the promised measures of reforms.

Finally skyrocketing prices will also not exist if these has been financed only by savings. 

This means that credit is ultimate fuel for runaway markets. And which entity is responsible for the origination of credit? 

Well the PBOC and their agents the China’s banking and financial industry.

The PBOC’s assets has shot to the moon with an explosive growth from about USD $.3 trillion in 2002 to about $5 trillion today or 15.7 times in 11 years (chart from Yardeni.com)

Such explosion in PBOC assets has also been reflected on China’s formal banking system where loan exposure has exploded from 90% of the GDP to 240% and counting.(chart from Zero Hedge)

With a growth quota in mind of the leadership, the already precarious debt level conditions will deteriorate further with the government owned banks dispensing more loans as part of the stealth stimulus to prop up the statistical economy.

So the runaway bubbles we are seeing today in China represents unintended consequences from deliberate policies implemented.

On China’s Bank Based ‘Silent Stimulus’

I have long been suspecting that the Chinese government has been implementing a stealth stimulus. 

For example here is what I wrote last May

The reality is that the Chinese government has already launched a stealth stimulus since last year.

This can be seen in the continuing credit growth in the Chinese banking sector as seen from ‘the chart from Dr. Ed Yardeni.

Most of the pick up in credit growth I believe has been directed to State Owned Enterprises (SOE). One must realize that Chinese economy remains heavily politicized where many firms are wards of the government. So Chinese policies can be coursed through them without official admission.

Forbes columnist Gordon Chang fills in the blanks

Beijing is funneling the “silent stimulus” through two state banks. CDB, as China Development Bank is known, will make large infrastructure loans to three provinces, Hebei, Jiangsu, and Qinghai.

Hebei will use loan proceeds for slum renewal and an airport zone, and Jiangsu’s funds will go to urban infrastructure and the province’s regional transport network. The money for Qinghai is for roads, railways, and waterways. Hong Kong’s South China Morning Post called the agreements“the latest sign of an effort by Beijing to prop up growth with targeted bursts of lending.”

The lender, which directly reports to the State Council, entered into memoranda of understanding with the three provinces. The agreement with Hebei was signed on the 9^th of this month, and it appears the other two were inked at about the same time.

Moreover, Agricultural Bank of China , one of the country’s Big Four, signed a loan agreement with the Shanghai city government on the 6th of this month. The 250 billion yuan proceeds will be used to establish the first “Hong Kong-like free-trade zone” in China and build Shanghai Disneyland.  Analysts were surprised by the size of the loan—12.5% of the city’s GDP for 2012—and by the fact that the municipality, ranked a province, itself borrowed the money. Premier Li is said to have been personally involved in the making of the loan to what is often called China’s largest city.

More on the bank channeled stimulus:

Yet on-the-ground observers report that the central government has been flooding the economy with money, at least since early July. J Capital Research’s Anne Stevenson-Yang notes that Beijing has been injecting stimulus through China’s five largest commercial banks. “I don’t think the debate is even about whether or not to stimulate: it’s all about what type of spending to engage in,” writes Yang, who often spots Chinese economic trends first. “There is a genuine acceleration in infrastructure spending and many announcements about how the government will accelerate ‘slum renovation,’ water projects, and roads.” She points out there has also been an obvious increase in some of the riskiest loans, those to local government financing vehicles, the notorious LGFVs.

The stimulus-on-the-quiet program is already having an effect. For example, the amount of steel for infrastructure overtook steel used in housing recently, an indication that government stimulus—not property construction—is now driving growth.

Like all politicians, the current administration seems focused on the approval generating short term measures aimed at attaining statistical growth goals. It’s all about preservation and expansion of political power and their attendant privileges. In short, political self-interests.

The difference in the stimulus has been in the constituents implementing such programs and the beneficiaries

Yet whatever gains from the stealth or ‘silent’ stimulus will be temporary.

The side effect will be the continued ballooning of systemic debt (charts from WSJ-Zero Hedge) that has been channeled through a massive property bubble. This bubble continues to inflate today in the face of rising interest rates 

Politicians have made the world increasingly fragile and vulnerable to black swans.

Video: James Buchanan on the Myth of Public Interest

Nobel prize winner in economics and public choice theorist James M. Buchanan offers his terse explanation on why--what populist politics perceives as "public interest" is a myth (hat tip Cafe Hayek)

There is certainly no measurable concept that’s meaningful that should be called the public interest. Because how do you weigh different interests of different groups and what they can get out of it? 

The public interest as a politician thinks, it does not mean it exist but what he thinks is good for the country… And to come out and say that, that’s one thing…but behind the hypocrisy of calling something THE public interest that doesn’t exist—that was what I was trying to tell them

On University of Chicago’s Raghuram Rajan as India’s Central Bank Governor

Austrian economist Peter Klein cheers the appointment of University of Chicago’s finance and banking professor as the Governor of the central bank of India, noting of Mr. Rajan’s familiarity of the Austrian Business Cycle.

Writes Professor Klein at the Mises Blog

Raghu Rajan is a very good neoclassical economist who has made important contributions to banking, finance, the theory of the firm, corporate governance, economic development, and other fields. He is also taking over as head of India’s central bank. Rajan is no Austrian, but he has a quasi-Austrian take on the financial crisis, and far greater appreciation for free markets in general than any of the key US or European policymakers. As I tweeted this morning, Rajan is about 1,000,000 times better than either Summers or Yellen. I’d gladly trade him for any US central banker.

Consider, for example, Rajan’s take on the financial crisis:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet.

As I wrote before, I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.

Rajan also wrote an interesting theoretical paper with Peter Diamond that echoes the Austrian theory of the business cycle: “[W]hen household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging [bank] runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off.”

Read the rest here

Having a free market proponent in the belly of the beast can both be a blessing or a curse. Although like Mr. Klein, one side of me wishes Mr. Rajan all the luck, another side of me tells me not to expect anything substantial.

While it may be true that Mr. Rajan has a magnificent track record of understanding central banks and the entwined interests of the banking system coming from the free market perspective, in my view, it is one thing to operate as an ‘outsider’, and another thing to operate as a political ‘insider’ in command of power.

Mr. Rajan will be dealing, not only conflicting interests of deeply entrenched political groups, but any potential radical free market reforms are likely to run in deep contradiction with the existing statutes or legal framework from which promotes the interests of the former.

Moreover, other political agencies, whose interests has been to promote the status quo, may run roughshod with Mr. Rajan perspective of reforms.

It would be interesting to see how Mr. Rajan will deal with  the present repressive “war on gold” policies by the Prime Minister’s Economic Advisory Council (PMEAC) whose interventionists actions has expanded to cover not only gold imports, but on gold transactions at every distribution level of the Indian economy.

In short, assuming the central bank governorship won’t just be about monetary, or banking policies but about the politics of bureaucracy, the welfare state and crony capitalism. 

Mr. Rajan will also have to deal with the huge resistance-to-change attitude from these groups.

In addition, in assuming the role of the proverbial hammer, where everything would look like a nail, the allure of the possession of the extraordinary power of political control over society risks overwhelming Mr. Rajan’s principles.

A great precedent would be former Fed Chair Alan Greenspan. Dr, Greenspan used to be an ardent Ayn Rand fan and a Ms. Rand influenced objectivist who embraced free market principles. Mr. Greenspan even authored the splendid, Gold and Economic Freedom in 1966. 

However upon assuming the Fed Chairmanship, Mr. Greenspan eventually abandoned free market principles to become a rabid inflationist or a serial bubble blower. Yet today’s lingering problems have, in effect, been a legacy of Greenspan-Bernanke actions.

True Mr. Rajan may not be Dr. Greenspan. But with the manifold challenging tasks ahead coming from different fronts, Mr. Rajan may want to take heed of Yoda’s advice to Anakin Skywalker: The fear of loss is a path to the dark side.

Quote of the Day: The Myth of Public Interest

The gist of it is that public servants, so called--politicians, bureaucrats, and their colleagues--tend to promote goals of their own even as they claim to be serving the public interest.  And this is not very difficult to grasp.  

The public is, after all, a vast number of citizens whose interests vary enormously so it is a pure myth that there is a public interest that can be served by public servants.  Given this plain fact, whose interest will public servants serve?  The interest they consider important. 

In the last analysis the so called public interest is really the private interests public officials like best.  Even the democratic process cannot sort out what the public interest is. (The best approximation is put forth by Thomas Jefferson in the Declaration of Independence where he identifies securing the protection of our basic rights as the purpose for which government is established, i.e., the public interest.)

Despite the hopelessness of pursuing and serving the public interest, politicians and their cheerleaders keep pretending that they have managed to overcome the hurdles facing them and assert that they are public servants instead of folks whose objectives are determined by lobbyists who represent innumerable, often conflicting, private and special interests.

That’s from professor Tibor Machan on the much overlooked Public Choice Theory on his blog.

Quote of the Day: Market Failures Does Not Justify Government Interventions

Market failure is a tricky topic even for professional economists. And when non-economists raise the examples of market failure that we discussed here, matters become even trickier. Not only do all of these terms have technical meanings that often do not match what the non-economist thinks the terms mean, but most non-economists also are unaware of the various criticisms that have been raised in the literature on these topics. Most important, non-economist critics of the market are frequently unaware of the comparative institutional analysis that public choice theory has made a necessary part of thinking about the role of government in the economy. Pointing out imperfections in the market does not ipso facto justify government intervention, and the only certain way that market "failures" are "failures" is by comparison to an unreachable theoretical idea. Market imperfections are not magic wands that make market solutions and government imperfections disappear. Real understanding of comparative political economy begins rather than ends with the recognition that markets are not always perfect.

This is the conclusion of Professors Art Carden and Steve Horwitz at the Econolog in discussing why so-called market failures in the context of externalities, public goods, asymmetric information, and market power (or monopolies) represent as “necessary—but insufficient—conditions for intervention to be justified”.

Cyprus President Warned Friends of Crisis

Events in Cyprus have been demonstrative of the wide distinction between how the pubic perceives governments are supposed to operate (the romantic view where government looks after the interest of the general welfare) with how governments truly operate (self interests).

In reality governments operates around the cabal of insiders, again take it from the events in Cyprus.

From the Daily Mail, (hat tip lewrockwell.com)

Cypriot president Nikos Anastasiades 'warned' close friends of the financial crisis about to engulf his country so they could move their money abroad, it was claimed on Friday.

The respected Cypriot newspaper Filelftheros made the allegation which was picked up eagerly by German media.

Germans are angry at the way their country has been linked to the Nazis and Hitler by Cypriots angry at the defunct rescue deal which called for a levy on all savings.

The Cyprus newspaper did not say how much money was moved abroad but quoted sources saying the president 'knew about the possible closure of the banks' and tipped off close friends who were able to move vast sums abroad. 

Italian media said the 4.5 billion euros left the island in the week before the crisis.

As an update on the swiftly unfolding events in Cyprus, Russia has rejected a deal with Cyprus.  Also the Cyprus parliament approved of instituting capital controls aside from other measures passed.

From Reuters:

As hundreds of demonstrators faced off with riot police outside parliament late into Friday night, lawmakers inside voted to nationalize pension funds, pool state assets for a bond issue and peel good assets from bad in stricken banks.

We live in very interesting times.