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On China: Engineers Build - Economists Devalue

Bruce Krasting's picture




 

 

I'm at a loss to explain what happened in the Chinese money system the past few weeks. Yes, the tip of the iceberg was the Wealth Management Products that matured in June. And yes, it's likely that things will cool down for a bit. But the guys at Deutche Bank see more trouble ahead. (FTAlphaville Link):

 

We would expect to see clearer indications of more cash flow problems across different industrial sectors in China in the near future.

 

There are only two possibilities for what has happened in China's funding markets. 1) A mistake was made, or 2) it was deliberate. The evidence tells me this was deliberate. The tripling of short term borrowing rates could have been avoided. But why would China try to derail its economy? The idea that the Chinese leaders chose to choke off credit to the shadow banking system and precipitate a funding crisis is hard to accept. I've been struggling to come up with an explanation. Possibly this chart provides an answer:

 

Screen Shot 2013-06-30 at 8.11.04 AM

 

The composition of the Chinese Politburo has changed remarkably. For the past twenty years the leaders in China were mostly engineers (in this case engineers = technocrats). What do engineers like to do? They build things. And that is exactly what China has has done for the past two decades. It built cities that no one lives in. It built highways, rail lines and airports that are not used. It changed the course of rivers with huge dams, in the process it uprooted millions and changed the climate. There is no precedent for what China has done the past few decades.

Building all of the stuff that China has constructed has proven to be a huge stimulus to the domestic economy. The raw materials that China consumed to build out the country fueled the global commodities boom. Damn near every nation on the globe benefited while China's engineers/politicians built things.

As of 2013, the composition of the leadership in China has changed dramatically. The engineers are gone. Today the leadership is comprised of Economists and Lawyers. Economists only look backward and opine on what has happened, they rarely have a vision of the future. Lawyers, are always cautious, and are more likely to say "No", than "Yes".

The following data sets must have those lawyers and economists at the Politburo losing sleep at night. China has been completely out of whack with the rest of the world when it comes to building stuff:

 

bric new

majorsnew

 

 

An economy that relies on 50% fixed investment for growth is going to stumble sooner or later. For China, with a $7Tn economy, it means that every 12 months another $3.5Tn of "stuff" has to get built. The new Chinese leaders have ten-years to leave their mark on history. They must understand that the 50% fixed investment that has fueled China's growth the past 2o years is now a busted model. If they have grasped this reality, then they also understand that they must act quickly to change things around. If a transition is inevitable, it's better to get it over with in the first three years of the new leadership. That way the last three years would have a chance of proving them right, and ensuring their place in history. What better way to transform an economy than to precipitate a recession? And what better way to precipitate a recession than to raise interest rates and destroy wealth?

 

If the Chinese economists and lawyers are not going to build things at the pace of the past, then something else has to fill the bucket. The only thing that I can see is the $3.5Tn of reserves. How that hoard of cash could be used without creating other problems is not clear to me. But those Chinese lawyers and economists are going to try to figure out ways to do just that.

If things unfold as I suspect, and the foreign currency reserves are used to prop up a sagging economy, then it will trump anything that Bernanke and his Taper Talk have done to global interest rates.

 

george_b_shaw_if_economists_laid_not_conclusion_invitation-re222dda98d674952acf47ec6d4451072_8dnd0_8byvr_512

 

 

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Mon, 07/01/2013 - 13:23 | 3710605 Never One Roach
Never One Roach's picture

luv ur artikles Bruce.

Mon, 07/01/2013 - 13:14 | 3710568 sangell
sangell's picture

That looks like a 'purge' in the leadership not a transition.

Mon, 07/01/2013 - 12:19 | 3710364 DeadFred
DeadFred's picture

It has been quite some time that the Chinese have lived with the conflict of their world view with objective reality. They are the Middle Kingdom and as such should be the center of civilization in our world, yet the long-nosed barbarians of the West hold the reins of power. In their opinion the West took power because the Chinese rulers were complacent and the West took advantage of their mastery of gunpowder in warfare. I gathered this from reading Mao's Little Red Book and from converstions with Chinese scholars over the years. I expect them to try to rectify that conflict soon, possibly within the month or at least the year.

The west is economically very vulnerable having tried to escape the last financial collapse by building a house-of-cards recovery. Everyone on ZH knows hows vulnerable these bubbles are and the Chinese are holding so many of the treasuries backstopping the scheme. Collapsing the West by putting the Chinese held treasuries up for fire sale would be seen as an act of war but not so much if a (manufactured) domestic liquidity crunch necessitated the sale.

The US military domination of our world is enabled by the Wall Street sceme and would dissolve quickly during a monetary crisis. IMHO the Chinese and Russians have been planning for this for years. Gold purchases to back the new trade currency, stockpiling raw materials and I would suggest they are building new cities ready to be occupied in a war crisis.

Is there anyone out there who can save me from this gloomy viewpoint? All I ask is to see a photo of those 'ghost cities' falling into disrepair. It's been years since they were built, if they are being maintained it means they expect to occupy them soon.

Mon, 07/01/2013 - 15:36 | 3711092 besnook
besnook's picture

china and russia have no intention of bringing the west down in such dramatic fashion. the usts held by china are an implied threat and, therefore, a defense against the aggressive usa. putin has been talking about a multipolar world since the day he came on the scene. russia(and iran and venezuela) has the energy china needs so china has become the horse pulling the multipolar cart with the yuan as its cargo. an agreement to use the yuan for all trade and even domestic business and banking needs between the brics and anyone else who wants to join(apec and asean countries sans the aussies and usa) would sink the dollar in a new york minute rendering the usts worthless and the usa bankrupt.

 

my take on the level of domestic capex in china is to compare it to post war europe and japan or even the meiji period of japan. in that context, considering the former state of the nation of china even as soon as the year 2000, the level is not outrageous. they still have a way to go to accomadate the population. if it is at the same level in 20 years then there is a problem.

exchanging the technocrats for lawyers and economists with decision making powers says china is transitioning out of the infrastructure build out to micro and macro economic domestic growth issues and the rule of law(even as i believe the chinese will coin a phrase similar to, "kill all lawyers" in mandarin)

 

you bring up an interesting point. what has happened to all those empty cities since first reported?

Mon, 07/01/2013 - 21:17 | 3712178 Imminent Crucible
Imminent Crucible's picture

They remain almost completely unpopulated and are rotting away:

http://www.youtube.com/watch?v=ei0FpwI1dqg

Mon, 07/01/2013 - 14:07 | 3710783 sangell
sangell's picture

GDP and population do not constitute military power. Israel is dwarfed by the Arab world but ( with access to US weaponry) maintains a military edge. The USSR had a puny economy relative to the US but maintained far larger conventional forces. Germany, defeated Russia in WW1 and fought France and Britain to a standstill. Japan with a population 1/5 China's overran much of China. China has no tradition of being a military power or an imperialist one.

Mon, 07/01/2013 - 16:28 | 3711272 DeadFred
DeadFred's picture

All of these are good points but I'm not trying to say Russia and China wish to be the new military super power, I am clearly saying they want the US taken out of that position. A multi-polar world is entirely compatible with what I foresee. A good case can be made to say the fall of the USSR was primarily due to the excess cost of the military. After limping home from Afghanistan and a few other embarassments such as a German teenager flying his dad's plane through the air defences overseen by one of the strongest poliburo members to land his plane in Red Square the military lost much of its credibility. They lost the ability to convince the population and other factions in the leadership that they were worth the drain on the nation's resources. The US is funding its government largely with funny money and can only do so because the world deems the currency worthy in the short run. Many investors are ready to jump for the exits when they determine that "the end" is near. When that happens the US will need to cut government costs and the military may wither the way the Soviet military did. Military adventurism will become a dim memory. My estimates on timing are mostly from reading the tea leaves of events, particularly the rash of events that have been destabilizing things since April 15. I may be paranoid in discerning manipulation and purpose in those events but I am fairly confident that whenever the dollar gets taken out the military will wither and China will flex its power. My understanding of human nature tells me China will move to hasten that time if they believe they can do it safely.

Mon, 07/01/2013 - 12:01 | 3710290 Charles Wilson
Charles Wilson's picture

"Spengler!...Paging Oswald Spengler!..."

Mon, 07/01/2013 - 11:46 | 3710223 Non Passaran
Non Passaran's picture

Okay, after reading the last two paragraphs 3 times, I finally "get it".
If the concluding sentence was less cryptic it would have been easier... Buy I was puzzled mostly because as far as I understand it the dollar reserves are not sitting there idly. The CB printed the yuan and with it bought the dollars, and with it it bought UST's. So now if they want to sell their UST's and spend that money, they won't end up with more money in circulation than there already is (unless they decide to print, but for that they don't need to sell UST's).

Mon, 07/01/2013 - 11:45 | 3710219 CreativeDestructor
CreativeDestructor's picture

Today's article is very weak and incorrect.

Mon, 07/01/2013 - 11:50 | 3710175 jonjon831983
jonjon831983's picture

Most definitely think they're trying to pinch their nose and take some bitter chinese herbal medicines.

 

The question is how to deploy the x Trillion in UST reserves... on the extreme side if they're willing to toss up the table and hit the restart button for the globe they could dump them... but for what assets?

 

Kinda like this scene in the movie Margin Call: http://www.youtube.com/watch?v=3nlQWRjBzcE

"Fuck you, you limey bastard."

 

""By the end of the day today almost everyone else in the world, including myself, will have considerably less money than they began the day with..... You, in this room, are the exception. You will leave this room richer. You will fire the first shot, I wish it didn’t have to be, but at times the market must eat its weak, and you all... are not the weak. We must strike quick, with no doubt, if you hear pause on the line, attack. 

 

By noon the SEC is going to be in here getting in your faces, sniffing around, you let us take care of them and you just keep going. We own what we are choosing to sell today and there is nothing they can do about it. 107 years ago this firm was founded, today we secure our place for next 107. You’ve got two minutes, finish this, so we can get on to the next one...""

Mon, 07/01/2013 - 11:17 | 3710110 i-dog
i-dog's picture

Brilliant sleuthing, Bruce!

Mon, 07/01/2013 - 11:13 | 3710093 Imminent Crucible
Imminent Crucible's picture

The leadership is now economists and lawyers. So China is being run by Kroogmans and Hillarys. You know that's going to end well.

Mon, 07/01/2013 - 14:56 | 3710968 WTFx10
WTFx10's picture

The puppet masters are still bankers

Mon, 07/01/2013 - 12:56 | 3710498 duo
duo's picture

yup, we're 40 years ahead of them, and England was 40 years ahead of us.  It's hard to believe that at one time in the 1800s, 90% of all the manufacturing machines in the world were in Great Britain.  Manchester => Detroit => Shenzen?

Mon, 07/01/2013 - 11:11 | 3710083 mirac
mirac's picture

interesting perspective...seems to fit the present situation

Mon, 07/01/2013 - 11:12 | 3710076 CheapBastard
CheapBastard's picture

good article. Thousands of new millionaires were created in the past 8 years there...some actually produce something and contribute to their society....many produced nothing but made lots of money from their China form of TARP.

Mon, 07/01/2013 - 10:17 | 3709903 RagnarDanneskjold
RagnarDanneskjold's picture

The missing component is politics. I suggest reading Red Capitalism for anyone who wants to understand, and also look at the Bo Xilai saga. Reforms halted in 2005 (when they were about to open the economy and push through market reforms). Power shifted from the PBOC to the Ministry of Finance, and the big investment funds were taken away from PBOC and put in the hands of MoF. Party insiders who control state owned companies were behind the 2009 lending spree pushed through the banking system.

Bo Xilai's ouster weakened this group. The PBOC is back in control: right after Bo Xilai was ousted, the first big news was the pilot financial reform in Wenzhou was green lit. It was halted in 2011. Then Wen Jiabao attacked the banking monopoly.

Now, Wen's successor Li Keqiang and President Xi Jinping are going after the speculation and corruption that is rampant in the SOEs and local governments. The corrupt are leveraged and the SOEs have used their power to choke credit off from the private economy, while speculating in real estate and non-core businesses. The new leadership is killing two birds with one stone.

Political reform in China taking place through economic channels

From last year: 

Why is Wen Jiabao criticizing the banks?
Mon, 07/01/2013 - 11:46 | 3710220 disabledvet
disabledvet's picture

yep. so "space program." that's interesting. obviously they have the largest standing army in the world...so you have to pay for that too. there is a massive amount of corruption...with the commensurate lack of oversight. "leakage" in the parlance of contract law. and obviously the greatest leakage is in the banking business. "never had a government project that shouldn't be funded." and that's the way that goes. China still has an inflation problem somewhat...so my guess is this is their answer. "we are not the renminbi" response. obviously we've heard a lot of responses as there's been a lot of chatter about "opening credit lines for yuan." currencies wars are real...the goal is always the same...devalue, devalue, devalue. China is not doing that and i find that both strange and intriguing. on the other hand they might be getting forced to because the Fed is now tapering. http://www.youtube.com/watch?v=R0fa7jeiHiM

Mon, 07/01/2013 - 10:14 | 3709880 new game
new game's picture

bk-verty goot speculation on those two face liar ass slant eye mofos

same here in amerika- the great deceiver-land of the not so free anymore...

haha- the world as it will never be- truth and liars in constant conflict!

so what will it be, truth and justice or same as the old?

i take choice two, cause nothing really ever changes as the

1 % controlling the 99 by lies, deception, mind control and stupidity of the majority.

 

Mon, 07/01/2013 - 16:03 | 3711187 negative rates
negative rates's picture

This is a result of bad policy. Too much city polution, people jumping off of buildings in pain, and food shortages have left the country side  weary of the city slicker dream. The people are not coming to fill the  human capitol jobs, the empty cities were built on borrowed money and now that needs to begin to be paid back on the short. Try to own a company and not pay your bills can lead to becoming a hostage. It could be the start of a bad thing.  

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