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Forget The Fake Statistics: China Is A Tinderbox

Tyler Durden's picture




 

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

When China's tinderbox economy implodes, who will be left to bid up the world's surplus commodities and real estate?

After 30 years of torrid expansion, perhaps the single most consequential factor in China’s economy is how much of it is a “black box”: a system with visible inputs and outputs whose internal workings are opaque.

There are number of reasons for this lack of transparency:

1. Official statistics reflect what officials want to project, not the unfiltered data.

2. Policy decisions are made behind closed doors by a handful of leaders.

3. There is little institutional history of transparency.

4. Many important statistics are self-reported and prone to distortion.

5. Large sectors of the economy are informal and difficult if not impossible to measure accurately.

6. Endemic corruption distorts critical economic yardsticks.

7. There is little historical precedent to guide policy makers and individual investors.

None of these is unique to China, of course, with the possible exception of #7: few nations in history (if any) have experienced an equivalent boom in infrastructure, credit, housing and wealth in such a short span of time.

Saving Face By Editing Data

As anyone who has lived and worked in Asia can attest, public perception (i.e. "face") is of paramount concern.  There is tremendous pressure to put a positive spin on everything in the public sphere.  Negative publicity causes not just the individual to lose face, but his boss, agency, company and family may also be tarnished.

For this reason, reporting potentially negative numbers accurately may put careers and hopes for advancement at risk.

This accretion of fear of reprisal/disapproval builds as it moves up the pyramid of command.  This process can lead to tragic absurdities being taken as truth.  In one famous example in Mao-era China, officials ordered rice planted in thick abundance along a particular stretch of road, so that when Chairman Mao was driven along this roadway, he would see evidence of a spectacular rice harvest.

In reality, China was in the grip of a horrific famine resulting from disastrous state policies (The Great Leap Forward). But since everyone feared the consequences of telling Mao his policies were starving millions of Chinese people, the fields along the highway was planted to mask the unwelcome reality.

Even the most honest reports reflect the biases of those summarizing feedback for their superiors. As a result, when the feedback finally reaches the top leadership, it may be inaccurate or misleading in ways that are difficult to detect.

The Dangers Of Opaque Leadership Decisions

All leaders have their own biases and experiential limits, and left unchecked by accurate feedback and honest dissent, these have the potential to generate disastrous decisions.

Perhaps the top leadership in China is soliciting honest dissent, but without a vigorously free media and multiple unedited feedback loops, this is unlikely for systemic reasons.

Most people—leaders and followers alike—seek to confirm their own views (i.e. confirmation bias). A system in which key decisions are not aired publicly and the trustworthiness of the data being considered behind closed doors is also unknown is a system designed to reinforce confirmation bias and yes-men.

In this environment, destructive policies may be supported by the chain of command despite the consequences.

Lack Of Institutional History of Transparency

Institutions with a long history of independence and a policy of priding transparency have the potential to counter the tendency of hierarchies to encourage confirmation bias and fudged feedback.

But China’s tumultuous history in the 20th century—invasion, foreign occupation, civil war, revolution, mass famines, the Cultural Revolution’s mass disruptions and purges, the end of Mao’s Gang of Four and Deng Xiaoping’s “to get rich is glorious” reforms—has not been conducive to the establishment of independent institutions.

Developing the independence of institutions in the midst of such unprecedented political, social and economic turmoil is a long-term work in progress. Though no comparison is entirely analogous, we can look at the first equally tumultuous 30 years of the American Republic (1790 – 1820) and the French Republic (1789-1819) for historical examples of the difficulties in establishing enduringly independent institutions.

Self-Reported Statistics

Self-reported data plays a significant role in any economic snapshot that measures sentiment and expectations. But when it comes to income, outstanding loans and other data, there’s no substitute for accurate numbers.

As a general rule, the larger the informal cash economy and the greater the leeway and the incentives to under-report, the lower the quality of self-reported statistics.

Take income as an example. In the U.S., the vast majority of non-cash income is reported directly to the tax authorities: wages, 1099s, sales of securities, etc.  The leeway to fudge income is low, which pushes the incentives to fudge onto the expense/deduction side of the ledger.  For this reason, IRS income data is more trustworthy than self-reported measures of income and employment.

Consider this chart of household income in China.  A survey of households found incomes were much higher than the officially collated numbers. In the case of the top earners, the difference was significant enough to skew a variety of key numbers such as household income as a percentage of GDP.

(Source)

The differences between official data and data collected by surveys is troubling for a number of reasons. Given the incentives to under-report (to avoid paying higher taxes), why should we trust the accuracy of self-reported income? Who’s to say that wealthy households don’t habitually under-report their true income even to surveys?

Given the ubiquity of the informal economy and shadow banking system in China, official data cannot accurately reflect peer-to-peer lending, private loans outstanding and many other data points that are critical to understanding income, risk and credit flows.

The Informal Economy & Shadow Banking

These discrepancies between actual debt and what’s reported could have monumental consequences should expansion turn to contraction and debts become uncollectible.

It’s been estimated that a third of all Chinese households engage in informal lending to friends and family, as well as to enterprises that pay high rates of interest due to the risky nature of their investments.

Interest can run as high as 34% -- loan-shark rates.

Even the slices of the credit/investment sector that are reported—for example, Wealth Management Products (WMPs)—are more Wild West than staid banking. WMPs are managed off-balance sheet and don’t require any reserves:

"Legally WMPs are not deposits. They are investment products that are managed ‘off-balance-sheet’ by banks, and there is little transparency about where the funds are going,” said Stephen Green, head of Greater China research at Standard Chartered in Hong Kong, in a note.

 

According to Green, the funds from different WMP products are often mixed and deployed to finance a broad pool of assets that more often than not fall into the sectors of the economy that regulators have attempted to fence off from normal bank lending (real estate, local government infrastructure, etc.), partly because these sectors are deemed to be particularly risky. In addition, the banks hold neither reserves of WMP deposits nor capital against the assets.

(Source)

In other words, transparency is low while risk is unknown but possibly high.  This volatile mix of opacity and risk is the perfect recipe for cascading defaults and catastrophic losses.

Endemic Corruption Distorts Data

In China, as in many developing economies, problems such as permit applications, tax bills or development rights are solved by greasing the skids of officialdom.  Just received a big tax bill? Maybe a friendly tax official can help reduce the tax in return for promises of favors and an envelope of cash.

While the central government is cracking down on highly visible corruption, the system of buying privileges with influence, favors and cash is too deeply entrenched to be eliminated in a few months or years by high-level policies.

As with all the factors listed here, the impact of corruption is difficult to assess -- and that’s what makes China’s economy such a black box: if what’s known is untrustworthy, and what’s not known is potentially destabilizing, then how reliable is any projection?

Few Historical Precedents to Guide Policy Makers and Individuals

In the U.S., analysts and policy makers can draw upon a long history of economic policies and debate their applicability to the present.  Rising income disparity, for example, is often compared to the Gilded Age of the late 19th century. The financial crisis of 2008 is often viewed as an analog of the 1929 crash that triggered the Great Depression.

China’s recorded history stretches back thousands of years, but in terms of applicable financial and economic parallels to the current economy, there is no precedent.  China’s leadership is truly in uncharted waters.  This in itself heightens the risk of miscalculation and basing policies on faulty premises.

In Part 2: Why China Is Extremely Vulnerable Now, we zero in on China’s real estate bubble, and the outsized risks it poses to China’s economy -- and the world.

As the housing bubble bursts, alongside the trillions of losses already experienced in the Chinese stock market, the flood of capital from China into world assets is going to be substantially compromised. Asset prices are set at the margin: what the highest buyer is willing to pay. For many years now, the world has become accustomed to China's dependable willingness to pay well in excess of everyone else. When China is no longer the highest buyer, how far will prices need to fall in order to match the next highest buyer's ability to pay?

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

 

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Mon, 08/10/2015 - 12:00 | 6410289 JustObserving
JustObserving's picture

Is the US really any different from China?  The PPT has been managing the markets since 1988.  The Fed has been attacking gold since 1971.  And a Deep State runs the land of the free.

As for the free and fair media:

"The Central Intelligence Agency owns everyone of any significance in the major media." -- William Colby, former CIA Director

Mon, 08/10/2015 - 12:01 | 6410307 Bokkenrijder
Bokkenrijder's picture

Yes, Americans speak up, are much more individual, much more creative and display much more entrepreneurship.

Chinese are just 1,3 billion obedient slaves looking at their government for guidance.

Mon, 08/10/2015 - 12:05 | 6410331 Publicus
Publicus's picture

Replace China with US and read this article again.

Mon, 08/10/2015 - 12:54 | 6410411 Bokkenrijder
Bokkenrijder's picture

How many of you lot have ACTUALLY been to China?

My recommendation: book your next vacation to China and enjoy the pollution, the fake watches fake DVD's and fake designer handbags. the empty houses and huge construction suites, and try to surf the internet which is more or less totally blocked. Go see it for yourself! Enjoy Chinese bureaucracy, and try (as an overseas outsider) to also invest in the economy. Perhaps buy some gold? Just make absolutely sure that it's not fake either, just like their imploding economy.

Mon, 08/10/2015 - 14:17 | 6410883 y3maxx
y3maxx's picture

Before any honest Chinese Economic news is published...W W 3 is a cinch.

Mon, 08/10/2015 - 14:16 | 6410890 y3maxx
y3maxx's picture

"Replace China with US and read this article again."

 

True, but the USSA currently dictates World financial policy.

W W 3 will even the playing field.

Mon, 08/10/2015 - 12:03 | 6410315 Amish FinEng
Amish FinEng's picture

A growing number of Americans are becoming increasingly aware that it is time to END the Federal Gov.

Mon, 08/10/2015 - 12:15 | 6410372 Winston Churchill
Winston Churchill's picture

i was talking to a couple in their late twentys last evening.They were surprising aware of

of the true situation, If briefly gave me some hope, but talking to others on a jobsite this

am dashed it.

Mon, 08/10/2015 - 12:07 | 6410336 Hitlery_4_Dictator
Hitlery_4_Dictator's picture

Blah, Blah, Blah, Rates, Blah, Blah, Blah, Maniplulation, Blah, Blah, Blah, China, Blah, Blah, Blah, Greece, Blah, Blah, Blah, Trump, Blah, Blah, Blah....everything is good....I'm not worried the Fed has it under control

Mon, 08/10/2015 - 12:27 | 6410424 KnuckleDragger-X
KnuckleDragger-X's picture

The truth will get you killed and the lies will get you promoted. The Chinese have perfected the bureaucratic brick wall and just like for most of their history, the bureaucrats always survive, just like cockroaches.....

Mon, 08/10/2015 - 11:59 | 6410290 ted41776
ted41776's picture

who will run the suicide net slave factories to produce all of our worthless disposable consumer goods?

Mon, 08/10/2015 - 11:59 | 6410294 JRobby
JRobby's picture

who will be left to bid up the world's surplus commodities and real estate?

 

Not many. The ones that can already own all the good stuff.

Mon, 08/10/2015 - 12:00 | 6410298 Amish FinEng
Amish FinEng's picture

Like their Tinderbox real estate market?

Mon, 08/10/2015 - 12:00 | 6410299 10mm
10mm's picture

I smell war.

Mon, 08/10/2015 - 12:26 | 6410420 Consuelo
Consuelo's picture

I smell $Treasuries, gold, ratcheting up rhetoric about 'currency manipulation', 'hacking', 'bullying neighbors', etc., and finally, enough flag-waving propaganda to get Boobus A. worked up enough to support a regional conflict with China.   So yes, in the end --- War.

 

 

Mon, 08/10/2015 - 12:06 | 6410334 Rev Kuhlaid
Rev Kuhlaid's picture

Replace "China" and "Chinese" with "USSA" and "Mercan" in this report and tell me there's a difference.

 

Onward thru the fog to the long awaited and much deserved collap$€!

Mon, 08/10/2015 - 13:47 | 6410779 monad
monad's picture

Replace "China" with "1%" and "Chinese" with "1%ers" and there's the world in a nutshell.

Mon, 08/10/2015 - 12:07 | 6410335 wmbz
wmbz's picture

 "Just received a big tax bill? Maybe a friendly tax official can help reduce the tax in return for promises of favors and an envelope of cash".

 

~ No different than any other gubmint!

Mon, 08/10/2015 - 12:11 | 6410357 malek
malek's picture

So what's the difference between the west's political-correctness "everyone's opinion has the same value" and east's face-saving again?

Mon, 08/10/2015 - 12:15 | 6410371 q99x2
q99x2's picture

Print

Mon, 08/10/2015 - 12:18 | 6410387 B2u
B2u's picture

Let's see what Ho Li Fuk has to  say.

Mon, 08/10/2015 - 12:21 | 6410399 CHC
CHC's picture

China needs to take a few more classes before they can compete with the United States.  The U.S. has hubris and arrogance in over abundance.  They - the Fed, bankers and Wall street CAN'T be embarrassed - they have zero morals and they're always rewarded for the worst of decisions - often illegal - but seriously - who in power gives a flying fuck?!?

Mon, 08/10/2015 - 12:28 | 6410430 Dorelei
Dorelei's picture

Again double post !

Tylers schizophrenia getting out of control ?

Don't shoot yourself in the face yet ! 

 

http://www.zerohedge.com/news/2015-08-08/chinas-black-box-economy-about-...

Mon, 08/10/2015 - 12:32 | 6410447 Consuelo
Consuelo's picture

CHS, like a horde of other $dollar bulls, has had a hard-on for China since 2008.   But therein lies the irony.   Just when you think the rest of the world is about to go under, and the $DX is about to go stratospheric in a wild feeding frenzy of 'Indirect' and 'Carribean Banking Center' bids, is when the garrot comes from behind.

 

 

Mon, 08/10/2015 - 12:55 | 6410525 PrimalScream
PrimalScream's picture

There is a HUGE amount of corruption in China.  The average citizen cannot take a bribe, or they will be shot.  But the power brokers regularly receive millions - even billions.  Their system is rotten on the inside.

China bought into its own "sucess story".  They believed their own hype. They should have created sound banking policies, strict policies on loans, and NO Shadow Banking System.  But instead, they adopted all the same financial sicknesses as the West.

They have a crash in stocks and a crash in real estate.  Ask Americans how WELL that turned out in 2008.  China is looking at the same thing, on steroids.

Mon, 08/10/2015 - 13:18 | 6410637 bluez
bluez's picture

It looks like China is mostly an awful place for various historical reasons.

The people in charge there appear to have many tricks up their sleeves, and they now have a lot of industry, which the US essentially gifted them via trade treaties and lack of tariffs.

The US "leaders" are virtually stupid, so we will presumably collapse before China does. Even if China had some sort of collapse, it would probably survive.

USans have become too detached from the gritty world, and this will be our downfall, I fear.

Mon, 08/10/2015 - 13:39 | 6410728 BigStupid
BigStupid's picture

1. Official statistics reflect what officials want to project, not the unfiltered data. 

Yep: Labor numbers, inflation, GDP

2. Policy decisions are made behind closed doors by a handful of leaders.

Yep: Doesn't matter who is in government - they're not in charge anyway

3. There is little institutional history of transparency.

Yep: Just because less effort is put into the story now doesn't mean we haven't been spoon fed crap for generations

4. Many important statistics are self-reported and prone to distortion.

Kindof Yep: pollution, orders, lethal use of force

5. Large sectors of the economy are informal and difficult if not impossible to measure accurately.

Yep: Uber, Google, Twitter, Apple, Facebook, GM, MIC...

6. Endemic corruption distorts critical economic yardsticks.

Yep: Banks are government now, or is it government runs the banks?

7. There is little historical precedent to guide policy makers and individual investors.

More or less: We have the precedent but are too arrogant to acknowledge - If you won't remember it, it's new to you!

We're talking about the great democratic puppet show right?

Mon, 08/10/2015 - 13:42 | 6410756 Dawgeatdog
Dawgeatdog's picture

The success of a fiat currency is with a nation's ability to delude the masses both domestically and internationally. It's anticipated China will have little trouble deluding the masses domestically, leaving the only other consideration, internationally. But currencies are priced as compared to other currencies. That being the case, its China's misinformation versus US misinformation versus EU misinformation versus Japan's misinformation, etc....  That being the case, it's easier to overlook China's wacky stimulus lending practices. 

Mon, 08/10/2015 - 13:49 | 6410782 monad
monad's picture

Get Arthur Anderson on the job. They can fudge this...

Mon, 08/10/2015 - 14:05 | 6410849 Dragon HAwk
Dragon HAwk's picture

If we do fight a war with China.. I hope all their weapons are  " Made in China "

 at least it will level the playing field since most of our electronics are made there as well.. good thing there are no back doors in that hardware.. oh wait..

 

Mon, 08/10/2015 - 14:11 | 6410877 bahaar
bahaar's picture

Corruption is an endemic problem in many developing nations. It's partly culture (due to faulty economic policies of the past) and partly because these countries don't have effective tracking system in place.  That said, it's worse under authoritarian regimes.  I remember reading in a book how during cultural revolution Mao came up with a 'genius' idea to double the rice output.  Simply reduce the space between rice saplings!  Farmers who knew better continued with their old practise.  However whenver a party official came to visit, they uprooted (sapling by sapling) from one field and replanted them in the adjacent field (which already had rice saplings) and pretended to abide  by Mao's rule.  And when the official left they reuprooted and replanted the saplings.  Result?  Work quadrapuled and rice output diminished (due to constant back and forth plantings).  Most people died either of starvation or exhaustion. 

Mon, 08/10/2015 - 15:12 | 6411034 asdfzxh
asdfzxh's picture

"public perception" thing, so not true

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