Monday, October 4, 2010

What China Is Thinking

“What—you want a piece of me, punk?”: In China, if you kill a panda bear—
even by accident—you will be executed. So DO NOT fuck with the pandas. 
  
We all have a sense of what the Chinese are thinking about the rest of the world—but we don’t really know. Of course, they tell us what they’re thinking—but that’s as polite and meaningless as when you ask your dinner guests how’s the food: They might look green around the gills, but they’ll invariably say, “Why, it’s wonderful—thank you!” 
  
So getting an actual document which spells out in black-and-white what the Chinese are really thinking is an eye-opener: Not so much for what it says—which on the whole is predictable—but for the emphasis it has. 
  
Recently, I got handed a copy of the Chinese economic evaluation of Japan, the European Union and the United States. The document was written for and by Chinese government officials who will be attending the G-20 summit in Seoul next November. This document will be the basis for their discussions with their trading partners, and outlines China’s concerns about those countries. 
  


I wouldn’t be surprised to learn that the document was deliberately leaked—in fact, I am treating it as such. The material does not contain any sensitive or actionable information—no tidbit like, “Psst! Next December 5? We’re buying 10,000 tons of gold on the open market!” 
  
Actually, the evaluation was much more fascinating—and important—than mere insider trading information: The document shows what the Chinese economic leadership is thinking, vis-à-vis the current economic situation of their major trading partners. 
  
In the notes I read, the U.S., the European Union, and Japan were all discussed in broad detail—but with curious accents: 
  
Insofar as Japan was concerned, the evaluation said—literally—“We approve.” They considered Japanese sovereign debt risk “negligible in the short-term”, and generally lauded the Japanese government’s efforts to prop up internal demand; their only concern was that these efforts not be withdrawn too quickly, in case such a hasty withdrawal kills what they see as a nascent Japanese recovery. 
  
The Chinese are concerned about Japanese deflation, though, and whole-heartedly approve of any measure to prevent the yen from further appreciating, up to and including creative measures by the Bank of Japan to inject liquidity into the markets. 
  
What was interesting was how, in passing, the Chinese notes mentioned the Japanese current account surplus which, by the language used, they consider a negative thing. They wanted the Japanese to “avoid exacerbating” the current account surplus and trade imbalances. The language was such that it was clear how the Chinese are very concerned that they not become Japan in a next recession: They look to the Japanese Lost Decades as something that could befall China, and an object lesson to be avoided at all costs. 
  
This gives some insight into their mania of keeping the renminbi weak versus the dollar. It’s not only so as to encourage exports—it’s so as to avoid renminbi deflation. 
  
However—natch—the evaluation makes no mention of current political tensions with Japan. Furthermore, it olympically ignores how China is goring the Japanese economy with its beggar-thy-neighbor trade, capital flow and monetary policies. My guess is, the Chinese won’t be spending much time jawboning with the Japanese in Seoul: It’ll be the quick handshake, the polite few words, then move on. 
  
As to the European Union, the evaluation makes it clear how nervous the Chinese were at the ad hoc approach Europe used when dealing with the Greek crisis. They want the EU to strengthen its Stability & Growth Pact so as to “prevent and resolve fiscal imbalances”. At the same time, they see an “urgent need” to set up a whole host of mechanisms to assure “financial stability”—id est, prevent another Greece, or at least to have the mechanisms and structure in place to efficiently handle another Greece. 
  
They also suggest that internal EU barriers be completely eliminated, as well as the application of other measures to further strengthen internal EU bonds—a suggestion which highlights a curious blindspot of the Chinese: They don’t seem to understand why the European Union Commission simply doesn’t order about the wayward elements of the Union, and make the whole of the peninsula more homogenous. 
  
They don’t seem to understand the political realities which define certain idiosyncrasies of the EU. A blindspot which I suppose is understandable—in China, they’d just shoot the dissidents. My guess is, they’d have shot the Greeks by now. (They’ll shoot you if you kill a panda, even if it’s by accident—so what’s shipping a few thousand Greek or Spanish or French protestors six underground?) 
  
Regarding the United States, the Big Kahuna: The Chinese are very worried—but they also view America with a bit of contempt. 
  
In their very first sentence, the Chinese state that U.S. fiscal deficit reduction is based on “over-optimistic and unrealistic growth assumptions”—that’s diplomat-speak for “Are you outta your fucking mind?” The second sentence tears apart U.S. GDP growth projections for 2010 and 2011, both the U.S. government’s, and that of leading U.S. economists. 
  
U.S. debt reduction is the big bugaboo of the Chinese—it permeates everything they write about America. They see it as an “imbalance” that will eventually affect all of the world’s economies. They think that American government claims that the deficit will be reduced by 50% by 2012 are “not entirely realistic”—again, diplomatic politesse that masks a real contempt for American self-deception. 
  
The Chinese are really exasperated that the U.S. does not seem to have the political will to tackle the enormous deficit. They do not think that the U.S. can achieve fiscal deficit reduction by spending cuts alone—they see the need to increase fiscal revenues. They worry that the U.S. fiscal deficit—which they believe will deteriorate in the medium term—will lead to increase interest rates. 
  
Most crucial of all, they see the U.S. failure to take concrete policy steps to curb the deficit as having a greater impact on the world’s economies than any trade issues American officials might be bitching about. It’s hard for a third-party observer to disagree with this assessment. 
  
Furthermore, the Chinese point out—sensibly—that the U.S. talks about increasing exports and reducing dependence on consumption—but the U.S. makes no mention of concrete steps as to how to achieve this, besides talk of “reducing foreign barriers to trade”. The most striking point here is, the Chinese view as “misdirected” the U.S.’s blaming foreign trade barriers for America’s failure to export. Again, third-party observer says? Score for China. 
  
Though they superficially laud the financial reform package the Obama administration recently passed, the Chinese are very worried about the TBTF banks, Freddie Mac and Fannie Mae. They think that the U.S. government has no exit strategy for its meddling in the financial system, or a clear directive as to the role of the intervened institutions in the financial system, or how they will be regulated. (Yes, I can see the irony: The Chinese genuinely worried about America’s meddling in its financial institutions. WTF?) 
  
Finally, they characterize both the U.S. government’s fiscal policy and the Federal Reserve’s monetary policy as “doubly-slack”. They wonder how the U.S. will ever fix its trade deficits and fiscal deficits, if both the government and the Fed are—to their eyes—asleep at the wheel. 
  
In other words, they don’t see the Fed’s and the government’s bailouts and stimuli (TARP, QE, and all the rest of it) as heroic measures that saved the system—they view the bailouts as policy weakness: Gymnastics that kicked the can down the road, but didn’t solve anything. Which, again, seems accurate: It was easier to save Fannie and Freddie and the Too Big To Fail banks, rather than letting them fail and going through the painful process of cleaning and purging the system. 
  
Bottom line: They don’t see either the Federal government or the Federal Reserve actually implementing concrete steps to achieve medium- to long-term solutions to the problems at hand, especially deficit reduction. And this makes them really nervous. 
  
That’s the upshot of this evaluation of their trading partners. 
  
As to themselves, the Chinese’s self-evaluation is rather interesting: First of all, they see their own easy money policy as having been a great thing. They consider it to have been the reason for sustained rapid growth during the last two-three years. Unlike Jim Chanos’ very smart evaluation—he thinks they are in a bubble, overheating and heading for a fall—the Chinese see their easy money policy as having been essential to keeping their economy going. They have no intention of tightening money anytime soon. 
  
As to their exchange rate policy, they’re also keen on it, viewing its “stability” as having been essential to China’s making its way safely through the Global Financial Crisis. 
  
They talked up their capital control policy—a lot: And it wasn’t convincing. They highlighted their efforts to change “slack controls” to “balanced management”, but for all the talk of “widening capital outflow channels”, the Chinese were intent on “strengthening [. . .] statistical monitoring and advance warning systems, [. . .] [so as to] ensure steady and orderly liberalization of capital [. . .] provided that risks can be controlled.” 
  
In other words, it wasn’t the Roach Motel model of capital controls (“Capital checks in, but it don’t check out!”) It was more of a Checkpoint Charlie capital control model: “You can pass through all you want—but we can shut you down whenever we want.” 
  
But what they seem to be keenest of all on is their domestic demand. They don’t worry that their current account surplus fell over the last few years with the crisis—they seem to view it as a natural byproduct of increased internal demand, something they are obviously very pleased with, and are trying to further foment. They highlight that 76% of GDP growth in 2005 was from domestic demand—and contrast that with 2008, where 91% of GDP growth was from domestic demand. 
  
This is how the Chinese see their own economy. 
  
Now of course, none of this is novel or remotely new. And you can take it or leave it as to my own reliability—I could be well making this all up. 
  
But assuming I’m not, the take-aways from the Chinese evaluation are really interesting—and make a lot of sense: 
  
One, the Chinese don’t want their economy to fall into the Japanese Lost Decade syndrome—which would make their own monetary and easy-money policies that much more understandable. It’s not merely to boost exports, it’s to prevent deflation. They will continue to keep the renminbi weak against the dollar, and if they can, weaken it further via expanding credit. 
  
This means that China’s bubble—which as I said, smart people like Chanos and now Nouriel Roubini are thinking might pop soon—might stay inflated a lot longer than anticipated. After all, the Chinese have the current account surplus to pay for such a bubble. So I wouldn’t bet against them. 
  
Two, the Chinese think America is a basket case—and they’re worried about a spike in interest rates crashing the American house of cards. Furthermore, they have a palpable contempt for American policy slovenliness—they don’t like the American self-deception, or their habit of blaming everyone but themselves, or their habit of outlining broad policy goals yet doing absolutely nothing to achieve them. 
  
Three, and I think most imporant of all, they are clearly intent on developing their internal markets: Anyone claiming otherwise doesn’t get the Chinese or their priorities. It’s not that they claim they want to foment domestic demand for the sake of political window-dressing, or to assuage American calls to “reduce import barrier”—it’s that the Chinese are highlighting domestic demand as an increasing component of their GDP’s growth because they are proud of this growing domestic demand. 
  
They clearly want this domestic demand to continue to expand, and become the engine of China’s future growth. That is where they see the future of their economy—not exports. 
  
If this is indeed what the Chinese are thinking, then their mercantilism would seem to be a stepping stone towards achieving a self-sustaining economy, where internal demand is satiated by internal production—in other words a balanced (and hermetic) economy. 
  
Now, is this evaluation on the up-and-up? Like I said at the beginning, I would treat this document as likely a deliberate leak. But none of the points—except for the Japanese omissions—are all that surprising, and in context make a lot of sense. So deliberate leak or not, I’d treat this as accurate and true. 
  
So when the G-20 summit takes place in Seoul next November 11, this is what the Chinese will be thinking when they chat up their largest trading partners—or at least claim that they’re thinking. 


14 comments:

  1. I am a Chines. I can tell you that Communist China is collapsing anytime soon just like the former USSR. When its economy with one billion people crumbled, it will be very unpleasant.

    I told my family in China to stock up and play "survivalist" games...LOL.

    The false information has been fed to the West by Propaganda Dept. of the Commies are really blind the West.

    Think of this : The Chinese cannot visit youtube, cannot use facebook...etc., how much do you think the Commie will tell the truth to the Chinese people and to the world?

    China's problems are out of your(Westerners) imagination.
    Try to google translate this research paper by a Communist party top rank official

    http://club3.kdnet.net/dispbbs.asp?boardid=3&id=6444070

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  2. Excellent essay, as usual. It has a lot of "personality". The way you present China's menu for these G-media summits reminds me of a bad relationship between two insincere people where the stronger person feeds and supports the ideas of the other, but trashes them on the side. Like, Here's my credit card honey, you bitch. Make sure you use it wisely, although I know you won't because you are an idiot, but I can't live without you.

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  3. China knows USA is a busted flush.
    They want a toehold in Europe, so becoming Greece's new best friend is a start *. (They are replacing the Squid).

    The long term plan is to pull Greece out of the Euro -sorry to push Germany out of the Euro- and leave China with a western empire.

    * They are probably buying up all London real estate as a pincer movement on the UK.

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  4. What do you make of Foreign Policy's Japan Syndrome article? Ethan Devine points out many stats that indicate China is more bubblicious than Japan ever was...

    China is far more dependent on exports and investment than Japan ever was, and the numbers are still moving in the wrong direction.

    In 1988, Japan's foreign exchange reserves stood at 5 percent of Japanese GDP and 0.7 percent of global GDP, whereas China's are now half of Chinese GDP and a full 5 percent of global GDP. Reserves of this magnitude have the potential to destabilize the Chinese and global economies.


    In the end, Ethan notes that China has history to learn from, whereas Japan didn't. So they can still change, albeit, they are a lot more imbalanced than Japan was before it popped.

    The killer quote, "When China's working-age population peaks in 2015, it will be 20 years after Japan's crested the wave, but it will do so at a much lower level of prosperity than was Japan's at that time. The harsh reality is this: Japan got rich before it grew old, and China will grow old before it gets rich."

    I don't see why they bothered with the analysis, since as you said, none of their "findings" are new. And it's quite silly that they want to export, but don't want to support our deficit, but don't care about Japan's loosey goosey.

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  5. I think this is a cruel joke, playing on the fact that Christine O'Donnell found a secret document, where China kills us all.

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  6. I know for a fact that China is frantically developing a huge internal economy because I am making many private investments there.

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  7. Where can I get this report?

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  8. People in glass houses should not throw stones. As the New Testament points out, it's easier to see someone else's flaws than your own flaws. This applies to nations.

    If the global economy is a truly a zero sum game, then for China to have a trade surplus, other countries have to have deficits. Wealth is being redistributed to China from the U.S. primarily. If the U.S. suddenly did fix its house, the lack of U.S. demand would hurt Chinese exports in such a way that Chinese internal demand would not be able to compensate for. If Chinese do want to increase internal Chinese demand, workers' wages should be rising and rising fast. Is this true? Or, are wages being kept low to keep profit margins stable? This is all I can find that's up-to-date:

    http://www.aolnews.com/world/article/chinese-workers-push-for-better-wages/19593310
    http://mrzine.monthlyreview.org/2010/li180810.html

    There's this from 2006:
    http://neweconomist.blogs.com/new_economist/2006/03/chinas_labour_p.html

    It appears that the Chinese have not been raising workers' wages until now, and only because of worker unrest. So, what is driving their internal demand for Chinese goods? Is it government spending on public works and infrastructure such as water pipelines and dam projects? It is possible that no Westerner really knows what is happening in such a closed society like China. The West totally missed the collapse of the USSR due to the latter's obsessive control of knowledge. China is almost as obsessive.

    The Chinese have no concept of win:win or what is termed a dual win. Their thought processes tend to focus on the extremely long term, and they employ experts who specialize in rather narrow fields of study for policy advice, see here: http://www.armedforcesjournal.com/2010/09/4696227 .

    While I haven't read the report, it's probably best to view it as an opening move in a poker or chess game. Whether the US is on the same page is debatable. It's highly likely that we are playing chess while they are playing poker as that fictional character James T. Kirk would say. I would also guess that the first commenter may have a point. The report could be a whole bunch of lies and wishful thinking if it is the result of Communist Chinese propaganda.

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  9. For China's sake one should hope the report is merely for public consumption since it doesn't begin to take the measure of what has occurred to date in the U.S.

    To wit: I am bemused by a report that lauds, however mildly, U.S. financial (non) reforms. Perhaps the ever so mildly positive words in the report are merely evidence of a diplomatic tone as regards utterly failed attempts to institute substantial financial regulation. The only problem is, if the Chinese report wanted to sound respectful regarding (bogus) FINREG, why take away with one hand what you gave with the other by sounding contemptuous regarding U.S. projections for growth in the coming years?

    As for the 64 trillion dollar question, namely how robust is the Chinese economy, well, let's just say that people whose opinion I respect, like Hugh Hendry, are deeply skeptical of the putative strength of the Chinese economy.

    Not to put too fine a point on it, but there is a lot of smoke and mirrors, propaganda, not to mention, vast corruption, underlying the Chinese economy. It's not just currencies that are racing one another to the bottom, entire nations are as well.

    That's my present view on the global situation. No one nation is going to come outon top in the 21st century. We are not replaying the mid to late 19th and early 20th century where the U.S. became the engine for global growth, and then, following WWII, the world's hegemon.

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  10. That's a great line,“over-optimistic and unrealistic growth assumptions." Of course the Chinese are guilty of the same propaganda.

    "When China's working-age population peaks in 2015, it will be 20 years after Japan's crested the wave, but it will do so at a much lower level of prosperity than was Japan's at that time. The harsh reality is this: Japan got rich before it grew old, and China will grow old before it gets rich."(from the Japan Syndrome by Ethan Devine)

    Great interview with Max yesterday by the way.

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  11. China has its own defaulted sovereign debt which S&P, Moody's and Goldman Sachs are complicit in hiding:

    http://www.istockanalyst.com/article/viewarticle/articleid/4548858

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  12. Collegues......." Da Lu " has more sociopaths than we yanks do. In the long
    we are fucked

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  13. In the new era of growth for China and for businesses, the challenge and opportunity is in an appropriate risk intelligent approach – taking the right risks and minimizing the bad risks. China

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  14. viewing its “stability” as having been essential to China’s making its way safely through the Global Financial Crisis.  buy from china

    ReplyDelete

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