June 10, 2012 The Macroeconomics of Chinese kleptocracy
China is a kleptocracy — a country ruled by thieves
(c) When given direct evidence of fraudulent accounts in the US filed by a large company with CPC family members as beneficiaries or management a big 4 audit firm will (possibly at the risk to their global franchise) sign the accounts knowing full well that they are fraudulent. The auditors (including and arguably especially the big four) are co-opted for the benefit of Chinese kleptocrats.
This however is only the beginning of Chinese fraud. China is a mafia state – and Bo Xilai is just a recent public manifestation. If you want a good guide to the Chinese kleptocracy – including the crimes of Bo Xilai well before they made the international press look at this speech by John Garnaut to the US China Institute.
China has huge underlying economic growth from moving peasants into the modern economy
The one-child policy drives massive savings rates
Low and middle income Chinese have very limited savings options
Bank deposits and life insurance as a savings mechanism in China
In other words real returns for bank accounts are consistently negative – sometimes sharply negative. You might ask why people save with sharply negative returns. But then you are not facing starvation in your old age because of the “four grandparent policy”. Moreover because of the underlying economic growth (moving peasants into a manufacturing economy) there are increasing quantities of these savings every year. This is the critical point – the negative return to copious and increasing Chinese bank deposits drives a surprising amount of the global economy and makes sense of many things inside and outside China.
The Chinese property market as a savings mechanism
Negative returns on bank deposits and the Chinese kleptocracy
Us Westerners see the skimming arrangements. If you want to sell something to the Chinese SOE you don’t sell it to them. You sell it to an intermediate company who sell it in China. From the Western perspective you pay a few percent for access. From the Chinese perspective – this is just a gentle form of looting.
And it is not the only one. The SOEs are looted every way until Tuesday. The Business insider article on the spending at Harbin Pharmaceutical is just a start. The palace pictured in Business Insider would make Louis XIV of France (the Sun King) proud. This palace shows the scale (and maybe the lack of taste) of the Chinese kleptocracy.
A normal business – especially a State Owned dinosaur run by bureaucrats – would collapse under this scale of looting. But here is the key: the Chinese SOEs are financed at negative real rates. A business – even a badly run business – can stand a lot of looting if it is (a) large and (b) funded at negative real rates. Those negative real rates are only possibly because there are copious bank deposits available at negative real rates to State controlled banks.
The cost of funds in China and the willingness to hold foreign bonds
Monetary threats to the Chinese establishment
Inflation (widely discussed) is known to produce riots and demonstrations in China – and is considered by Westerners to be bad news for the Chinese establishment. And there are good reasons why the Chinese riot with inflation – the poor who save because they are going to starve – get their savings taken away from them.
But ultimately the Chinese establishment like inflation – it is what enables their thievery to be financed.
The more serious threat is deflation – or even inflation at rates of 1-3%. If inflation is too low then the SOEs – the center of the Chinese kleptocratic establishment will not generate enough real profit to sustain the level of looting. These businesses can be looted at a negative real funding rate of 5 percent. A positive real funding rate – well that is a completely different story.
The real threat to the Chinese establishment is that the inflation rate is falling – getting very near to the 1-3 percent range.
Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps.
But that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils). The SOEs will not be able to pay positive real returns to support that new division of spoils. The peasants can only receive positive real returns if the SOEs can pay them – and paying them is inconsistent with looting.
If the SOEs cannot pay then the banks are in deep trouble too.
All because the inflation rate is dropping. Maybe they can stop it dropping. The Chinese establishment has a vested interest in getting the inflation rate up in China. Because if they don’t all hell will break loose.
Unless the Chinese can get the inflation rate up expect a revolution.
Chinese government debt
A financial crisis in China could be another reason for the market to change direction. Even after the recent surge in local government debt, China’s total government debt is a modest 53% of gross domestic product. Still, the central bank’s efforts to contain the explosive growth of the shadow-banking system may not work. The leap in short-term rates to 30% in June could be a warning sign (Gary Shilling: How to prepare your portfolio for the next market shock. March 11, 2014. Bloomberg news).
Problem no. 1: slowing growth. From Reuters:China Growth May Dip Below 7%: Government Adviser
Problem no. 2: falling inflation. From Zarathustra at Also Sprach Analyst:China’s inflation fell to 3.0% yoy in May 2012
Problem no. 3: liquidity. Zarathustra again:Credit Suisse: China is in a liquidity trap
Problem no. 4: money supply. And there we get to our definition of inflation: as shrinking money supply and velocity of money. Ambrose Evans-Pritchard: Global slump alert as world money contracts