Thursday, May 5, 2011

The Chinese Miracle

Since we've recently looked at Japan, let's take a look over at China.

Ask Americans the conventional wisdom about China and they will tell you two things: that they make all our stuff, and that they're becoming the new middle-class country. While growth has stalled in the West, the story goes, China's phenomenal growth - around 10 percent a year for the last decade or so, will pull the global economy forward like a locomotive, ensuring the global economy can just continue growing forever. "One Billion Consumers!!! " proclaims the salivating business community. Eventually, Chinese one or two generations out of rice paddies will be driving SUV's and sipping Starbucks lattes as drive into their office jobs from the suburbs, just like Americans.

As you may be able to tell, I don't buy it. The "Chinese Miracle" is just the latest gimmick by the investment class to get the people with money to keep buying into the pyramid scheme that is global capitalism. It's also the final gambit to keep the illusion of eternal growth going. When you start doing a little research outside of the investor class cheerleading, you arrive at a substantially different picture than we are fed on the evening news.

A word about that "vast Chinese middle class."  It turns out they are a lot smaller than we were led to believe. The conventional line fed to us, both in China and the United sates, is all we have to do is get a diploma and a comfortable middle-class lifestyle will be available for everyone in the "knowledge economy." In the knowledge economy, the story goes, there will be suburban mansions and SUV's for everyone. I'm a bit skeptical. There are over a billion people in China. They're all going to have middle-class jobs, really? See the following article from The New York Times: China's Army of Graduates Struggles to Find Jobs:

...Often the first from their families to finish even high school, ambitious graduates like Ms. Liu are part of an unprecedented wave of young people all around China who were supposed to move the country's labor-dependent economy toward a white-collar future. In 1998, when Jiang Zemin, then the president, announced plans to bolster higher education, Chinese universities and colleges produced 830,000 graduates a year. Last May, that number was more than six million and rising.

It is a remarkable achievement, yet for a government fixated on stability such figures are also a cause for concern. The economy, despite its robust growth, does not generate enough good professional jobs to absorb the influx of highly educated young adults. And many of them bear the inflated expectations of their parents, who emptied their bank accounts to buy them the good life that a higher education is presumed to guarantee.

"College essentially provided them with nothing," said Zhang Ming, a political scientist and vocal critic of China's education system. "For many young graduates, it's all about survival. If there was ever an economic crisis, they could be a source of instability."

Doesn't sound that different from the United States. does it? The article continues:

In a kind of cruel reversal, China's old migrant class -- uneducated villagers who flocked to factory towns to make goods for export -- are now in high demand, with spot labor shortages and tighter government oversight driving up blue-collar wages.

But the supply of those trained in accounting, finance and computer programming now seems limitless, and their value has plunged. Between 2003 and 2009, the average starting salary for migrant laborers grew by nearly 80 percent; during the same period, starting pay for college graduates stayed the same, although their wages actually decreased if inflation is taken into account.

Chinese sociologists have come up with a new term for educated young people who move in search of work like Ms. Liu: the ant tribe. It is a reference to their immense numbers -- at least 100,000 in Beijing alone -- and to the fact that they often settle into crowded neighborhoods, toiling for wages that would give even low-paid factory workers pause.

No wonder the latest polls show three-quarters of Chinese workers as "struggling":

In results that seem to contradict a similar poll by the Pew Research Center, Gallup’s 2010 global wellbeing survey, issued this week, found only 12% of Chinese people thought of themselves as what Gallup calls “thriving,” while a whopping 71% said they were struggling and 17% said they were downright suffering.

How can things be so bad when China is supposed to be the world's great success story? It turns out that China has the second largest number of impoverished people in the world after India. Even people who have jobs and are considered to be a part of the middle class are having a hard time living a comfortable life. Consider Li Xiangwen, a senior art designer at a magazine in Shanghai:

She lives on a good wage, but struggles, she says, with the cost of living in this expensive city.
She has bought a flat, but it is not close to her office, so she has also bought a car in order to get to work easily.

"After paying my mortgage and the expenses for my car, there's not much left," she says.
Both those purchases mark her out as one of China's richer consumers.
But like many young professionals living in cities in Europe, where inflation is also climbing, she says she does not feel well-off at the moment.
 "I feel the pressure on me is quite high," she complains.
In many ways Li Xiangwen has achieved the Chinese dream.
She has a good job, a car and a roof over her head.
She says she earns more than three times what her parents used to, but she does not get the subsidies they did.
She is paid more than they were, but also has to spend a lot more.
"Most of their generation had houses provided by the state," she says. "They had company shuttle buses they could take to work. It was rare for people to have their own cars, so they saved quite a lot."
"The gap between the wealthy and the poor wasn't so big, so people felt quite happy most of the time, quite comfortable and relaxed."

Today, she believes it is different for the city's younger workers.

They face greater competition for each job, as well as high inflation.
If they are lucky enough to own their own home, there are high costs to service the mortgage.
"When everyone else has a house or a car, inevitably you feel the pressure. You feel you have to work hard on your life, so even if you have these possessions you don't necessarily feel happier than your parents did," says Ms Li.

China's highly idiosyncratic nature is also summarized in this Nicholas Kristof column:

What’s the trade-off between imprisoning a brilliant Nobel Peace Prize-winning dissident like Liu Xiaobo and saving hundreds of thousands of babies’ lives each year through improved health care? There isn’t one. The two sides of China are incommensurate. They are the yin and yang of 21st-century China.

The United States tends to perceive China through a Manichaean lens — either the economic juggernaut overcoming poverty and investing brilliantly in alternative energy, or the Darth Vader that tortures dissidents. In fact, both are equally real. Likewise, China abuses trade pacts, but it has also been appreciating its currency (mostly through inflation) much more than Americans give it credit for.

The truth about China is that it's one of the most unequal societies on earth. China is dependant upon cheap labor. Let me say that again: China is dependant on cheap labor. That's not going to change, ever. Chinese labor needs to remain cheap so that American goods are cheap enough for even broke Americans to keep the "consumer economy" going, as Dylan Ratigan points out:

Which brings me back to the strikes. American CEOs have exported not just our job base, but all the labor unrest that can come with it. China is running out of capacity to make our products, and commodity prices are going up for them as well. So inflation is hitting Chinese workers very hard right now — one of the causes of the trucker strike was a significant hike in fuel prices. The Chinese government quickly made concessions to the strikers, and is broadly attempting to deal with an incredible gap between the rich and the poor. But as Reuters noted, they aren’t doing this because of goodwill.

China makes what America consumes. Take, for instance, Walmart. Walmart is increasingly a Chinese company these days, orchestrating the shipping of goods made by incredibly poor Chinese workers to increasingly poor American consumers. Apple is another hybrid Chinese company, a middle-man. Steve Jobs makes billions running a design, retail, marketing, and R&D shop in the US known as Apple. His business partner Foxconn CEO Terry Guo makes his billions making iPads, iPods, and iPhones with 800,000 “iSlaves” in China.

This is a system, and the strategy behind it is quite explicit. Economists have designed it, and they call it fighting inflation. Since wage gains contribute to inflation, stopping wage gains is the goal of the international trading regime. The natural end result is low wage workers in China selling to high debt consumers in America. You get an unstable system with a deeply immoral core, but hey, at least there’s no inflation.

As you can see, China's battle against inflation is being lost. What has been the result? Read this analysis of China's Highly Unequal Economy:

Why does China have an economy that is highly unequal and dominated by the state?  The answer is quite simple when considering China’s political system and contemporary history. Despite economic reforms that liberalized goods markets and the labour market, the state continues to hold a tight grip over most of the financial institutions. The financial sector in essence takes money from foreign exchange earnings and from household savings and channels it to state-owned firms controlled by the central or local government. Having little choice, households in China must deposit money in the state banks, and when there’s inflation as there is today, they earn a negative real interest rate from the banks because the government fixes deposit rates at a level that is below inflation. Meanwhile, real estate developers with political connections and large state-owned enterprises can borrow money at interest rates that are near zero in real terms. In effect, the Chinese financial system channels wealth from ordinary households to a small handful of connected insiders and state-owned firms. To be sure, other Asian countries have also pursued this state-led financing model. But China has pursued it for the longest period of time. Meanwhile, there’s still no liberalization of the financial sector in sight.

At the local level, local governments confiscate the other major source of wealth—land and real estate holding—often giving residents illegally low compensations. Without political accountability and elections, ordinary people can do little to change what amounts to property theft. Even escalating welfare spending in recent years can’t make up for the large transfers of income and savings from ordinary households to the wealthy and connected, which are shaped by government policies.

As a result of all this, ordinary households actually get poorer in relative terms and even in absolute terms. Meanwhile, although growth appears robust, the nature of the growth has changed over time.  As Yasheng Huang at the MIT Sloan Business School has documented in his Capitalism with Chinese Characteristics, the healthiest period of growth in China was in the 1980s, when farmers made and sold light manufacturing goods and agricultural outputs to rapidly emerging goods markets.  Into the late 1990s, however, China ‘restructured’ its banks so that they could continue to channel cheap loans to state-owned behemoths, now even larger due to consolidation in the 1990s. Growth from that point increasingly relied on net exports and state-led investment and decreasingly on household consumption.  Although growth of this sort can continue for a few more years, the vast majority of China’s population won’t see many of the benefits.

What has been the result of the above policy? It's pretty easy to see. In recent years, as the West has come apart economically and become too poor to buy Chinese junk (when I was younger, this referred to a ship), the Chinese have resorted to massive building projects to continue "economic growth" at all costs. The only problem is, the average citizen can't afford to live in any of the new buildings, as this widely circulated news report from Australia demonstrates:

China's Housing Bubble-->

It turns out that many of these buildings are of poor quality:
The quickly built but cheaply made buildings in Beijing will not literally fall down, but will deteriorate. Wall paint will peel and elevators won't work. Buildings will become uncomfortable because they will not have been properly maintained. That's when people will start to realize they've paid a lot of money to buy a place in the Central Business District and they've paid management charges, but nothing works and everything looks really poor. But the developers will probably be long gone by then, so I'm not sure what people will do.

Many buildings in Beijing are built with the cheapest materials available, which tend to degrade quickly. This is a worryingly common phenomenon. There are many buildings here that appear as if they are 10 or 15 years old, but are really just five years old. That's a little bit sad.

I have a 75-year-old apartment in New York, but it's still in great condition. You don't see that here. Fast and cheaply built apartment complexes dominate the property market here and there will be future consequences for this. And it might be apartment owners who end up paying them.

Why are there vast cities that are empty while millions lack adequate housing? It's the manic logic of global capitalism. It's the logic of growth for the sake of growth. It's highly unlikely this will just "work itself out", as Charles Hugh Smith points out:
Dumping hundreds of billions of yuan into illiquid, mostly luxury dwellings is a catastrophic misallocation of capital in a country with an average per capita income of $3,000 per year. But that gross misallocation of capital is only part of the problem: since the vast overhang of luxury flats is illiquid and cannot be sold, these "investment properties as savings" are a black-hole capital trap: the invested capital cannot be turned back into cash.

Once the cash has been dumped into the black hole of illiquid real estate, it cannot escape; as with physical black holes in space, there is an event horizon beyond which the capital cannot be recovered. In China's real estate market, that is the moment when the buyer's funds are transferred to the developer.

This trapping of China's vast private capital in illiquid, rapidly depreciating investment properties will have far-reaching negative consequences going forward. When the time comes to transfer their "savings" back into cash, owners will find that their flats are worthless due to deterioration and/or the inability to find a buyer at any price.

All these luxury flats are speculative; many are empty and will never be inhabited. When the citizenry finally understand that the Central Government cannot stop prices from falling, or provide a deep, liquid market for re-sales, then panic will take hold, just as it does in the collapse of every bubble.

Unfortunately, investors in China will discover too late that luxury flats are not equivalent to cash in savings accounts, for the money only flows one way near a black hole: over the event horizon and into an inescapable capital trap.

At the end of the Australian news broadcast, you can hear them stating the obvious: when the bubble burst it will lead to serious unrest. You can hear the frustration in the voice of George Jiao (I hope that's not his real name) interviewed in the video, who is far more typical of the average Chinese person that the newly-minted millionaires constantly trumpeted in the western press, particularly in America where zombie Horatio Alger myths live on. The truth is, there are teeming millions of George Jiaos out there, and this keeps the Chinese government awake at night. They know that the same root causes that precipitated the uprisings in the Middle East and North Africa are present in China - a vast, dispossessed proletariat with little to lose, living in the shadow of great wealth, and an unholy collusion between bureaucrats and wealthy business interests. That is why China spends more on suppressing internal dissent than it does defending itself against foreign enemies:

China has been undertaking a pervasive crackdown on dissidents, ratcheting up their information monitoring and arresting the prominent dissident artist Ai Weiwei on trumped-up charges. Does this sound like a contented middle-class society to you? The reason for the heavy-handedness is simple - China used to have one of the most equal societies in the world, in part thanks to what was termed the "Iron Rice Bowl."  Now, thanks to economic "reform" they are a society of haves and have-nots,  and the effect is the same as everywhere else on earth - the rich are getting richer, the poor are getting poorer, and an entrenched and often corrupt oligarchy makes the rules for their own benefit.

One of the notable economists finally starting to see the obvious is Nouriel Roubini. Dr. Roubini achieved fame for predicting the bursting of the housing bubble before it happened, which to my mind makes him less like Nostradamus and more like the little child in The Emperor's New Clothes. His realistic take when everyone else was deep in the herd mentality earned him the nickname "Dr. Doom." In a widely cited article he wrote a few weeks back, he states very clearly what should be obvious - China has massive overcapacity:

China has grown for the last few decades on the back of export-led industrialization and a weak currency, which have resulted in high corporate and household savings rates and reliance on net exports and fixed investment (infrastructure, real estate, and industrial capacity for import-competing and export sectors). When net exports collapsed in 2008-2009 from 11% of GDP to 5%, China’s leader reacted by further increasing the fixed-investment share of GDP from 42% to 47%.

Thus, China did not suffer a severe recession – as occurred in Japan, Germany, and elsewhere in emerging Asia in 2009 – only because fixed investment exploded. And the fixed-investment share of GDP has increased further in 2010-2011, to almost 50%.

The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.

Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth.

Several Chinese policies have led to a massive transfer of income from politically weak households to politically powerful companies. A weak currency reduces household purchasing power by making imports expensive, thereby protecting import-competing SOEs and boosting exporters’ profits.

Low interest rates on deposits and low lending rates for firms and developers mean that the household sector’s massive savings receive negative rates of return, while the real cost of borrowing for SOEs is also negative. This creates a powerful incentive to overinvest and implies enormous redistribution from households to SOEs, most of which would be losing money if they had to borrow at market-equilibrium interest rates. Moreover, labor repression has caused wages to grow much more slowly than productivity.

More and more economic commentators are starting to come over to this point of view. Roubini is calling for a hard landing in 2013. I think the timing is arbitrary. A crash WILL happen, it's just a matter of when. It's clear that China cannot keep building empty apartments and malls and trains forever. The vast gulf between the have-nots is not going to go away, and when the bubble bursts, things are going to get ugly. Dylan Ratigan details some of the efforts by US companies to keep Chinese wages low, and points out the obvious similarities with the Middle East:

Food price hikes sparked strikes in Egypt, which eventually turned into a political revolution. The Chinese government isn’t stupid, but it is trapped. Their strategy is to take American know-how by undercutting us on price, using protectionist measures that we stupidly allow. Our own corporate oligarchs are well-aware of this dynamic as well. They have been preparing for this moment for some time. Walmart (along with GE and even more surprisingly, Google) led the fight in April, 2007 to gut a new labor law proposed for Chinese workers on issues like collective bargaining, severance, etc. The American Chamber of Commerce in Shanghai is using aggressive tactics to ensure that Chinese wages would remain low.

Perhaps there is something ironic about aggressive lobbying tactics by multinationals being used effectively in both communist and capitalist legislatures to suppress worker rights. Or perhaps not. But you cannot suppress reality forever, and the strikes in Shanghai show that top-heavy gains eventually have consequences, even for those who make the rules. It’s not always as dramatic as Mubarak’s fall, but then again, Mubarak’s fall wasn’t the point when those first Egyptians began striking in 2007. It was the rising prices.

Ultimately, the biggest factor may be simply the fact that there is too much pressure on supplies of raw materials and energy sources to keep the planet growing forever. Growth is always seen as a panacea for inequality. We've seen just how fake "growth" in China has been. When it finally comes to a halt, then what? Many have pondered this question:

We are in an era where the availability of natural resources is not sufficient to support the wealth levels that the developed world has grown accustomed to, along with the speed of growth with which the developing world is trying to approach those same levels.  So, this is represented by oil prices rising (along with food and other commodity prices more generally).  But the effect of this is not to place a uniform drag on growth, because the global mind has not accepted this truth yet.  Instead, the global economy keeps trying to grow in a way that is inconsistent with the resource constraints, and then some part of the system tears and gives way.

So, in 2007/2008 the sector that gave way was the American subprime consumer, along with a significant chunk of the financial system that was predicated on the idea that poor Americans could continue to take on more and more debt indefinitely.  Instead, rising gas and food prices eventually destabilized the finances of that sector of consumers, they started to default, then their lenders started to default, financial contagion set in, and the situation was only stabilized with massive extraordinary interventions by sovereign governments.  That worked, but left a lot of the sovereigns in significantly weaker condition than before.

Now poor Americans borrowing more and more to bid house prices higher and higher was always an unsustainable trend that was going to end in tears one way or another.  But the timing was likely determined by the oil/food price shock that ended in 2008.

So now, just three years later, here we are again with oil and food prices rising fast, and the question in my mind is this: what part of the global fabric tears next?  And when?

Sorry about the rambling nature of this post, but China is a big subject. Let me summarize the above insights:

1.) resource shortages leading to:
2) rampant inflation leading to:
3. low rates of economic growth and even greater separation between the haves and the have-nots leading to:
4. the real-estate bubble bursting leading to:
5. millions of empty apartments amid widespread unemployment and homelessness leading to:
6. widespread social unrest leading to:
7. the wheels coming off of Chinas "boom" and a Chinese Great Depression leading to:
8. The collapse of globalized corporate capitalism leading to:
9. Billions around the world in poverty with no social mobility leading to:
10. Global unrest, collapsing governments, etc.

...Leading to hopefully, the world after globalized corporate capitalism. Wash, rinse, repeat. As Charles Hugh Smith wrote so perceptibly, China is global capitalism's last fix. Once it fails, the whole system will go down. The Chinese curse "may you live in interesting times" may not have been actually said by the Chinese*, but it is apt.

I recommend checking out some of the other posts on China from Of Two Minds:

And also The Wall Street Journal's excellent China Realtime Report:

*It was actually written by Ernest Bramah, an English author.

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