Friday, April 13, 2012

Big Trouble in Big China

The World Bank report on China’s prospects stresses several key challenges facing its economy which are perfect background material for the current political crisis gripping the country. The executive summary says China must reform to keep growing: remove government distortions in resource allocation; fix the growing income gap between the bosses and the peons; start innovating as opposed to copying; rein in the unsustainable pollution and stop playing a zero-sum economic game with the rest of the world. It concludes that China can continue to grow very rapidly, but the easy days are over. The hard slog has begun. In a fine, it is a case of “reform” or implode.

The Epoch Times, a publication which focuses on Asian affairs, analyzes the banking section of the World Bank report and concludes that if you thought Fanny and Freddy’s intervention in the housing markets were good ideas, then you’ll love China.

“Despite the many reforms introduced so far, the Chinese financial system remains repressed, unbalanced, costly to maintain and potentially unstable,” according to the recently released 400-page World Bank Report “China 2030.”

The report suggests that China’s financial sector is constrained by state ownership and regime interference. The Chinese state uses the financial sector to enforce its policies, preventing lending institutions from becoming a true market force.

“Banks have been used as instruments of the government’s macroeconomic and sectoral policy goals and have not always been in a position to lend prudently. While this may have facilitated accomplishment of policy goals, it has also exposed banks to a greater risk of deteriorating loan portfolios,” according to the World Bank report.

The Congressional Research Service issued a report on the stability of the Chinese banking system in February, 2012. It concluded that while “China’s banking system has been gradually transformed from a centralized, government-owned and government-controlled provider of loans into an increasingly competitive market … others are concerned that many of China’s banks may be insolvent and that China may experience a financial crisis.” In other words, there may be bomb ticking in their somewhere. But open source analysts don’t know for sure.

According to these commentators, efforts to resolve a serious accumulation of non-performing loans (NPLs) only disguised the problem. In addition, China’s NPL situation may have been worsened by its November 2008 stimulus program and the emergence of “local government funding platforms” that generated an estimated $1.7 trillion in local government debt. A financial crisis in the city of Wenzhou revealed the previously underappreciated risk associated with China’s “underground” banking activities. Some analysts fear that a sharp decline in China’s property values could precipitate a financial crisis that could effect the U.S. economy.

This is the background against which the Bo Xilai saga is being played out. The Party boss was dismissed and his wife arrested for the murder of a British businessman. The whole Politburo transition process has been thrown into turmoil. The Economist characterizes the political crisis as the “shattering of the facade”. The fracture lines described in the World Bank and CRS reports are mirrored in the recent political showdown. In the Economist’s narrative, Bo Xilai emerges as the champion of Big Communism from the Chinese version of Chicago whereas the prime minister, Wen Jiabao, comes off as someone trying desperately to steer China away from the oncoming meltdown.

Mr Bo’s opponents (presumably led by President Hu Jintao and the prime minister, Wen Jiabao) have shown unexpected strength by purging Mr Bo so thoroughly. But their battle is not over. Mr Bo was much loved by a “new left” force in Chinese politics which admired his big spending on public welfare, especially social housing, and his fondness for state-owned enterprises. On April 3rd Mr Wen expressed unusual frustration with the state’s grip on the financial system, saying the state banks were a “monopoly” that must be broken. Progress, however, will be tortuous, notwithstanding the battering the left has suffered as a result of Mr Bo’s fall. Powerful interests, especially state firms, remain an obstacle. Political reform, which Mr Wen has repeatedly called for, is even less likely to make headway in the months ahead. Officials are fearful of any adjustment that might upset stability before this year’s leadership changes.

Much mess is left to be cleared up in Chongqing. Mr Bo’s crackdown on crime, although widely admired by ordinary Chinese, created suspicions among private businesspeople. They thought that he was looking for ways to seize their assets so as to use them for more public spending. One property now in the Chongqing government’s hands is a 20-hectare (50-acre) villa and golf-course development, with a near-finished Hilton hotel. Its former owner (as well as of another Hilton in central Chongqing), Peng Zhimin, was jailed for life last year for various offences, including bribery and prostitution. It remains unclear how the government will dispose of this vast, confiscated wealth.

It seems clear that China, far from being the rock upon which a world economic recovery can securely be founded, is itself wrestling with many of the issues facing Europe and America today. Malinvestment and bubbles. Houses proved to be like tulips after all.

China’s plight can only be bad news for Europe. Louis Woodhill, writing in Forbes, notes that “Spain Is Headed For a Major Economic Crash”. The new government raised taxes, as President Obama wants to do, in order to reduce its deficit but that only resulted in killing what was left of business. “If people want to know what life looks like in the ‘Prohibitive Range’ of the Laffer Curve, all they have to do is to visit Athens. Greece is literally falling apart. Unfortunately, by raising taxes, Spain is making exactly the same mistake that the Greeks made.”

They fought arithmetic and arithmetic won. Today the Spanish government can collect at a higher rate, if it can find anyone solvent enough to pay taxes. Jose Guardia at Barcepundit remarks on the irony: “¿ESPAÑA se hunde por culpa de astutos villanos o de simples estúpidos?” — who sank Spain? The players or the useful fools? How about the useful fools led on by the players?

The Eurozone’s “big bazooka” response to its own crisis may have momentarily stopped the deficit hydra in Greece. But it only moved the locus of trouble to even bigger countries. Spain is teetering on the brink. Can the Eurozone call China for help? If it called right now it might get a busy signal. China has big troubles of its own. Europe might want to sing:

There’s a message in the wire, and I’m sending you this signal tonight.
You don’t know how desperate I’ve become
And it looks like I’m losing this fight.
In your world, I have no meaning, though I’m trying hard to understand.
And it’s my heart that’s breaking down on this long-distance line tonight.

But who’s listening? How do you say, “hasta la vista” in Chinese?



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