Understanding China, One Blog at a Time

An American in China

Impending Crash of the Chitanic- China’s Economy is Screwed

Posted by w_thames_the_d on June 12, 2012

Here is a comment from Brewskie. While scanning for China dirt I came across the article and saw that he had left his mark. His comment was something about the prevalence of corruption and poor customer service even being rooted in Confucian China. He then said something about Chinese companies act as if they are doing us a favor by serving us (my words). I whole-heartedly agree with his assessment and found it insightful.

Here is a note from the BrewMan

Found this good piece about the prospect of Chinese deflation, and it really got me thinking; it was like a curve ball I didn’t see coming that smacked me in the forehead, but it was a good thing. Could it be somewhat like what happened to this college drop out, who one night got kicked in the head so many times be muggers, he became a mathematical genius?
Now to the main attraction, the thesis of the author’s argument is this: deflation will kill the SOEs. A year ago inflation was a problem but now China’s harbored adulation for seemingly deflating the inflation dragon (though food inflation remains precariously high: up 7% a month ago). However, the author, John, believes inflation was preciously what the CCP wanted: the Chinese extraordinary savings rate in the face of high inflation in the midst limited investment opportunities (this is partly why so many Chinese buy apartments) meant that in the face of high inflation, they were earning negative returns; citizens’ bank deposits of course are what fund SOEs’ loans, and they can borrow huge amounts thanks to negative returns. Deflation, or low inflation (say 1-3 percent), turns negative funding into positive returns on savings, and the author argues SOEs will not be able to sustain payments for positive returns.
In other words, how sustainable is the Chinese experiment? High inflation was hurting the poor hard, especially with the important staple of food (as it it now); however, if the author’s correct, low inflation or deflation spells disaster too, as SOEs – the masters & commanders of China’s command economy – will be doomed for Davy Jones’s abyss. How will China fare as her property market unravels?
I’ll let the man’s words speak:
“You can’t get much different from 1 percent in a bank deposit. Life insurance contracts (a huge savings mechanism) are just rebadged bank deposits – attractive because the regulated rate is slightly higher.
This is a lousy savings mechanism because inflation has been between 6 and 8 percent (but is now lower than that and is falling fast). At almost all times (except during the height of the GFC) the inflation rate has been higher – often substantially higher – than the regulated bank deposit (or life insurance contract) rate.
And those deposits are mostly lent to State Owned enterprises.
The SOEs are the center of the Chinese kleptocracy. If you manage your way up the Communist Party of China and you play your politics really well may wind up senior in some State Owned Enterprise. This is your opportunity to loot on a scale unprecedented in human history.
Us Westerners see the skimming arrangements. If you want to sell kit (say high-end railway control equipment) to the Chinese SOE you don’t sell it to them. You sell it to an intermediate company who on-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.
The more serious threat is deflation – or even inflation at rates of 1-3 percent. 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.”

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