The news last week followed the sun. It began with doubts about Ireland’s solvency…then moved to fears that California would default…and ended on Friday with doubts about China. Word on the street was that the Middle Kingdom wanted to dampen down inflation. They were going to raise rates and tighten credit.
The Chinese blame Ben Bernanke for increasing the supply of dollars and causing inflation in emerging markets and commodities. Bernanke points his finger at the Chinese. Replying to charges of reckless endangerment, “they made me do it,” he says. The Chinese wouldn’t raise the yuan…so he has to lower the dollar.
That’s what’s nice about paper currencies – you can manipulate them. Which is exactly what the US is doing…trying to manipulate its dollar downward…while simultaneously charging China with being a “currency manipulator.”
Which just goes to show how little honor there is among central bankers.
Maybe it was the China story. Maybe not. But for one reason or another there was no bullish follow-through on Friday. The Dow barely ended the day in positive territory. Gold stood stock still.
So, what is going on in China? We decided to get to the bottom of it.
Friday, we had a Chinese businessman in our office. He had come to see us about starting up a venture together in China.
“Nobody…nobody…knows for sure what it going on,” said he. “On the one hand, there are plenty of excesses and bad investments in China. There must be. We’ve been growing so fast. And there must be a lot of bad debt hidden in the banking system, for example.
“But on the other hand, China is booming. There have never, ever been so many people working so hard to make money. It’s a bit like the US probably was a hundred years ago. Only bigger. Faster. And with more government involvement.
“There might be plenty of problems…business failures…bankruptcies…and financial blow-ups. But I doubt that the China story will end any time soon.”
We don’t think the story will end. We think it will become more and more fascinating…and more exciting. You can’t grow at such a breakneck speed without breaking someone’s neck. And any time the government is heavily involved in planning an economy, you can be sure the plans will be bad ones. They will control too much…and then they will lose control.
Our friend Dylan Grice, analyst at Société Générale, has more on this story:
Is it possible they’ve…(sharp intake of breath) already lost control? And if so, who’s to say what will happen if the asset inflation goes into reverse? Maybe when the authorities engineer the slowdown they desire and tell investors it’s safe to buy again, those investors won’t want to buy. In which case a hard landing shouldn’t be beyond the realms of imagination.
Forget US de-leveraging, this represents the largest deflationary risk to the world economy
So long as China’s credit growth continues at its current pace, aided by the liquidity the Fed is flooding world markets with, and encouraged by artificially low interest rates, the primary risk Ems (Emerging Markets) face today remains that of a bubble.
This might sound a very bullish note on which to end. It isn’t. And let me be crystal clear about why: a bubble is not a bullish scenario. It’s not bullish for the EM economies themselves, their citizens or for the world as a whole. The fact is all bubbles end in tears.
Tears. Did you hear that, dear reader? Tears. Let’s be sure they’re not our own.
And more thoughts…
Our brother-in-law is a Baptist minister. At a recent wedding, he had this comment.
“I don’t like doing weddings. Statistically, half of all marriages fail. I always worry that my work will be undone.
“I prefer funerals. I’ve never had one of them fail. They put a man underground; he stays there.”
*** For further reading on why America is doomed to bankruptcy, here is our new friend Laurence Kotlikoff, writing on Bloomberg Opinion:
The bipartisan National Commission on Fiscal Responsibility and Reform, led by former US Senator Alan Simpson and former chief of staff to President Bill Clinton, Erskine Bowles, spent nine months studying the nation’s long-term fiscal policy and devising a plan that purports to keep the country from going broke.
Speaker of the House Nancy Pelosi must have spent all of nine seconds reviewing the panel’s draft proposal before declaring it “simply unacceptable.” I think Pelosi’s right, but for different reasons.
The co-chairmen’s draft proposal includes many provisions that Democrats should love.
It would cut military spending, raise the ceiling on payroll taxes for Medicare and Social Security, make the retirement program’s benefit schedule more progressive, kill tax breaks for capital gains and dividends, drop deductions that primarily help the rich, increase benefits for the elderly poor, boost gasoline levies and, to compensate for broadening the tax base, lower rates for everyone, especially for the indigent.
There are four recommendations that Pelosi, apparently, doesn’t like:
– Raise Social Security’s retirement age by two years, to 69. (Psst, Pelosi, it would do so over 65 years – a very long time.)
– Cut the corporate income tax rate. (Psst, this sounds good for business, but it’s actually good for workers because a lower corporate rate will attract more foreign investment, making US workers more productive and helping them earn a higher wage. Many public finance economists like myself consider the corporate income tax a hidden tax on workers.)
– Limit growth in Medicare benefit levels. (Not by much.)
– Lower rather than raise the top tax rate on the rich. (If you take account of the elimination of deductions, this is a progressive tax reform.)
Perhaps her protest is strategic to ensure the plan stays as is. Either that or she doesn’t know how to take yes for an answer.
The problem with the proposal isn’t that it helps the rich or hurts the poor. It does neither. The real problem is that it continues to kick the can down the road when it comes to protecting our kids from our nation’s ever growing bills.
Look carefully at the plan and you’ll find relatively modest spending cuts and tax increases over the next decade. In 2020, non-interest spending is only 3 percent lower and taxes are only 5 percent higher than the Congressional Budget Office now projects. Together these adjustments total 2.5 percent of gross domestic product.
Contrast this with the 8 percent of GDP fiscal adjustment undertaken by the British, not in 10 years, but this year.
The co-chairmen’s slides show US finances improving dramatically after 2020, but that’s because of their heroic assumption that the government will limit non-interest spending to 21 percent of GDP instead of letting it rise, over time, to 35 percent of GDP as the CBO says will happen under current policy.
The CBO isn’t trying to scare us. The nonpartisan agency is legitimately terrified of the interaction of three developments: the country’s aging population, excessive growth in health-care costs and the introduction of the new health-exchange program.
Spending related to these factors explains almost all of the CBO’s post-2020 projected growth in federal non-interest spending. And its forecast is based on highly optimistic assumptions about the growth in health-care costs beyond 2020.
For example, the employer-based health-care system, which now insures the majority of the population, is assumed to stay intact. But the system is likely to unravel given the modest penalties employers will face for not insuring their workers and the significant subsidies they can arrange for their low- and moderate-earning workers simply by sending them over to the federal health exchange for health insurance. If this happens, Uncle Sam will find most Americans in its health-care lap.
Unfortunately, there is nothing in the draft recommendations that prevent the country from aging or federal health-care benefit levels from rising faster than per capita GDP. Indeed, the proposal endorses letting health-care spending grow faster than GDP. On the other hand, they say “additional steps should be taken as needed” to control health-care spending growth.
Where have we heard this before?
But if federal spending rises after 2020, as the CBO projects and our demographics and health-care systems appear to dictate, their plan leaves us with a fiscal gap of $153 trillion. Or, in other words, bankrupt.
(Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning, Inc. and author of Jimmy Stewart Is Dead.)
for Markets and Money