Notes from Enzio's appearance on Bloomberg TV on July 19.
Dedicated to my father, Count Friedrich Karl von Pfeil, member of the plot to kill Hitler on July 20, 1944.
Everyone talks of overheating. Do you buy into this? No!
• First, China's growth is driven by SUPPLY, not by demand. Indeed, exports and investments are rising strongly, so I don't see how "overheating" can occur if the supply of goods is increasing. Perhaps one of my erstwhile mentors, Friedrich von Hayek, or my friends and brilliant economists like Arthur Laffer, Ingo Walter and Woody Brock never got around to teaching me this.
• Secondly, even the asset markets are not overheating: the normal Chinese still has 94% of his money rotting away at negative real interest rates in the bank, so how can he be "over" exposed to stocks with six percent of his money?
So what do you make of rising inflation, then?
• You have to dissect it to see why it is rising. It is cost-push, not demand-pull inflation, arising from food prices lurching forward, namely -
o It is a supply-driven phenomenon driven by constraints in the pig pen, namely
- floods mean that infrastructure such as rails and roads that link pigs to sales outlets is impaired, so less pork gets to the market;
- floods and drought also mean that the price of grain has shot up, crimping farmers' margins when raising pigs;
- last year, the very low pork prices resulted in farmers producing less pigs (the "cobweb cycle"), and
- on top of which, there is plenty of blue ear disease going around, infecting pigs
• Thus, even the Chinese Central Bank, the PBOC, cannot control God and thus nature!
And how about the economy overheating?
• First, we in Hong Kong literally are sitting on the doorstep of an industrial revolution. Don't forget that China's land mass is two percent bigger than America's, but its per capita GDP is only four percent of America's: this means that the numbers off which China calculates its growth are tiny. That makes it easy to create sparkling growth figures.
• Secondly, we repeat that China's growth is a supply-driven phenomenon. This means that investments and exports are rising. So we are dealing, as with food inflation, with a supply-driven phenomenon.
• Don't forget that Beijing has a growth mandate: if it does not create jobs, it will be out of a job. Deng's "to get rich is glorious" remains China's "software" in the hearts and minds of people. Add to this that there is the 17th Party Congress this Fall, and the Olympics next August. How can Beijing possibly want growth momentum to slow down? To cue of Lord Eric Roll's wonderful A History of Economic Thought: you cannot separate politics from economics.
• Finally, beware of the false precision of China's (growth) statistics:
o if you ask a room full of economists "what is so gross about gross domestic product" most people would not know the answer
o yet, everyone mouths that China's GDP grew by 11.9%: we wonder if they actually know what they are talking about?
So where are you on market worries about imminent "tightening" measures, then?
• The Talmud teaches us that we do not see things as they are, but as we are. So, our culture, our childhood etc. affects how we view the world.
• This wisdom applies to China: most people view China's economy through Western eyes: this is either who they are, or how they have been trained, thus the "but as we are" from the Talmud
• However, one thing I learned from Hayek and thus from Popper was: forget the argument, but scrutinize the assumptions
• So when we observe China through Western eyes, we get to assume that tightening works. But, there are two structural impediments blocking this in China:
o Hardware. We all know that China has no pervasive banking and legal system, so how can tightening measures transmit throughout the whole economy?
- Thus, if they raise interest rates by a sweltering 27 basis points: so what? Companies that are favoured by local officials etc. still have access to funding, and
- if they cut the tax on deposits by 20% - so what? Mr. China is still getting a negative real interest rate on 94% of his cash assets - so he will continue piling into the market where he can earn money.
o Software. China strikes me as a medieval society where survivalism is key. Hence the constant talk about what people eat, maddening as it is to my mind. "To get rich is glorious" and that makes sense: China's land mass is that of America's, but its income is four percent of Americans'. So of course China is going through a free for all, "grab it while you can." Tough to impose the rule of law in such a wild west - and don't think that America or Europe were any different when they were medieval! "The sky is high and the emperor is far away" means that Beijing can exert very little influence over avaricious local governors etc. who hide behind Kenneth Lieberthal's useful "matrix muddle": nobody knows who ultimately is in charge, and that arbitrage is used for personal aggrandizement.
Will any of this governance issue be conveyed in this fall's 17th party congress?
• Absolutely: Deng's "to get rich is glorious" is going to go head-on with Hu's vision of an "harmonious society". Already, China's conservatives have written Hu an open letter attacking the vices of liberalism, such as allowing capitalists into the Communist Party. We always have felt that Chinese were never "communist" (Talmud wisdom, again!); instead, they are fantastic pragmatists, and that is what will see them through. But, this whole governance issue is at the heart of how China moves forward, and thus has to get plenty of airing at the Party Congress.