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Despite surging stock and real-estate markets which have some economists worried about another...

Despite surging stock and real-estate markets which have some economists worried about another bubble, China's Premier Wen Jiabao says he will stick to the country's "proactive fiscal policy and moderately loose monetary policy." (ETF: FXI, PGJ)
Comments (6)
  • I recently theorized in a SA comment that Chinese monetary and fiscal policies might be designed to deliberately inflate asset bubbles to create a widespread wealth effect that will kickstart a domestic consumption economy to augment and partially replace their export dependent economy. Now Chinese officials are openly admitting that this is precisely their goal. US officials are also almost to the point of admitting openly that they are pumping towards asset price reflation, and that there is nothing wrong with this method as this is how fiat money economies work.

     

    The global evolution toward pure fiat currencies progressed throughout the 20th century. Unlike gold whose physical limitations constrain growth, fiat money imposes no constraints on growth. China is following the US example of how to use fiat money to develop your economy and get rich quick.

     

    The money and the growth are based on nothing more solid than hope and expectations about the future, but the growing infrastructure and other economic goods that are built are real--which in effect justifies the financial hope and expectations about the future. That is the nature of fiat money. I would argue that it is the nature of any kind of money. The value of money is created by people's belief that some currency or other has value, whereas roads and houses and food are real economic goods whose value depends on our material needs and wants rather than our beliefs.

     

    In a fiat system, periodically large amounts of debt must be destroyed by 'downturns in the business cycle', which are recessions and depressions, where debt is destroyed via business and personal bankruptcies and writedowns of bank loan debt. Otherwise the extreme levels of debt, and the excessive asset prices all that debt-money supports, put a psychological brake on further expansion of the cycle. So you must reset your system from time to time to get the numbers down in line with what your people feel comfortable with.

     

    Banks who lent into the uptrends become insolvent during the downturns. Insolvent banks do not 'have to' be liquidated. That's a decision for governments and regulators. Bankruptcies and debt writedowns are an essential phase of the fiat money growth producing cycles, and fractional reserve banks are the front line credit-money creators, so you need your banks to remain in place for the next runup of the cycle.

     

    Your banks must be allowed to do a reset of their asset to liability ratios. If a bank balance sheet is A = K + L (assets, which is the market value of the collateral banks took against loans) = bank capital (warrants and shareholders' equity) + liabilities (liabilities are largely customers' deposit account balances), then during downturns when bank asset values fall far below the amount of money the bank's customers have on deposit, and the difference is way more than the bank's capital (which is also declining as share prices drop in a downturn), then the balance sheet must be allowed to go negative during downturns.

     

    It could be argued that bank balance sheets should only have to balance over a complete business cycle, not every quarter or every year. Otherwise you suffer our present procyclical scenario where a rising economy and rising asset values encourages greater bank credit creation and even greater asset price runups; and the whole scenario is accelerated into reverse during downturns when everyone is trying to sell assets to repay debt rather than take on new debt to buy them.

     

    We seem to be trying to operate a fiat money based economy on financial economics and financial morality that are suited to another type of monetary system. The obvious alternative to our debt-money system is a 'free' money system where the government creates the fiat money and distributes it into the economy by funding entitlements, paying salaries and buying stuff or giving it directly to its citizens. Then rather than a banking system that creates ALL the money as loans which are debt, our banking system would leverage up from the 'free' money its depositors' placed in the banks to earn a return.

     

    I might argue that there is nothing inherently wrong with a 'fractional reserve' banking system that creates new money as debt, as long as there is someone in the system who can create 'free' money to even out the uneven distributions that capitalism generates (i.e. the successful end up owning all the money and the unsuccessful end up with all the debt and the economy grinds to an impasse). In this system the government could just add more money when debts get too high and nobody has to pretend there's any solid fundamental reason for it other than the desire of all of us to keep the thing running because it's a hell of a lot better than crashing into a depression. Money is just numbers and really, are we going to let numbers dictate our economy?

     

    The only real brake on the unlimited growth that fiat money makes possible is the real economic limits on our ability to find and produce resources. Money is just numbers and you can manipulate numbers however you like. But resources are physical and they have their own reality which we can only manipulate with real physical effort, which is 'work'. We have probably already produced most of the easy to access resources this planet offers and from here on in it takes an increasing expenditure of resources like energy to produce diminishing returns of resource extraction. But classical economics is a different beast than money and we are talking about keeping the money system going so I won't go further off topic.

     

    China seems to have learned the lessons of the most successful capitalist economy in history and is now following the US lead. Good for China. And unless we start running really short on resources, good for us, too.
    9 Aug 2009, 04:23 PM Reply Like
  • Derryl:

     

    A superb expository. Thanks for taking the time.

     

    A particulary insightful paragraph, I believe:

     

    I might argue that there is nothing inherently wrong with a 'fractional reserve' banking system that creates new money as debt, as long as there is someone in the system who can create 'free' money to even out the uneven distributions that capitalism generates (i.e. the successful end up owning all the money and the unsuccessful end up with all the debt and the economy grinds to an impasse). In this system the government could just add more money when debts get too high and nobody has to pretend there's any solid fundamental reason for it other than the desire of all of us to keep the thing running because it's a hell of a lot better than crashing into a depression. Money is just numbers and really, are we going to let numbers dictate our economy?
    9 Aug 2009, 06:20 PM Reply Like
  • In US, people say: "don't fight the FED."

     

    In China, don't fight Premier WEN ... Communist Party will do everything needed to grow the economy (bubble or no bubble) ...

     

    Long FXI at least until October 1 (60th Anniversary of People's Republic) ... there will be no problems (if there is, CCTV will not report it) until People's Congress in October ...
    9 Aug 2009, 07:00 PM Reply Like
  • Governments and banks can pretty much create, loan, and give away as much money as they wish, as long as that money is accepted as having value. In the past, the free market imposed a strict discipline on a country's fiscal policy: devaluing its currency and selling off its debt if things got sloppy.

     

    Now Europe, Japan, Canada and the US are in same mess, with China holding the trump card in terms of selling off US debt. The difference between now and 20 years ago is that there appears to have been a general agreement that, for the time being, all countries will keep their interest rates low, and not let currencies shift too much one way or the other. For now.

     

    Looking ahead, regardless of whose currency collapses first, or whose debt goes up in interest rates the fastest, the obvious winner is commodities. As the same amount of "stuff" will be worth more and more "paper."
    9 Aug 2009, 08:17 PM Reply Like
  • I'm long XPP.................and have enjoyed periodic ownership of EDC. It seems most emerging mkts are emerging from this quite nicely. I'm keeping an eye on the Asian mkts right now. They haven't had a chance to react to the US unemployment numbers yet.

     

    It doesn't matter if the numbers are for real or cooked, what matters is how the investing world reacts to them.
    9 Aug 2009, 08:24 PM Reply Like
  • derryl wrote:
    " China seems to have learned the lessons of the most successful capitalist economy in history and is now following the US lead. Good for China."

     

    WOW, So much inaccuracies in just one sentence:

     

    a). The USA does not have a capitalistic economy for a long time. America had an ersatz/crony capitalism.

     

    b). The USA "most successful capitalist economy" was the result of the post-WWII US imperialism using it military might for economic colonization of Latin America, Asia and Africa. These "good" days are gone for ever.

     

    c). Furthermore, don't forget that China is still a communist country. China's economic model is a somewhat mixture of Stalinist & Fascist economies. Back in 1930s, Stalinist Soviet Union accomplished a gigantic transformation from a backward peasant country into a world economic & military superpower. Hitler also was able to achieve great economic successes. However, all these centrally-managed economies eventually collapsed.

     

    d). Finally, a major geopolitical confrontation between China and USA/EU is just starting. It will become ugly pretty soon.
    9 Aug 2009, 09:51 PM Reply Like
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