ObjectiveFunction

U.S. and China: Lecturing Each Other on Trade

I'm not an economist, so I'm sure I'm missing some fundamental point, but it seems the liabilities aren't the worrisome thing. It's abrupt and massive declines in the value of the underlying "assets" in a glut, as their inability to earn the expected cash flows to service those liabilities becomes clear. Without lender forbearance or government subsidy, bankruptcy results and equity (wealth) is wiped out.... extremely rapidly.

Sorry, Michael, what am I missing here?

On Nov 21 08:38 AM Michael Pettis wrote:

> Objective, by financial crisis I mean a very rapid adjustment in
> which balance sheets break down. I don't think that will happen in
> China because the liqudity of liabilities is much less than we might
> think. My guess is that China will experience what Nick Lardy called > a "long landing", in which excess capacity will be ground out over > several years of much slower growth.

U.S. and China: Lecturing Each Other on Trade

Nice insights as always, Michael, but your closing paragraph is pretty meek....

"China has had a ferociously rapid expansion in domestic credit. Does that mean that China is on the verge of a crisis? No. I don’t think China will have a crisis, but I do think that after the fiscal stimulus runs out of steam, probably after another two or three more years, we are going to enter a long and difficult period of much slower and more volatile growth..."

While I'm not predicting "blood in the streets" much less "civil war" either, it is a fact that huge asset bubbles tend to end messily and spectacularly as people face the hard reality that all the "assets" they've bid up to the skies aren't going to pay economic returns for some time, if ever, and rush for the exits.

No doubt the PRC government will backstop the credit system, intervene selectively and otherwise maintain a semblance of social and economic order. But abrupt and massive wealth destruction, loss of faith in markets and truncated expectations for the future will be traumatic for Chinese society -- particularly the aspiring educated classes -- just as they have been for Americans.

My own fear is that in China this trauma will manifest itself not in meaningful reforms but in a witch hunt for plausible (and traditional) scapegoats, e.g. foreign devils. And for foreign investors with illiquid assets in China, that means two words: sovereign risk.

China's Stimulus: Wasteful or Wise?

Oh, and any time I see a map of high speed rail with all the major cities connected by tidy straight lines, I just laugh and laugh.

The draftsman has clearly never traveled overland in China (or never flown over central China on a clear day either).

China's Stimulus: Wasteful or Wise?

Sorry Mad, but this is typical McKinsey fortune cookie "insight" on display here. They, and especially their lead guys (salesmen!) are brilliant-on-paper dilletantes, proclaiming gospel truths on stuff they know little to nothing about. It all sounds great at 50,000 feet, but the moment you go below the Powerpoint level, completely unactionable.

AFRICA has accounted for >90% of GDP for most of human history, if you take us all the way back to homo habilis. What in the hell does that priceless insight tell us about the near future? Nothing. But I'm sure a lot of McKinsey's Chinese clients like this kind of stuff because it feeds their adolescent nationalist self-importance.

I've lived and worked in Asia, admire many aspects of their culture and work ethic, and am all for the Asian Century -- it's already here, and welcome! -- but there are some very fundamental and difficult societal issues that China needs to resolve before their nation will become Hong Kong ^4, much less a more dynamic economy than the USA.


On Nov 16 04:48 PM Mad Hedge Fund Trader wrote:

> cvt I have long sat beside the table of Mckinsey & Co., the best> management consulting company in Asia, hoping to catch some crumbs> of wisdom. ... Asia has accounted for 50% of world GDP for most of human > history. It dipped down to only 10% over the last two centuries, > but is now on the way back up. That implies that China’s GDP will > triple relative to our own from current levels. A $500 billion infrastructure > oriented stimulus package enabled the Middle Kingdom to recover faster > from the Great Recession than the West, and if this doesn’t work, > they have another $500 billion package sitting on the shelf. But > with GDP of only $4.3 trillion today, don’t count on China bailing > out our $14.4 trillion economy. China is trying to free itself from
> an overdependence on exports by creating a domestic demand driven > economy. The result will be 900 million Asians joining the global > middle class who are all going to want cell phones, PC’s, and to > live in big cities. Asia has a huge edge over the West with a very > pro growth demographic pyramid. China needs to spend a further $2 > trillion in infrastructure spending, and a new 75 story skyscraper> is going up there every three hours! Some 1,000 years ago, the Silk> Road was the world’s major trade route, and today intra Asian trade> exceeds trade with the West. The commodity boom will accelerate as> China withdraws supplies from the market for its own consumption,> as it has already done with the rare earths. Climate change is going> to become a contentious political issue, with per capita carbon emission
> at 19 tons in the US, compared to only 4.6 tons in China, but with
> all of the new growth coming from the later. Protectionism, pandemics,> huge food and water shortages, and rising income inequality are other> threats to growth. To me this all adds up to big core longs in China> (FXI), commodities (DBC) and the 2X (DYY), food (DBA), and water> (PHO). A quick Egg McMuffin next door filled my other needs.

China's Nine Nations

Very useful primer.

My Visit to the U.S. Treasury

David, I am deeply glad that the Treasury is listening to you.

Very interesting closing comment about a prosperous middle class being an anomaly in human civilization.

Since the days of Athens, an energetic, prosperous yeomanry is essential to building and sustaining a society of laws in which a broad mass of citizens:

(a) can choose to earn a living in a different way than their fathers, by dint of their own creativity and hard work
(b) can enter and reasonably enforce arms-length contracts with strangers
(c) are free from arbitrary (i.e. unpredictable) confiscation of wealth by authorities.

There may be some merit in the Jared Diamond view that such yeomanries are merely the accidental by-products of cheap or plentiful resources (e.g. olive trees plus a long coastline), but the fact remains that the economic and social wealth (and perhaps, happiness) they generate is substantial. And that such "anomalies" are worth fighting to keep and expand.

Even societies which don't (or no longer) hit the Jeffersonian ideal and are dominated by a ruling "in group" (oligarchy, nobility, priesthood) -- shore themselves up by cultivating some form of meritocratic talent pool -- e.g. the mandarins of imperial China, the Jesuits, or Communist institutes.

Of course, the extent to which this "social talent pool" can, or should be, kept in being artificially by means of subsidies or wealth transfers (entitlements), is certainly open to debate. At a certain point, it becomes a matter of bribing the mob with bread and circuses.

What Rebalancing of Chinese and American Consumption?

Sir, any idea what venue the bands are playing at Hampshire College (13 Nov)? The link just takes you to the college site and the show doesn't appear on any of their calendars. Thanks!

Banking Concerns and Chinese University Rankings

Be interested to look over the next 20 years and see to what extent China follows the French model, where CEOs nearly all come from the same few grands ecoles, or the US model where CEOs are as likely to come from "non-elite" schools as elite ones (except in professions like banking and law where elite school grads dominate).

An Ivy League degree is still a major asset, to be sure, but in corporate America the C-level isn't nearly as dominated by elite school college/MBAs as one might think. Especially if you exclude the many people who came out of "Podunk State" and were then sent to an elite exec MBA program only after they'd already marked themselves as rising stars in their companies.

Chinese Railways and Speculating Pig Farmers

The jury is definitely out as to whether China's overbuilding today to meet tomorrow's infrastructure needs will turn out to be a smart play (i.e. the most productive investment of their people's wealth) in the long run (10-20 years).

For one thing, you're using today's technologies. For railways, that might be a safe bet unless, say, maglev widely displaces conventional rail within the next 20 years. Or for conventional electric power. But what if, say, you spend $50bn paving the Gobi desert with expensive solar panels (that are basically sophisticated computer chips and need long distance transmission), only to find that 5 years later someone's invented a cheap, rugged stick-on solar roof tile? Or hydrogen cells have become economical?

Example: If you're ever on Hawaii's big island, drive down to the windy south tip. There you'll see two arrays of wind farms -- a 5 year old farm operating and a 15 year old farm next to it, idle and rusting. Both of these were supposed to be running for 30 years or more.

Second, you don't ever truly know what demand for this infrastructure is going to be tomorrow, and predicting this for 10-20 years out is even harder than for 5-10 years out.

If you've underbuilt, you'll strain the assets and underperform, and may need whole new expansion projects later (which often requires significant rework). Ask any highway builder in a growing "edge" city -- as soon as you build or widen roads, traffic appears to clog them.

Or even worse, you overbuild and the facilities are underused due to behavioral or demographic shifts. Or people don't use it as expected because it's too hard to get to now (e.g. numerous airports which built in virgin farmland but now find themselves surrounded by busy city streets). Now you have a white elephant.

Predicting the future is a VERY tricky game when there's billions of dollars at stake that must be financed and repaid. Just because these projects are "public works" does not relieve them of their obligation to pay for themselves. Otherwise they just create a long-term drag on the public purse, displacing future investment opportunities.

Growing Pains Create Friction Between China and India

Oh yes, just as white folks suffer from irrational fears of a "yellow peril", there's an equally bigoted segment in China that believes that 1/4 of the earth's landmass ought to be Chinese by right, and that all the rich open spaces -- e.g. the Americas, Australia and Siberia -- were unfairly stolen by Europeans from 1700-2000.

So watch out, Russians, especially since they're committing demographic suicide even faster than the Chinese.

What You Don't Know About Gaming Could Make You Obsolete

Important and enormous topic. I'm sure I have nothing novel to add here, except to note that a lot of games (e.g. MMORPGs) do involve substantial social interaction and collaboration (team play), via text and voice. It just uses a new media, language and customs that older generations have trouble adapting to (and some therefore find menacing or degenerate).

Geekspeak and acronyms are just the tip of the iceberg here -- entirely new sets of social customs (what used to be called "Netiquette" but has now spread well beyond chat rooms) are continually evolving for use by a global and multicultural meta-community most of whom speak English imperfectly (native or not).

This new means of collaborating and communicating is already widely used in professional networks and communities in "techie" fields, and of course in the media business (marketing and increasingly journalism). Other more traditional functions are quickly following suit.

Chinese Railways and Speculating Pig Farmers

Excellent piece. I loved the Bloomberg item. It's like the old saying "when your plumber or unemployed second cousin starts giving you stock / real estate tips, it's time to get out".

Mr. Pettis is the most clearheaded and honest commentator out there on China, although he clearly deeply loves China too, and predicting severe economic reversal there gives him no pleasure.

In contrast, a lot of SA readers (not implying that any of the other comments here fall into this category) seem to want to cram everything they read on China into some cultural meta-narrative, either:

(a) the "decline of the decadent West / rise of the East" (the latter summoning ancient racist images of inscrutable Asiatic hordes sweeping out of the steppe), or...

(b) the equally crude and racist narrative of "China at last claiming its 'rightful' share" -- by implication, 25% -- of the world's resources and power, after centuries of malevolent white oppression and exploitation. (And how dare those foreign devils criticize anything we do).

Much like emerging Germany in the late 19th century, powerful, self-confident and energetic but also self-pitying, resentful of neighbors and increasingly, openly racist and xenophobic. And look where that led....

Toward a New Theory of the Cost of Equty Capital

Remember that "cost of capital" isn't just the (average) cost to raise new capital in the markets. It is also the "opportunity cost of capital", i.e. the point at which you're better off taking your project dollars (in your example, operating cash) and investing them externally (i.e. in a diversified bundle of stocks and bonds) instead of in your company's projects. That's why it's often referred to as a "hurdle rate".

On Oct 19 10:33 AM Tom Armistead wrote:

For example, I recently saw an analyst use 13% weighted averaged cost of capital for a company with no debt, in point of fact they had a huge cash surplus. So if a company doesn't have to raise money what is their cost of capital?

Is There Really a Global 'Cabal' Aiming to Dump the Dollar?

Good read, thanks. You, Mike Pettis and, for macroeconomics, Andy Xie, are the best commentators on China right now.

Lights at the End of the Tunnel

Still betting on at least one Pandemic to wipe out a large chunk of the poor, separating societies with a competent social order and resources from those which will be decimated. To quote the DKs "the rich will have more room to play..."

One other semi-relevant comment: seems to me that ~3/4 of the most driven, talented under-30 people I encounter in my business (Eastern USA) are of South Asian heritage. Ambitious too -- virtually every person who has reached out to me via my college and MBA networks has been a South Asian. The Asian century is already here, and welcome.