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Musings Report 2021-39 9-25-21 Will China Pop the Global Everything Bubble? Yes
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Will China Pop the Global Everything Bubble? Yes
That China faces structural problems is well-recognized by China Experts. The list of articles in the August issue of Foreign Affairs dedicated to China reflects this:
Xi's Gamble: the Race to Consolidate Power and Stave Off Disaster
China's Economic Reckoning: The Price of Failed Reforms
The Robber Barons of Beijing: Can China Survive its Gilded Age?
Life of the Party: How Secure Is the CCP? (Chinese Communist Party)
These structure issues include: a demographic cliff resulting from the one-child policy, soaring wealth-income inequality, pervasive corruption, public health issues (diabesity, etc.), environmental damage and a slowing economy.
What the conventional analysts do not fully grasp, in my view, are 1) the existential threat to the CCP and China's economy posed by its unprecedented, metastasizing debt-asset bubble and 2) its incipient energy crisis.
As I explained in a recent blog post, What's Really Going On in China?, the CCP and the government informally institutionalized moral hazard (the disconnection of risk and consequence) as a core economic policy.
Every financial loss, no matter how risky or debt-ridden, was covered by the state (via bail-out, refinancing debt, new loans, etc.) as a "cost of rapid development," a reflection of the view that some inefficiency and waste was inevitable in the rapid development of industry, housing, infrastructure and a consumer economy.
What China's leaders did not fully understand was this implicit guarantee of bail-outs--the equivalent of "The Fed has our backs"--incentivized debt-funded speculation as the lowest-risk, highest-return "investment," especially when compared to low-profit, risky investments in low-margin export industries. (Recall the average profit margins of Chinese exporting enterprises is 1% to 3%.)
This is the hidden driver of China's sagging productivity and economy: debt in all sectors is skyrocketing to fund speculation, not productivity.
This institutionalization of moral hazard has incentivized the least productive and highest-risk gambles--not just for large conglomerates like EverGrande, but for middle-class households who invest in the shadow-banking system (unregulated private-sector pools of capital lent out to risky borrowers at high rates of interest) or by buying second, third and fourth "investment" flats.
The contradictions in this mass investing of savings in empty condos are systemic and dangerous: 1) once a flat is rented, it loses value due to being "used" and 2) the vast majority of the market for "investment" flats is illiquid, as most new buyers want a new flat, not an old one, so the market for old flats is extremely thin outside the inner rings of Beijing and Shanghai.
This mass investment in illiquid empty flats has generated social and financial perversities: now that flats in desirable areas cost 30-40 times an average white-collar salary, young people must gather up the entire extended family's savings in order to afford a flat. Those young men who are unable to buy a flat find their marriage prospects are dismal.
One result of the marriage of state control and private-sector Wild-West speculation is a truly vast wealth-income divide that is bound up with corruption in a mutually reinforcing feedback: the richer you become, the closer to power you get, and vice versa.
Since China's informal shadow-banking system is opaque even to state regulators, it's quite possible that China's leaders do not have a full grasp of the systemic risk bound up in the excesses of shadow banking. To paraphrase Donald Rumsfeld's famous dictum, this is an unknown unknown for China's policy makers.
This truly monumental accumulation of debt and speculation is now an existential threat to the Party on two levels:
1) since all bubbles pop regardless of any other conditions, when this bubble pops, the economic blow will be severe enough to threaten the Party's control of the economy
2) the crushing of phantom wealth will cause people to seek a scapegoat, and the Party is Target #1 since it coddled the well-connected and wealthy but did not protect the 99% from the dire consequences of the bubble bursting.
Having engineered the bubble's expansion by creating mountains of debt and implicit promises of bail-outs, the CCP and government have backed themselves into a corner: there is no graceful, pain-free way to deflate a speculative bubble of such astounding proportions.
Considering the life history of President Xi (especially his first-hand experience of the Cultural Revolution 1966-1976), his writings and his consolidation of power, it is clear to me that Xi understands the bubble is close to escaping his control and so time is short and the policy options are limited to triage, that is, saving the healthiest and letting Nature take care of those closest to expiring.
I also consider it likely that Xi grasps the absolute need to break the near-universal confidence that the state will bail out everyone who borrows and speculates so wildly that their gambles go bad.
The consensus assumption in the West is that "China can't afford to let Evergrande fail" because this enormous conglomerate will obviously topple many dominoes, generating great financial pain.
I think the that President Xi's view is the opposite: "we can't afford to bail out Evergrande" because that would open the floodgates of moral hazard that Xi is trying to close.
The state bailing out private-sector gamblers (and state-owned enterprises) is what led to the massive moral hazard-debt bubble that Xi is determined to pop now while he still can control the process.
In other words, President Xi understands this is the do-or-die moment to regain control of an out-of-control moral hazard driven financial bubble, and the only way to do so is to push the losses onto everyone with exposure, the driver being the stark choice to either regain control by popping the bubble now or letting it expand and implode in an uncontrolled (and hence Party-threatening) fashion.
Xi concluded that the first step to being able to push the losses onto everyone with exposure to speculative bets was to consolidate power to such a degree that the usual self-interested factions that would use their power to evade the consequences could be forced to accept their share of the losses.
Given the history and structure of the Party, this required Xi to extend his control to levels not seen since Deng or Mao.
In my view, Xi correctly concluded the hour was getting late and the institutional resistance to the end of the implicit promises of state bailouts and endless debt expansion could only be overcome if his political power was near-absolute.
The popping of moral hazard and the debt-speculation bubble are necessary to preserve CCP and state power; half-measures that protected the armies of corrupt cronies would only increase the public's outrage when the bubble finally burst.
In this light, Xi's multi-year campaign against the most visible corruption and his recent touting of "common prosperity" have set the stage for his forcing the end of moral hazard and the controlled demolition of the excesses of debt and speculation that have harmed the economy and threatened the control of the CCP.
Now comes the grand irony. China's ability to generate stupendous amounts of new debt basically bailed out the global economy in 2008-09, 2015-16 and 2020. Yes, the Federal Reserve bailed out the global banking sector (to the tune of $16 trillion or more in backstops and credit lines) in 2008-09 and inflated a speculative bubble in the U.S. by creating $3.5 trillion in quantitative easing, but China's expansion of debt was an equally important source of global demand, which is what stopped global economies from sinking into recession.
The cost of these "saves" were not understood at the time: the elevation of moral hazard to quasi-religious status in the U.S. and China and the expansion of debt-funded speculative bubbles to unprecedented heights.
There are only two policy options:
1) Grasp the nettle and refuse to bail out debt-funded speculative excesses, thereby popping the Everything Bubble, or
2) play the game of keeping the bubble expanding until it implodes on its own, an end-game made inevitable by the systemic instabilities intrinsic to bubbles.
Xi has correctly chosen Policy #1, and to do so he has positioned the Party as the defender of the people, i.e. anti-corruption, shackling the Big Tech billionaires like Jack Ma, and announcing that the state will not bail out EverGrande.
The Federal Reserve and the political leadership of the U.S. have foolishly chosen Policy #2, inflating the bubble while letting the consequences of this moral hazard bubble--wealth-income inequality and corruption--explode higher, fatally undermining the credibility of both the Fed and America's political class.
As the supply chain disruptions have revealed, the global economy and financial system are tightly bound systems, and as such are extraordinarily exposed to the risks of cascading collapses as key nodes become chokepoints or break down.
While the Federal Reserve prints trillions to further inflate the bubble, global energy shortages are already crippling key sectors in the economies of China and the EU. Reality is about to intrude on the Fed's fantasy that speculative bubbles in the U.S. can remain disconnected from the real-world global economy forever.
In summary: the popping of the global Everything Bubble is not Xi's goal; it is the inevitable second-order effect (collateral damage) of China's debt-speculation bubble popping.
Given the tightly-bound financial system, the collapse of EverGrande is far more the story of dominoes toppling rather than direct losses: it's not the direct losses that will bring down the global financial system, it's the dominoes toppling as those who take the direct losses implode and become insolvent, missing their loan/bond payments, being unable to meet their counterparty obligations, and so on.
The consensus in the West is that China cannot afford to let its bubble pop because the pain will be so severe. Those who believe this have a poor grasp of Chinese history, especially in the 20th century.
What few in the West fully comprehend is that the CCP's history is of one bloody purge after another, of supreme leaders consolidating power and then unleashing a Cultural or Economic Revolution to eliminate rivals and consolidate power.
If crushing China's bubble is the nuclear option, Xi has reason to be confident he can push the pain level to 11 and most will accept it; those who don't will either join Jack Ma in forced retirement.
In a nuclear conflict, the leadership who starts it has to believe they can sustain the damage and survive. That's how I reckon Xi thinks about ending moral hazard and popping the bubble in China. He and the CCP will survive, but the odds of success get worse the longer he waits.
He may even calculate that the West will be effectively weakened as the global Everything Bubble bursts, and China can advance simply by dint of surviving due to 1) Chinese people's immense ability to survive hardship (1966-76 is still very much in living memory) and 2) Xi's willingness to crush any dissent in order to secure the CCP's hold on power.
We've heard many first-hand accounts of everyday sacrifices and losses in the Cultural Revolution from friends who would hesitate to repeat the accounts publicly, even in the U.S. Even those who escaped house arrest, beatings, demotion, imprisonment, being sent down, etc., suffered hardships that are unimaginable to Americans and Europeans accustomed to always-on abundance.
To mention just one example, a single egg was divided into four as a special treat for a family of four. This is not hardship in a textbook, this is very much a memory of the living.
The grand irony is that rather than save the global economy by expanding its own debt bubble, China will pop the global Everything Bubble. To state the obvious, being a linchpin in the global economy makes China a consequential domino. Anyone who thinks the Fed's speculative bubble in the U.S. can magically become immune to the collapse of tightly-bound global dominoes is indulging in magical thinking.
China's extreme excesses of debt and speculation are already unraveling, and Xi is backed into a corner. There is no cost-free escape, only triage, and Xi has charted a path to preserve the Party's control by forcing everyone but his inner circle, from corrupt officials to Big Tech to sprawling conglomerates to middle-class households who own three "investment" flats, to absorb the inevitable losses of China's unprecedented bubble popping.
The line of dominoes that is already toppling extends around the entire global economy and financial system. Plan accordingly.
Highlights of the Blog
Podcast:
Charles Hugh Smith: Fed Assuring 80% To 90% Collapse Of Bubble (1 hour, with Paul E.)
Posts:
Are We Really So "Rich"? A New Way of Defining Wealth 9/25/21
What's Really Going On in China 9/23/21
America 2021: Inequality is Now Baked In 9/22/21
Now That the American Dream Is Reserved for the Wealthy, The Smart Crowd Is Opting Out 9/20/21
Best Thing That Happened To Me This Week
We made lau-laus this week, which is meat and/or fish wrapped in taro leaves and pressured-cooked for about an hour. We tried making some with Lau Pele, a.k.a. Tongan Tree Spinach, (the crinkly leaves in the foreground) and found the taste and texture basically indistinguishable from the taro leaves.
We grow our own taro, Lau Pele and ti leaves, the long inedible leaves with a center stem, which are tied around the lau-laus to secure them during cooking.
From Left Field
Are we eating ourselves to extinction? Of the 6,000 plant species humans have eaten over time, the world now mostly eats just nine, of which just three – rice, wheat and maize – provide 50% of all calories.
Aquifer decline in California-- quick, find a replacement for California agriculture...
Soaring energy prices in Europe are forcing U.K. factories to shut down--but energy is infinite, right?
Trust in a Collapsing Economy -- trust has already collapsed....
Maladaptive Beliefs-- why bagholders cling on and suffer catastrophic losses....
A History of Human Waste as Fertilizer
Nancy Fraser: "Cannibal Capitalism" Is on Our Horizon -- or it's already here....
Digital Currencies Pave Way for Deeply Negative Interest Rates-- negative rates destroy the banking sector, but other than that, they're great....
Disney+ is killing the blockbuster movie with its identikit mega-hits
What’s Your Raise Really Worth? Inflation Has Something to Say About It.
Maine Will Make Companies Pay for Recycling. Here’s How It Works.
The cause of the UK's food and petrol shortages is Brexit – yet no one dares name it -- this overlooks the dependence on intermittent power sources, probably because it isn't PC to assign any responsibility to rising dependence on wind and solar...
"The first symptom of true love in a man is timidity, in a young woman, boldness. This is surprising, and yet nothing is more simple." Victor Hugo
Thanks for reading--
charles |
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