Twofish's Blog

January 1, 2009

The Non-Collapse of China

Filed under: academia, china — twofish @ 6:08 pm

You saw huge leverage in investment banks, because with leverage the higher bonuses you can pay in the good times, and when everything falls apart it is someone else’s problem. Part of the problem is in the 1990’s when investment banks switched from the partnership model in which the owners of the bank had unlimited liability and were careful to the joint-stock corporate model in which the high level managers can pay themselves big bonuses and walk away when things fall apart. Another problem is that you ended up with an extremely fragmented system in which it was possible to find gaps in the risk control system.

You run into big problems when no one cares about risk which is what happened with the American financial system but not the Chinese one. *Someone* has to care about risk and it could be partners with unlimited personal liability, some government agency, or the Communist Party. The trouble with “privatization is god” advocates is that they get rid of the socialist controls without putting in adequate capitalist controls, and the result is widespread looting followed by financial collapse. It happened in Russia, it happens in China. It happened in Wall Street. People that believe that “privatization is magic” have to explain why it happened on Wall Street.

In 2000, Gordon Chang wrote a book “The Coming Collapse of China.” I’d really be interested if Chang, Minxin Pei, or Yasheng Huang would write an essay “Why the Chinese Financial System Didn’t Collapse But the US Financial System Did.” I have my answers, I’m curious what theirs are. One possible answer is “just wait a year and you’ll see things fall apart.” Possible, after giving this answer year after year, it gets a bit old, and you have to wonder if there is anything new.  It’s also pretty useless.  All human institutions are impermanent.  Some day the Chinese banking system will collapse, some day the Communist Party will fall, some day the sun will stop shining.  Saying something will happen eventually is useless.  What’s important is whether it happens tomorrow, next year, next decade, or next century.

One thing about me is that I try to be non-ideological and data-driven.  I’m not going to say that you won’t have a collapse in the Chinese banking system.  What I am saying is that if I’m right about how the world works, there won’t be a systemic collapse in the next two years (although I wouldn’t be too surprised if you had isolated bank failures).  If there is a systemic collapse, then it looks like I was wrong.  It’s happened before, and I’d much rather lose an argument than end up trying to advocate bad policy.

Advertisements

11 Comments »

  1. “Some day the Chinese banking system will collapse, some day the Communist Party will fall, some day the sun will stop shining. Saying something will happen eventually is useless. What’s important is whether it happens tomorrow, next year, next decade, or next century.”

    This is interesting, and I prefer to think that the probability of any one of these outcomes increases or decreases under certain conditions. There are cyclical factors at work that will drive up bad debt in the financial system – which is already apparent in the data and the banks themeselves has expressed concern about. There is also the possibility that things will happen as they have during previous cycles where problems were ardently denied and covered in bogus numbers, until they were suddenly huge and required hundreds of billions of yuan in recapitalizations (big numbers relative to GDP then, and possible only because the government controls national private savings). There is little to suggest that such behaviors have changed if you look at this from the bottom up, from spending time tromping through city after city seeing what is going on beneath the numbers. That said, on one hand the system faced bigger structural problems in 2001-2002, althought the potential scale of these problems was smaller in an absolute sense. Today, the structural problems are comparaively smaller, the downside risks are much much larger in absolute sense, and the capacity of the government to push through fixes is shrinking as a result of factionalism, a generally counter cyclical phenomenon.

    There is always concern in China that once policy is loosened that “chaos” runs rampant. This is true, but this comes mostly from a perspective that the economy should be controlled, rather than managed. If the powers that be continue to try to control things that are far beyond their capacity to do so, rather than “step back from the micro economy”, as some in various agencies advocate, then a situation where things are “out of control” is almost a foregone conclusion. The problem is that economic management in China still revolves around the apportionment of interests – control of resources and the commanding heights. This comes ahead of coherent policy implementation, and is a fundamental barrier policy reform in too many areas. But bad systems don’t always fail, despite the scale of looting of the economy that has taken place. Any self respecting cunzhang is a millionaire, with any self respecting gaoganzidi not content until they have a few hundred million out of the country. Guofuminqiong is not sustainable.

    Comment by W — January 2, 2009 @ 1:21 am

  2. You fail to mention Zhiwu Chen of Yale in the post.

    I can almost guess Chang, Pei, Huang and Chen et al. responses to this post, “Yes, the American financial system did fail, but we know, WE KNOW that in theory and in practice, the American system works better than the Chinese current system 99% of the time. All the academic studies and ground experiences demonstrate this. All we need to do is to IMPROVE the American system so that 1% failure won’t cause the domino fall as we witness right now. But the Chinese one, the Chinese system is FUNDAMENTALLY flawed. Yes, it survived. But IT DOES NOT PROVE the superiority of the Chinese system over the American’s. China dodged this bullet because of 1)luck 2)underdevelopment of financial system 3)capital control 4)autocratic regime 5)Asian propensity to save 6)… And we know that China will fail one day because of 1)back luck 2)underdevelopment of financial system 3)capital control 4)autocratic regime 5)Asian propensity to save 6)…”

    Add to this persuasive argument are the awesome credentials they possess: Harvard, Yale, Priceton, M.I.T., Cornell, Michigan, Carnegie endowment, Baker & McKenzie, op-ed at NYT, WaPo, etc.

    And you, Twofish, is just a mid-level white-collar “slave” in Wall Street jungles.

    Comment by anonymous — January 2, 2009 @ 6:45 am

  3. A couple of more thoughts on the question of why the Chinese financial system did not collapse is simply because the government can and has appropriated national private savings at will to bail out systemic waste, fraud and corruption. No debate about the last round of bail outs, which were the right thing to to, but crossed the desks of only a handful of bureaucrats. China has and will socialized financial risks, taking what amount to national savings and recapitalizing its banks. The US has done the same thing this time around, except this is a fiscal operation that will have to be backed by the issuance of debt that government (and eventually tax payers) will have to take responsibility for. The government in China has repeatedly recapitalized the banking sector at virtually no cost to itself, putting the tab on other entities.

    Comment by W — January 2, 2009 @ 9:27 am

  4. The size of successive bailouts and market crashes in China – a developing country – relative to GDP have been far larger than anything in the US, even the current packages. Why do you call the US a collapse, and China a non-collapse? The scale of wealth destruction and waste has been far larger in China relative to GDP. So, the US financial system has collapsed, and China just has problems? Please. This is why you come across as apologists for the Chinese government. We have just been through the second great wave of wealth destruction in the Chinese stock market, mostly because of a constellation of bad and insufficient policy, but everyone still talks about this like it is a non-issue, precisely what the government wants to them to do. The US economy has just gone through another cyclical episode of wealth destruction, and it is all anyone can talk about. This is as is should be for those concerned, and eventually will get to the deeper elements of profound policy failures. So again, my question is: why do you call the US (and European) episodes a collapse, and identify China’s cyclical crashes as just problematic?

    As for the academics you mention above, I am quite sure that all of them would like to see China strong and successful. Aside from Gordon Chang, they are adovcates of economic reform agendas to these ends, and that is the thrust of their analysis. They, like many of their colleagues that have argued for a long time about structural flaws in the US economy, imply that bad systems can go on indefinately, but that there are clear areas where improvement is possible.

    Comment by Anonymous — January 4, 2009 @ 8:01 am

  5. Anonymous: Why do you call the US a collapse, and China a non-collapse?

    Because on 1/1/2008, the United States had five investment banks and on 1/1/2009, the United States had no investment banks. We survived the crash of 2008, but we were literally hours away from a total meltdown of the US and world financial systems.

    Anonymous: The scale of wealth destruction and waste has been far larger in China relative to GDP. So, the US financial system has collapsed, and China just has problems?

    Yes. There are a lot of problems with the Chinese economy, but at the end of the day, it muddles through with all of the problems. The comparison is between a person with chronic diabetes and hypertension and a super-fit runner that suddenly dies of a heart attack. Dead is dead, and the US came within hours of a total financial collapse.

    Anonymous: We have just been through the second great wave of wealth destruction in the Chinese stock market, mostly because of a constellation of bad and insufficient policy, but everyone still talks about this like it is a non-issue, precisely what the government wants to them to do.

    It *is* a non-issue because there were enough reserves to keep stock market losses from destroying the rest of the economy, and because very little Chinese wealth is kept in the stock market. You can argue that Chinese government media restrictions stop discussion in China, but there is nothing to stop discussion among people in the United States over these issues.

    People knew that the stock market was a bubble and so policy was developed assuming that it was a bubble, so when the bubble popped, there was damage but it was minimal.

    Anonymous: So again, my question is: why do you call the US (and European) episodes a collapse, and identify China’s cyclical crashes as just problematic?

    Because we know that China will have a cyclical boom-bust cycle and we can prepare for it so that these cycles don’t wreck the economy. China has had a lot of boom-bust cycles over the last thirty years and there are well known recipes for dealing with them.

    Very few people believed things in the US would get as bad as they have.

    Anonymous: As for the academics you mention above, I am quite sure that all of them would like to see China strong and successful.

    But wishful thinking doesn’t change things. The thing about the Chinese economy is that nothing in the last year has happened that people weren’t expecting in 2007 or even 2004. China has huge bad real estate loans, people have been discussing what to do with that since the mid-1990’s, and there are things people are doing to try to improve policy. By contrast, in 2006 if you told the academics that the US economy would behave in the way that it did, I’m sure that most of them would have laughed at you.

    Comment by twofish — January 4, 2009 @ 6:03 pm

  6. anonymous: “Yes, the American financial system did fail, but we know, WE KNOW that in theory and in practice, the American system works better than the Chinese current system 99% of the time.”

    So what?

    When that 1% puts the world financial system at risk, 99% isn’t good enough, and knowing that the American financial system is better than the Chinese one tells you nothing about what to do with the Chinese financial system.

    anonymous: . But the Chinese one, the Chinese system is FUNDAMENTALLY flawed. Yes, it survived. But IT DOES NOT PROVE the superiority of the Chinese system over the American’

    Personally, I think that the American financial system is superior than the Chinese one. So what?

    The problem with the American financial system is that it is very, very good. Too good. Being good makes you think that you are perfect, and a good system that thinks that it is perfect is more dangerous than a bad system that knows that it is broken. In the case of the Chinese system, because people know and knew that it had problems, you can develop things to compensate. So when the stock market blows up (as everyone knew that it would), people bring out the plans and policies that were developed to deal with it, and nothing seriously bad happens.

    anonymous: Add to this persuasive argument are the awesome credentials they possess: Harvard, Yale, Priceton, M.I.T., Cornell, Michigan, Carnegie endowment, Baker & McKenzie, op-ed at NYT, WaPo, etc.

    1) So what? Credentials are bogus.

    2) Even if they aren’t…..
    2a) You can find equally well credentialed people that disagree with them (Joseph Stiglitz, Louis Kuijs to name two)
    2b) Some of them write anonymous blogs

    anonymous: And you, Twofish, is just a mid-level white-collar “slave” in Wall Street jungles.

    It’s one thing to have an “ad hominem” attack. It’s quite funny to have an incorrect “ad hominem” attack. One thing I like about the internet is that because you don’t know who you are arguing with, you have to base your arguments on facts and analysis, because if you start going “ad hominem” (i.e. you’ve never worked in a bank and you have no academic credentials), you end up looking a bit silly when it turns out that its not true.

    So suppose it turns out that I did attend a big-name elite school and have a Ph.D. degree, would you accept my arguments? Of course not, and you’d be silly to do so. So why bring up the topic in the first place?

    Comment by twofish — January 4, 2009 @ 6:23 pm

  7. Te US has had successive boom-bust cycles, as one would expect, with this last one having been more extreme. So, the US has also “muddled through”, too, rather than having collapsed. Even if the carnage on Wall Street was 4X what is has been, this would still be smaller relative to GDP than China’s last bailout in total. You still insist on looking at China’s forex reserves as a stand-by facility of sorts for whenever the economy gets into trouble, and that is simply wrong. So your argument is that financial sector repression over time is prudent, and therefor beneficial? I have just been through rural areas of Anhui, Henan and Hunan, a circuit that I have made for just about each of the past 10 yrs, and I can say that overall conditions are quickly getting worse than they did in the wake of the E. Asian crisis. To contrast this reality with the causes leading to the accumulation of all of the “reserves” you keep talking about, it makes one wonder what in the world China is saving for.

    Comment by Anonymous — January 5, 2009 @ 5:11 am

  8. The United States was damned lucky. It was days maybe hours away from a total systemic meltdown.

    I’m not looking at forex reserves. I’m looking at internal RMB reserves. Once you have a crash, you need to wipe out all of the bad debt. If you have to take it out of depositor money , and which point you have banking runs, and this breaks the system for decades.

    anonymous: So your argument is that financial sector repression over time is prudent, and therefor beneficial?

    My argument is absent a very sophisticated and well run economic system, that it’s the least bad of policy options. To build a good financial system takes years, perhaps decades, and in the mean time, there will be crashes, and you need to make sure that you survive the crashes so that you can continue building the system. If you don’t have the reserves, then the moment you have a crash, then you’ve wiped out all of the work that you’ve had building the system.

    The reason reserves are important is that if the banking system collapses then you no longer have a way of allocating resources at which point China becomes Latin America and Russia, which haven’t even gotten to square one. If you keep the banks open and operating then once the initial shock gets absorbed you then start massive infrastructure spending. If the banks are crushed then you cannot do this.

    Anonymous: it makes one wonder what in the world China is saving for.

    If you want an answer to this, look at Mexico, Russia, and Brazil. Once you’ve eliminated the ability of people to save either through banking defaults or hyperinflation, then any sort of economic growth just stops. If you keep the financial system solvent, then you are looking at six to nine months of hell followed by recovery. If the financial system falls apart, then you’ve killed any hope of economic growth for a decade and possibly more.

    Comment by twofish — January 5, 2009 @ 5:41 am

  9. Yes, a functioning financial system is important.

    I am wondering from your perspective on Wall St., when the system was so close to meltdown, what saved it? The TARP funding was not spent, and the world didn’t end. Why not? Was the signal enough. The spike in inter-bank rates points to the seizure in credit markets, but this “sudden stop”, does not appear to have procuded the crash to end all crashes. Wondering about your thoughts on what has prevented things from getting worse.

    Comment by Anonymous — January 5, 2009 @ 7:51 am

  10. anonymous: I am wondering from your perspective on Wall St., when the system was so close to meltdown, what saved it?

    There wasn’t one thing but rather a series of dozens of decisions from the Fed and Treasury each intended to keep the financial system from collapsing. Basically the financial system was on fire and buy dumping massive amounts of water (i.e. loan guarantees and bailout money), Treasury and Fed kept the system from imploding.

    There were two very real dangers that could have easily destroyed the world economy in Septemeber/October 2008.

    1) chain reaction of bank and corporate failures. In the weeks after Lehman collapsed, there were massive withdrawals and threats of withdrawals from investment and commercial banks, and a lot of banks went under. However, we were extremely close to a mass chain reaction in which one bank going under would have pulled others down causing a domino effect that would have destroyed banks by the hundreds. Most people didn’t notice this because FDIC kept small deposits from going to their bank and pulling out all their money, but large depositors were either pulling their money out or threatening to.

    2) collapse of the short term commercial paper and money market. US businesses do not keep cash in safes so they depend on the commercial paper and money markets to get the operating cash they need. Those markets were on the verge of collapse. In the case of money markets, people were pulling their money out, causing the unthinkable to happen (i.e. losing principal on overnight deposits). Once you have one money market fund go other, then all of the rest would have likely folded. The same thing was happening to the commercial paper market.

    Without commercial paper and money markets, businesses do not have the cash to operate, and they would have been forced to liquidate to survive, and once that happens, things just would have gotten worse.

    anonymous: The TARP funding was not spent, and the world didn’t end. Why not?

    TARP was just one small part of a huge effort to stabilize the markets. Even the fact that Treasury had to go to Congress for emergency funding was scary, and the intention was to ask for one big lump sum that would cover any possible outcome. If Treasury and the Fed had gotten one of the other steps wrong, then TARP wouldn’t have mattered.

    anonymous: The spike in inter-bank rates points to the seizure in credit markets, but this “sudden stop”, does not appear to have procuded the crash to end all crashes.

    That’s because the Fed stepped in and started buying vast amounts of commercial paper ($330 billion at last count.)

    anonymous: Wondering about your thoughts on what has prevented things from getting worse.

    Once people stop counting lifeboats and see that there is enough there for everyone, then people stop fighting each other to get into one. Since September the Fed has pumped in about $1.2 trillion into the economy, and Treasury another $400 billion give or take.

    And that’s still a drop in the bucket compared to the asset writedowns, but it was enough to keep the system from falling apart (for now at least).

    Comment by twofish — January 6, 2009 @ 3:47 am

  11. The 2008 case could be modelled as a clash of cultures – cash vs credit, based on subconscious determinisms –
    as Cicero stated : one cannot have private property without debt . Culturally the US could never deal with a cash only China – just as Christianity and Budhism have conflicting ideas of heaven : one life with debt and private property and property law vs re-incarnation and debt as a sin to carry over , with marshall law.
    Totalitarianism is regarded as inherently evil – and this may be the lesson the Chinese , as well as the US and Australia need to learn , or re-learn – as such a consideration is made in texts such as The State and the Citizen. The stupidity or senility or ignorance of political leaders should never be under-estimated.

    Comment by Bob Dix — February 4, 2009 @ 7:55 am


RSS feed for comments on this post. TrackBack URI

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Create a free website or blog at WordPress.com.

%d bloggers like this: