- First, China will emerge and American will feel threatened;
- China will then seem ubiquitous if only because people are looking for it more often;
- China will purchase things that seem quintessentially “American,” and the jingoist rhetoric will heat up;
- Economic manipulation will cause China’s economy to look comparatively better than ours, increasing calls for statist intervention;
- China will blow up;
- Nobody will care anymore.
We are almost to the end of this cycle. China’s books are so bloated with fake money and unsustainable corruption, the blowup is inevitable (though no one knows when). However, that has not stemmed the tide of calls for statist intervention along the lines of the “China model.”
And so I present an article (admittedly old, which I had bookmarked and forgotten about), by Ross Kaminsky about how the Chinese model is the wrong model for the United States, notwithstanding certain calls for imitation. Here is an excerpt, but as always, you should go ahead and read the whole thing.
The professional left in America and their chattering-class useful idiots have followed a consistent pattern for a century: sympathizing with tyranny in their musings over how to implement policies fueled by jealousy and an undying fear of economic liberty.
There has hardly been a better example in recent years than Andy Stern’s Wall Street Journal December 1st op-ed entitled “China’s Superior Economic Model.” In his article, Stern approvingly quotes Intel Corporation co-founder and former CEO Andy Grove who stated in a 2010 Business Week article that there is “emerging evidence that while free markets beat planned economies, there may be room for a modification that is even better.”
…As someone who was studying economics in college in the mid-1980s, I endured countless comments about how American corporations’ narrow focus on “next quarter’s earnings” (as if that were true) was congenitally inferior to the longer-term view supposedly taken by Japanese companies.
Over the next several years, the Japanese bought Rockefeller Center (from my alma mater, Columbia University), CBS Records (purchased, renamed, and still owned by Sony), and the famed Pebble Beach golf course.
Harvard professor Ezra Vogel published (actually in 1979) a book called Japan As Number One: Lessons for America, in which he argues, as a reviewer for the Economistmagazine put it, “that the United States should give itself a political and cultural heart transplant.
…In 1995, the Mitsubishi Group, which had purchased Rockefeller Center, forced the project into Chapter 11 bankruptcy, losing nearly two billion dollars for their efforts. And a few years later, as GolfDigest‘s Mark Seal put it, when Peter Ueberroth put together a group to buy Pebble Beach for less than the Japanese had paid for it, the deal “bankrupted a Japanese boom-time golden boy, and, most recently, sent an army of Japanese bankers back home with little to show for their seven years of superlative stewardship but their good names.”
Since then, Japan has turned in not just one but two “lost decades” with its persistent near-zero interest rates frequently being described as “pushing on a string.” According to a recent Heritage Foundation study, “In 2010, the Japanese economy looks to have been smaller than it was in 1992, an incredibly poor result. It is not just a matter of a decline in output; it is also a remarkable decline in total wealth.
…So when you hear people — especially non-economists with political agendas — long for the statism that characterizes most of America’s economic competitors, listen with great skepticism.
That, in a nutshell, is exactly the kind of progression I am talking about. If you are interested in bubbles as a phenomenon, or at least a further explication of the Japanese bubble (and many others), I would recommend “Devil Take the Hindmost,” by Edward Chancellor.
And then I would recommend some reflection on the current state of Chinese “state capitalism,” as if such a thing could possibly exist in the long term.
Now that China’s coming collapse is getting quite a lot of press (though not enough), I must point out one of my regrets in writing this blog, and that is the fact that I never really fleshed out my opinion, first stated more than a year ago, that China is due for a horrific day of reckoning:
Hugh Hendry gives an interview with King World News. He opts to unhitch his wagon from China’s star before it starts to fall to earth again. Key quote: “I am just intrigued as to the optionality, as to the profits that could be made, should that revert. And because it’s deemed to be impossible, the trade is actually asymmetric. By golly if I am right, I can make a lot of money.” Indeed you can, Hugh. And if you’ve missed his prior interview entitled “I Would Recommend You Panic,” you should check it out. Stay tuned to this blog for further insight into why China of the 2010s is Japan of the 1980s.
The parallels to historical bubbles are overwhelming, and there is particular similarity to the Japanese bubble of the 1980s. The fact is, China’s economy is written on paper. The data available are fabricated, and even where they are real, they are circular and without a basis in reality.
The reckoning is inevitable, as I’ve mentioned before as well:
Rather than reflecting the true time preferences of the citizenry, inflationary actions push consumers to buy more now – right up until the point when the bubble bursts and they can’t buy anything at all. Mark my words, China will get there.
Consider this post too little, too late, but at the very least my humble contribution. China is going down, and at least now I can say “I toldja so.”
MSN Money columnist Jim Jubak has a new column up called “10 reasons to love rising prices.” It is startlingly bad. I haven’t seen such a monumentally mind-boggling set of ironies and ignorances in years (this side of the Huffington Post). Let’s go through his ten reasons why inflation is good:
Inflation keeps deflation from the door. Deflation can kill an economy (just ask the Japanese). With prices going lower every day, consumers have constant pressure to put off purchases because “it will be cheaper tomorrow.” This is no way to run a modern consumer economy. Even the Chinese know it’s a bad idea to discourage consumer spending.
This is what you’d call a “false dilemma.” If there is no inflation, Jim Jubak would have you believe that deflation necessarily takes its place. How about a stable currency instead? And remember that the specter of deflation is not all it’s cracked up to be.
And the crack about the Japanese shows a fundamental misdiagnosis of their problem. Granted, the Japanese economy is multi-faceted thing, but in simple terms, their deflation was brought about by a massive corrective action in response to inflation. Get rid of the inflation problem first, and you won’t have to deal with its aftermath.
And about the Chinese discouraging savings: by forcing consumer spending to goose your (irrelevant) GDP figures, you are forcing the natural tradeoff between investment and consumption to tip more toward the consumption end. Rather than reflecting the true time preferences of the citizenry, inflationary actions push consumers to buy more now – right up until the point when the bubble bursts and they can’t buy anything at all. Mark my words, China will get there.
Inflation gives us the illusion that we’re making progress in our work lives. And that illusion provides critical grease for the economic wheels. Wouldn’t a 5% raise feel good in 2011? Wouldn’t it make you feel appreciated at work?
We are honestly supposed to believe that inflation, which cancels out our savings, reduces our real purchasing power, and makes us poorer, is a good thing because it provides the illusion that we are making progress? If you are seriously recommending that we trade real wealth for an illusion of progress, you have no business providing investment advice.
Inflation makes consumers feel richer, so they buy more. Policymakers are still trying to get the U.S. economy revving so that it produces more jobs. Waking up each morning knowing that your biggest asset, your house, is worth less doesn’t make you want to strap on that American Express card and drive to the mall. (Don’t give me this stuff about nominal versus real prices. We all live in a nominal world.)
Again, Jubak is assuming that consumer spending is an adequate proxy for wealth. It is not. All increased consumer spending means is that there is less for investment. The unsustainable path leads right down American Express Lane, straight to the mall.
And don’t give me “this stuff” about a nominal world. Is that what Jubak will tell people in the future when his stock picks produce no real return? “Sorry, but that inflation that I advocated for ate up all your gains. I know your paper gains won’t put food on your table, but hey, don’t blame me. You’re the one who decided not to live in the ‘nominal world.’”
Inflation makes consumers feel that saving is worthwhile. I’ve been trying to teach my kids to save. Do you know how impossible that is when banks pay 1% or less on the traditional passbook account?
So much irony here that I find it difficult to know where to start. Inflation quite literally reduces savings, and yet Jubak is saying that we need inflation to spur savings? Seriously? And regarding the 1% interest rate; it tends to be difficult for banks to offer more when the central bank is holding their interest rate target down – which causes inflation! You want higher bank rates? Try tightening the money supply and nipping inflation in the bud.
By eroding the value of money, inflation reinforces the value of concrete assets. That’s important in a world that needs to do a lot of investing in finding and developing new supplies of commodities such as oil and copper.
First of all, eroding the value of money does not “reinforce the value” of assets, it just makes assets go up in price (remember that money is not wealth, it is just a medium of exchange).
And the idea that someone like Jubak can “know” whether the world “needs” more oil and copper is just ludicrous. That allocative function is carried out by the spontaneous, impossibly complex system of market pricing, including the pricing of money. Keep the price of money artificially low, and all you end up with is an asset bubble. We have seen this happen just recently.
Did holding interest rates down “reinforce the value” of housing?
Inflation is essential to ending the slump in the housing markets. Cheap mortgage money isn’t enough to get buyers into the market when they’re afraid that the price of the asset is about to slump. We need inflation’s help to get us back to the good old days when homeowners could count on their houses being worth more (in nominal dollars, I know) every year.
Aaargh! It pains me to see someone so painfully shortsighted! Yes, everyone would like to live in a time of constant “good old days,” but it simply is not possible. By going back to the policies that brought us the biggest crash since the Great Depression, Jubak would be setting us up for…another monumental crash! Brings to mind Einstein’s definition of insanity.
And while we’re at it, we need inflation to make debt loads more affordable long term. How? By shrinking the real value of that debt every year. Owing $450,000 on a mortgage is much easier if inflation is eroding the value of that debt every year by 3% or so.
Right, because creditors don’t take inflation into account or anything. No, the only entity that inflation truly helps out in the long run is the government. Why keep a lid on runaway debts when we can print our way out of the vig? Inflation is gasoline on the fire of government profligacy, but real people simply do not have the option to inflate away their debts. Which brings us to:
Without inflation we have no hope of containing the U.S. national debt. The U.S. government needs inflation to reduce the real value of the its debt even more than strapped homeowners do.
No hope? How about we cut spending? Total government revenue has averaged about 18% for pretty much the entire country’s history. Despite fiddling with tax increases, decreases, loopholes, etc., revenue is remarkably stable. If you want to reduce the debt, cut spending to a sustainable level. Period.
Try to inflate away your national debt and good luck getting anyone to buy your paper in the future. In reality, there is no difference between outright default and the gradual, insidious default by devaluation. And the movers and shakers behind the capital markets are absolutely not fooled.
Inflation is also crucial to restoring our personal and national financial discipline. At current interest rates, money is simply too cheap for the federal government and Congress to pay much attention. At current interest rates, the payment on the U.S. national debt comes to just $414 billion a year. That’s a ton of cash, but it’s not enough to crowd out spending on crucial government programs. Inflation pushes up interest rates so that we can’t afford to build that lame weapons system in some congressperson’s district. Then, whammo, we have a crisis on our hands. And we all know we’re not going to fix this problem without a crisis.
Hmmm, interesting. This point finally admits to the real goal of inflationary policy: fomenting a crisis. Of course, trying to fix “the problem” with an inflationary crisis becomes a little ridiculous when you realize that inflation is the crisis.
Best of all, inflation makes it easier to tell stories that begin “When I was your age . . . “
Sure, you’ll be destitute, savings all dried up, using your Social Security checks as kindling for your fire barrel under the I-35 overpass, but think of the stories!!
Mr. Jubak, you have outdone yourself. And not in a good way.
QE2 has touched off quite the furore lately, and from around the world, but among the most interesting comments are those from domestic investment professionals, who are charged with making money from madness. Throwing his hat into the ring today is Jim Jubak, from MSN Money. In an article entitled “Oops, has the Fed done it again?”, Jubak lays out the story behind QE2, and how it is just another step in a by-now-very-familiar cycle: pump up the money supply, watch the economy take off, the economy crashes terribly, so in response, pump up the money supply.
Happily, he also offers some investing advice. (Not that I endorse Jim Jubak or any professional stock picker, but if you choose to heed the advice, so much the better that you found it here.)
Let’s go through the article:
2000. 2007. 2011.
Is the Federal Reserve about to do it again? Is the Fed about to preside over the creation of another financial bubble?
Asset prices in the world’s emerging economies are climbing on the crest of a flood of dollars from the Federal Reserve. Central bankers in the world’s emerging economies have started to worry about what will happen if all the hot money flowing into their economies and markets suddenly starts flowing out.
“As long as the world exercises no restraint in issuing global currencies such as the dollar,” Xia Bin, an adviser to the People’s Bank of China, said, “then the occurrence of another crisis is inevitable.”
The only problem with this lead-in is the fact that it references only the past decade. In fact, the world is full of examples of monetary manipulation, asset bubbles, and currency crises. For a very good reference text (yep, it’s a whole book), I’d recommend Jesus Huerta de Soto’s Money, Bank Credit and Economic Cycles, published for free by the Mises Institute.
If you’re uncomfortable with a “hardline” Austrian viewpoint, I would also recommend the more “agnostic” financial history entitled “Devil Take the Hindmost,” by Edward Chancellor. For far more Keynesian take (but still mostly objective), I’d suggest the updated “Manias, Panics, and Crashes: A History of Financial Crises,” by Charles Kindleberger.
But 10 years after the bear market began in March 2000, the Nasdaq has barely recovered half its losses. From a high of 5,048.62, the market had clawed back to 2,578.98 at the close Nov. 5. That means the Nasdaq Composite Index is still down 49%.
True enough. Again, though we haven’t recovered from 2000, it seems the more important point is the fact that we haven’t learned our lesson from the late 17th century, when the first modern financial bubbles appeared in response to financial manipulation.
In the fourth quarter of 2002, when short-term interest rates were 1.23%, the real median price of a U.S. house was $197,219. (All these prices are corrected for inflation.) By the fourth quarter of 2005, the real median price was up to $262,634. That’s a 33% increase in the median price of a house in just three years — without inflation. That’s extraordinary appreciation for an asset like a family home in the United States.
And cheap money made it possible. It was possible to buy and flip for a quick profit. Possible to refinance and take money out to buy more stuff. Possible to buy more house than you could afford. Possible to find a lender who would lend you more than the house was worth. Possible to find a lender who wouldn’t ask questions about your income or credit record.
By 2006, this price appreciation had peaked. The median real price of a house that year ranged from $250,000 to $263,000. But by the second quarter of 2007, it had dropped below $250,000. And it kept on dropping. By the bottom, which nationally may have been the first quarter of 2010, the real median price of a house was down to $169,158.
That’s a drop of 36% from the 2005 quarterly peak to what may be the bottom in 2010. (And because the house they live in is by far the most valuable asset most families own, and because home ownership rates in the United States are much higher than stock ownership rates, that 36% drop in housing prices was more devastating for most families than a 77% drop in stock prices.)
There’s your housing crisis in a nutshell. This is why the 2008 downturn has been called the most devastating since the Great Depression, but it isn’t surprising that housing was affected. Capital investments, including hard assets and real estate are very prone to overinvestment (“malinvestment”) in the Austrian parlance when credit is artificially cheapened.
And now on to the present:
That track record suggests that “What, me worry?” isn’t a reasonable response to the Federal Reserve’s two rounds of quantitative easing, a strategy that pumps money into the economy to try to get it moving more quickly. The first round, which ended only this spring, saw the Fed buy $1.7 trillion in Treasurys and mortgage-backed securities. The new round announced last week would add $600 billion of Treasury buying to the total.
The dangers of these two programs to the U.S. economy are scary enough. The Federal Reserve is buying all these debt instruments on the cuff. The Fed doesn’t actually have the money to pay for these purchases. Instead, it is creating dollars out of thin air — printing them, figuratively at least — and at the same time creating a huge liability on the Fed’s own balance sheet. Of course, the Fed may be able to pay off that liability by selling the bonds back to the market someday, but you’re entitled to wonder where the buyers for $2.3 trillion in U.S. debt and mortgage-backed debt are going to come from.
If you’re the kind of person who worries when you see a big debt and no obvious way to pay it off, then the Federal Reserve’s current balance sheet undoubtedly worries you.
Why yes. Yes it does. In investment terms, the short-run questions are which assets will be pumped up, but the real long-term question is when will the next crash be, and how much worse will QE1 and QE2 make it? Unfortunately for the rest of the world, the fact that we’re dynamiting our own financial system is not something that other countries can sit on the sidelines and watch. Given the prominence of the United States and its dollar, we are affecting the entire world. And the results will not be pretty. Jubak again:
But those aren’t the possibilities that worry me most or that have overseas central bankers screaming in protest. The big problem is what will happen to that $2.3 trillion created by the Fed. The dollars certainly don’t all stay in the United States.
So far, China, India, Germany and Brazil have been very public in their disdain for our reckless wielding of this financial A-Bomb. I doubt it stops there, especially when the defaults begin. You’ll note that Brazil has been critical; they’ve also been a serial defaulter. Just as speculators plugged money into housing in 2004, watched it soar, and then lost their shirts when it came crashing to earth in 2008, so I fully expect at least one country to take off on the back of asset inflation, excite investors as the “next big thing,” and come crashing spectacularly down several years from now in one big default. It would not surprise me if Brazil falls into that category. Of course, we’d better hope China doesn’t – they have nukes.
And speaking of nukes, the inimitable Peter Schiff has an article today in the Business Insider entitled “Bernanke is Engaging in the Monetary Equivalent of Nuclear War.” An excerpt:
As the world awaits another $600 billion flood from Bernanke’s printing press, central bank governors from Brasília to Tokyo are preparing to respond in kind. This is the monetary equivalent of a nuclear war, except instead of radiation, bombs of inflation threaten to make the world economy uninhabitable for saving and productive enterprise.
…Chinese Commerce Minister Chen Deming said as much in an interview on October 26: “Uncontrolled” issuance of dollars is “bringing China the shock of imported inflation.” Most emerging markets are the same way. In order to prevent rapid economic dislocations, and often to appease their powerful export lobbies, these countries seek to maintain a status quo versus the dollar – whether through inflation as with China or capital controls as with Brazil and South Korea, or both.
In short, the currency war is really just the rest of the world trying to shield itself from a barrage of nuclear dollars.