The sticker rate, however, ignores local government liabilities, which are a major source of infrastructure financing. “Local Financing Platforms” (地方融资平台) borrow from banks, and provincial / local government bureaus are ultimately liable. Provincial governments have begun to issue bonds through the central government, but the amount as of yet is miniscule compared to the amount of bank borrowing. Several reports; see here (Economic Observer), here (Jinan Daily, Chinese), here (FT China Confidential) and here (Xinhua, Chinese) have noted that the total amount of loans secured by local government bureaus is somewhere around Rmb6tr at the end of 2009. There is only reason to worry, however, if these liabilities turn sour, which many onlookers think is inevitable, citing the scale of credit expansion, and the notion that there cannot possibly be enough profitable investments left to make. This argument alone is dubious, though there is plenty of substantive evidence to worry about an increase in non-performing loans. For example, the Nov. 23 Jinan daily article notes that there have been instances of Local Financing Platforms abusing their privileged position (and lack of transparency among banks) to illegally obtain credit, effectively double counting infrastructure financing needs on a variety of projects:

Since the beginning of this year, rapid increases in loans have become a common phenomenon. For some, this is taken as proof of economic growth. However, in fact, what if it is really true? Local government investment platform business loans have become the main form [of this trend]. Regional and commercial banks have utmost confidence in local governments, but in practice the survey conducted demonstrated that, there are still a number of local financing platforms that just want to improve their own conditions, and exploit the opaqueness of information between banks to expand their position, to illegally obtain credit, harming banks’ interests.

These types of illegal activities are broadly of several types: the first is exploiting financing offered by numerous banks [simultaneously], illegally obtaining credit. For example, a park environment renovation construction project in some city in Jiangsu province had a planned investment of about Rmb800mn, of which nearly Rmb300mn was financed directly by the investment platform. For the first half of 2009 this company applied for a Rmb500mn project loan, and at the same time, used the same project to apply for another Rmb200mn in a revolving financing loan from a completely different set of banks. Though project financing relies on bank loans for efficacy, this is true in name only.

今年以来，城商行贷款激增成为一个普遍现象。这曾被一些舆论一度视为经济增长的有力佐证。但是，事实果真如此？通过地方政府融资平台公司贷款，是目前政府类贷款的主要表现形式。尽管城商行对地方政府高度信任，但实际调查显示，仍然有一些政府融资平台公司为了达到自身运作目的，利用与银行之间信息不透明的可乘之机或自身强势地位，违规侵占信贷资金，损害银行利益。

而这些违规现象基本有以下几类：一是利用一个项目向多家银行融资，套取信贷资金。如江苏某市的一个园林环境整治建设项目，计划总投资约8亿元，其中有近3亿元自筹。该公司2009年上半年在向某城商行分行申请到5亿元项目贷款的同时，又以同一项目向当地另一股份制银行分支机构申请到2亿元流动资金贷款，建设资金基本依赖银行，项目资本金有名无实。

So the banks will be left holding the Asian-manpurse-satchel; who cares, since Chinese banks are also normally cited as being well capitalized. Non-performing loans made earlier in the decade were swapped by state established Asset Management Companies in 2003 that issued bonds to the banks at par for the non-performing loans, guaranteed by the PBoC and Ministry of Finance (worth about Rmb1.8tr), thus removing bad loans from bank balance sheets. If more NPLs ensue as a result of the behavior described above, banks may be left with an unexpectedly large losses. Recently CBRC mandated a slightly higher capital reserve ratio, but not by as much as was rumored. Still, banks have had to go back to raising more funds for continued loans (more here and here, in Chinese). Reuters ran a similar article yesterday.

Taking these together, Pivot Capital estimates that China’s public debt is somewhere in the neighborhood of 62%, much more comparable to international standards. China certainly does have more wiggle room for its size than many Western nations, and could probably continue to float Rmb bonds for a while if it needed to; but it’s total capacity to continue to expand fiscal stimulus type measures may be more limited than is commonly thought. Thanks to JG for pointers to many of the above links.

I’m fairly certain we lived through an instance of shady infrastructure financing last year. In Wuchang, there is an intersection known as 街道口, where highway construction was halted for over a year due to protestations by Wuhan University’s President, who holds a party rank equal to the city governor, since the highway was going to go right through the university (rather, ‘over’ a part of it). The intersection in question would have benefited from an overpass, a four-lane highway seemed like overkill. Maria details the event here. As a result of the stalled installation, one of Wuchang’s busiest intersections was perpetually jammed, from about 7am-7pm. A friend likened it to a “giant idle gas belching urban gash.”

An earlier post repeated Michael Pettis’ argument that investment in high technology doesn’t necessarily guarantee commensurate economic gain, particularly given that labor in China isn’t as productive as labor in the U.S. or Japan. Think of doctors and their secretary: a doctor could do his own scheduling, but at some income level it makes sense to pay someone else to do simple tasks. The same is probably true of a migrant worker – he’d be perfectly willing to take a 12 hour truck from Wuhan to Shanghai, and it wouldn’t have cost Chinese taxpayers quite so much to repair roads as importing a shiny new high speed train from Japan. Two things to consider:

• China’s average productivity is low, but there are several pockets of very high productivity (especially if they build the underwater tunnel to Ta|wan?) Shanghai to Beijing in 5 hours on a maglev sounds very appealing.
• Productivity is increasing over time, and since the results of infrastructure investment don’t really go anywhere (harder to build when the Yangtze River Delta has 150 million people living in it); they might as well over-invest while labor is cheaper?

Non-performing loans will certainly increase as a result of the current investment binge, but the magnitude of increase in totally unserviceable NPLs will largely be determined by how fast productivity and general economic conditions play catch-up with a deep and advanced capital structure. Large scale infrastructure investment tends to be path dependent, especially when you can’t bulldoze any house in your way at whim (I [perhaps naively] believe that institutions will continue to liberalize in China. For the moment it’s a lot easier to draw a line on a map and say BUILD, peasants be damned). Had the US built an extensive rail network along with the interstate highways in the 1950s we might not be quibbling over ethanol.

“China is where we are putting most of our money out of the BRICs,” Peter Schiff, president and chief global strategist for Darien, Connecticut-based Euro Pacific Capital, whose clients have more than $2 billion in assets, said in a telephone interview. “Valuations are certainly better there. That is where the growth and profits are going to be.”

… Shenyin & Wanguo said it estimates the Shanghai Composite will rise as much 22 percent in the fourth quarter, compared with estimated gains of as much as 30 percent at GF Securities and 44 percent at Galaxy.

“We see the Shanghai Composite setting a new high for the year in the fourth quarter as signs increase that China’s economic rebound is accelerating,” said Teng Tai, a China Galaxy Securities strategist in Beijing. He predicted a “very strong rebound” in earnings.

For some context: there’s been a lot of discourse regarding unemployment among college graduates in China, and general low level of salaries for even those graduating from top universities. Non-controlled TonySurveyTM results indicate that in Wuhan, a newly minted Wuhan U. (considered a top-10 school in the Mainland) grad can expect between Rmb 1.2-2.5k (US$ 170-380) per month. In Shanghai, it’s about twice that. A very good job (in Shanghai) would net someone Rmb 6-8k (US ~$900) per month – if they can find a job. In the past year there has been a lot of concern with graduate unemployment. The figures for average graduates are sort of comparable to experienced migrants: the average migrant can make between Rmb 800-1.5k per month; the amount goes up if they work in a larger city / possess trade skills (the max I’ve heard is about Rmb 2.5-3k, which is unusual).

Despite the massive wage differential between U.S. graduates and the rest of the world; there’s been some concern in the U.S. that graduate salaries are falling on average, and wage income inequality is generally increasing; certainly magnified by the awful employment situation throughout the last year. This Businessweek article doesn’t account for demographic changes – are boomers as a group more likely to have college degrees, and their retirement increases the percentage of the working population without a degree? That seems unlikely, but boomers would have much more experience – comparing a 25 year old with someone who has a Bachelor’s degree and 25 years of experience doesn’t tell you that much about long-term wage trends. It probably also depends on what people are studying – interesting comparison here between fields.

In general, Chinese education is rife with plagiarism, rote memorization and absenteeism. This is certainly less pronounced at the major universities, where exchange students and guest researchers are often posted, but is not representative of the higher education system as a whole. Even though China graduates ~600,000 engineers every year, McKinsey Global Institute (as of 2003) indicates that most of them are unemployable by Western standards, due to quality of education and language barriers. That’s certainly not a reason to ignore the low rate of graduation in these fields in the U.S. (would be nice to do a grad degree in CS or statistics, but first one must pay for the dumb thing), but it is a bit of perspective. Education in China isn’t yet all that developed by international standards, and won’t be for a while. This does beg the question as to why massive infrastructure investment is going into Burj Dubai mockups and bullet trains and not improving the quality of education. The answer I imagine is simply that improving education quality is very, very difficult.

Here are some of the replies to the original post:

Because when you all were at university you were busy flirting with girls, playing computer games. A university diploma doesn’t mean anything, the critical element is whether or not you can add any value.

因为你们在大学里忙着泡MM玩网游,大学文凭不能代表什么,关键是你能创造多少价值.

American graduates’ salaries are high because America demands that many college graduates, besides, America’s basic level level education isn’t really much at all. If you haven’t gone to a university, one with a good brand name, your lifestyle level will comparatively not be very good.

Chinese graduates cannot command value because China’s economy is currently in the developing stage, and originally doesn’t demand that many college graduates.

美国大学生收入高，是因为美国需要那么多大学生，并且美国的基础教育水平不怎么样，如果不是以大学升学、考名牌大学为目标的高中生，文化水平是相对比较低的；

中国大学生不值钱，是因为中国现阶段的经济发展水平，本来就不需要那么多大学生，大力发展高等教育本来就是出于推迟就业、缓解就业矛盾、迎合农村人希望 跳农门的心理赚钱的，从资源角度看，根本就是浪费教育资源，把本该提高高等教育水平的投入花在了高等教育普及化上；给本来应该去做农民工的人一张大学文 凭，最后收入还不如农民工，因为浪费学习专业技能的时间和机会，在大学里混文凭。

Because China doesn’t need university graduates, it needs migrant laborers! China’s GDP relies on cheap labor to manufacture; it’s the world’s factory ~ it doesn’t rely on technology to manufacture; on this point there’s no possible way to compare it to the U.S. or Japan.

因为中国不需要大学生，需要民工！中国的GDP都是靠低廉的劳动力创造的，世界工厂嘛~而不是靠科技创造的；这点跟日本美国根本没法比…

It shouldn’t be so! Because the costs of education can’t be compared; there are lots of households that are collectively contributing to help students make it to graduation. They should be able to make back their money.

It’s not so! It should also be an effective investment. Think of politics, class struggle and this sort of thing – the more one studies the more stupid they speak. Of course, our constitution is based upon class struggle, so if there’s no study of that then that’s no good either.

不应该，因为教育成本不能同日而语，一个家庭要供养一个学生直至大学毕业所付出的是很多的。应该得到适当的回报。

不是吧！那也要是有效投入才行。像政治啊，阶级斗争这些东西越学得多可能越傻的说。当然，我们的宪法是以阶级斗争为基础的，不学还不行。

… The second objection – perhaps not so different from the first – is that since China is so much less developed than Japan was in 1987, an infrastructure investment surge is a lot more sustainable. After all, Japan already had great infrastructure in place at the time, so that much of its new investment after 1987 was inevitably in the form of highly wasteful “bridges to nowhere”. Since China has much lower quality infrastructure stock, they argue, there is much more it can do in the way of sustainable investment.

I am always a bit puzzled by how widely-held these views seem to be, especially in China but also abroad. The idea that being poorer makes policy easier can’t have emerged from looking at the experience of developing countries. I suspect that it arises from assuming that poverty does not represent differences in real factors – worker productivity, education, the institutional and legal framework, etc. – so much as in policy mixes.

It is true that poorer countries are able generally to achieve faster growth rates than richer countries, perhaps because they have only to play catch-up, but there is little evidence from other countries that poverty leads systematically to more profitable investment or to more sustainable consumption growth. I think both objections stem from implicit assumptions that there is some highly attractive upward limit to either consumption or infrastructure investment, and that the further away we are from that limit the stronger the attraction towards it. But if that assumption weren’t mistaken poverty should have ended long ago.

And the key point for me:

… The scope for nominal improvement in infrastructure is certainly higher in China than in Japan, but nominal improvement doesn’t matter. It is the economic value of that improvement that matters, and the economic value of improving the railroad in China is not necessarily higher than in Japan since, for example, every hour of transportation time saved in Japan may be substantially more valuable than an hour saved in China.

In fact I would argue – as have many economists, by the way – that China’s obsession with high-technology or state-of-the art infrastructure is extremely wasteful because the benefits of the most advanced technology only justify the costs if labor productivity and labor costs are very high.This is perhaps another way of saying that China’s highly capital-intensive growth is far from optimal for China, and probably only reflects the fact that capital is so cheap in China, at least for the capital-intensive SOEs that get the bulk of bank financing. This means that achieving Japan-style levels of infrastructure are not necessarily the best way to invest in infrastructure.The optimal infrastructure level in China is lower than the optimal in Japan, so the fact that China starts from a lower base does not automatically mean that it has more scope for profitable investments.

Studying the lessons from Japan’s lost decade(s) is key for anyone seeking to understand today’s post-bubble world. But a closer reading of Japan’s financial history illuminates today’s China far more. In the early 1980s, on the eve of its financial liberalisation, Japan was the rising power from the East set to overtake the West. Younger and growing rapidly, it was still a decade away from its climactic and catastrophic bubble peak. This is where China is now…

They argue that the bubble will inflate when China liberalizes its currency. It’s already taken a lot of steps in that direction (settling cross border trade using Rmb, issuing Rmb bonds, listing wholly foreign stocks on the Shanghai exchange). Full convertibility may only be several years away: at that point the Rmb appreciates vis-a-vis the USD, to around 3-4Rmb per dollar. The argument is that money is flooding into China during this period, sticking to anything that looks remotely like an infrastructure project.

There are good reasons to be concerned about China within the next 20 or so years, but very few of them are because China bears any sort of similarity with Japan. From an American perspective the narratives are perhaps analogous purely due to the notion that ‘upstart liberalizing Asian country may overtake U.S. economic hegemony.’ That’s it, and it’s a rather ethnocentric viewpoint (SocGen analysts should be French?) They do point out important demographic trends, but this too is analogous with much of the rest of the world.

The two competing notions present within media discourse, 1) an overheating China destined to implode and 2) inevitable rise of great power are both oversimplifications, and not necessarily mutually exclusive, especially depending on your time scale and degree of geographic specificity within China.

… Shares in dozens of other companies sell for two, three or even four times as much in Shanghai or Shezhen as they do in Hong Kong. The average sells for 42% more…

Chinese real estate, already at lofty levels, has risen alarmingly fast lately… average home prices in some cities on the mainland, such as Shanghai and Shenzhen, may have risen by more than a quarter since the start of the year. That may leave average prices in relation to household incomes higher than they are in New York, London, San Francisco and Sydney.

… The Chinese economy continues to grow — it expanded by 7.9% in the second quarter – the real juice, as usual, has come from easy money.

Bank lending is at high levels. The Chinese government has embarked on a $586 billion stimulus plan that includes giant infrastructure projects to keep the economy rolling. Interest rates are low: Since last September the typical three-month deposit rate has fallen by about half, to 1.7%. So mainland Chinese investors are looking for other ways to grow their money.

Capital restrictions make it difficult for that group to invest abroad, so lot of their money has flooded into real estate and the “A” shares…

Research Reloaded notes:

The government may fear the potential repercussions of deflating asset prices in the short term so much that they are willing to ignore the longer term consequences of fueling asset prices further. Fair enough, sounds like standard human nature when it comes to politics and just today Chinese officials have said they will investigate price gains but won’t cap new lending.

Katsenelson ups the ante and explicitly suggests deflation as an inevitable likely future scenario:

It appears that deflation is a more likely scenario as China is ridden with overcapacity – the country was geared for much higher global growth… in the long run, inflation appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.

Prior to the crisis, the central government was largely worried about ‘hot money’ inflows caused by high interest rates that couldn’t be altered due to the currency regime – allow the currency to appreciate, ‘hot money’ inflows would cease, and exports would fall. It seems they are in a similar sort of bind now – Chinese investments have long been cheap (even from a Chinese perspective) due to the exchange rate. Some of these commentators have pointed out that now China’s export machine lacks the security net of growing global demand, a-la 2003-2007, and so the eventual bubble pop is going to be even worse than had it occurred in 2008, at the peak of the global recession.

The optimist says that China’s domestic demand can pick up the slack – the pessimist notes that most domestic consumers are more price sensitive than their European and American counterparts, purely due to lower average incomes, but also the ‘cultural element’ I’ve argued previously. Personal opinion: there is a lot of pent-up demand for apartments, cars, air conditioners, washing machines… and evidence to support that increases in income are plowed directly into these products. However, if incomes stagnate, they are also much more quick to substitute out of such ‘necessities.’ There are extremely active second hand markets for all sorts of things, all the way down to half-smoked packs of cigarettes and half-empty bottles of liquor – the point being that decreases in income at any level will affect consumption patterns throughout a larger part of the distribution for just about every type of consumer good.

As a result of this (and numerous other factors I’m not smart enough to note), the notion here therefore seems to be manage this transition away from export reliance as slowly as possible – and why not? For the time being, they have a very deep bowl – let us hope the punch is not spiked. [Sorry to torture the metaphor. In reality, punch spiking isn't really practiced here - 白酒 doesn't mix so well. Need to work on cross-cultural allegories: 'the tea leaves are muddled - let us hope we do not misinterpret.' No...]

The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments (with no need to roll over existing debt for a decade) could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them. In the real world, of course, governments roll over their debt on a very frequent basis. As a result, governments are vulnerable to higher debt service costs if market interest rates change. If markets move to price in the consequence of higher inflation by raising nominal interest rates, then the debt service cost will rise and increase the debt. Thus a period of high inflation will tend to raise both the numerator and the denominator of the debt: GDP ratio.

That makes sense. Meanwhile, Andy Xie, former former Morgan Stanley analyst (via Ritholtz) says China is “one giant ponzi scheme,” that will come crashing down as soon as U.S. interest rates go up:

While China is experiencing weak exports now, the weak dollar allows China to release the liquidity saved up during the boom in the past five year without worrying about currency depreciation. How far would the bubble go and for how long?

It is not too hard to understand when the bubble would burst. When the dollar becomes strong again, liquidity could leave China sufficiently to pop the bubble. What’s occurring in China now is no different from what happened in other emerging markets before. Weak dollar always led to bubbles in emerging economies that were hot at the time. When the dollar turns around, the bubbles inevitably burst.

There’s also the notion that a weak dollar is driving commodity prices (again, from Ritholtz). There’s been a lot of fanfare about China’s stockpiles, since metals are more tangible than IOUs. Roubini warns:

“My concern is that China might have accumulated an inventory of commodities that is probably excessive to the growth of its economy,” …

… [China] suffers from real overcapacity. And now growth comes from borrowing — and hundreds of billion-dollar decisions made on the fly don’t inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.

There’s also that pesky issue about declining electricity consumption, which doesn’t quite square with growth in what should be an energy intensive economy. Most construction here is also very labor intensive – infrastructure projects might involve more bamboo and sweat than electricity, at least during the initial phases. Simultaneously, consumers here are cutting back on recently obtained luxuries like air conditioning and lighting, since they are used to living that way. Dubious, but plausible?

Even the locals are restless. This week’s Southern Weekly has a whole section devoted to 中国式复苏能否继续 (‘Can Chinese Style Recovery Continue’), with the following graph showing ‘number of new investment projects’ (black line) and ‘planned investment projects’ (gray line). Unfortunately the available data doesn’t go past January ‘09 – presumably both data points continue climbing:

This notion that every investment project is deadweight needs to be explored further. China is big, underdeveloped, and has such an excess supply of skilled and semi-skilled labor that it might not matter that centralized planning doesn’t work – any infrastructure project will have some positive return… Maybe.

There is some validity to the claim (made by locals) that basic infrastructure needs to come online in order for people to consume more; the classic story is that a washing machine is useless in the numerous smaller cities without reliable power / water supplies. Too often Westerners suffer from a bias of visiting Shanghai or Beijing and extrapolating those conditions for the rest of the country.

That being said, there are huge barriers to overcome. Throwing money at random infrastructure projects in a useless way is just a symptom of the more endemic problems of corruption and regime uncertainty at local levels. Chinese leadership is aware of these, whether they can be remedied in any meaningful way is another matter entirely.

Original article below, highlights translated:

Yin Chengji, spokesperson for the Ministry of Human Resources and Social Security, responded with comments about the situation of university students being hired by fake contracts. The Ministry cannot ignore this problem.

Several university graduates have posted comments on the internet indicating that universities, in order to increase the ‘Recent Graduate Job Rate,’ have spared no effort in giving as of yet unemployed students false contracts, the so-called “forced hiring” problem…

As of July 1st, [according to 'Graduate Employment Rate' measures reported by universities] the nation has 4.5 million 2008 graduates with secure employment contracts, representing approximately 68% of 2008’s graduating class. This is almost identical to the similar period last year.

The Ministry’s research statistics indicate that this year there are 6.1 million graduates, plus 1 million [unemployed from last year] totaling 7.1 million recent graduates in the job market; throughout the entire country at least 3 million have still not secured actual job contracts. The Ministry of Human Resources and Social Security will strive to achieve an 88% employment rate among this years’ recent graduates by year-end.

政府不会放任毕业生虚假签约

针对近日引起社会广泛关注的大学生“被就业”问题，人力资源和社会保障部新闻发言人尹成基24日回应，对于个别高校毕业生虚假签约的情况，政府部门不会放任。

有大学毕业生在网上发贴称，学校为了提高就业率，让没有就业的大学生千方百计获取一纸就业签约，这就是所谓的“被就业”。尹成基在此间举行的人力资源和社会保障部上半年新闻发布会上表示，对于个别弄虚作假的情况，该部将会同教育部等有关部门认真对待和解决，“政府部门不会放任”。

截至7月1日，全国已有415万高校毕业生落实去向，就业签约率为68％，与去年同期基本持平。

数据显示，全国今年有610万名应届大学毕业生，再加上去年毕业未就业生100万人，总计710万人，全国仍有近300万毕业生未实现就业。人为资源和保障部门表示，力争今年年底，实现应届高校毕业生就业率88％以上。

Update: Michael Pettis writes:

I have been writing for three years that unemployment among college graduates in China was soaring, and that authorities were understandably nervous.  So nervous, it seems, that they have been putting pressure on university to do more to get jobs for their graduates by limiting their next-year enrollment to the number of graduates this year with jobs.

There’s an increasingly strong sentiment in China that these funds should be used to benefit the nation, rather than being lent to the U.S. and other rich countries. Premier Wen Jiabao said earlier this week that China should “combine the use of foreign exchange reserves with the ‘going out’ strategy of enterprises” (in Chinese here). That echoed earlier government statements — a deputy administrator at the State Administration of Foreign Exchange, for example, also raised the idea in February of using the reserves to support Chinese companies’ growing outward investments.

There’s a strong notion here that reserve accumulation has only benefitted the U.S. – completely ignoring the fact that much of it was necessitated to support exports with an artificially cheap currency. In the U.S., the sentiment seems ‘the Chinese own us,’effectively  blaming the pusher for whatever cheap debt binges we have engaged in during the last 10 years. This view (Asian savings glut as a major cause of the recession) is overplayed, but it’s certainly an element. People also tend to gloss over the positive effects that cheaper imports had. Sure, consumption is generally less preferable to saving, but certainly some people benefitted as a result of cheaper products / inputs into other manufacturing processes. Whether it was worth the systematic imbalances, and readjustment is an open question.

Niall Furgeson has often said that the ending of this relationship could be caustic, comparing China to Weimar Germany. That more U.S. legislators are not calling for punitive tariffs against China for currency manipulation is surprising; a year ago it only seemed like a matter of time. At this point would it even be possible to encourage Yuan appreciation without being antagonistic? The longer the current system persists, the more useless policy levers will become to U.S. politicians. Whether such levers are appropriate is a different question entirely, especially since tariffs and boycotts would not be well received. Perhaps a social movement to buy less, and live within means? Absurd. Better use tariffs.

… it sounds to me like Chinese investors have the same irrational exuberance that once gripped U.S. markets. No one likes to stand in the way of a runaway train.

On some level, China’s situation could end up being worse than ours: generally our investors bet on bubbles with their own money. In China, that money is coming from government stimulus and loans.

On the optimistic side, the author fails to note that a lot of Chinese are also very similar to us with regards to buying useless, expensive crap. Anyone who rails against conspicuous consumption in the West should take a stroll down one of the more affluent boulevards of a Chinese city. There is also no glory in saving money on something nice – a premium price is worth it’s weight in bragging rights. Credit cards are also becoming a problem. My generation in the U.S. takes materialism as a given, and just as often glorifies potemkin poverty (some of us, anyway). Where is this crassitude-with-Chinese-characteristics coming from? The fact that it’s all very new, for starters – there’s also something about hierarchy in transitional economies… Not quite sure what though. Regardless, there’s still a lot of slack left, at least in terms of what some people are willing to put, and many want to take out.

Considering underutilized ‘consumption capacity’ and the vast amount of underemployment (both skilled and unskilled) the case for ‘dumb investments’ becomes somewhat more complicated. Certain periods of the Industrial Revolution had all the characteristics of a bubble, and the same fundamental factors were at work (large amounts of labor underutilization, and rapid returns to simple investments in infrastructure and mechanization). The context of authoritarian cronyismharmonious socialist society matters, but were we really so different?. Forcing the narrative into a ‘bubble-no-bubble’ lens is going to lead to analytical errors and oversimplification of an extremely complex and interesting process.

Take, for example, the litany of positive indicators:

… Record Loan Addition, Record Money Supply, Record Auto Sales, Record Imports of Copper, Iron Ore, and Coal, Strong Property Sales.”

The above list comes from Vitaliy Katsenelson (The Next Great Bubble: China). His point is largely the same one that Professor Michael Pettis has been making – without a market ready to replace the U.S. and soak up large amounts of exports, China (certain parts of it, anyway) are in for a much rougher time than everyone’s been used to.

On the other side, the only hard evidence available seems to be just that: collapsing exports throughout Asia (and the suggestion that even this trend could be reversing?)

There are of course, other concerns: anecdotal reports of large amounts of unused infrastructure; unclear numbers of non-performing loans (if I understand the situation correctly, all of the State Banks are able to carry commercial loans at book value, even when nothing actually happens with the building. Might this develop / pop analogous to the U.S. bubble? Can they be held long enough to become performing loans?)

Talk to most people here and you’ll get the same response. A street vendor, when asked of his opinion of the global crisis, put it thus: “there are over a billion people here. We don’t need to rely on the U.S. If every one of us buys only a toothbrush from you, you’d be rich.”

Sure – assuming everyone brushes their teeth [or values it enough to buy a new one and maybe forego a meal.] Extreme, crass example – the more nuanced counterpoint, one that Pettis has been making for a long time now, goes something like:

… if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, as it almost certainly will, to a subsequent explosion in non-performing loans, in the next few years just as China is expanding its production and struggling with US reluctance to absorb its rising excess capacity, the resolution of the NPLs will itself constrain Chinese consumption. Resolving future NPLs, in other words, will reduce future domestic consumption growth in China, just as the current resolution in the US of bad loans and shattered household balance sheets must come with reduced US consumption growth.

Why are they pursuing this strategy, instead of trying to wean themselves from the debt-fattened teat of Uncle Sam? It has a lot to do, unfortunately, with the people I spend my mornings talking with, and what they might do if they can’t find work for a long period of time.

The policy reaction to all sorts of problems – from simple things like traffic accidents and internet censorship – to these grand, impossible to grasp concepts, always seems founded on a tacit assumption of palpable fear that the country is sitting on a tinderbox. It’s a sense you don’t get just by watching the news about China, or even living here – though my position is rather privileged at present.

Chinese policy makers must realize the risks they are taking by sacrificing longer term growth for immediate gain. Perhaps there’s no other feasible way. Like my street vendor, they seem to have bought the line (hook + sinker) that 1 billion+ couldn’t possibly go wrong. History, unfortunately, is littered with examples to the contrary.

… Chinese policy makers are caught between a rock and a hard place — as Chinese policy makers cannot choose between different fundamentally conflicting objectives.

1) China both wants to maintain the RMB’s link to the dollar and avoid adding to its already large dollar exposure. Yet so long as China pegs to the dollar and runs a sizable current account surplus, it is hard to see how China can avoid adding to its dollar holdings.**

2) China is torn between its interest as a creditor and its interests as an exporter. China’s commercial interests would be best served by an even larger US stimulus, one that helped spur US demand for China’s goods. China’s reserve managers though worry that the US won’t be able to finance a large stimulus and thus are worried that a rise in Treasury supply would reduce the value of China’s existing Treasuries…

And the Chinese will probably move more of their purchases into treasuries (as a percentage of total holdings) given the sorry state of just about everything else. From my limited perspective, I remain optimistic – then again I’m in the position of holding a U.S. citizenship and am capable in Chinese language. 

So here’s the plan: Put California up as collateral for U.S. Treasuries. Cede California to the People’s Republic if things get ugly (I mean, 1) why on earth do we want to keep it and 2) California already has a very nice Chinese name – it’ll fit right in). Seriously, even in worst case scenario, everyone will be fine. Chinese people are very charming, and life here is so idiosyncratic as to be entertaining. It isn’t *that* bad.