Tuesday, September 8, 2009

The Rise and Rise of China

From the early point in this blog, I have emphasised the importance of China in the world economy, and this view is now shared by the mainstream. China has rapidly moved from being an important element of the world economy into becoming one of the central actors. On a bookshelf crowded with books about China, I have a copy of James Kynge's 'China Shakes the World', a book with a title which many would have taken as poetic fancy at the time of writing. For those of us who actually witnessed the growth of China, it was simply a statement of reality. China was already shaking the world at the time that the book was written, but most of the West had simply not noticed. We are all now paying attention.

In July 2008, I had the following to say for the prospects for the Chinese economy in the economic crisis:

The Chinese economy may, or may not be, at a point where internal growth within China has the potential to take up the slack. Has it yet reached that point? It is very difficult to say. It is a finely balanced point, but the economic growth of the coastal areas is now being replicated in the interior. Can the growth in the interior maintain the momentum of the coastal cities? The Chinese government has huge reserves to draw upon should the economy falter, and may seek to use those funds to further develop the interior of the country. There is also an ongoing and dramatic process of infrastructure investment which may help carry China through the bad times.

Furthermore, China has being making ever stronger inroads into markets such as Africa, and South America. Whilst these can not replace the US and European markets, they may serve to ameliorate the effects of a downturn.

Much as I expected, there was a massive 'stimulus' for the Chinese economy, much of which is directed at the interior. A summary of the stimulus is given by the China Daily:

The Chinese government announced its 4-trillion-yuan ($585-billion) stimulus package in November last year to boost domestic demand and economic growth amid the global downturn. The money will be mainly spent on new highways, railways, housing, schools, hospitals and environmental protection projects.

I have discussed in many posts the change in the balance of the world economy, always with China in mind. For example, in an article in TFR magazine, I used the example of the SUV and Tata Nano to illustrate the changes in the distribution of consumption that would flow from the crisis. However, I had not guessed that China would actively encourage such changes. Just one aspect of the stimulus has been the subsidy of car purchases, and the result of the policy has been widely reported:

Sales of cars, sport-utility vehicles and multipurpose vehicles, rose to 858,300, the China Association of Automobile Manufacturers said in a statement today. Sales fell 6.2 percent in August 2008 as the Olympic Games damped demand.

This year, a 4 trillion yuan ($586 billion) stimulus plan has shielded China from the global recession, helping car sales jump at least 45 percent for four months in a row. Full-year sales of cars, trucks and buses may hit 12 million, the government said last week. Surging demand helped Geely Automobile Holdings Ltd., China’s biggest privately owned carmaker, to double profit in the first half.

Alongside the stimulus measures, there has been a massive surge in bank lending in China, underpinned by government policy. However, the massive growth in lending is widely believed to have fuelled a stock market and property bubble within China, such that the Chinese government is now seeking to reign in the expansion:

China will study the use of “regulatory tools” to adjust bank lending after the nation had a record 7.37 trillion yuan ($1.1 trillion) of new loans in the first half, a deputy central bank governor said today.

The People’s Bank of China will “study use of regulatory tools to adjust banks’ lending activity,” Deputy Governor Su Ning said at a forum in Shanghai, without elaborating. China’s central bank will also “emphasize” monitoring of asset price changes and watch international capital flows, he said.

China’s record credit expansion, which helped economic growth rebound to 7.9 percent in the second quarter, also raised concerns that bank loans have been diverted and used to buy shares and real estate, fueling gains in stock and property markets. Benchmark shares, which gained 57 percent this year, are in “deep bubble territory,” according to former Morgan Stanley Asia economist Andy Xie.

The China Banking Regulatory Commission will take “effective” steps to prevent bank loans from being diverted to the stock and property markets, the China Securities Journal reported today, citing Wang Huaqing, the regulator’s discipline chief. Banks that fake loans and earnings reports will also face harsher punishments, the report cited Wang as saying.

What we are seeing is that the Chinese appear to have learnt the lessons of the economic crisis, and are seeking to avoid lending being diverted into asset price bubbles, though it is quite possible that the action is too late. I was in China in 2007, at the time of another surge in the Chinese stock market, and witnessed the mentality of investors first hand. Many people I met were playing the stock market, and were being amazed at how much money they could make. They congratulated themselves on how smart they were, without realising that a monkey could have picked stocks and still seen them rise.

Likewise, with property, it was possible to see huge numbers of brand new apartment buildings, but at night there would be no lights on in the building. What was happening was that individuals were investing in property, and leaving the apartments empty in the expectation of sale at a later profit (in China, once an apartment has been lived in, the value falls). Large numbers of shopping malls were being built, but whether there was sufficient demand for the expansion was questionable.

In this case, I am reporting what was taking place in 2007, and it is not clear that the situation is the same this time. However, I suspect that the situation is very similar, and that there are problems on the horizon, in particular now that China is taking its foot off the credit accelerator. Recent volatility in the Chinese stock market may only be the start, as the degree of irrationality of Chinese investors makes even Western investors appear rational. This, in conjunction with the opacity of information, makes the Chinese stock market a genuine casino.

Despite the surge in interest in China, problems remain in having a clear understanding of China, such as the opacity of the information of what is actually happening in the country. Figures are massaged and manipulated, governance is hidden behind a wall. Even when there is an announcement of import, it is often made by a proxy for the government, such that the government can float an idea whilst still being able to deny it as policy. It is hard to be certain of what is, and is not, happening in the Chinese economy.

A good starting point for consideration of the underlying Chinese economy is the level of activity within the economy. The official figures for this are widely viewed with suspicion, such that it has now become commonplace for electricity usage figures to be used as a proxy for the level of activity. This is a report from August by AFP:

Power consumption in China rose for a second successive month in July, official data showed Friday, giving more hope that the world's third biggest economy is recovering from the global slump.

The six percent year on year increase, released by the National Development and Reform Commission, followed a 3.8 percent lift the previous month.

Before June demand had been falling continuously since October, according to previous media reports citing government data.

Despite the rise, electricity use in the first seven months was down 0.9 percent from the same period a year earlier, the commission, the nation's top economic planning agency, said in a statement.

The commission gave no reason for the recent increase but it came at the same time as a rebound in the industrial sector, which consumes more than 70 percent of the power in China.

Industrial output -- a main gauge of activity in plants across China -- rose 10.8 percent in July from a year earlier, the National Bureau of Statistics said this week, on top of a 10.7-percent hike in June.

Such figures do suggest a major perking up of activity within the Chinese economy. The question is how much of the activity is built upon the government's stimulus to the economy, and high risk credit expansion?

In the meantime, Chinese exports, the driver of Chinese growth are starting to stabilise after the major contraction that followed the commencement of the economic crisis:

Chinese exports fell less sharply in August from year-earlier levels than the 23 percent drop seen in July, as the overall outlook for overseas shipments improved, a top customs official said on Monday.

Li Kenong, vice head of the General Administration of Customs, also told Reuters that exports grew in August on a month-on-month basis. He declined to give specific figures.

"From the recent months' figures we can say that China's exports will definitely become better and better over time, but it is still difficult to judge when it will turn to positive growth," Li said on the sidelines of a news conference.

The comments underpin optimism that, even though net exports will probably exert a negative pull on gross domestic product growth this year, the extent of the decline is easing as demand stabilises in Western countries.

So where does all of this leave the underlying state of the Chinese economy? The first point is that, unlike countries like the UK and US, China can afford the fiscal stimulus, and there are projects that can actually be funded with some purpose. China does still need more infrastructure, and the country has the savings and resource to fund this. With regards to property and the stock market, these do present risks on the horizon. However, having said this, if China can stabilise and recommence growth in exports, this would limit the problems that might arise.

As many readers will be aware, China now has somewhere in the region of $US 2 trillion of reserves, with a third of the reserves held in US treasuries. What we are now seeing is that China has the power to make or break markets. It was apparent that this would be the case some time ago, and I wrote the following in a post a long while ago:

The key difference that arises from such scale is that China has the potential to massively impact upon any market with which it is involved. The sheer size of their reserves means that they can swing any market up or down according to their actions. Aside from this difference, which requires a circumspect approach from China, I would probably find myself having made the same recommendation that I made to individuals nearly a year ago. This was that gold was the best prospect and an asset that might survive the turmoil (though I offered many caveats to this advice, as I am not an investment advisor).

We are now seeing that effect actually playing out in the gold market. This consideration from a report in the Telegraph, from a Chinese individual who is described as a roving Chinese economic ambassador:

“Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market,” he said.

In other words, China is buying the dips, and will continue to do so as a systematic policy. His comment captures exactly what observation of gold price action suggests is happening. Every time it looks as if the bullion market is going to buckle, some big force steps in from the unknown.

The massive holdings of treasuries have been a topic that I have discussed at some length in many posts in the blog. In one post, I speculated that China would seek to quietly offload its store of treasuries, doing so whilst not alarming the market and destroying the value of all of their $US holdings. In order to do so, I suggested that they would shift their holdings into other assets, and seek to embark on a shopping spree:

I mentioned at the start of the post that gold represented a good opportunity for China, but there are limits to how far China might take such a policy. The same might be said for other precious metals. However, it does seem quite likely that precious metals will play a larger part in China's overall mix of assets. This still leaves the central problem of what else China might move into, if it moved out (is moving out of?) of US treasuries? The same analyst who points out that China can not shift into gold, also argues more broadly that there are no credible alternatives to US treasuries.

However, the analyst makes a basic error in thinking that China would have to take an all or nothing approach. He does not consider that China might spread their reserves over a wide range of assets, and this is my best guess for the direction of China's policy. If they follow this strategy, and implement it with care, China has the potential to rapidly jump towards becoming the world's most powerful economy.

The first step is to manage the sale of US treasuries with the greatest of care, such that they gain as much value of the sales as possible before the $US collapses. As they move out of $US they would likely buy as many precious metals as possible without driving the price too high, as well as buying into emerging market, European and Japanese bonds. In doing so, they will be taking risks but with the benefit that they will be positioning the RMB as the next reserve currency. Furthermore, it is no secret that China has been trying to buy into various commodity companies (or natural resource companies), such as the ongoing saga of the Chinalco purchase of Rio Tinto or their wider expansion of investments in this sector.

If you have time, I might suggest that you read the post in full. Since writing the post, much of what was then speculation has become reality. The only missing element is the collapse of the $US and, as I have detailed in previous articles, the $US is looking ever more unstable. My expectation is that, as the $US collapses, China will go on a shopping spree in which, in the economic chaos, they will seek to purchase key companies at bargain basement prices. In doing so they will leap frog up the technology hierarchy.

Another element of the consideration of China's economic ambitions has been an ongoing subject of the blog. This is the ambition of China to replace the $US as the world's reserve currency, a suggestion that was widely considered to be impossible at the time that I started writing about it. In a series of articles, I have followed the tentative moves towards this goal. In July of this year, I pulled together many of the points made in previous posts, and provided an update on the progress of China towards their reserve currency goal. Once again, you may wish to read the post in full, as I will just quote a couple of sections here:

I have long argued that China is using the idea of an SDR reserve currency as a stalking horse. In positioning the SDR as the replacement for the $US, China can engage the support of other countries like Russia, India and Brazil, who might blanch at the prospect of the RMB as the reserve currency (e.g. see here for discussion of support for the SDR in relation to India and Russia).

The underlying reality behind the challenge for reserve supremacy is that China is increasingly the linchpin in the global financial system. Whatever China does with its massive reserves quite literally shapes the world financial system. China quite literally has the power to make or break any asset or any market, as can be seen in the attention paid to every utterance from China regarding the $US. When a country has such economic firepower, it is puzzling that anyone might suggest that it is not ready to take on the role of a reserve currency. I can only assume that many analysts are taking the SDR stalking horse seriously, and are not considering the vacuum that will be left when the $US finally collapses under the weight of quantitative easing and fiscal profligacy.


The only question marks that remains over the RMB as a reserve currency are largely to do with whether China can continue the present economic momentum, and the timing and nature of the collapse of the $US. When I first wrote about China for the blog in July 2008, I highlighted the risks for China, but concluded that on balance I favoured the view that China would emerge in the ascendant in the economic crisis. Whilst still issuing a note of caution, the developments since that time are even more favourable for China. With regards to the collapse of the $US, it is quite astounding that it has defied gravity this long.

As the current situation stands, the RMB is looking very much like the new reserve currency, and it is not going to become the reserve currency in ten or twenty years time, but in the near future. It may be that SDRs will be implemented as a reserve on a temporary basis during the transition, for long enough for China to satisfy the aspirations of the other supporters of the SDR. However, unless China's ascent is halted (e.g. through civil unrest), it is almost certainly going to succeed in the ambitions for the RMB.

The latest news appears to confirm China's ambitions. This is a recent report from the New York Times:

The Chinese Ministry of Finance said Tuesday that it would issue 6 billion yuan worth of government bonds in Hong Kong, a major step to internationalize its currency at a time of concern about the dollar.

The yuan bond issue, the equivalent of $879 million, will “promote the yuan in neighboring countries and improve the yuan’s international status,” the ministry said on its Web site.

“The first step toward internationalization is regionalization,” Shi Lei, a currency analyst at Bank of China in Beijing, said during an interview. “China wants to develop the offshore market in Hong Kong.”

What appeared to many analysts as an impossibility, the replacement of the $US by the RMB, is fast moving towards a real possibility. One interesting speculation is that the move by China to accumulate gold might be the first steps towards a gold standard RMB, but I would reemphaise that this is nothing more than wild speculation at this stage. However, in the coming currency chaos, such a move would absolutely secure the status of the RMB.

The last element in the consideration of China is the mercantilism that is the centre of Chinese economic policy. I have detailed the many mercantilist practices of China, and have railed against the acquiescence of the West to such policies. Their manipulation of the RMB, various trade barriers, and disregard for intellectual property have been common themes. I will not re-state the points made in previous posts, but simply point out that China has been playing to its own rules, and those rules have been mercantilist in approach.

I have covered some considerable ground in this long post. Even so, bearing in mind the complexity of the situation in China and the role of China in the world economy, the post has only brushed over the subject. It has also not considered the ongoing risks for China, which have been detailed in many previous posts. In particular, there is a risk that, if the Chinese economy does at some stage suffer a severe contraction, there are significant risks of major unrest within China. Whilst I have emphasised this in previous discussions, I am now less convinced of the risks. Yes, there are question marks about what might happen with any further collapse in exports, if consumption in the West contracts further. Yes, there are potential problems when the stimulus recedes and lending is tightened.

However, the record of China to date suggests that they have the potential to ride the coming storms.

Having followed the progress of Chinese policy, it has become ever more apparent that they have been playing the 'great game' to win, and that they have played their hand beautifully. It is impossible in one post to convey how they have achieved their current position as the preeminent actor in the world economy. I find myself with a grudging admiration for the way in which they have positioned themselves, and find a measure of contempt for the politicians in the West who have allowed China to play the game so effectively. As the current situation stands, we are witnessing the shift of economic power from the West to the East, with China emerging as the world economic super power.

At this stage, such a rise by China is still not guaranteed, but as each month passes by, the probability of their success appears to be growing. It looks like the 21st century will be the century of China, and that the 'great divergence' described by Pomeranz is coming to an end (note 2). China is returning to its place as the centre of the world.

Note 1: I have listed below links to some previous posts on China. As you follow the posts, it may be apparent why it is that I have become increasingly confident that China will be so central to the world economy in the future. Within the posts it will be apparent why I have so much confidence in the success of China.

  1. July 2008, China - What Future?
  2. August 2008, China Propping up the $US
  3. January 2009, Free Trade 'Yes' - Mercantilism 'No' - Why China Should be Shut Out
  4. January 2009, The Myth of the Eternal Status of the $US as 'the' Reserve Currency
  5. February 2009, China's Pivotal Role in the Next Step for the World Economy
  6. Fenruary 2009, China and the US - Fighting on the Edge of a Cliff
  7. March 2009, Economics and Power, the Loss of US Power
  8. March 2009, China, Gold and the $US
  9. April 2009, China as the World Economic Power?
  10. April 2009, The RMB as the Reserve Currency
  11. May 2009, China, the RMB and the $US
  12. July 2009, The RMB as the Reserve Currency - an Update
There are many other posts that discuss China, and these can be found here (a search against the word 'China' on the blog). As I have mentioned, I have seen China as being a vital part of the world economy for a long time...

Note 2: I am not convinced in all respects about the arguments put forward by Pomeranz in his book on the 'Great Divergence'. However, he is correct in identifying China as having a consistent history as an economic powerhouse, and that the divergence from this role with the rise of the West was an exceptional event (or series of events).

Note 3: I was provided with many links to assist me with this article, when I proposed writing it. I am very grateful for these, and one of particular interest is the prospect of China defaulting on derivatives contracts. I wanted to use the article, but simply ran out of time/space. I would, however, suggest it as an interesting read. It is rather puzzling.


  1. I forgot to mention that the many links against the last post by Lefty Feep were not (his description) link spam, but were all very interesting.

    I also noted the very interesting post by an anonymous poster on SDRs. This is a very interesting subject, and I may take a longer look at this in the future.

    Lord Keynes points to the risks of bubbles in China and suggests controls on capital. My answer is that the only solution is the fixed fiat currency I have discussed in a previous post.

    Another poster has linked to China's possible restriction of supply of certain metals, and this is just a further case of Chinese mercantilism that I have discussed previously. The link can be found here.


    Carl: A tough question, but one which I think has been covered in the blog in the early stages of the bank bailouts. I would have let them fall, and taken the short, sharp pain that followed, along with the risks of social unrest. It is difficult to summarise what I discussed over many posts, but I was always against the bailouts. Time will show whether I was right or wrong.....

    The Rational Martian: GDP as a measure is a problem with ongoing current account deficits and net borrowing. My solution to these problems is in the fixed fiat currency system that I have discussed in another post. However, GDP is even more flawed than I have discussed previously. In essence, economists are trying to measure something which can not be measured. They are mistaking what can be measured for what is actually taking place. A fundamental problem. I would like to detail why, but it is a very complex argument which I will need to leave for another time.

    I will leave the responses to comments here, but would like to express my appreciation for the many links. I would like to comment more, but time has run out....

  2. Some Comments on The Rise and Rise of China

    The early part of your post illustrates many of the points I have been making: that (1) Keynesian economic policies and (2) financial regulation and capital controls are effective policy tools. China has used, and is now using, both: the stimulus (which is Keynesianism) and (2) financial regulation. Your post concedes that they are working. For instance:

    What we are seeing is that the Chinese appear to have learnt the lessons of the economic crisis, and are seeking to avoid lending being diverted into asset price bubbles, though it is quite possible that the action is too late.

    So you are conceding that these regulatory tools can be effective? That we could have used them in the West as well in the 1980s and 1990s? That we could have avoided the asset bubbles that brought on the 2008 crisis?

    Lord Keynes points to the risks of bubbles in China and suggests controls on capital. My answer is that the only solution is the fixed fiat currency I have discussed in a previous post

    Actually, it’s not me, but policymakers in China and Asian governments turning to tighter controls on capital inflows, the very policy that could also have been applied to the West to stop excessive East Asian money from causing assets bubbles here.

    See my blog:


    In the case of China, they may tighten capital controls which they already have.

    The last element in the consideration of China is the mercantilism that is the centre of Chinese economic policy. I have detailed the many mercantilist practices of China, and have railed against the acquiescence of the West to such policies. Their manipulation of the RMB, various trade barriers, and disregard for intellectual property have been common themes. I will not re-state the points made in previous posts, but simply point out that China has been playing to its own rules, and those rules have been mercantilist in approach.

    In fact, the West used much the same mercantilist methods to become rich in the 19th century, with tariffs and protectionism as the main tools. What has happened is that from the 1970s onward neo-liberalism and the obsession with free markets has infected the policymakers and governments of Western countries.

    It is free market and free trade fanatics who have destroyed the US and the UK industrial economies, not Keynesian policy makers or state interventionists.

    One exception is Germany which still uses industrial policy and (surprise, surprise!) still has a remarkable industrial economy with trade surpluses (so much so that it even gives the whole EU a trade balance!).
    The US and the UK could rebuild their industries and economies, but it will be post-Keynesian economists who will do it, not advocates of laissez-faire or Adam Smith.

  3. ...I was always against the bailouts. Time will show whether I was right or wrong.....

    I don't think it will. Allowing Lehman Brothers to go to the wall has already been written into history as a prime reason for the recession, and whatever happens in the future will not change that. If things get worse it will just be taken as further proof of that 'fact'.

    Even now, the cause of the Great Depression is assumed, by most people, to have been a lack of boldness in public spending, and it is impossible to prove otherwise, regardless of it having happened 80 years ago.

  4. Steve Keen has an interesting new post on DebtWatch using the data of Barry Eichengreen and Kevin O’Rourke:

    So “green shoots”, or selective reporting? There is no doubt that the immense government stimulus packages across the world have slowed the rush into Depression. But the force that caused the crisis in the first place—excessive private debt accumulated in a Ponzi Scheme laundered through share and house-price bubbles—is still with us. Until that debt is addressed, the downward rush of deleveraging is likely to resume as soon as governments wind back their spending in the false hope that the crisis is over.

  5. Thanks CE.

    I come here to read the good analysis by yourself, but also for the conversation between your commentators, so I usually only post a quick link so as not to interrupt the flow. I just felt that since I had so much information to convey I was hogging the thread a little. (not to mention the few hours it would take to read all the links)

    When I read about China reigning in bank lending, I had a flicker of hope that they might actually be coming off the "bubble things up and expect thing to get better before it bursts" path of the western powers. It will be interesting to see if they can manage it and if it will teach the west anything.

    I must admit than when I heard of China threatening defaulting derivatives I hadn't time to read about it, assumed it was real estate derivatives and thought was a bluff as that bubble is too big to start a panic about defaults on.

    On realising it was commodities derivatives it seemed more credible, as while it would still set a dangerous precedent, the damage could be contained to some extent.

    The link I posted last article set the stage and showed the players - big names like Goldman and JP Morgan vs several Chinese state owned firms who rely on the price of oil.


    The follow up post


    went into more detail, showing how several firms were advised (by goldman and others) that oil would soon goto $200 so they bought derivatives to hedge against that event.

    As we know, the oil price plummeted and those contracts were a problem for the firms that bought them. In October of 2008 Nanshan Power brought the legality of the derivative into question - In December it terminated the contract and Goldman didn't contest it - As the article states this is a precedent for the newest Chinese threat, it didn't come out of the blue.

    In short the threat seems quite credible - it is well known that China is buying into commodities in a big way - it is now seeking ways to protect it from predatory firms speculative instruments.

    I do not think you could have done it justice as a few paragraphs in this post CE, a post would be appropriate a little later when more information comes to light or news of actual defaults happening.

    With regards to SDR's and Chinas wish for a new reserve currency (preferably it's) I have heard you state a few times that China has been talking up SDR as a new reserve currency. Presumably as you say, as a stalking horse to position its own currency instead.

    What if they are too successful and the SDR or similar IMF instrument got its way and became the reserve? What would that do to the balance of power (apart from making Alex Jones and his fans go horse from screaming about the NWO taking over)

    Also of note is that the UN is itself calling for a new reserve currency.


    While trying not to be too cynical, the IMF and world bank are are of the same breed of bankers that preach "free trade" which practises favouritism to certain countries while allowing others to be despoiled. Will the same problems of globalisation carry on regardless?

    Knowing that you are are of a libertarian bent CE, I'd just like to point out that I think your view of the free market can work well on a local level - provided that large monopolies cannot take over and capture the financial and government sectors. But globalisation is just a double-speak for raking most of the worlds worth to the big boys.

  6. The_Rational_MartianSeptember 10, 2009 at 7:57 AM

    CE,thanks for your response.

    While a fixed fiat currency system has its salient points, we don't have such a system now, but society still deludes itself using flawed and incomplete GDP figures. Can you suggest a methodology for presenting the true picture at this time, not in a hypothetical perfect world?

    On another topic, while I subscribe to libertarian principles myself, it has to be said (and Lord Keynes has) that the free market system of the West has shown itself to be spectacularly incompetent at optimal resource allocation. The state directed system prevalent in China may not remain prudent over the long term, but it has definitely come out on top this time round.

    This raises an interesting point as to whether free markets (and maybe freedom in general?) is the best way forward in a society composed mostly of dim individuals with a herd mentality and incomplete information. Is it better to leave the important decisions to a few scholars?

  7. I am not sure that China wants the RMB to replace the USD as the world's reserve currency. The speech by Zhou Xiaochuan in March 2009 clearly indicates this.


    "Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries' demand for reserve currencies. On the one hand,the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities��on the other hand,they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists."

    I maybe naive, but I feel the statements that are now coming out of China are far more honest and believable than the trash that emanates from the forked tongues of the short term profit/election seeking western scoundrels. The Chinese, wherever you meet them, are, without exception, interested in long term stability and prosperity. This is diametrically opposed to the millisecond mentality of Goldman Sachs and their damn trading computers.

  8. Anonymous:

    Many thanks for a very interesting comment. I would not be so trusting in the statements of official Chinese policy statements. For example, they have spoken of a 'peaceful' rise of China, but are now developing a blue water navy. A blue water navy is for power projection, not for defence.

    With regards to the Triffin dilemma, I do not believe that the same problem was apparent with £sterling when it was a reserve currency, but I am open to correction on this. In the meantime, it appears that China is accumulating bullion, and this (as I have speculated) might mean a future gold standard currency.

    The Rational Martian:

    I am sympathetic to the views that you are expressing, as many share them. However, I would contest that anything like a free market has existed at all. I wish I had kept the link, but I saw an excellent article about 6 months ago which listed all of the regulation and intervention roles of just the Federal Reserve.

    This is just one agency, but if you add them all together, then there is no way that you can call anything that has happened 'free market'. As I pointed out in my post on banking reform, the emergence of securitisation was a direct response to regulation, as were the emergence of SIVs, and this is taken from a Bank of England paper. I could go on....

    Then there are examples like the Japanese QE pumping liquidity into the US, the Chinese currency manipulation and so forth...

    In this respect, I share the views of the Austrians, who quite rightly point out that there is the use of smoke and mirrors to distract from the role of central banks in this crisis. Without such manipulations, without the Basel framework, a minor crisis of adjustment instead of a disaster.

    Lefty Feep:

    Thanks for the update on the defaults. I will keep an eye out on this story. I find it somewhat puzzling, as I have mentioned.

    With regards to SDRs, I can not see how they might become a genuine reserve currency. I will try to post on this to explain why in the future, as this takes considerable explanation.

    Whilst being of a libertarian bent, as you put it, I diverge with the Austrians and Libertarians on regulation of business size and share of market. I do believe that there is a role for this kind of regulation.

    However, minimising government involvement in business also minimises the ability for particular companies and organisations to co-opt government, and avoids conflict of interest, and revolving doors between business and government.

    The recent articles on Goldman Sachs illustrate the problem with too much government intervention, with government agencies increasingly dominated by commercial interests.

    As for globalisation, this is a problem if you take a nationalist perspective, but not if you take an internationalist perspective. Having witnessed Chinese growth first hand, I have seen the difference that growth resulting from globalisation makes. As I once asked an individual, would you be willing to stand at a village road and turn back poor Chinese peasants seeking a better life in the cities?

    However, the entry of such peasants into the labour market increases the supply of labour, and that impacts on the value of labour broadly. If you are a sheet metal worker in the UK, for example, you are faced with new competition. Whilst your wages go down, the peasant who has moved into the new factory sees an improvement in their earnings. This is redistributive.

    Is this a good or bad thing? That, as I have said, depends on whether you take a nationalist perspective.

    I will try to respond to the other comments later, if I have time.

  9. Response on Globalisation and China

    As for globalisation, this is a problem if you take a nationalist perspective, but not if you take an internationalist perspective. Having witnessed Chinese growth first hand, I have seen the difference that growth resulting from globalisation makes. As I once asked an individual, would you be willing to stand at a village road and turn back poor Chinese peasants seeking a better life in the cities?

    You can’t point to China’s success as proof of the orthodox policies of globalisation, because China simply doesn’t follow those policies.

    How can a country with capital controls, state-owned banks, a fixed currency, a large state-owned industrial sector, subsidies to key domestic industries, huge non-tariff barriers, a very cautious and protected trade policy, an activist industrial policy, and (now) a massive Keynesian stimulus package be an example of the success of globalisation!! [as an aside, take a look at why China’s steel industry dominates the global market . It wasn’t through globalization!; I would also note that one of the keys to the success of China’s stimulus is that the major banks are state-owned and can simply be instructed by the state to expand lending, unlike private banks in the West].

    In short, Chinese peasants are not flooding to the cities because of globalisation at all, but because of policies that are the opposite of what we call globalisation.

    Furthermore, if you want an example of the real effects of orthodox globalisation, take a look at the catastrophe it has produced in Latin America, the Caribbean, and Africa.

    Argentina is the result of pure neo-liberalism or globalisation, not China.

    There are, of course, two factors that have been important in the rise of China: (1) Foreign direct investment and (2) international trade.

    But, in fact, an international system of Keynesianism, financial regulation, controls on short-term capital movement is perfectly compatible with long-term foreign direct investment and increasing international trade, just as it was in the Bretton Woods era.

    It is a complete myth that Keynesianism, industrial policy, controls on the flow of “hot money” and state intervention cannot exist alongside strong international trade.

    Nobody is asking “poor Chinese peasants seeking a better life in the cities” to turn back.

    And, most extraordinary of all, you seem to have neglected to mention that the huge export-led growth model which employs so many peasants (which you also partly blame for the de-industrializing of the West) is not really sustainable in the long term. An alternative Keynesian/social democratic system of providing free or cheap medical care, pensions, education, and social services would free up domestic Chinese demand to consume goods made in China, so that internal consumption can be the engine for growth.

    And doing that would have nothing to do with globalisation, which demands the relentless privatisation of social services – one aspect of neo-liberalism that China did follow, but is precisely what has harmed its domestic growth and its people so much.

  10. More on China's rejection of globalization and free trade:

    “The Chinese [regime] employs direct and indirect subsidies such as grants, interest loan subsidies, debt forgiveness and tax concessions to prop up state-owned enterprises, introduce new technology and expand or build new capacity." .... At the end of 2006, a state decree ordered that the state would maintain “absolute” control over SOEs that were deemed critical to national security and economic livelihood: defense, electric power and grid, petroleum and petrochemical, telecommunications, coal, civil aviation, and shipping.
    .... If the Chinese regime wants to compete in a certain market dominated by the United States or other foreign countries, the state will designate that industry as “pillar,” and then the state will provide subsidies and pay for R&D.

    China’s Industrial Policies Hurting U.S. Industries and Workers .

    Finally, the Americans are realising that they need an activist industrial policy as good as China's.

  11. While the official line is not 100% clear on the defaults and the links I provided (by the authors own admission) are only conjecture based on what evidence is available, circumstantial or otherwise, I think there is increasing evidence of protectionist measures, between China and other countries.

    The following link is a good summation of recent examples. Minor mostly, but the general background does not paint a picture of rosey trade relations


    The SDR as a reserve currency doesn't feel right to me either - I have heard it mentioned elsewhere but have the nagging feeling that myself and others have confused China talking about needing a new reserve currency, while mentioning SDR's and getting them mixed up as meaning the same - any explanation that shows they are different would be helpful.

    I think we will have to agree to differ with regard globalisation and regulation. I have read too many discussions between yourself and Lord Keynes and others to think I could change your mind about things - especially as I am more focused on psychological dynamics than economic theory.

    I do understand your points, but I feel there are other explanations that could point to what has happened and what could be done to help stop it happening again.

    your question - would you be willing to stand at a village road and turn back poor Chinese peasants seeking a better life in the cities?

    I would not turn back anyone - it is their own decision for good or ill. But I would educate them of the risks they could be heading into, that they could end up poorer than they are now physically, mentally and spiritually, as well as economically due to the dangers of the city, what they could lose when they leave the farm and how what they hope to gain might not end up being what they get.

    Point out that those who are there are apt to treat you well when you are in their favour and useful to them and discard you when you are not.

    In short - treat them like adults and let them make an adult decision based on risk vs reward as a pose to the fantasy that the capitalist system portrays of plenty for those willing to work - (and ignoring what happens to the losers) If they understand that that dream is just an advertisement and are willing to take the risk then send them off with good wishes, otherwise let them think a little more about if they really need to go there or are just lured in by glittering promises.

  12. The Chinese rulers must be fretting with the rising tide of opinion putting them firmly at the head of the superpower serpent. They must fear the limelight revealing their version of sleight of hand governance, bringing about the downfall of their own house of cards; as the furthest West of the Western consumer looks inwards and cancels their subscription to the Eastern tupperware party.

    Romford DOC: -

    CE. I did buy it, but now i'm not so sure. I am sure I firmly believe that all view's are worthy of consideration whatever their worth.

  13. UN wants new global currency to replace dollar @ http://www.telegraph.co.uk/finance/currency/6152204/UN-wants-new-global-currency-to-replace-dollar.html

  14. China’s Capital Controls: the Key to Stopping Bubbles

    This report by the Bank for International Settlements shows that China’s capital controls are still effective:

    current official restrictions appear to have effectively limited cross-border flows and thereby segmented onshore/offshore markets. In particular, the spreads between the onshore yield and offshore NDF-implied yield on the Chinese renminbi suggest that cross-border arbitrage has not equalised onshore and offshore renminbi interest rates. This segmentation questions the view that China has no independent monetary policy.

    Are China's capital controls still binding? http://www.rieti.go.jp/en/events/05031901/pdf/5-1_ma_2.pdf

    The destabilizing inflow of short-term capital has been a problem in China since 2005 (and contributed to the stock market and real estate bubbles there), but if you have an independent monetary policy like China you can raise interest rates to cool the economy as a first measure that will be effective:

    If you fear that your economy is growing too fast, and thus inflation is on the rise, responsible central bank mantra dictates that you should raise interest rates .... But this is exactly where the problem lies. If you raise interest rates in an economy open to capital flows, at the same time as the world’s money centers have low or almost zero interest rates, what happens? Almost certainly, you will attract more capital from overseas. This capital inflow will likely feed into your domestic credit boom and further the run-up in asset prices, housing construction, and other bubble-related phenomena.


    Thus with controls on capital inflows and tighter domestic financial regulation, bubbles can be minimised.

    China can do this, and will most probably be able to deal with the large capital inflows it is now experiencing.

    We in the West could have done the same thing to prevent the devastating bubbles that have plagued Western economies since the 1990s.

    All that is needed is to a return to an updated version of Bretton Woods era policies.

  15. A good Denninger article.


    Global shipping has 12% idle ships when they should be in their busiest time moving Christmas goods? Doesn't look like much of a recovery to me.

  16. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.



  17. I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.



  18. A few more links off the topic but interesting.

    "Inflation falls to lowest since January 2005"


    Consumer Price Index (CPI) fell to 1.6% in August, above the consensus forecast of 1.4%.

    The RPI measure of retail price inflation, which includes housing costs and is used as a benchmark for pay deals, stood at -1.3% in August against -1.4% the month before and analyst forecasts of -1.5%.

    A lot more could be said about how this is possibly misleading besides the headline - and check the comments - lot of people complaining that prices haven't gone down in food , leading to questions about how the data is gathered.

    "Unemployment hits highest since 1995"


    And the FTSE still goes up without a waver all day. Do you think they hide the newspapers on the trading floor to avoid upsetting the bulls?

    "U.K. Banks to Post $215 Billion Losses, Moody’s Says"


    An end to boom and bust? transfer the exploding and imploding to the banks instead and let the rest of the economy rot? Strange plan Gordon.

    "US credit shrinks at Great Depression rate prompting fears of double-dip recession"


    "For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said. "

    Debt deflation, massive foreclosures, unemployment, protectionist brinkmanship, over inflated stocks with rats leaving the sinking ship, foreign investment plunging, questions asked about the Dollar as reserve, million or so (depending on who you ask) marching on Washington and is a throwaway news story in most venues, and another million things I could being up that has gone wrong and is not reported either. Sure looks like green shoots to me.

    How longer can they keep pumping it all up with more debt when the consumer is tapped out and deleveraging, or just giving up and walking away because they have seen the banks get away with it. A jobless recovery has been touted, now a consumerless economy?

    Helicopter Bens Magic show is going to make Derren Brown jealous, I mean Derren only faked predicting the lottery, Bennie is trying an even bigger trick with the whole damn economy with an even lamer excuse and the public is lapping it up.

    I wonder if he and others cheerleading will still say they couldn't have predicted it when the whole thing goes bang?


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