Wednesday, November 17, 2010

China's Leadership as Economic Ignoramuses

In early November, the average price of 18 staple vegetables rose 62.4% y/y, according to the Ministry of Commerce, reports Roubini Global Economics.

This is, of course, the result of China propping up the dollar against the renminbi. There is only one way the Chinese were able to do this, by printing huge quantities of renminbi. Now they pay the price.

Bottom line (and EPJ is already blocked in China, so it is easy for me to say) you are really dealing with a Chinese leadership that is a bunch of economic ignoramuses.

Think about it. Domestically they have out-of-control inflation. Their global finance is a mess, since they are stuck with trillions in U.S. Treasury security paper, which Bernanke is, literally, devaluing by the minute.

Just to prove they are clueless, they are about to institute price controls, which suffocate the economy. Since this is China, expect executions of smugglers, who try to get food to the people via the black market once the price controls kick in and cause shortages.


  1. "Just to prove they are clueless, they are about to institute price controls, which suffocate the economy."

    Is this really a surprise? I appreciate they they may have introduced free market reforms but at heart they are still communists aren't they? Now if you were saying the UK and USA were on the verge of price controls that would be different ... but maybe still unexpected.

  2. I am not sure why the attempt to stabilize their exchange rate with the dollar makes them ignoramuses. Certainly they are implementing administrative measures to accomplish this stability, and this is destabilizing prices in the domestic economy, but that was already known to be a problem. They simply made a cost-benefit analysis and concluded the one was acceptable in order to achieve the other.

    Moreover, once the US announced further steps to print money, China realized this would intensify the domestic price problem.

    So, since these were entirely predictable difficulties, what is the real problem?

    China's domestic economic activity is priced in yuan, but its lucrative export sector -- amounting to about one third of the economy -- is, to a very large extent, priced in dollars.

    Very few countries have experienced a situation where a third of all economic activity is superfluous to domestic demand.

    Now put yourself in Hu's place; you have a choice: you either let dollars and euros circulate freely in the domestic economy as currency alongside the yuan (or even dollarize your economy); and, thereby, lose all control over domestic economic policy. Or, you are compelled to incrementally reassert administrative control over the economy.

    In the first instance, the bottom falls out of your export markets, as employment in the US and Europe crash. In the second instance, you gradually generate the sort of shortages typical of a command economy.

    Add this final consideration: for you the entire economy is just one huge company -- a company you control -- and a very profitable company at that. You want to stay in control of that company, just as any other CEO.

    What would you do?

  3. Charley2u,

    Very few countries have experienced a situation where a third of all economic activity is superfluous to domestic demand.

    100% of my investment activity is superfluous to my "domestic demand", every single day, and yet I have no personal economic crisis to speak of. I imagine many/most people find themselves in the exact same situation in your average division of labor economy.

    The problem has nothing to do with what proportion of their economy is export oriented, import oriented, foreign oriented or domestic oriented. The problem they are experiencing is all due to monetary manipulations as a result of utilizing fiat currencies.

    These problems are not unique to China but in fact are present in one form or another in all countries of the world using fiat currencies.

    Pay attention, dude!

  4. Have you ever heard of the fallacy of composition? It goes something like this: I can avoid eating meat and nothing will happen to the meat industry. So we all can avoid eating meat and the industry will not suffer.

    What may be true for the individual is not necessarily true for the whole. So while you and I may set aside a portion of our wealth and not consume it, that wealth is likely to be invested to meet demand in other corners of the economy.

    However, in the case of China, the country as a whole is investing and consuming less than it is producing -- which is pretty virtuous in comparison to the United States of Kleptocracy, but poses a big problem for China.

    China has a serious problem with what to do with all of the cash accumulated. And, since the scale is so unprecedented, it is unfair to simply call them ignoramuses (ignorami? whatever.).

    This is not a feature of fiat currency economies, but arises anytime a national economy consumes less than it produces. And, unless you can offer some evidence, I think it is not correct to maintain that it is the result of monetary manipulation. So far as I can tell, the surpluses accrued long before any manipulation took place.

    But, all this is aside, since the question is what do they do about it. They don't know what to do about it. My point was that not knowing what to do about it is not the same as being ignorant.

    It is actually fun to watch them squirm as they try to figure out what to do and not head back into the command economy they just left.


  5. Charley2u,

    Go read a book, and preferably one of the Austrian economics variety.

    You also may want to try being less gullible and naive. You trot in here and expect people to believe the Chinese Communist Party is merely IGNORANT of economics? As in, "Sorry about that whole Communist Revolution/Great Leap Forward thing... we were trying our best with the knowledge we had at the time, we were simply ignorant of the alternatives that didn't include mass, violent intervention of the society and its economic system"?

    Don't answer that. Don't bother responding. I've clued you in once already and you refused to take the bait, I won't waste my time trying a second or third time.

    Good luck to you, and the Chinese communist leadership-- a very "ignorant" bunch, in its requisite parts or as a whole!

  6. I am not sure I understand your hostility. I simply offered an observation that China is dealing with a problem they never knew they would face: having too many dollars and euros in their reserves.

    Am I supposed to believe they are in complete control of events, and planned to be where they are? In that case, how did they get into this predicament?

    I don't subscribe to Austrian economics, but I do enjoy reading the opinions of Austrian thinkers. When I have a question about what you write, the response should not be "go read a book." You just might be wrong even from the standpoint of Austrian economics. Austrians do disagree with each other, or have you not noticed?

    In your case, however, you seem to assume your reader to be uncritical sheeple, and that is fine. I will read you, but refrain from comments in the future.


  7. @Charley2U

    Your comments are always welcome here.

    I get the sense that you may have gotten the impression that the comment to you was from me.

    It wasn't. Your reasoned response was welcome, and so will any future comments.I may not always agree but, keep'em coming.

  8. Charley,

    I responded to your question and you tried to lecture me on logical fallacies as if I were making one, when I was not.

    I lose my patience when I explain your error and you respond by repeating your error, as if I didn't read it and respond to it the first time.

    There is no such thing as "China as a whole." That is the whole problem with your analysis. I gave you a simple example to show you this by pointing out that I consume little of what I produce, personally.

    As you've noticed, "China as a whole" has a trade surplus. For the sake of simplicity, let's assume this surplus is evenly divided amongst all Chinese, meaning all Chinese are producing more than they consume and exporting some of that abroad.

    What is the problem? There is no problem. There is not a problem for a Chinese individual, given he arrived at the decision to consume less than he produces voluntarily, and there is no problem for "China as a whole" because "China as a whole" is simply all the Chinese individuals themselves.

    Where does the problem arise? It arises with the role of government debt and fiat currencies. If you read Wenzel's original post, you see that the Chinese are printing up new currency to maintain their peg to the dollar. This is inflation and over time it can contribute to large pricing problems within the economy as the new money, which is not neutral, sloshes around from one part of the economy to another.

    The problem is the money printing. Prices are rising because money is being printed. The Chinese Communist leadership respond by trying to ban the natural reaction of the markets, which is to let prices rise to a new equilibrium point for the larger amount of money. This necessarily will create shortages, deprivation and REAL economic hardship for many.

    This is basic economics, whether you're an Austrian or not, even the clueless Keynesians and neoclassicalists agree that all the implementation of a price control can accomplish is a shortage if the control is a maximum price, or an overabundance of the particular good or service if a price floor is put in place.

    This has been known for a long time. A looooong long time. Wenzel is giving them the benefit of the doubt in judging them to be ignoramuses. He doesn't go so far as to question their motives, that is to say, accuse them of knowingly imposing these conditions to maintain their grip on economic power.

    I hope that makes sense to you. I do hope you'll read more Austrian economic literature. You may learn something from it and you'd save yourself a lot of silly comments.

  9. Charley,

    I went and dug up a few links on this topic that will be helpful to you if you read them. I don't think you will be any further confused after considering Mises writings:

    (These all come from Human Action Chap. 17, Indirect Exchange)
    Observations on Some Widespread Errors (deals with "neutral money" fallacy)
    Balances of Payment (self-explanatory, I hope)
    The Anticipation of Expected Changes in Purchasing Power (explains why prices are rising in China, and why price controls do not address the root cause, which is therefore why the Chinese leadership are ignoramuses, at best)
    The Determination of the Purchasing Power of Money (again, hope this is self-explanatory what this is about)

    I can't find it at the moment (might actually be in one of the sections I just linked to) but Mises also explains the error of the desire for a "stable" or "constant" money, a money whose value/purchasing power never changes. Come to think of it, it might be in the Determination of Purchasing Power section. Anyway, it's a good explanation of why the Chinese leadership's currency peg is problematic and anti-economic to begin with. It's a vice, not a virtue... I hinted at this in my first few posts when I said the problem is fiat currencies in the first place. Government's are always and everywhere trying to peg and "fix" the value of their currencies relative to other monies and other commodities and always in vain. Mises explains why.

    The final comment I want to make, which you seem to have ignored last time, is to re-emphasize, STRONGLY, that you need to be wise to the fact that we're talking about the decisions of the CHINESE COMMUNIST PARTY. Ignore what the mainstream media and your average China-bull investor thinks, this is not a free market country and the leadership's sole concern is "How do we maintain power for ourselves" not "How do we find a path to greater prosperity for everyone?" As I mentioned, one telling example in this case would be something like the Great Leap Forward.

    Anytime your policies result in the death by starvation of millions, and require the brute force of a police state to implement, you may, just may, want to check your premises and reconsider what you're doing if in fact you are acting in earnest and simply trying to help everyone be economically better off.

    But I doubt that-- they're communists.

  10. Thanks -- I made just that mistake exactly.

  11. I agree China is not a free market. China's dilemma can best be understood as a problem of a company town, where the company owns everything -- including the government. It is a perfect monopoly.

    (This is just another way of saying the government owns the economy: if the government owns the economy, the economy can be thought of as a company that owns the government)

    The CCP is simply the management and owners of this company -- I alluded to this in my first post. (I usually make this argument to marxists, which upsets them to no end.)

    This COMPANY produces and exports far more than its own work force consumes. It is a very profitable COMPANY, but has a problem: its massive returns from exports cannot be profitably reinvested in the domestic market for two reasons:

    1. It would drive up domestic wages and other prices.

    2. It is in the form of dollars and euros which cannot freely circulate in the economy as legal tender.

    It has a really big problem that it has tried to solve by buying US treasuries, gold, oil, base metals, etc. But the money continues to pile up as fast as it disposes of it.

    It can let its currency rise, but this would depreciate its main assets: dollars and euros. Moreover, the problem is deliberately being aggravated by US quantitative easing which exerts even more pressure on its currency.

    The banksters in Washington know this, so they are tightening the screws. Unless China figures out what to do next, it will either have to relax control over its money and crash like Japan, or, it will have to increasingly lock down the economy -- price controls etc.

    They are not stupid or ignorant about monetary policy -- indeed, they invented paper money while Europe was lost in the Dark Ages -- they just have no reasonable options at this point.

    And, Bernanke knows this as well, which is why tomorrow he will be tweaking their nose in a speech as he further humiliates them and backs them into a corner.

    Now, I don't know if my speculation is correct, but I do know it is far more nuanced a situation than at first it seems. There is a lot of naked international power politics in this thing.

  12. Charley,

    You are about half right. You were making sense until you started explaining the "problem" again. You are beginning your analysis of the "problem" in the present, when the source of the "problem" is in the past-- establishment of a fiat currency with the decision to "peg" the value of that currency to the dollar.

    The reason the Chinese have these humongous Forex reserves (and therefore have a "problem") is because of that peg.

    Two other things:
    1.) Don't compare the current Chinese leadership to rulers of the 12th century as if they are somehow the same people.
    2.) They are stupid/ignorant about economic theory by virtue of the fact that they're running a communist political economy. As I hinted at before (twice, this is the third time now, curious when you will treat this seriously though you at least admit above it's not a free market), either the leadership doesn't care about economics because they're more concerned with power, in which case these "economic policy" discussions are meaningless to them, or they are economic ignoramuses if they thought that their subversion of the free market would result in increased economic prosperity for the people in general.

    The "problem" didn't magically appear today. What we're seeing today are the consequences of problematic policies implemented long ago. The "problem" is not massive forex accumulation-- the problem was their fiat currency system and peg established decades ago.

    The confusion you seem to be suffering from would be akin to seeing rising prices and saying "Oh man, this is a problem!" and ignoring that the "problem" was the massive money-printing job in the prior period which inevitably led to the rising prices today. In that case, the question wouldn't be "What do we do about these rising prices [the symptom of the problem]" but rather "What do we do about this massive money printing [the problem]". Of course, the simple answer is, end it. Anything else is a half-measure that won't ever succeed, permanently, in arresting the various symptoms of the problem.

    You're getting closer...