Follow up to the China kleptocracy post

The China kleptocracy post has received a lot of comment - mostly favourable. It was my first post to get 100 thousand views. I would like to thank all that commented on it (especially Paul Krugman who was good for about 35 thousand page views).

Only a few of those views are from China. My post was blocked by the Great Chinese firewall.* That said, within China the people who have been in business there for more than a decade were mostly in agreement. The people who have been there a couple of years were less in agreement. Bill Bishop (who I read and respect) was in the less in agreement group.

I will not name the people in agreement because many have to live in China.

My thesis was

(a). The savings rate in China was abnormally high driven by the one-child policy,
(b). The options for investing those savings for most the population were extremely limited - mostly bank deposits.
(c). The bank deposit market was rigged so that deposit rates were consistently below the inflation rate.
(d). That repressed interest rates were mainly used to subsidize state owned enterprises and that
(e). This funded the widespread looting of State Owned Enterprises by party officials.

Demographics is outside my field of expertise and I received (and expected) most criticism on the demographic point. The first bit came from my business partner who thought that the high savings rate and the property boom came in part from the (extreme) gender imbalance in China. The gender imbalance is another artefact of the one-child policy - where selective abortion and infanticide produce a large shortage of female babies and (later) eligible women to marry. This drives male preening behaviour - and the most successful preening behaviour for a man is to be rich and to own property. This is an extension of the men-will-do-anything-for-sex argument - and in this case "anything" is own apartments and big (negative return) bank balances.

Unknown to me this was the subject of a serious academic paper by Shang-Jin Wei - a professor of finance and economics at Columbia University who supports the men-will-do-anything-for-sex argument with lots of fancy econometrics.

There was little objection to my argument about limited options for saving in China. That seemed self-evident - however those limited options are being undermined by capital flight. The Chinese are washing an incredible amount of money through Macau. That money is being saved outside the Chinese banking system - and is thus not subject to extreme financial repression.

There is also little objection to my suggestion that bank deposit rates are rigged below the inflation rate. China dropped the regulated bank deposit rate recently as the inflation rate declined. However - and it was the point of my post - negative real interest rates are declining in China because inflation is declining.

The fourth point - that the repressed interest rates are the main source of subsidy for Chinese State Owned Enterprises was backed up very strongly by Michael Pettis. There are other sources of subsidy. For instance tobacco is largely provided by a State Owned monopoly and tobacco use is not subject to much social sanction making the tobacco company unbelievably profitable (and hence able to pay very high salaries and benefits to senior staff). Indeed Michael Pettis points to a Mainland think-tank - Unirule which suggests that monopoly and direct subsidies have accounted for as much as 150 percent of the profitability of the State Owned Enterprises over the last decade. Pettis himself calculates that repressed interest rates may have accounted for another 400 to 500 percent of total profitability over this period.

Monopoly profits and financial repression are a subsidy from the household sector. Pettis thus states the obvious - five hundred to six hundred and fifty percent of SOE profits come from a subsidy from the household sector.

Absent subsidy the SOEs are staggeringly unprofitable. In a market economy a business that goes from making X per year to losing X per year usually fails or closes pretty quickly. A business that goes from making X per year to losing 5X per year crashes and burns very rapidly.

Absent the subsidies the whole SOE sector with its current expense base crashes and burns very quickly. By far the biggest subsidy is the subsidy of being allowed to borrow at repressed interest rates.

This of course leads to the fifth part of my argument. That was that the expense base of the SOEs was the (looted) income of Communist Party apparatchiks. Here surprisingly the New York Times came to my rescue with an article about the difficulty of economic reform in China. Reform in this article really meant reform of State Owned Enterprises. The difficulty was that:

Publicly controlled enterprises have become increasingly lucrative, generating wealth and privileges for hundreds of thousands of Communist Party members and their families.

That is - of course - precisely my point. And the Times goes on to say that the Government is moving to stifle debate on anything that challenges this status-quo.

Deflation of course will challenge the status-quo anyway. If 400-500 percent of the profitability of SOEs comes from financial repression then the end of financial repression will result in the collapse of the State Owned sector and the collapse of the wealth and privilege led by "hundreds of thousands of Communist Party members and their families". I suspect that the centre would find it increasingly hard to control their regional elites and the regional elites would revolt. [Revolution is almost always an affair of the second-tier elite versus the first-tier elite - the masses rarely drive it. This would be no exception.]

However in the face of that the centre would do anything to keep the inflation rate high. Ben Bernanke might not literally be prepared to throw dollars out of helicopters. The Central Committee - they might go there...



John

*I have been informed by someone that blogger is always blocked in China. The Chinese people who were telling me they can't get the blog usually get it via a virtual private network.