Sunday, June 10, 2012

The Macroeconomics of Chinese kleptocracy

China is a kleptocracy of a scale never seen before in human history. This post aims to explain how  this wave of theft is financed, what makes it sustainable and what will make it fail. There are several China experts I have chatted with – and many of the ideas are not original. The synthesis however is mine. Some sources do not want to be quoted.

The macroeconomic effects of the Chinese kleptocracy and the massive fixed-currency crisis in Europe are the dominant macroeconomic drivers of the global economy. As I am trying a comprehensive explanation for much of the world's economy in less that two thousand words I expect some kick-back.

China is a kleptocracy. Get used to it.

I start this analysis with China being a kleptocracy – a country ruled by thieves. That is a bold assertion – but I am going to have to assert it. People I know deep in the weeds (that is people who have to deal with the PRC and the children of the PRC elite) accept it. My personal experience is more limited but includes the following:

(a). The children and relatives of CPC Central Committee members are amongst the beneficiaries of the wave of stock fraud in the US,

(b). The response to the wave of stock fraud in the US and Hong Kong has not been to crack down on the perpetrators of the stock fraud (so to make markets work better). It has been to make Chinese statutory accounts less available to make it harder to detect stock fraud.

(c). When given direct evidence of fraudulent accounts in the US filed by a large company with CPC family members as beneficiaries or management a big 4 audit firm will (possibly at the risk to their global franchise) sign the accounts knowing full well that they are fraudulent. The auditors (including and arguably especially the big four) are co-opted for the benefit of Chinese kleptocrats.

This however is only the beginning of Chinese fraud. China is a mafia state – and Bo Xilai is just a recent public manifestation. If you want a good guide to the Chinese kleptocracy – including the crimes of Bo Xilai well before they made the international press look at this speech by John Garnaut to the US China Institute.

China has huge underlying economic growth from moving peasants into the modern economy

Every economy that has moved peasants to an export-orientated manufacturing economy has had rapid economic growth. Great Britain industrialized at about 1 percent per annum. It was slow because all the technology needed to be invented for the first time. During the 19th Century US economic growth – once started – ran about twice the rate of the UK. They copied the technology which was faster than inventing it. Later economies (eg Japan, Malaysia, Thailand, Korea) went later and faster. As a general rule the later you industrialized the faster you went – as the ease of copying went up. In the globalized internet age copying foreign manufacturing techniques and seeking global markets is easier than ever – so China is growing faster than any prior economy.

This fast economic growth – which would happen in a more open economy – is creating the fuel for the Chinese kleptocracy.

The one-child policy drives massive savings rates

The other key fuel for kleptocracy is a copious supply of domestic savings to loot. The reason Chinese savings levels are so high is the one-child policy.

In most developing countries the way that people save is they have multiple children hopefully to generate a gaggle of grandchildren all of whom are trained to respect their elders. Given most people did not live to old age if you did you became a treasured (and well cared for) family member.

This does not work in China. Longevity in China is increasing rapidly and the one-child policy results in a grandchild potentially having four grandparents to look after. The “four grandparent policy” means the elderly cannot expect to be looked after in old age. Four grandparents, one grand-kid makes abandoning the old-folk looks easy and near certain.

Nor can the elderly rely on a welfare state to look after them. There is no welfare state.

So the Chinese save. Unless they save they will starve in old age. This has driven savings levels sometimes north of fifty percent of GDP. Asian savings rates have been high through all the key industrializations (Japan, Korea, Singapore etc). However Chinese savings rates are over double other Asian savings rates – this is the highest savings rate in history and the main cause is the one-child policy.

Low and middle income Chinese have very limited savings options

The Chinese lower income and middle class people have extremely limited savings options. There are capital controls and they cannot take their money out of the country.  So they can't invest in any foreign assets.

Their local share market is unbelievably corrupt. I have looked at many Chinese stocks listed in Shanghai and corruption levels are similar to Chinese stocks listed in New York. Expect fraud.

What Chinese are left with is bank deposits, life insurance accounts and (maybe) apartments.

Bank deposits and life insurance as a savings mechanism in China

Bank deposits rates are regulated. You can't get much different from 1 percent in a bank deposit. Life insurance contracts (a huge savings mechanism) are just rebadged bank deposits – attractive because the regulated rate is slightly higher.

This is a lousy savings mechanism because inflation has been between 6 and 8 percent (but is now lower than that and is falling fast). At almost all times (except during the height of the GFC) the inflation rate has been higher – often substantially higher – than the regulated bank deposit (or life insurance contract) rate.

In other words real returns for bank accounts are consistently negative – sometimes sharply negative.

You might ask why people save with sharply negative returns. But then you are not facing starvation in your old age because of the “four grandparent policy”. Moreover because of the underlying economic growth (moving peasants into a manufacturing economy) there are increasing quantities of these savings every year. This is the critical point – the negative return to copious and increasing Chinese bank deposits drives a surprising amount of the global economy and makes sense of many things inside and outside China.

The Chinese property market as a savings mechanism

Chinese people have very few savings mechanisms. The major ones (bank deposits and their life-insurance contract twins) have sharp and consistently negative real returns.

Beyond that they have property.

Bank deposits have sometimes 5 percent negative returns. If you got 1 percent negative returns from  property – well – you would be doing well. Buying an empty apartment and leaving it empty will do fine provided you can sell the property at some stage in the future.

It is commonplace amongst Western investors to view the see-through apartment buildings of China as insane. And they may be a poor use of capital. But from the perspective of the investors – well they look better than bank deposits.

Negative returns on bank deposits and the Chinese kleptocracy

Most Chinese savings however are not invested in see-through apartment buildings. Bank deposits still dominate. The Chinese banks are the finest deposit franchises in human history. They can borrow huge amounts at ex-ante negative real returns.

And those deposits are mostly lent to State Owned enterprises.

The SOEs are the center of the Chinese kleptocracy. If you manage your way up the Communist Party of China and you play your politics really well may wind up senior in some State Owned Enterprise. This is your opportunity to loot on a scale unprecedented in human history.

Us Westerners see the skimming arrangements. If you want to sell kit (say high-end railway control equipment) to the Chinese SOE you don't sell it to them. You sell it to an intermediate company who on-sell it in China. From the Western perspective you pay a few percent for access. From the Chinese perspective – this is just a gentle form of looting.

And it is not the only one. The SOEs are looted every way until Tuesday. The Business insider article on the spending at Harbin Pharmaceutical is just a start. The palace pictured in Business Insider would make Louis XIV of France (the Sun King) proud. This palace shows the scale (and maybe the lack of taste) of the Chinese kleptocracy.

A normal business – especially a State Owned dinosaur run by bureaucrats – would collapse under this scale of looting. But here is the key: the Chinese SOEs are financed at negative real rates.

A business – even a badly run business – can stand a lot of looting if it is (a) large and (b) funded at negative real rates.

Those negative real rates are only possibly because there are copious bank deposits available at negative real rates to State controlled banks.

The cost of funds in China and the willingness to hold foreign bonds

The Chinese Government (and the banks are part of the government even though they are listed) has access to seemingly unlimited bank deposits at negative real costs.

When you have copious funds at a negative cost a lot of investments that look stupid under some circumstances suddenly look sensible. US Treasuries look just fine. Don't think the Chinese are going to stop holding Treasuries. The Treasuries yield far more than they pay the peasants. The Chinese make a positive arbitrage on holding low rate US bonds.

Monetary threats to the Chinese establishment

The Chinese kleptocracy – and indeed several major trends in the global economy – depend on copious quantities of savings at negative expected rates of return by middle and lower income Chinese.

There are two core threats to this system – one widely discussed – one undiscussed.

Inflation (widely discussed) is known to produce riots and demonstrations in China – and is considered by Westerners to be bad news for the Chinese establishment. And there are good reasons why the Chinese riot with inflation – the poor who save because they are going to starve – get their savings taken away from them.

But ultimately the Chinese establishment like inflation – it is what enables their thievery to be financed.

The more serious threat is deflation – or even inflation at rates of 1-3 percent. If inflation is too low then the SOEs – the center of the Chinese kleptocratic establishment will not generate enough real profit to sustain the level of looting. These businesses can be looted at a negative real funding rate of 5 percent. A positive real funding rate - well that is a completely different story.

The real threat to the Chinese establishment is that the inflation rate is falling - getting very near to the 1-3 percent range.

Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps.

But that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils). The SOEs will not be able to pay positive real returns to support that new division of spoils. The peasants can only receive positive real returns if the SOEs can pay them - and paying them is inconsistent with looting.

If the SOEs cannot pay then the banks are in deep trouble too.

All because the inflation rate is dropping. Maybe they can stop it dropping. The Chinese establishment has a vested interest in getting the inflation rate up in China. Because if they don't all hell will break loose.

Unless the Chinese can get the inflation rate up expect a revolution.



Jeff Matthews said...

The mechanics of deflation on the carry trade would be a good footnote.

If Joe Biden could read and comprehend this he would say something like "This is f-ing important stuff!"

Well done and thanks.


Tsachy Mishal said...

The remninbi has been appreciating versus the dollar in recent years plus short term rates in China are higher than in the US. It would have paid to hold short term deposits in China in recent years rather than in the US.

While I agree with a lot of what you wrote Im not certain how you come to the conclusion that "The Treasuries yield far more than they pay the peasants." Maybe that will happen in the future but it is not what happened in the past.

Anonymous said...

China Inflation Falls As Economy Stalls

Anonymous said...

John, jesus, with all due respect...
Don't write for BI!

Scroll through it a bit - you'll see how one can expose himself... negatively by having his signature on that site ;)

As for the article, if you consider China a kleptocracy, you should really go see mazer russia ;)))))))

Worst of all, from my rational but specific persepctive, is that, as you write, Chinese kleptocracy tends to steal from overseas while our russian... "guys" steal mostly from own country's budget directly.


Anonymous said...

And, John,

think as someone with first-hand expertise I should try my hand at thinL I don't think you get what "enables the looting" right.

the point that "the looting" is looting a difference between rates is OK one, but it's not actually the prime driver. The prime driver is:

Closed borders.

Which encircle a world of entirely different business norms, including, importantly, "normally expected" return rates.

In other words, you say Chinese business won't be able to support looting if they can't finance at low or negative rates, because you naturally assume that these businesses operate at inherent "established worlf norm" 10-20% profitability before taxes.

Well, how about the NORM being 50% or 100%?

Shouldn't happen because... hang on, import competition? CLOSED BORDERS.
(Which could be anything from direct regulations to unwritten "practices" all the same).

You did scoped that Chinese banks offer negative effective rates to citizens cuz said citizens can't move capital elsewhere. Make next logical step: Chinese salaries being what they are for lack of options, and Chinese prices (compared to costs) all the same.

now THIS is the real base for looting. Rates are just an icing on the cake.


Henry Singleton said...


You're talking about nominal rates John is talking about real rates, adjust your comment for inflation and your conclusion changes

Kyle said...


Great article -- one area that you left out is all the stories about china's kleptocrats. Moving their families and wealth out of the country -- seems like they agree the risks are rising for their class. Are those stories a real trend or mere one off anecdotes?


Anonymous said...

Excellent, insightful article! This explains some of the mad Chinese investments in BC (Canadian) real estate recently.

Woland said...

There are many issues which you raise on which I
would like to comment, but i will confine myself to
just one- the one child policy. With a population of 1.3 billion people, China is the world's largest state.
It is less agriculturally self sufficient than India and
many other neighbors, and it is moving up the food
chain terms of protein consumption, which requires
greater grain input. In short, it may well be close
capacity with respect to food. Now, you may be a
Cornucopian, or you may be a Herman Daly fan
of environmental economics, and depending which
is the case, you may want the population to grow
rather than remain stable. One thing is for sure,
however, and that is that when the safe limit of
population growth is reached, there will be an
elderly "pig in the python" phenomenon to contend
with. The same phenomenon is present in Japan
and other developed nations, so why is it only a
danger to China? Is more kids really the solution?

Sunset Shazz said...


This is masterful. Great post.

Anonymous said...

hi John, lived many years in China...thanks for printing the truth about the place. you are one of the few who seem to really care about the chinese peasants.

Anonymous said...

John, china is a democratic state compared to what is now happening in Russia

Anonymous said...

It is well worth reading, if you havent already, a book called 'red capitalism'. Great insight on how the chinese financial system works. Review here:


Anonymous said...


Anonymous said...

The looting can be explained in simpler ways. Officials taking bribes, overcharging/skimming off the top/other shenanigans at state companies, paying the poor and middle class workers very little.

Anonymous said...

Interesting post but isn't Gov corruption global and just a question of degree?

The Australian system is fairly corrupt, just that media ownership is concentrated enough that no-one kicks up much of a fuss.. at least in the mainstream media.

Crony capitalism lead to the Fed government boosting the banking industry by sponsoring RMBS junk bonds on one side while simultaneously pumping up demand with FHB incentives on the retail side.

How did any of this serve the interest of any group other than a bunch of bankers and politicians?

Wilfried said...

Hmm... did the Chinese invent looting big companies? Maybe they looked at top managers in western companies (banks included) and thought: Why should we do worse?

Nemo Incognito said...

its a peculiar artifact of the intelligentsia's consciousness that inflation is considered a big problem. That made sense in the French revolution when no one had assets and food was 60% of living costs, in a world in which food is 12% of CPI and most people own real assets a collapse in real returns is far worse.

Its deflation that really causes stuff to break down, even in middle income countries. Pity the talking heads on TV are too lazy to go back to first principles on this stuff.

Wilfried said...

To give an example what I mean just remember the early days of Global Crossing before its bankruptcy, well summarised in Wikipedia.

Longshorttrader said...

You wrote, "What Chinese are left with is bank deposits, life insurance accounts and (maybe) apartments"

You left out physical gold. As I understand it, is widely used in China, as a store of value.

OGT said...

You're wrong about the one child policy being responsible for China's savings rate. We know this because the savings is not being done primarily by households, who earn an historically low percentage of the nation's income, around 50%. The financial repression you cite along with land appropriation, the exchange rate manipulation, and labor market manipulation all push income into SOE's and banks, who are the one's doing the majority of saving.

Otherwise good article.

Edward said...

Great article, thank you. And I agree with Dmitri: stay away from Business Insider, which has a comment section up front and in bold filled with absolute lunatics. There is no comment restrictions and people can use different aliases, so the same person can comment a hundred times. It is truly a rag no one should get associated with, ruins one reputation. At least until they clean up that comment section and hire real journalists. Pragmatic Capitalism and Abnormal Returns are much better, more serious aggregators.

Edward said...

Great article, thank you. Absolutely brilliant. And I agree with Dmitri: stay away from Business Insider, which has a comment section up front and in bold filled with absolute lunatics. There is no comment restrictions and people can use different aliases, so the same person can comment a hundred times. It is truly a rag no one should get associated with, ruins one reputation. At least until they clean up that comment section and hire real journalists. Pragmatic Capitalism and Abnormal Returns are much better, more serious aggregators.

Anonymous said...

What about the Kleptocrats on Wall Street? By manipulating world prices, they have made billions and killed millions.

The people in Washington waste more money through incompetence than China does through theft.

Anonymous said...

"In most developing countries the way that people save is they have multiple children hopefully to generate a gaggle of grandchildren all of whom are trained to respect their elders."

This has got to be one of the most stupid and insulting generalizations I've ever read.

Anonymous said...

The story in India is similar, except that the thieves are democratically elected, and therefore change every 5 years in a never ending game of musical chairs.

Corruption is rampant in the administration - everyone from the central government ministers down to the local councilors is out to make hay before they are voted out of office. For a couple of examples, just look up Telgi stamp paper scam, various defense procurement scams (Arthur Miller's All my sons is played out in real life everyday), Telecom auction scam.

Capital markets are mostly a device for the wealthy to loot the middle class. There is no social security net. Inflation runs close to 10%, most savings vehicles have negative yields.

Anonymous said...

Woland. The article doesn't exclude the pigs in pythons in places like here in NZ, it just focuses on the most extreme case which is China. The post-war baby boomers will find that we are, for many reasons, unsupportable.

Similarly, the article is about the kleptocracy, not carrying capacity, which is also stretched in other places. But as the GFC rolls out, the immediate threats are financial and, while the Greeks may riot a bit then go back to the family plot (or commit suicide in distressing numbers) and the Spanish may do the same, the Chinese have a tradition of long periods of calm followed by paroxysms of staggering violence.

John is not even looking at the effects on so-called foriegn investment in China, just at the next probable trigger for the violence. And when that happens, what do we think will happen to all that cheap crap they export?

BTW, kudos for restating the one-child policy as the 4 grandparent policy. If anyone had thought to put it that way in the 60's, there would have been a revolution right there. And carrying capacity would have been exceeded in China about 20 years ago, while there was still plenty of cheap oil to finance a serious war in SE Asia.

We may have dodged a bullet only to hit a wall.

Robert in Chicago said...

I'm the 28th comment, so I'll pick something different from the others. Your last point: I am being dense. Why will a continued lower inflation rate, which benefits the masses, cause a revolution? It's usually the masses who revolt.

Anonymous said...

The savings rate is 3.5% for 1 yr deposit. I don't know where you get 1% from. Also the inflation is always lower than 8% as you mentioned in your article.

Anonymous said...

The savings rate is 3.5% for 1 yr deposit. I don't know where you get 1% from. Also the inflation is always lower than 8% as you mentioned in your article.

Harry said...

China realised in 2010 that the 4 grandparent policy will be a problem, and so they introduced an alteration to the policy - that if a married couple are both only-children, then they can have 2 children.

Since your whole argument is relying heavily on this misunderstanding, it would be nice to hear what you have to say about this. Doesn't it show the Chinese government is making some effort?

Anonymous said...

This article stops short of a major point. Much of the stolen money is taken out of the country. The smart money - i.e., government / SOE officials - have been shorting China for years by stealing and moving the money offshore. This trend is more pronounced every day, as evidenced by Macau VIP gaming revenue increases. The off table betting in Macau VIP rooms is probably 3-5x the amounts on table. Extreme amounts of money (usually corrupt proceeds) are being taken out of the country.

If the insiders in the Chinese system don't have faith in China's future, why should anyone else?

Mark B. Spiegel said...

>>Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps... Unless the Chinese can get the inflation rate up expect a revolution.<<

I absolutely do not understand how "b" (the conclusion) follows from "a" (the premise). Will someone please explain why if the peasants are happier with less inflation, less inflation will cause a revolution?

Godfree Roberts said...

China is EVERYTHING on a scale never seen before. Its government, for example, is admired and trusted (85% - 95%, say Pew, Edelman, and Harvard) on a scale not seen before in peacetime human history. Its policies for lifting people out of poverty have succeeded on a scale not seen before. It has sustained a rate of economic growth never seen before in human history. Though still a poor country, its people are more food-secure than ours in the USA, the world's richest country. And far less anguished than ours, too (both from Gallup).
It's a big country, baby. Bigger than even your imagination.

Ross said...

Fantastic! I was just publicly ruminating [1] about the asymmetrical nature of the recent interest-rate raises/cuts in China. This explains it perfectly. Thanks!


Anonymous said...

Great article. Reminded me of the Clayton Christensen's comment about the how culture (specifically our religious history) is key to our capitalist system. (see on page 2 para 3).



John Hempton said...

To Robert and the anonymous person - there is not the underlying economic income to pay a large positive real return to the peasants on their savings. There is just not enough profit in society.

If you need to pay the peasants a positive economic return everything else collapses.


Mark B. Spiegel said...

John Hempton wrote:

>>To Robert and the anonymous person - there is not the underlying economic income to pay a large positive real return to the peasants on their savings. There is just not enough profit in society. If you need to pay the peasants a positive economic return everything else collapses.<<

But you spent the whole article pointing out that because of high inflation + low interest rates, the peasants haven't been getting a large positive real return for YEARS. But now with lower inflation it would seem that their real return greatly improves, so again, how is low inflation more "revolution causing" than high inflation?

John Hempton said...

Yes Mark. It is the negative returns received by peasants that finances all that theft.

Without the negative returns the kleptocracy is impossible.

Mark B. Spiegel said...

John Hempton wrote:

>>Yes Mark. It is the negative returns received by peasants that finances all that theft. Without the negative returns the kleptocracy is impossible.<<

Exactly! So how does a revolution follow from LESS kleptocracy? Is the privileged class going to revolt against ITSELF? In fact it's just the opposite, in that if inflation DOES stay high they WILL have a revolution, so the kleptocracy will clearly have to live with "stealing less" (i.e., lower inflation) or it will be put in a position where it's unable to steal anything at all; i.e., in jail or in front of a firing squad.

philbrick said...

Broadly correct, but you're overlooking a couple of key factors. One is that the Asian growth model (ultra-low cost of capital driving exports) eventually leads to colossal over-investment and a bust - see Japan, S Korea, Taiwan etc. This could be avoided by slowing fixed asset investment and exposing the SOEs to competition, but the weight of vested interests makes serious change very difficult.

Although the bureaucracy, the army and the universities are riddled with corruption, there are quite a lot of honest senior administrators in the Party who have long been pressing for reform. Their problem is that they are caught between the vested interests who don't want any change and the Party's very real fear of social unrest ("mass incidents"). Hence it is unlikely that they will be able to do enough - e.g. hukou liberalisation, secure land tenure, SOE competition, increased transparency - before it all turns pear-shaped.

The collapse of the USSR worried the Party enough to cause major reforms, but since then success and wealth have bred smug over-confidence in too many of the leadership, so I don't disagree with your prognosis.

Anonymous said...

John, it would be interesting to get Michael Pettis to comment on your post.


Anonymous said...

John, I think your premise is correct, although I disagree (partly) with the broad conclusion.

Herein lies the problem with fiat currencies. Inflation can almost 'always' be manufactured. It is easy to maintain negative real interest rates when you control the banking system and the currency. I guess what I mean is deflation is not a 'threat', as they can always create inflation (the opposite is not true). And since they control the currency, they can always push money directly/indirectly to SOEs - funding is never a 'real' problem. Which would lead one to question the value of the Renminbi, but that is a separate story.

As it pertains to your article, I think the issue is whether the government can maintain negative interest rates (inflationary), while maintaining social stability/the facade of wealth creation among the commoners. From economics standpoint, the question is whether there is sufficient productivity increase to bridge the above gap. Again, another big topic for a separate story.

Just a thought.


tiru said...

Hey John, just another input here talking about the authenticity of China's macro numbers. I did some very rough calculations a few weeks ago on my blog wrt to China's inflation numbers and GDP numbers here:
Would like you to have a glance and give us your thoughts on this.

Chris said...

Thievery in China by government officials?! Come on, John, be serious. Next you'll be telling us that Putin and the FSB are looting Eurasia.

China is a shining example of global wealth redistribution. Everyone wins. It's called capitalism ... with Chinese characteristics!

Anonymous said...

Great article! As you wrote at the start nothing really new, but I'm jealous the way you summarized it all in a short, understandable and coherent story. A skill I do not possess.

Anonymous said...

very interesting reading John, just feels like the conclusion is rushed.

So high inflation causes riots, and deflation causes trouble for establishment. I really struggle to see how this is any different in the west.

Benny and the ink jets have madly being trying to avoid deflation it is seen as the death scenario....

Dude, not matter where you go it the "distribution" that matters and the means by which the "masses who are asses" are kept in check...

F.S. said...

I have to say that your thesis reflects massive misunderstanding of the real economy by a typical finance guy. A finance guy only sees zero sum and sees it through the lens of money. But you can't eat/breathe/live in money. While your premise that China is a kleptocracy may be true, it is not necessarily the determinant factor for the Chinese macroeconomy. To see it you have to think of the real economy, not just finance.
The savings in the real economy is the total factor productivity. Number one is education. Chinese university admission rate has gone from 3% to 75% in 30 years. Literacy is 99% among young people. Number two in capital investment. All you need to see is how fast the bottom wage has been rising recently to know that there must be automation going on at a massive scale.
Peasant savings? What peasant savings? You must be kidding right? There is little surplus from farming because the farmland per capita is pathetically low. Unskilled labor wage is much higher than some other Asian countries (the Philippines, Vietnam, India for example) so the peasants are gaining from the productivity lift not thieved from.
Thieving at the top and top/middle certainly creates massive incentive problems and barriers to further rise in productivity but they could not have been stealing from the peasants. Maybe the first 30 years of PRC they were mostly taking from the peasants but that didn't get them very far did it? That could only sustain a level of standards of living similar to to DPRK.
Oh, please also give us an example of non-kleptocracy? You mean in every other economy the top income bracket (you are probably one of) add just as much or more value than they take from the economy?

Anonymous said...

I just wanted to highlight OGT's comment again. He is correct, it is not the One Child Polciy at all.

The big savers are the SOEs. Which is why consumption has collapsed during the 2000s, from an already historically low number to a genuinely unique percentage previously unseen by the human race in an industrial society.

If it was just the one child policy parents freaking out about not starving then the trend would begin much earlier, whether by the parents of children born in the 80s who were the first one child policy cohort, or by the parents of children born in the 90s when Premier Zhu 'reformed' the SOE and destroyed so much of China's social security system which was administrated directly to SOE employees by the SOE. The so called iron bowl system.

Anonymous said...

Most of what you said makes sense from an economist's point of view... but it ignores the cultural aspect, which is so important to understanding China and other Oriental nations. Chinese have great love and respect for the elderly... they were well-looked-after even during the great famines of the past centuries and now that the grandparents are saving up, they are also likely to leave a mini fortune for their one and only grand child when they depart. The grand child, already believer in traditional values, hard work and service to elderly, further loves it when this happens and passes on the story to his fellow countrymen. So the one-child policy which leads to four-grandparents policy which leads to revolution and economic collapse theory is not necessarily a prophecy. Yes, if a collapse or social revolution were to happen, it (your theory) may be one way of explaining it!

Anonymous said...


Strange that you still don't get the point after several explanations.

If deflation occurs the SOE's and banks will likely go bust. With a savings rate of over 50% what do you think the masses will do if their life savings are lost? Duhh!

Sam Reeves said...

In general I would say your article is spot on.

I would like to make a few corrections though:

1. The Chinese use savings extensively because they still don't trust pensions. Many also do invest in the stock market. There are some pensions available if you were a civil-servant. Which let's face it, doesn't help the average Joe.

2. Although it can't be said China is exactly a welfare state, they actually do have some unemployment benefit in some cases. It's just pitifully low is all, and is not as widely available as in some western countries.

Good article though. Definite food for thought.

dearieme said...

"... isn't Gov corruption global and just a question of degree?" You might as well say that in the 30s and 40s all governments executed people, so Stalin and Hitler differed only in degree. Later Mao differed only in degree. Bonkers!

As for revolution, the four grandparents will be reluctant to see the grandson risk his neck in revolution; but then he might not consult them. I'd guess the outcome not to be a new government in a single state, but to be several warring states. Which will have nukes. Oh Jesu!

John Hempton said...

dearime - I do not think this revolution will come from the poor. The poor in China are met with tanks. Inflation annoys the poor - the poor riot at least until the army comes.

The problem with deflation is that it bankrupts the structures that support the elite.

Revolution here comes from failure of the power structure - ie from within - not from people oppressed by the current power structure.


Anonymous said...

The most glaring” klepto-system” is the banking one whereby banks create deposits via granting of loans .Advances on Credit cards are charged @ 2% per month whilst banks’ demand deposits are interest free! Talk about revolution…

Anonymous said...

I'd like to see some in depth side-by-side compare and contrast of the ways that the elites take money out of the system in China, the west (US and EU), and Russia.

Longshorttrader said...

I can't believe I'm the one saying this, seeing I was all about short gold in Q3 2011, but based on this post, as well as all the comments, physical gold seems the fact, the fact none of these comments mentions physical gold tells me it's a good place to look.


Anonymous said...

I don't see how low inflation can be described as an unexpected "problem". I mean, China's low inflation and economic slowdown were done by design.

They were worried about high inflation, so they raised interest rates 5 times, starting in 2010. They knew this would cause low inflation and lower economic growth.

For example here is a story from Jan. 2010 - the title says it all:

All they have to do now is lower their interest rate, which will cause higher inflation. And the Chinese people will accept those low interest rates because they have no choice (ie: there is no better place to put their money, as you correctly explained).

Nicole Hamilton said...

Krugman's column sent me here.

Fascinating ideas! Your arguments about the consequences of China's one-child policy and the domino connection to their savings rate and everything else are brilliant. I don't yet know they're correct, but they're definitely brilliant.

Anonymous said...

At some point doesn't families wanting "first born males" become a problem ? 1.13:1 (m:f)

Anonymous said...

We think of this as greed, corruption, kleptocracy, etc., wherever it happens. China being the most macro instance of a phenomenon which is, at this point, clearly, global.

What "corruption" at the top means, historically -- as this has been proven countless times since the times of the Egyptian Pharaohs -- is that the entire political economic system is about to implode. Logically or illogically, the most sensitive to this fact are often in power roles, and their behavior becomes "greedy" during the last stages as they realize there will be no "long term" for them, politically or economically. Same as with any Banana Republic.

We are clearly at the global breaking point. This should be cause for serious alarm, as the catastrophe at this scale could, truly, be final for our species.

Don't just sit there; do something.

Anonymous said...

To those who asked why the peasants would revolt if inflation were low, the answer is right above that statement: "If the SOEs cannot pay then the banks are in deep trouble too." The SOEs have "borrowed" the peasants' bank deposits, counting on high inflation to pay back the "loans." Low inflation means they can't pay off the loans, so the deposits - the peasants' life savings - are gone, the banks fail, and the peasants revolt.

Anonymous said...

I would think all BRIC nations are mafia economy where the "elites" rob from their countries. They all lack political and economic check-and-balance in the process.

Unknown said...

Chinese elites have become very adept at moving illicit money offshore. Bo Xilai's family was reported (by Chinese state media) to have moved at least $1.2 billion offshore alone.

Global Financial Integrity's conservative estimates find that $2.74 trillion illicitly flowed out of China from 2000-2009.

Jack Albrecht said...

This is great analysis.

I particularly like the complete lack of focus on what is being done with the looted money.

You stay on point very well. I guess that 2000 word limit helped.

DR said...

Massive mal-investment financed by a government enforced easy money regime?

This post sounds positively Austrian.

Anonymous said...

This article is so extreme as to be meaningless. Far too many generalizations without any supporting facts. China has 20$ of the world's population, 7% of the arable land and 1/3 the global average water per capita. What exactly did you expect them to do to control population. Every single major nation in the world went through exactly the same developement issues as China is going through now. And China, like all those countries, has a very strong group who are striving to continue the reform that has taken place over the past 30 years. As someone once said, by all means light the way forward, but recognize the distance travelled, You have done neither.

Nightrunner said...

Interesting but hold moral judgements. It was just reported that a median US family lost 40% of its household wealth between 2008 and 2011. Compare with China.

Fusca said...

The analysis is correct, other BRICS have similar problems, Russia and Brazil are neither democratic nor fee economies. Cleptocracy is what they have in common. Unfortunately Brazil is a cleptocracy since 2003, when the bolivarian party PT assumed the State as a private asset of its components.

Unknown said...

Meh. Would be a lot more credible if you explained how exactly the kleptocracy is so omnipotent as to keep all the money internal, when in reality a true kleptocracy would be corrupt all the way through - including allowing those with enough 'ante' to get their money out.

It would also be more credible if all the moaning about negative savings rates was in reference to the US ZIRP... as opposed to just the so-called Chinese kleptocratic savings rates.

And don't even get me started on the supposed lack of 'equal justice under the law'. Do we really need to be throwing rocks given the 2 Bushes as President in the nearly in the same decade?


Anonymous said...

I find the discussion of the One Child Policy primarily in terms of economics morally disgusting. Take a look at the web site "Women's Rights Without Frontiers" to see what it looks like. Forced abortions at late stages; the baby is laid on the bed beside the mother and the family is billed for the "procedure." There's a lot worse than robbery going on in China. S Moore, Tennessee

Anonymous said...

John as usual great work. Would somebody show this to Jimmey Rogers?

Vincent Cate said...

At some point the Chinese will realize they are better off buying gold or silver than taking a guaranteed loss of 5% per year. If they up the inflation rate it will help people figure this out faster. Fiat money does not do well when nobody uses it.

Anonymous said...

I like your assessment of how the Chinese kleptocracy works, but I have to disagree with your predictions for the future. If their current theft method stops working, they'll just set up a new one. They have the political power to do it. Acemoglu and Robinson's "Why Nations Fail" provides a very good discussion of how kleptocracies, or "extractive institutions" as they call them, use many different means to the same noxious end of stealing from the masses to enrich the elite. Ultimately it comes down to the intersection of political and economic power. As long as the CPC monopolizes political power in China, they can structure the economy in whatever way they want to make themselves disgustingly and undeservedly wealthy. They do have to make sure the peasants don't get mad enough to cause a mass uprising, but falling inflation is not going to bring them down, it'll just force them to put on their thinking caps and find a new way to skin the cat.

John Hempton said...

That last comment - about how Nations Fail - is spot on. (I have read that book and loved it...)

The problem is that the transition from one extractive set of institutions to another is rarely smooth.

Is what happened in Egypt a revolution? Will it matter that the next set of institutions are also extractive?

The implications for (say) Australia of a revolution from one set of extractive institutions to another is still ugly.


Anonymous said...

> So where is the money that is > being stolen going:
> US treasuries?;
> Canadian real estate?;

at least some part of it is going into SEA real estate -- RE in nice countries like canada isn't seen as safe -- theft and graft could be prosecuted in court and properties taken away -- but RE in Thailand? it's official than Bangkok will be underwater in 2025 (thai government says so), but central BKK properties continue to rise in price

Roderick said...

Another common savings mechanism in rural China - and anywhere else people lack access to decent alternatives - is livestock. I used to work on an agricultural development programme in Gansu and was often amazed at the flocks people would have, or the places they would keep a pig, particularly if the household had older people (ie cheap labour) to look after animals. Ag development "experts" often decry the low productivity of these animals and call for agricultural reform, without realising the role they play in savings, as your article makes clear.
I've done some work related to livestock as savings here:

Will said...

Very interesting analysis- a few points

1. not sure about peasants being owners of deposits (45% of deposits are from the richest 1.5%)

2. what keeps the financial repression going is the closed currency- if money leaks out so that deposit growth of the banking system can't keep pace with loan growth the system collapses.

3. clearly the implication of your analysis is that liberalisation of interest rates and opening up of capital account is a long way off.

4. an interesting angle is the role of the H share market as a means for elites to get their money off shore- with the help of western IBs.

5. I guess point should be made that this is a system that has delivered millions of people out of poverty in a relatively short period of time- no system is perfect

L' said...

Very interesting analysis, I especially like the four grandparent policy part. As Chinese people shouldn't place deposits or invest in Chinese stocks if they know the truth, the good and only alternatives are real estates both in China and Hong Kong, or gold. This explains a lot of things that happened in the past.

While the establishments were milking the SOEs they fed them nicely with inflation and growth. Now they have nothing to feed the SOEs they must sell it but they shouldn't because if they do people will find out there is nothing left inside.

China must react but they can cannot print so much money as they are now heavily indebted. The only way out is routing foreign money back to China but they need to weigh between their intended internationalization of RMB (essential for a larger looting mechanism) and the stability of their throne.

Horatio P Jones said...

A large volume of Chinese savings available at negative real interest rates is a strong factor at work pushing interest rates down in the western world.

Or, seen in the goods markets, cheap Chinese exports flood the world, depressing opportunities for profitable investment elsewhere.

It is the gap between Chinese production and Chinese consumption that has led to many of the Western world's problems. The mortgage crisis in the US, first striking the sub-prime market, had its roots in the fact that low-wage workers in the US were not getting real wage increases due to Chinese competition. The debt crisis in Europe in some part stems from efforts to prop up growth in countries that compete with China (at least to some degree).

As Chinese demographics shift...this whole thing will start to unwind. In fact, it's starting already...

Anonymous said...

Very Insightful Article
A few points

Holding US Treasuries
- Given Chinese Currency is undervalued(though its appreciated wrt USD over the last 5 year @3% CAGR) even the low rate of return on deposits may be a better deal than holding US Treasury Securities.

One Child Policy
- I also believe there is severe under employment in countries like China and India. If we compare the labor force fully employed as % of eligible population between China and the developed nations, China might be on the lower side. That I think will insulate it for at least
one generation from Japan like demographics and also help raise living standards rapidly.

Negative Interest Rates
-The reducing negative interest rates might be a concern if it reduces demand. That in turn will prompt another stimulus leading to higher inflation and of course more money in the hands of the looters. Not to say the world will applaud China for the stimulus. I think this game can go on for a while.

Anonymous said...

Very interesting topic, and Krugman invited us to read this new insight. Thanks for Krugman to let us see that the State run economies and the governments that loves the intervention of the State in the Economy are not so "good" and effective as his recommendations suggest.

Absalon said...

It is the gap between Chinese production and Chinese consumption that has led to many of the Western world's problems.

Now there is a piece of the truth.

Anonymous said...

dont know what all the finger pointing is about lads, the slightly bigger problem of the derivatives bubble makes all else pale in comparison, frankly all the so called economic experts that I see on this and other sites are laughable, nero fiddling while rome burns springs to mind DONT YOU GET IT YET THE SHOWS OVER!!!!

Anonymous said...

While I enthusiastically believe the basic premise that China is corrupt from the top to the bottom, I think more nuance is needed here.

Shouldn't we distinguish a state owned enterprise that might be skimming 3% of the profits into pockets of bureaucrats from reverse merger entities whose goal was to defraud shareholders of 100% of the invested money? In theory a state owned enterprise with a 3% skim might be a reasonable investment if it has growth and high free cash flow. If it gets sold off because of the foul smell of Chinese smallcaps, might that be a good investment *at some price*? Example: Guangshen Railway GSH?

Anonymous said...

Why piss on the Chinese? The same is being done to the Middle Class of any of the "Western" nations.

Henry Balfour said...

I start this analysis with China being a kleptocracy – a country ruled by thieves.
end quote.
America is ruled by sociopaths, and its people are looted by corrupt capitalist elites. Any of the recent exposures of Wall St houses get through to you ? So, are the Chinese authorities any different. Is the pot calling the kettle black ?

Anonymous said...

Richard Koo had an interesting perspective on the theory of a connection between a lack of safety net, demographics & high savings rate. Summary:

Anonymous said...

Nice article. In the long run there are severe macro-economic repercussions such as the lobsided demographic structure each child has two parents, four grandparents and theoretically 8 great-grandparents to care for. That means extremely high lavbour productivity.

kleptocratic systems tend to be based on a pyramid structure where the "generated returns" are not completely based on actual wealth, but at least in part on hot air. That is not tenible in the end, see the financialcrises in europe.

Absalon said...

"the slightly bigger problem of the derivatives bubble"

That the derivatives market far exceeds the debt market, the equity market and the global economy seems to me sufficient proof that most derivatives are not "hedges" and indeed are probably being used for some alternate improper purpose.

cig said...

I'm not a quantity surveyor but that "palace" as evidence of kleptocracy seems weak. We'd need to know the cost per square foot and how it compares with standard HQ buildings at comparable Western companies. From the photo you can't tell whether it's solid gold or injection moulded shiny plastic. These neoclassical facades also don't look particularly expensive if mass produced. I'd bet that their site is cheaper per worker than the Apple flying saucer.

Also we'd need to put it to scale, a posh atrium and a couple of floors of executive suite can be a tiny and barely relevant percentage of building costs if it's in a 10000 worker factory complex, and not necessarily out of line with what Western companies spend on exec suites (a less glitzy style is not necessarily cheaper to build).

More generally I think the claim of kleptocracy should be measured: how do the Chinese one-percenters fare compare to one-percenters elsewhere? I don't know the answer, but we need a bit more evidence than has been submitted so far.

Anonymous said...

Keep purchasing and holding the Treasury is not out of financial return calculations; rather, they clearly understand that's the business licence fees that they have to pay to keep them in business aka power in China.

Anonymous said...

Maybe useful to watch Akira Kurosawa's movie "The bad sleep well" about post-war corporate corruption in Japan... though China could easily be an order of magnitude worse.

That Retired Guy said...

Great article, and 'hat's off' for having the guts to come out and say it!

Further thoughts here:

ピリット said...

When I scan-read US Corporate Law for the first time, it was quite a surprise to me because it was basically about how to siphon out money accumulated in a corporation legally. The corporate low has evolved along that line. Since the revelation many years ago, I've gotten it that is what power is and it's no accident that 90 percent of US Congress have been made up of riches. They are aware of that with understanding what power can accomplish.

Awareness of people holding power about power knows fundamental differences regardless of capitalism, communism, democracy etc. They gather at Devon or some exclusive resort and are pleasantly surprised to find how many common concerns they share.

Anonymous said...

I think the argument is diminished somewhat by the fact that savings rates are not 1% as stated.

As mentioned by others, the 1 year deposit rate is 3.5% and the 5 year rate is 5.1%. Having your money 'tied up' for five years generally isn't a problem if you are indeed saving to avoid 'starving in old age'.

Longer term real rates are actually thus roughly zero percent to very slightly negative; certainly not steeply negative enough to facilitate a high level of looting?

Adam Heslop said...

Amazing article as usual john.

Defining Quality said...

Replace the word "China" with the words "United States" and you can see how China just copied our Kleptocracy.
Sad but true IMNSHO!

Defining Quality said...

What you say is also true of the US economy which has clearly morphed into a Kleptocracy - of the RICH -by the RICH - for the RICH.
Government sponsored Capitalism aka Kleptocracy is faling the people all over the world. TRILLION$ have been stolen!
A fact of current observed reality - IMNSHO!!!!!!!!

Laban said...


"... a broad consensus of Chinese economists says the country is overdue for another big push to encourage private enterprise and to foster a shift toward a more consumer-driven economy. The challenge, they say, is turning back China’s domineering state sector. But that seems increasingly unlikely. Publicly controlled enterprises have become increasingly lucrative, generating wealth and privileges for hundreds of thousands of Communist Party members and their families. And in a clear sign of its position, the government has moved to limit public debate on economic policy, shutting out voices for change."

plxtal said...

i am chinese and i applaud you...this is exactly what we need to push us forward and why we will overtake the US in 10 years, during then people like you will still be bashing on the same exact things.

there is nothing new in this article. people have been bashing china for decades and where it is now?

but i see you just learned what china is i can understand how you feel about it compared to what you know about your country. just ask a very simple china growing more or less corrupted and kleptocratic than before?

people just simply don't learn that they don't learn. keep up the bashing, we really and seriously need it to keep going forward.

Anonymous said...

Really recommend a quick read of Yu Hua's "China in Ten Words" to the author and commenters alike. Any discussion of China as a kleptocracy without so much as a brief nod to the social mores (or lack thereof) that got it where it is today is ... incomplete, to put it kindly.

One of the things that struck me -- and I've lived and traveled quite a bit in SE Asia, where the corruption is similar in scope but very different in feel -- was the simple acceptance, on a really deep level, of fraud being just as good as the real thing. Things like falsified interviews being published as genuine because that's how the journalist "imagined" a famous person would respond, or those infamous knock-off electronics that barely resemble the genuine article.

When there's no stigma attached to such practices, when it's shrugged off or warrants no attention in the first place, why shouldn't falsified bank records be just as good as the real thing? And with the corruption so deeply entrenched, doesn't this stop being a moral question and become a matter of simple survival? Honesty can still quite literally get you "disappeared."

And then there's the phenomenon of "blood barons," blood bank traders, who have built outrageous personal wealth by pimping out poor peasants to hospitals... and the fact that this is a tremendous improvement on the prior state of affairs.

I know economists are still fighting to be taken seriously as a "hard" science, but as long as squishy humans are involved in the process of pushing money around, the soft stuff is relevant. You can't predict whether the kleptocracy will self-correct, slowly consume itself over a period of decades, or explode in bloody Cultural Revolution II: Kleptocratic Boogaloo if you're sticking your fingers in your ears every time history and culture come up.

Anonymous said...

Your synthesis is interesting but incomplete.

For one thing, there have been many kleptocracies which have lasted for decades or even generations. Take Marcos in the Phillipines or Suharto in Indonesia, as recent examples.

Likewise, a subtler approach is used by Lee's family in Singapore. Briefly, it's very difficult for foreigners to do business there unless they go into partnership with one of Lee's children. That is accepted, perhaps grudgingly, in Singapore as being the done thing for business, although it certainly means that general populace must suffer higher prices, etc.

Another point is that the rulers of China are not squeamish. They are, after all, communists. They heartily endorse the view that you can't make an omlette without breaking eggs. And they were brought up to believe that the end justifies the means. So they will do whatever it takes to stay in control.

Don't forget that they saw their fathers kill tens of millions of dissidents during the cultural revolution. Indeed it was the obvious success of that repression which has emboldened the current generation of party leaders.

The mistake that we Westerners often make is to think that our values are shared by others. In the present context, there are many 'bleading-heart liberals' in the West who make the mistake of thinking that their ideals are shared by everyone indentifies themselves as of the 'left'. The problem, however, is that the Chinese communists are of the old school - their aim is to seize power and to hold it all costs.

So, I don't think there will be a revolution in China. There may be rumblings from time to time, but any organised threat will be crushed ruthlessly.

Anonymous said...

The real way they steal from the peasants is through acquisition and rezoning of farmland into urban land which is then developed and sold off at 100x the price.

Until the peasants own the land they farm they are condemned to poverty.

This rezoning and government-developer linked corruption is responsible for a huge portion of the corrupt wealth generated and it is literally all about stealing from farmers.

Government workers and SOE workers on the other hand were granted their own apartments over a decade ago in the cities .

No country has raised peasants from poverty without land distribution programs. Having land gives them assets , financial stability and something to borrow against eg for factory setup or to finance childrens education.

An example of a successful Land distribution policy was in Taiwan during Japanese rule and then afterwards with the KMT.

Anonymous said...

So if the official deposit rate is 3pc and lending rate is 6pc, what are funds really being held / loaned at to borrowers / SOEs to enable 'looting'?

Mark B. Spiegel said...

The article is still very interesting but the conclusion is still wrong.

For those of you who say that there will be a revolution because a low rate of inflation will endanger the banks holding the peasants' savings, it's the easiest thing in the world for the Chinese Central Bank to guarantee those savings with its printing press.

Therefore (as I said much earlier in this comment thread) the real revolutionary danger comes from the "masses" fed up with an excessively HIGH rate of inflation, so if the kleptocracy wants to stay in power it will simply have to "steal less;" it's most certainly not going to revolt against ITSELF, because whatever would result from that would certainly be inferior to, say, simply cutting its current income in half.

Anonymous said...

May I suggest you avoid travel to mainland China for a while.

Anonymous said...

An interesting assessment of the relevance of inflation & deflation in Chinese politics and economics. To everyone who says 'tsk tsk those terrible Chinese officials' might I remind you of the continuing Wall street, Fed & Government rip off where banks enjoy deregulation when times are good and bailouts when the chickens come home to roost. But you are probably a banker so you're blind to your own klepto traits.

The most important issue raised here for me was the US stock scams. What are we western governments doing about preventing our stock markets from becoming a black market at the hands of Chinese SOEs? Especially since the Chinese are now making it harder to tell the difference from legitimate operations and sharks?

Thanks for raising these issues.

Unknown said...

This article is so extreme as to be meaningless. Far too many generalizations without any supporting facts. China has 20$ of the world's population, 7% of the arable land and 1/3 the global average water per capita. What exactly did you expect them to do to control population. Every single major nation in the world went through exactly the same developement issues as China is going through now. And China, like all those countries, has a very strong group who are striving to continue the reform that has taken place over the past 30 years. As someone once said, by all means light the way forward, but recognize the distance travelled, You have done neither. ensure vs insure

Anonymous said...

Kleptocracy, like mafia, is a word. I agree with a lot of what you write, but I wonder how different you consider China to be from the rest of the world. Is the US a kleptocracy? To put it another way: does the political economy of the US enrich a small elite at the expense of the wider population? Think about the bailouts. Think about the stagnation of middle-class incomes for the past three decades. Think about the Gini coefficient. To use the word kleptocracy suggests the system is evil and unsustainable. I don't think it's so black and white. I don't think the US system is evil, though it clearly serves the interests of the rich few over the many. I don't like China's system, but they have made enormous economic progress there, and people's lives on the whole have got much better. I don't think this is all a mirage, or destined for reversal and collapse. Similarly, I don't think all Chinese listed companies are dishonest. We can point to plenty of corrupt US companies - Enron, WorldCom, CountryWide, the banks. That doesn't make the US stock market as a whole a ponzi scheme.

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