Catching up With China: Tocquevillian Revolution, Credit Bubble Morphs and Grows, South Sea, War

February 22, 2013

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Weibo users and Chinese politicians are using a Tocquevillian pre-1789 French Revolution as a template for China. The Old Regime and the French Revolution hit the best seller list, and vice-premier Wang Qishan “recommended” it. ~ businessinsider

Historian Paul A. Rahe has long made the analogy, prompting a couple articles:

"Further news from the Front Suggesting that China Might Be in a Pre-Revolutionary Condition" and "What Occasions Revolutions"

For more than thirty years, at meetings of the Institute of Current Affairs,  I have been arguing that China would eventually come apart at the seams.

All that it would take, I argued, would be an economic downturn — and the place would blow up.

Speaking of which, Carmen Reinhart, in a 2009 PBS interview, raises the specter for an inflation and domestic debt crises in China, not just a banking crisis (a forecast made in this space long ago).

…many of the indicators in China have the markings of red lights of early warnings. It is also the case that these indicators may flash a warning for awhile before the crisis ultimately erupts;

…one of the contributions of our book is to document domestic debt crises (these often go together with banking crisis). While these often have limited international consequences, they are extremely damaging in terms of both output and inflation consequences. Complacency about China (and other emerging markets) at this juncture is not a great idea. ~ Carmen Reinhart

In "Waiting for a Crisis" Andy Xie, formerly of Morgan Stanley, had this to say recently:

"China’s credit-fueled investment model "is essentially a pyramid scheme," cautioning that "constraints have appeared."

I agree, export growth to developed markets is limited, wage costs are increasing, stimulus impacts food inflation (makes up 50% of household spending),  the environment, and people fed up with their land (read people are getting 2% of the value of land as compenstation.

Trust companies in China’s shadow banking system lent 5x more in first 11 months of 2012 vs 2011

The government has simply blown the credit and infrastructure bubble bigger -companies are fleecing foreign investors yet again raising money through junk bonds, like they did following 2008.

GMO’s James Montier says as much in "Feeding the Dragon: Why China’s Credit System Looks Vulnerable."  I’ve mentioned all of these things before, but it’s worth a refresh. The only thing relatively new is that the Credit growth is bigger, has moved to the shadow banking system, and capital flows out of the banking system have accelerated.

Beijing seems to be on the verge of losing control over the credit system. Savings are migrating from deposits in the state-owned banking system to higher-yielding nonbank credit instruments.

Furthermore, rich Chinese are increasingly willing to evade capital controls and take their money out of the country. As a result of these developments, deposits in the banking system are becoming less stable. “Red Capitalism,” namely the ability of the Chinese authorities to direct the country’s enormous savings for their own ends, faces an existential threat.

It brought to mind the still apt "Assume China Will Have a Financial Crises, What’s Next?" that I wrote in Sept 2011.

Lessons from The 1997-1998 Asian Financial Crises suggest the next stage of the crises will be missed debt payments by a major Chinese firm. This will trigger a crises of confidence about other firms. The debt and corruption is systemic, so it could be a property developer, SOE, financial institution, or industrial company.

What happens then? The central government is displeased at the corruption and abuse at the local level. They could let them fail. We can assume bailouts of SOE, Banks, and corporations, putting their sovereign rating at risk. It’ll be interesting to see if these banks are able to fleece foreign investors one more time and raise capital. Or rather, at what price they will be able to do so.

The answer is yes; Chinese banks successfully raised capital from the Middle East and U.S. Banks following the 2008 crisis. However, Goldman Sachs recently sold their stake in ICBC, yet yield starved foreign investors have come back for more, purchasing bonds of accounting challenged Chinese corporations.

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Bubbles can grow bigger, but this quote is apt, which applies equally to the west:

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. ~ Ludwig Von Mises

The U.S. Energy Information Administration is out with their latest estimates of oil in the South Sea.

Middlebury College put together a great map showing the myriad of overlapping claims, as well as the location of oil fields in the South Sea:

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Businessinsider points out that these “9 Wars That Were Really About Commodities” not ideology.

Speaking of the South Sea, in a Washington Post interview, Japan’s Prime Minister Shinzo Abe says:

China has a “deeply ingrained” need to spar with Japan and other Asian neighbors over territory, because the ruling Communist Party uses the disputes to maintain strong domestic support, Japanese Prime Minister Shinzo Abe said in an interview.

Clashes with neighbors, notably Japan, play to popular opinion, Abe said, given a Chinese education system that emphasizes patriotism and “anti-Japanese sentiment.”

Like the West, Abe is fond of printing money. This brings to mind a quote:

Endless money forms the sinews of war. ~ Cicero

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