China’s Continuing Credit Expansion is Starting to Worry the IMF

Posted by PITHOCRATES - September 15th, 2013

Week in Review

As the U.S. fiscal year draws to a close the Republicans and Democrats are digging in their heels over the upcoming debt ceiling debate.  The Republicans want to cut spending and taxes to rein in out-of-control spending.  So they don’t have to keep borrowing money.  Running up the national debt.  The Democrats, on the other hand, say, “Who cares about the debt?  We’ll be dead and buried when the nation collapses under the weight of this mammoth debt load.  As long as we get what we want why should we care about future generations?”  At least, that’s what their actions say.

A lot of leading economists on the left, Keynesians economists, see no problem in running up the debt.  Print that money, they say.  Keep that expansion growing.  What could possibly go wrong?  Especially when the federal government has the power to print money?  Just look at what the Japanese did in the Eighties.  And what the Chinese are doing now (see As the West Faltered, China’s Growth Was Fueled by Debt by Christina Larson posted 9/12/2013 on Bloomberg Businessweek).

As demand for Chinese exports diminished in the wake of the financial meltdown, the Chinese economy kept humming at more than 9 percent annual gross domestic product growth each year from 2008 to 2011. The trick? “A huge monetary expansion and lending boom,” says Patrick Chovanec, chief strategist at Silvercrest Asset Management and a former professor at Tsinghua University’s School of Economics and Management in Beijing. With bank lending restrictions loosened in late 2008, “Total debt accelerated from 148 percent to 205 percent of GDP over 2008-12,” according to a May 2013 report from research firm CLSA Asia-Pacific Markets. When Beijing tried to rein in the banks beginning in late 2010, shadow banking—lending outside the formal sector—exploded. Today “China is addicted to debt to fuel growth,” according to the CLSA report, with the economy hampered by “high debt and huge excess capacity with only 60 percent utilization.”

The Beijing-based firm J. Capital Research dubbed 2012 the “Year of the (White) Elephant” in a report detailing some of China’s questionable infrastructure build-out. To take one example, 70 percent of the country’s airports lose money, yet more are being built in small and remote cities. At the shiny new Karamay Airport in far western Xinjiang province, there are four check-in counters serving two flights daily. Local governments have splurged on “new towns” and “special zones,” many of which have already fallen into disrepair. The $5 million Changchun Zhenzhuxi Park, intended as a scenic area, is now a large public garbage dump, as the local landscaping bureau never agreed to provide maintenance. Near the southern city of Hangzhou, a forlorn replica of the Eiffel Tower overlooks a faux Paris—the ersatz arrondissement attracted hardly any residents, and local media have dubbed it a ghost town.

“In China, you often hear people say they’re building for the future,” explains Chovanec. “But if you build something and it’s empty for 20 years, does that make any sense? By that point, it may already be falling apart.”

The classic Keynesian argument for economic stimulus is the one about paying people to dig a ditch.  Then paying them to fill in the ditch they just dug.  The ditch itself having no economic value.  But the people digging it and filling it in do.  For they will take their earnings and spend it in the economy.  But the fallacy of this argument is that money given to the ditch-diggers and the fillers-in could have been spent on something else that does have economic value.  Money that was pulled out of the private sector economy via taxation.  Or money that was borrowed adding to the national debt.  And increasing the interest expense of the nation.  Which negates any stimulus.

If that money was invested to expand a business that was struggling to keep up with demand that money would have created a return on investment.  That would last long after the people who built the expansion spent their wages.  This is why Keynesian stimulus doesn’t work.  It is at best temporary.  While the long-term costs are not.  It’s like getting a 30-year loan to by a new car.  If you finance $35,000 over 5 years at a 4.5% annual interest rate your car payment will be $652.51 and the total interest you’ll pay will be $4,018.95.  That’s $39,018.95 ($35,000 + 4,018.95) of other stuff you won’t be able to buy because of buying this car.  If you extend that loan to 30 years your car payment will fall to $177.34.  But you will be paying that for 30 years.  Perhaps 20-25 years longer than you will actually use that car.  Worse, the total interest expense will be $23,620.24 over those 30 years.  That’s $58,620.24 ($35,000 + 23,620.24) of stuff you won’t be able to buy because of buying this car.  Increasing the total cost of that car by 50.2%.

This is why Keynesian stimulus does not work.  Building stuff just to build stuff even when that stuff isn’t needed will have long-term costs beyond any stimulus it provides.  And when you have a “high debt and huge excess capacity with only 60 percent utilization” bad things will be coming (see IMF WARNS: China Is Taking Ever Greater Risks And Putting The Financial System In Danger by Ambrose Evans-Pritchard, The Telegraph, posted 9/13/2013 on Business Insider).

The International Monetary Fund has warned that China is taking ever greater risks as surging credit endangers the financial system, and called for far-reaching reforms to wean the economy off excess investment…

The country has relied on loan growth to keep the economy firing on all cylinders but the law of diminishing returns has set in, with the each yuan of extra debt yielding just 0.20 yuan of economic growth, compared with 0.85 five years ago. Credit of all types has risen from $9 trillion to $23 trillion in five years, pushing the total to 200pc of GDP, much higher than in emerging market peers…

China’s investment rate is the world’s highest at almost 50pc of GDP, an effect largely caused by the structure of the state behemoths that gobble up credit. This has led to massive over-capacity and wastage.

“Existing distortions direct the flow of credit toward local governments and state-owned enterprises rather to households, perpetuating high investment, misallocation of resources, and low private consumption. A broad package of reforms is needed,” said the IMF.

Just like the miracle of Japan Inc. couldn’t last neither will China Inc. last.  Japan Inc. put Japan into a deflationary spiral in the Nineties that hasn’t quite yet ended.  Chances are that China’s deflationary spiral will be worse.  Which is what happens after every Keynesian credit expansion.  And the greater the credit expansion the more painful the contraction.  And with half of all Chinese spending being government spending financed by printing money the Chinese contraction promises to be a spectacular one.  And with them being a primary holder of US treasury debt their problems will ricochet through the world economy.  Hence the IMF warning.

Bad things are coming thanks to Keynesian economics.  Governments should have learned by now.  As Keynesian economics turned a recession into the Great Depression.  It gave us stagflation and misery in the Seventies.  It gave the Japanese their Lost Decade (though that decade actually was closer 2-3 decades).  It caused Greece’s economic collapse.  The Eurozone crisis.  And gave the U.S. record deficits and debt under President Obama.

The history is replete with examples of Keynesian failures.  But governments refuse to learn these lessons of history.  Why?  Because Keynesian economics empowers the growth of Big Government.  Something free market capitalism just won’t do.  Which is why communists (China), socialists (the European social democracies) and liberal Democrats (in the United States) all embrace Keynesian economics and relentlessly attack free market capitalism as corrupt and unfair.  Despite people enjoying the greatest liberty and economic prosperity under free market capitalism (Great Britain, the United States, Canada, Australia, Hong Kong, Taiwan, South Korea, etc.).  While suffering the most oppression and poverty under communism and socialism (Nazi Germany, the Soviet Union, the communist countries behind the Iron Curtain in Eastern Europe, the People’s Republic of China under Mao, North Korea, Cuba, etc.).

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Countries Outside the Eurozone want those Inside to Increase their Firewall before they Commit to more IMF Funding

Posted by PITHOCRATES - January 29th, 2012

Week in Review

The road to save the Eurozone must pass through a firewall.  A big pile of money that can rush in and stop another crisis from taking hold and spreading.  Money that will just sit there.  And because it’s there it will give everyone confidence that the Eurozone is okay.  Because if something happens again there’s that big pile of money just sitting there to help stop anything bad from happening.

It will be there, say, in the rare chance that a member state has another debt crisis and can’t raise money in the bond markets.  This money will address that crisis.  Keeping the state and the banking system calm.  And liquid.

It is reassuring what a big pile of money can do.  Just sitting there.  If they just let it sit there.  Which is easier said than done.  In fact, this was very difficult to do in many pension funds.  All that money just sitting there.  Doing nothing.  While budget deficits were growing.  So they borrowed a little every now and then.  Until those funds became dangerously underfunded.  So setting up this firewall may be easier said than done.  Because all of the Eurozone member states have deficits.  And large debts.  They may be a little skittish putting in more money to try and save a member state.  Especially if that state is beyond saving (see IMF leads global push for euro zone to boost firewall by Paul Carrel and Emma Thomasson, Reuters, posted 1/28/2012 on Yahoo! News).

Countries beyond the 17-country bloc want to see its members stump up more money before they commit additional resources to the IMF, which this month requested an additional 500 billion euros ($650 billion) in funding…

In a carefully worded keynote address, Merkel suggested doubling or even tripling the size of the fund may convince markets for a time, but warned that if Germany made a promise that could not be kept, “then Europe is really vulnerable.”

On Friday, U.S. Treasury Secretary Timothy Geithner pressed Europe to make a “bigger commitment” to boosting its firewall.

Two bankers who attended meetings with Geithner at the Forum said on Friday the United States was looking for the euro zone to roughly double the size of its firewall to 1.5 trillion euros. There was no immediate comment from the U.S. Treasury.

Some countries want a free pass on their irresponsible spending ways.  They want help.  But they want other people to pay for it.  While other countries have been carrying a much larger weight than others.  Like Germany.  The richest economy in the Eurozone.  Whose taxpayers may be growing tired of being the go-to country in times of bailouts.  And the U.S. wants the Europeans to spend more to save the Eurozone.  About twice as much.  Making the price of membership so high some may just consider leaving.

“The euro zone is a slow-motion train wreck,” said economist Nouriel Roubini, made famous by predictions of the 2008-09 global banking crisis.

He expected Greece, and possibly Portugal, to exit the bloc within the next 12 months and believed there is a 50 percent chance of the bloc breaking up completely in the next 3-5 years.

Hong Kong’s Chief Executive, Donald Tsang, said no matter how strong the euro zone’s firewall is, the market will look at the nature of the economies it is protecting.

“If it is protecting insolvent economies…no matter how strong the firewall is, it won’t survive,” he said..

So it may not help no matter how big the firewall is.  Because most countries don’t want to be told what to do.  And won’t change the way they run their countries.  And without fixing the underlying problems (excessive government spending) there’s no saving the Eurozone no matter the size of the firewall.

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The IMF wants to Double their Resources to Bail Out the Eurozone

Posted by PITHOCRATES - December 25th, 2011

Week in Review

The IMF wants more of our money.  So they can help governments maintain their irresponsible ways (see IMF urges members to boost funding under 2010 plan by Lesley Wroughton posted 12/22/2011 on Reuters).

IMF chief Christine Lagarde on Thursday urged member countries to quickly sign off on an agreement last year to double IMF resources and give under-represented nations, such as China, greater voting power in the global lender.

The changes to members’ quotas, which determine how much each country contributes to the IMF and their voting shares, are critical as a euro zone debt crisis escalates and is set to slow global growth in 2012…

As of December 12, just 53 countries, holding 36 percent of total IMF quotas, had approved the increases. Approval by members holding about 70 percent of quotas is needed to implement the changes. Some countries require their legislatures to authorize the changes.

The measure still requires approval by the U.S. Congress, where Republicans are taking aim at any IMF move to bail out troubled euro zone countries, saying they don’t want American funds involved.

IMF resources?  You know what that means.  More of our money.  So they can give it to other people.  Like those in the Eurozone.  Where they won’t cut back on their government spending and live within their means.  Instead they want us to cut back on our spending.  So we can give them our tax dollars.

With only about half the votes they need to increase their spending (and our taxation), it doesn’t look good for the IMF right now.  You see, the problem is that it’s just not one country in need of assistance.  Right now governments all around the world are living beyond their means.  Even the United States has entered the fraternity of nations who irresponsibly live beyond their means.  Which makes it difficult to help pay for other nations.  Because we’ll just push ourselves closer to where they are now.  And once we do who will be there to bail out us?

Keynesian economists say no big deal.  Just print more money.  Which is what central banks are for.  But it was those central banks that created the crisis in the Eurozone in the first place.  And doing more of what gave you a problem is not likely to solve that problem.  No matter what the Keynesians say.

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