Can the Chinese bail out the Europeans?

The China Model Is Unsustainable

Property bubble: Zhengzhou New District features vast public buildings that have never been used

by Doug French

While the pols in Europe endlessly consider how they will paper over their financial crisis, "ring fence" Greece and the other PIIGS pass austerity programs, and still get reelected, some speculate that perhaps China will step forward to bail out the eurozone.

In recent years a number of investment gurus have touted China as the new financial powerhouse, while at the same time the country serves as punching bag for both sitting and would-be American politicians. Senator Charles Schumer claims the Chinese are manipulating the yuan, causing millions to lose their jobs in America. "More than any single stimulus program we could pass into law, forcing China to revalue its currency is the biggest step we could take to protect American jobs," Schumer said. "This is not about China-bashing. This is about defending the United States."

Donald Trump unleashed this tirade on Wolf Blitzer's CNN Situation Room:

They're manipulating their currency. Intellectual property rights and everything else are a joke over there. They're making stuff that you see being sold all the time on Fifth Avenue, copying various, you know, whether it's Chanel or whatever it may be, the brands, and just selling it ad — ad nauseum. I mean this is a country that is ripping off the United States like nobody other than OPEC has ever done before.

But is China the capitalist powerhouse everyone thinks they are? This China-is-taking-over-the-world talk makes a person wonder if members of the Politburo of the Communist Party of China pored over Human Action, implementing a better Misesian capitalist mousetrap.

However, Chinese economic growth has exploded on the shakiest of financial systems, Carl E. Walter and Fraser J.T. Howie point out in Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise. The country's central planners do their best to keep as many of the 1.3 billion people employed as they can; building vacant cities and dozens of large infrastructure projects along with releasing eye-popping "official" GDP numbers. All of this has some observers believing China will use every barrel of oil, yard of cement, and pound of yellowcake the world has to offer.

Nonetheless, reading Howie and Walter's eye-opening book makes a reader wonder how the whole Chinese economy hasn't imploded already. The Chinese have developed stock markets and debt markets, pension funds, home loans, and credit cards. From afar it looks sort of like capitalism, providing comfort to investors. However, the authors point out; "[Investors] would not feel that way if China explicitly relied on a Soviet-inspired financial system even though, in truth, this is largely what China remains."

Red Capitalism is clearly written, but at the same time it is so littered with acronyms standing for the various government entities that comprise the thicket of state organizations that make up the Chinese financial system the reader is constantly confused. Take for example this sentence:

By 2005, Huijin had become the controlling shareholder on behalf of the state and enjoyed majority representation on the boards of directors of CCB and BOC and, together with the MOF, of ICBC, CDB, ABC and a host of other financial institutions.

Got that?

The upshot from following the alphabet soup of entities, created to make loans to the state sector and friends of the state, is that when the loans go bad, which an extraordinary percentage do, then new entities are created into which to move the debts: from good banks to bad banks to worse banks.

"It is a simple fact that China's financial system and its stock, bond and loan markets cater only to the state sector, of which the 'National Champions' represent the reddest of the Red," write Howie and Walter, who go on to point out that "China is a family-run business."

Forget supply and demand; in China, the system serves the country's political elite. While the oligopolies that dominate the economy appear to be private, these entities are really state controlled and operate under a patronage system that pervades all aspects of the Chinese economy.

The National Champions, explain the authors, along with "their family associates and other retainers plunder the country's large domestic markets and amass huge profits. With nationwide monopolies or, at worst, oligopolies, these business groups do not want change, nor do they believe that foreign participation is needed."

"The Chinese financial system would seem to be built on sand running through a Rube Goldberg hourglass. "

Chinese bank depositors provide the capital to finance the insiders. But when the loans go bad and the banks go bankrupt, it's left to the party to provide continuous bailouts. "In short, China's banking giants of 2010 were under-capitalized, poorly managed and, to all intents, bankrupt 10 years ago."

As nonperforming loans are pushed from good banks to bad, with China's Ministry of Finance providing its guarantee to the bad loans at par, banking life goes on, and the economic miracle remains alive, backstopped by the lender of last resort, the People's Bank of China, levered at 1,233 to 1. The result is underlying assets are never liquidated and zombie banks and crony-led corporations are left in place to squander capital.

The Chinese financial system would seem to be built on sand running through a Rube Goldberg hourglass.

Geithner, Paulson, and Bernanke didn't come up with anything new on this side of the Pacific in 2008, but took a page from the Chinese problem-solving playbook — "shifting money from one pocket to another and letting time and fading memory do the rest." European finance ministers are now attempting the same trick.

While China looks to be a constant growth machine, as the authors point out, its economy has been a series of booms and busts. In what will be strikingly familiar to Americans, Howie and Walter write, "Putting money on deposit with banks or playing the bond market is hardly worth the effort; interest rates are set in favor of state borrowers, not lenders, so they do not provide a real return over the rate of inflation."

The money supply grew at a rate of 13.5 percent in August, while the price of pork — the meat preferred by most Chinese — increased by over 45 percent from last year. And while the Chinese government says prices are up 6.2 percent, the price of all food was up 13.4 percent in August from 2010.

So the Chinese play the stock and property markets, hoping for a big score. "Chinese history and bitter experience teach that life is too volatile and uncertain to take the long-term view," write the authors. Hans-Hermann Hoppe would contend it is the prevalence of government force — stealing through taxation, regulation, and inflation — that have increased time preferences.

US investors have piled into the shares of large Chinese companies with some success, but the authors wonder, "how can an investor look at PetroChina and compare it with ExxonMobil when it is nearly 85 percent controlled by the state and will remain so as long as the Party remains in power?"

Plenty of Americans are now aware of how deeply in debt their government is. And certainly Europe's troubles are well-known. But China too has a debt problem. The authors add up debt obligations of various sorts including nonperforming loans now guaranteed by the Chinese government. The total comes to nearly 76 percent of GDP, exceeding the international standard, and the burden will likely grow.

Writing for the Casey Report, James Quinn described China's economy as "a house of cards," and pointed out, "Fitch downgraded the country's credit rating and warned there was a 60% chance the Chinese banking system will require a bailout in the next two years."

In the same issue, Doug Casey wrote,

It's not just Europe, the U.S. and Japan that are riding for a fall but also the Chinese. What's coming up, in other words, is a worldwide financial and economic cataclysm. Let's just hope that the political, social and military fallout from the coming financial/economic collapse aren't too severe.

So can the Chinese bail out the Europeans? Not hardly.

We can't just go save someone," said Gao Xiqing, president of China Investment Corp., China's huge sovereign wealth fund. "We're not saviors. We have to save ourselves," he said at a weekend panel discussion.

"State interference in economic life, which calls itself 'economic policy' has done nothing but destroy economic life," wrote Ludwig von Mises.

The Chinese economic miracle is nothing but a redder version of Keynesianism. Like all interventionism, the Chinese system is destined for a hard fall.