Workers of the world unite

Children of the Revolution

China's 'princelings,' the offspring of the communist party elite, are embracing the trappings of wealth and privilege—raising uncomfortable questions for their elders.

By JEREMY PAGE

Bo Xilai, with his son, at a memorial
 ceremony held for his father
in Beijing, in 2007.

One evening early this year, a red Ferrari pulled up at the U.S. ambassador's residence in Beijing, and the son of one of China's top leaders stepped out, dressed in a tuxedo.

Bo Guagua, 23, was expected. He had a dinner appointment with a daughter of the then-ambassador, Jon Huntsman.

The car, though, was a surprise. The driver's father, Bo Xilai, was in the midst of a controversial campaign to revive the spirit of Mao Zedong through mass renditions of old revolutionary anthems, known as "red singing." He had ordered students and officials to work stints on farms to reconnect with the countryside. His son, meanwhile, was driving a car worth hundreds of thousands of dollars and as red as the Chinese flag, in a country where the average household income last year was about $3,300.

A look at China's leaders, past  and present, and their
offspring, often known as 'princelings.'

The episode, related by several people familiar with it, is symptomatic of a challenge facing the Chinese Communist Party as it tries to maintain its legitimacy in an increasingly diverse, well-informed and demanding society. The offspring of party leaders, often called "princelings," are becoming more conspicuous, through both their expanding business interests and their evident appetite for luxury, at a time when public anger is rising over reports of official corruption and abuse of power.

State-controlled media portray China's leaders as living by the austere Communist values they publicly espouse. But as scions of the political aristocracy carve out lucrative roles in business and embrace the trappings of wealth, their increasingly high profile is raising uncomfortable questions for a party that justifies its monopoly on power by pointing to its origins as a movement of workers and peasants.

Their visibility has particular resonance as the country approaches a once-a-decade leadership change next year, when several older princelings are expected to take the Communist Party's top positions. That prospect has led some in Chinese business and political circles to wonder whether the party will be dominated for the next decade by a group of elite families who already control large chunks of the world's second-biggest economy and wield considerable influence in the military.

"There's no ambiguity—the trend has become so clear," said Cheng Li, an expert on Chinese elite politics at the Brookings Institution in Washington. "Princelings were never popular, but now they've become so politically powerful, there's some serious concern about the legitimacy of the 'Red Nobility.' The Chinese public is particularly resentful about the princelings' control of both political power and economic wealth."

The current leadership includes some princelings, but they are counterbalanced by a rival nonhereditary group that includes President Hu Jintao, also the party chief, and Premier Wen Jiabao. Mr. Hu's successor, however, is expected to be Xi Jinping, the current vice president, who is the son of a revolutionary hero and would be the first princeling to take the country's top jobs. Many experts on Chinese politics believe that he has forged an informal alliance with several other princelings who are candidates for promotion.

Among them is the senior Mr. Bo, who is also the son of a revolutionary leader. He often speaks of his close ties to the Xi family, according to two people who regularly meet him. Mr. Xi's daughter is currently an undergraduate at Harvard, where Mr. Bo's son is a graduate student at the Kennedy School of Government.

Already in the 25-member Politburo, Bo Xilai is a front-runner for promotion to its top decision-making body, the Standing Committee. He didn't respond to a request for comment through his office, and his son didn't respond to requests via email and friends.

The antics of some officials' children have become a hot topic on the Internet in China, especially among users of Twitter-like micro-blogs, which are harder for Web censors to monitor and block because they move so fast. In September, Internet users revealed that the 15-year-old son of a general was one of two young men who crashed a BMW into another car in Beijing and then beat up its occupants, warning onlookers not to call police.

An uproar ensued, and the general's son has now been sent to a police correctional facility for a year, state media report.

Top Chinese leaders aren't supposed to have either inherited wealth or business careers to supplement their modest salaries, thought to be around 140,000 yuan ($22,000) a year for a minister. Their relatives are allowed to conduct business as long as they don't profit from their political connections. In practice, the origins of the families' riches are often impossible to trace.

Last year, Chinese learned via the Internet that the son of a former vice president of the country—and the grandson of a former Red Army commander—had purchased a $32.4 million harbor-front mansion in Australia. He applied for a permit to tear down the century-old mansion and to build a new villa, featuring two swimming pools connected by a waterfall. (See the article below.)

Many princelings engage in legitimate business, but there is a widespread perception in China that they have an unfair advantage in an economic system that, despite the country's embrace of capitalism, is still dominated by the state and allows no meaningful public scrutiny of decision making.

The state owns all urban land and strategic industries, as well as banks, which dole out loans overwhelmingly to state-run companies. The big spoils thus go to political insiders who can leverage personal connections and family prestige to secure resources, and then mobilize the same networks to protect them.

The People's Daily, the party mouthpiece, acknowledged the issue last year, with a poll showing that 91% of respondents believed all rich families in China had political backgrounds. A former Chinese auditor general, Li Jinhua, wrote in an online forum that the wealth of officials' family members "is what the public is most dissatisfied about."

One princeling disputes the notion that she and her peers benefit from their "red" backgrounds. "Being from a famous government family doesn't get me cheaper rent or special bank financing or any government contracts," Ye Mingzi, a 32-year-old fashion designer and granddaughter of a Red Army founder, said in an email. "In reality," she said, "the children of major government families get very high scrutiny. Most are very careful to avoid even the appearance of improper favoritism."

For the first few decades after Mao's 1949 revolution, the children of Communist chieftains were largely out of sight, growing up in walled compounds and attending elite schools such as the Beijing No. 4 Boys' High School, where the elder Mr. Bo and several other current leaders studied.

In the 1980s and '90s, many princelings went abroad for postgraduate studies, then often joined Chinese state companies, government bodies or foreign investment banks. But they mostly maintained a very low profile.

Now, families of China's leaders send their offspring overseas ever younger, often to top private schools in the U.S., Britain and Switzerland, to make sure they can later enter the best Western universities. Princelings in their 20s, 30s and 40s increasingly take prominent positions in commerce, especially in private equity, which allows them to maximize their profits and also brings them into regular contact with the Chinese and international business elite.

Younger princelings are often seen among the models, actors and sports stars who gather at a strip of nightclubs by the Workers' Stadium in Beijing to show off Ferraris, Lamborghinis and Maseratis. Others have been spotted talking business over cigars and vintage Chinese liquor in exclusive venues such as the Maotai Club, in a historic house near the Forbidden City.

On a recent afternoon at a new polo club on Beijing's outskirts, opened by a grandson of a former vice premier, Argentine players on imported ponies put on an exhibition match for prospective members.

"We're bringing polo to the public. Well, not exactly the public," said one staff member. "That man over there is the son of an army general. That one's grandfather was mayor of Beijing."

Princelings also are becoming increasingly visible abroad. Ms. Ye, the fashion designer, was featured in a recent edition of Vogue magazine alongside Wan Baobao, a jewelry designer who is the granddaughter of a former vice premier.

But it is Bo Guagua who stands out among the younger princelings. No other child of a serving Politburo member has ever had such a high profile, both at home and abroad.

His family's status dates back to Bo Yibo, who helped lead Mao's forces to victory, only to be purged in the 1966-76 Cultural Revolution. Bo Yibo was eventually rehabilitated, and his son, Bo Xilai, was a rising star in the party by 1987, when Bo Guagua was born.

The boy grew up in a rarefied environment—closeted in guarded compounds, ferried around in chauffeur-driven cars, schooled partly by tutors and partly at the prestigious Jingshan school in Beijing, according to friends.

In 2000, his father, by then mayor of the northeastern city of Dalian, sent his 12-year-old son to a British prep school called Papplewick, which according to its website currently charges £22,425 (about $35,000) a year.

About a year later, the boy became the first person from mainland China to attend Harrow, one of Britain's most exclusive private schools, which according to its website currently charges £30,930 annually.

In 2006, by which time his father was China's commerce minister, Mr. Bo went to Oxford University to study philosophy, politics and economics. The current cost of that is about £26,000 a year. His current studies at Harvard's Kennedy School cost about $70,000 a year.

The folly of central planning

Alternative Energy's Alternate Reality

By Bill Frezza

Creating a “green energy” economy may be the most daunting central planning task ever attempted. It entails nothing less than the reengineering of our entire energy infrastructure. And, like all central planning schemes, it is based on a roadmap that eschews real-world experience and sound economics in favor of utopian ideology driven by political connections.

Now the experiment is unraveling, having barely begun. As the parade of government-subsidized failures like Solyndra, Stirling Energy, SpectraWatt, Evergreen Solar, Beacon Power, and others mount, now is a good time to look at how all the pieces of the alternative energy puzzle are supposed to fit together—and what happens when they don’t.

Everyone acknowledges that electricity generated from wind and solar cannot be produced and delivered at prices that compete with coal or gas. However, alternative energy advocates believe that someday the cost curves will cross, and that government subsidies will accelerate that day’s arrival.

For this to come true, multiple problems have to be solved before taxpayers run out of money or patience. Along the way, the alternative energy industry has to avoid getting sidetracked into the wrong technologies, as this will delay the eagerly awaited carbon-free future.

First, technology has to be invented that can deliver unprecedented levels of efficiency in the conversion of low energy-density sources like wind and solar into electricity suitable for transmission over the grid.

Second, the prices of fossil fuels have to rise, either because reserves become depleted or through the passage of regulatory encumbrances, such as a massive carbon tax.

Third, new techniques need to be developed to store electricity produced only while the sun shines or the wind blows, allowing that stored energy to be delivered later, when it is actually needed.

Fourth, massive transmission system upgrades need to occur to transport electricity from the wind and solar farms where it is produced to the urban areas where it is consumed.

Finally, unknown problems that crop up when immature technologies are brought to market have to be identified and resolved—from the scarcity of critical materials never before consumed in large quantities to the siting of massive structures that disturb the view of influential public figures. And, of course, after decades trying to protect wildlife from oil spills and other calamities, we must avert our eyes as windmills annually massacre millions of birds, many of them supposedly protected as endangered species.

Failure to solve any of these problems can doom the whole enterprise, stranding investments. Picking winners and losers in this interconnected risk management puzzle is like playing ten games of roulette simultaneously—you can only win if every bet comes in. Yet this has not dissuaded the Department of Energy from smacking your money down. So, how is our Nobel Prize-winning high roller doing?

Conversion efficiency is, indeed, climbing—very slowly. Under unsubsidized conditions, wind and solar would be nurtured in niche markets that fossil fuels cannot satisfy. In time, improvements might expand the market beyond those niches.

But when government subsidies are used to prematurely scale up technologies that make no economic sense, these early experiments become frozen in amber. Speculative investments counting on those subsidies fail. Solyndra was one such failure. Loss-making operations at scale can only be sustained while the mandates and subsidies last. Take away that expensive government support and the businesses crash.

Meanwhile, mature technologies are not standing still. Thanks to fracking and horizontal drilling, proven reserves of gas and oil are soaring, holding fossil fuel prices in check. Even as the Obama administration throws regulatory sand into the gears to slow these developments, newly accessible oil and gas isn’t going anywhere. Sooner or later, it will be pumped out, delaying the day at which the cost curves cross.

Attempts to store enough electricity to power the grid predate current environmental fashion. The motivation has been to reduce the cost of running expensive peak-load generators. However, the storage problem has not yet been solved because the physics are very, very hard. Dozens of ideas have been tried and found wanting, including flywheels, compressed air, pumping water uphill, and mammoth ultracapacitors. And if a practical technique is ever found, its primary economic benefit will not come from enabling windmills and solar farms, but from allowing the expansion of base-load fossil fuel generators, making it possible to reduce the fleet of peak-load facilities.

Then there is the upgrade of transmission lines. Political pressure can be used to force regulated transmission companies to agree to install new high voltage lines. But imagine how long the permitting and construction process will take when company executives are as loath to make these malinvestments as NIMBY-objecting residents are to have towers erected on or even on sight of their land.

The likelihood that all of these problems will be solved simultaneously before the political winds shift is vanishingly small. As we enter an election year, it is easy to see why the venture capital community is rapidly abandoning early-stage alternative energy investments, shifting their last bets to late stage deals, hoping to cash out before the party is over.

No one knows when the final chapter in this saga will be written, but we can be sure it’ll make a fine addition to a book describing the folly of central planning.

Creative Destruction

Back to 1693

By Martin Hutchinson

The eurozone crisis, which could have been defused initially by allowing Greece to depart the euro, has now taken on a much more serious aspect. If, as seems possible, Italy, Spain and even France lose the confidence of the international debt markets and are forced to write down debt, then government debt of prime countries will no longer be considered a risk-free asset. That will take markets back beyond the traumas of the 20th century, beyond the relatively serene 19th century, beyond even the institution-forming 18th century.

It will undo the 1751 triumph of the forgotten financier Samson Gideon in forming the immortal Consols, will undo the sterling if self-serving 1721 work of Sir Robert Walpole in preventing the South Sea crash from destroying the British government bond market as the Mississippi crash did the French one, and will even

undo the 1694 foundation of British credit, the formation of the Bank of England. Life for government bond dealers will revert to a primitive Hobbesian state of nature, nasty, brutish and short. But will the rest of us suffer, except in the short term?

Based on the bond market as we have known it over the last century or two, only Greece was bound to default. Its problem was not so much its starting ratio of debt to gross domestic product (GDP), but the fact that its GDP was over-inflated, being based on hopelessly unrealistic living standards for the Greek people.

Once the Greeks were paid at a level at which the country's economy would balance - no more than US$15,000 or so in GDP per capita compared to 2008's overinflated $32,000 - Greek GDP would be halved, and its debt/GDP ratio doubled to a level approaching 300%. That would have been beyond the highest levels ever successfully reduced without default - 250% of GDP by Britain after 1815 and again after 1945. Since Greece is a notoriously undisciplined society, with poor tax enforcement and an open economy whose citizens keep much of their wealth abroad, a Greek default was and is inevitable in the best of circumstances.

The same is not, however, true of Italy and Spain. Italy's competitiveness has declined by about 20% against Germany's in the last decade. However its debt level is only 120% of GDP, or say 150% of GDP if Italy's living standards and GDP declined by the necessary 20%. Since its budget deficit under the competent management of Silvio Berlusconi's finance minister Giulio Tremonti was only about 3-4% of GDP, Italy's position by the standards of the last two centuries is perfectly manageable without default being more than a distant threat.

Similarly Spain has a budget deficit of around 7% of GDP, and a housing finance sector that is a mass of bad debts, with house prices still to descend to market-clearing levels, but its official debt is only 61% of GDP, and its economically odious Zapatero government is on the way out.

The level of market panic about Italian and Spanish debt indicates that the comforting parameters of 19th and 20th century sovereign debt finance no longer hold. The principal reason for this is the determination by the eurozone authorities to break the rules by which debt markets have traditionally been governed. Instead of allowing Greece to default or rescuing it completely, they arranged an inadequate debt-financed bailout that simply postponed Greece's inevitable exit from the euro and increased its debt. Then they arranged a "voluntary" writedown of Greek private sector debt, which was subordinated in repayment to the monstrous institutional and government debt created by the bailout.

When the Greek government attempted to get referendum or electoral support for the "reforms" imposed by the eurozone authorities, the authorities replaced the Greek government with a eurozone stooge, without democratic legitimacy. Eurozone authorities repeated this stooge imposition process with the long-lasting and economically capable Italian government of Silvio Berlusconi, who they regarded as euro-skeptic and excessively devoted to free market and low-tax principles. Berlusconi was replaced with a government dominated by europhiles and the left, which had been decisively defeated in the previous election.

Finally, and most damagingly, the euro-zone authorities prevented the modest $3.5 billion of Greek credit default swaps (CDS) from paying out, thus drastically devaluing the CDS of Italy, Spain and France, whose volume is of the order of $40 billion each. They have thus called the entire CDS market into question, at least for sovereign names, and have badly shaken the security of international contracts. By doing this, according to Gillian Tett of the Financial Times, they removed the protection that Deutsche Bank, for example, thought it had obtained this year by buying CDS on $7 billion of its $8 billion Italian exposure.

Investors in PIIGS (Portugal, Ireland, Italy, Greece and Spain) debt thus now face the reality that they have been subordinated arbitrarily to the international and eurozone institutions. Their ability to protect themselves by CDS purchase has been removed. The security of their debt contracts themselves has been called into question.

Finally, investors' protection against coups and revolutions, that monetary and fiscal policy were being set by democratically elected governments acceptable to their people, has been removed by the imposition of governments wholly lacking in democratic legitimacy. If those governments impose policies that the populace finds intolerable, as is very likely, there is now far more chance of outright popular revolt or coup d'etat, since ordinary democratic change has been blocked.

In short, the protections given to government debt progressively in the last three centuries have been removed. The rationale for the Basel committee rating government debt at zero in banks' risk calculations has been exposed for the fraud it always was. Since government levels of taxation are close to the Laffer Curve yield peak in most countries, [1] the protection given to investors by the taxing power has also been rendered nugatory.

Investors are no longer in the position of investors in the solid, well-managed government debt of Walpole and Lord Liverpool, in which the phrase "as solid as the Bank of England" made British debt sell at the finest international rates. Instead, they are in the position of the goldsmiths lending to Charles II, charging 10% for their money and liable to be ruined at any point by a Great Stop of the Exchequer, like that of 1672.

I have written before in some detail about the likely effect on the global economy of the removal of government debt markets. In general, it should improve financial availability for the private sector, while starving profligate governments of the means to implement "Keynesian" stimulus and other wasteful policies. Thus it may well improve economic performance in the long run, certainly compared to the anemic growth and high unemployment suffered in most countries since 2009.

Needless to say, however, the 2010s will be a grim decade, because the transitional and wealth effects of eliminating the government debt markets that have formed the centerpiece of the last three centuries will be enormous - a Reinhart/Rogoff depression of spectacular severity.

However, there is another effect of transporting the world financial system back to 1693 - the year before the Bank of England was established. The European Central Bank will be bankrupt because of its holdings of worthless PIIGS debt, and it is most unlikely that German taxpayers will consent to recapitalize an institution that has failed so badly, after first eliminating their beloved deutschemark. The Bank of England, the Federal Reserve and the Bank of Japan will also be legally insolvent, since in their policies of quantitative easing they have acquired gigantic quantities of assets that will drop catastrophically in price once interest rates rise.

The Fed, for example, is leveraged 60-to-1, and it was recently calculated that a rise in long-term interest rates of only 40 basis points would be sufficient to wipe out its capital. Needless to say, a rise of 4-5% in long-term interest rates, back to a historically normal level 2-3% above the true level of inflation, would put a hole in the Fed's balance sheet that in current stringent budgetary conditions would be politically impossible for the US Treasury to fill.

Thus if a debt default in the eurozone spread even partially to the over-indebted economies of Britain, Japan and the United States, not only will government bond markets be wiped out, but central banks in their current form will disappear also.

In the long term, this should also prove a blessing. My colleague and co-author, Kevin Dowd, has been trying for some years to persuade me that the ideal monetary system is not only a gold standard, but one entirely without a central bank. I had always resisted this, believing in the positive qualities of the privately owned Bank of England of the 1797 Old Lady of Threadneedle Street Gillray cartoon, [2] the 1844 Bank Charter Act and the elegant inter-war Montagu Norman, the hero who removed the 1929-31 Labour government by omitting to tell that bunch of economic illiterates that leaving the gold standard was an available option.

However, lovers of central banks cannot deny that the Fed bears a substantial share of the responsibility for creating the Great Depression and an even greater share of the responsibility for creating the 2008 crash and the period of grindingly high unemployment that has followed. Thus the existence of a central bank is no longer a battle won and lost in 1694, but must be considered to have become a live question.

If government debt markets across Europe collapse and central banks worldwide are rendered insolvent, the fiat currencies of the world are no longer likely to command enough public confidence to be workable. Like successive generations of Argentine pesos and Ecuadorian sucres, they will have to be junked. Further, since there is unlikely to be a figure like Weimar Germany's Gustav Stresemann, able to create a new and workable fiat "rentenmark" out of a mythical monetization of land values, a return to a gold standard will be not only inevitable but irresistible, since it will have been imposed on the ruins of the current system by the global private sector.

With a gold standard, and central banks in ruins, a truly free banking system will also be inevitable. Most large existing banks will have failed along with their central banks, with no more money for bailouts and their regulatory institutions thoroughly discredited.

The new central bank-less gold standard banking system that arises from the ashes of the old will be perfectly workable, as in 18th century Scotland, 19th century Canada and the United States between 1837 and 1862. It will permit only minimal government, but will allow the private sector, particularly the small-scale private sector, to flourish as never before.

As after 1945, from the chaos of monetary ruin will emerge a new global economy that is stronger and healthier, provides better living standards for its citizens and imposes far fewer taxes, scams and state-aided rip-offs on their wealth than does the current system.

But the intervening decade is certainly not going to be easy or pleasant.

Notes

1. Laffer Curve - a theoretical representation of the relationship between government revenue raised by taxation and all possible rates of taxation.

2. See here. .

Supply & Demand RIP

Venezuela Repeals the Laws of Supply and Demand

By Mark Perry

The twisted logic of Venezuela's price controls:

1. Under President Hugo Chavez, Venezuela's central bank has doubled the money supply over the last four years.
 2.  Because of the the doubling of the money supply, Venezuela is experiencing the highest annual rate of inflation in the Western hemisphere at 27%. 

3. In response to the high inflation, the Venezuelan government just announced it is expanding price controls to cover many basic consumer items like toothpaste, coffee, toilet paper and deodorant to prevent "monopolies from ransacking the people." 

4. The move to expand price controls sparked panic buying by consumers, which is causing shortages of many products. 

5. The Venezuelan government is accusing people of panic buying with the intent to hoard consumer items and capitalize on the shortages by selling products in the future at higher prices.   

Conclusion: According to the Chavez government, the shortages of key consumer goods in Venezuela are being caused by consumers, who are guilty of engaging in panic buying, hoarding and "capitalist" behavior.  The inflationary monetary expansion, rising consumer inflation and government price controls have nothing to do with the shortages.  After all, “The law of supply and demand is a lie,” said Karlin Granadillo, Venezuela's head of its price control agency.

It is happening right now

Protesting reality

Yes, Reality Sucks. Fantasy can be much more fun. Portugal is a perfect case in point: Portuguese unions launch austerity strike. Some Quotes:

"A general strike called by Portugal's two main trade unions brought the troubled eurozone nation to a virtual standstill on Thursday."    ....... 

"Complicating the drama was a decision by the ratings agency Fitch on Thursday to downgrade Portugal's debt assessment a notch to BB+ because of the eurozone nation's "adverse economic outlook."   ....... 

"The government of Prime Minister Pedro Passos Coelho is trying to implement tax hikes and pay cuts agreed in May with the European Union and the International Monetary Fund in exchange for a 78-billion-euro ($105 billion) bailout package. Portugal's previous Socialist government headed by Jose Socrates collapsed in June after failing to persuade parliament to adopt austerity measures."....... 

"To meet the EU-IMF bailout terms, Portugal is supposed to lower its public deficit, which stood at 9.8 percent of gross domestic product in 2010, down to 5.9 percent by the end of this year. A recent estimate of 8.3 percent has put that goal in doubt. The forecast for 2012 is no better, with the budget deficit supposed to sink further to 4.5 percent. Last Monday, Finance Minister Viktor Gaspar conceded that the economy would shrink next year by 3 percent, leaving little scope for fresh revenue.  Joblessness is set to rise to 13.4 percent."

Gee whiz, the banks won't lend them any more money to maintain a fake, debt-based life style. Why would they, if they know it cannot be repaid?

Some of these countries have been, in effect, ripping off gullible lenders just as much as people taking mortgages or student loans who know they can never really pay them unless they get very lucky. It's close to theft, or fraud, or something.

Related, and good from Anderson: The Eurozone Crisis Is Also a Governance Crisis — Isn’t It? A quote:

"One is tempted to conclude, at this point, that the political theory of the EU today is being written by financiers and financial analysts in their credit reports.  They are anxious, after all, only secondarily about markets.  They are primarily anxious about governance and structures of governance — because the markets are trying to figure out whether the institutions of the EU and its members are serious about their legal and political commitments, and in what ways and to what extent. The state of the markets depends upon the state of these several institutions. And the state of the institutions — given that the legal rules and their application is apparently deeply in flux, unless one simply assumes that the rule of law is whatever discretionary action European leaders decide upon this week — is a matter of conjuring forward the political theory of these institutions. 

So they, the financiers, are conjecturing the possible governance futures of the eurozone and the EU.  They are trying to assess political risk which, in this case, consists of making bets based in considerable part upon the theories of governance they ascribe to the EU, its institutions, and its member states.  They are market analysts reluctantly turned political theorists because it is political theory that suggests one path or another for the application of legal regimes that appear to be much less determinate than once thought.  For George Soros, the move from one to the other is natural and logical; for most credit analysts and hedge fund managers, this is a strange turn indeed."