The world goes a bit more broke today as it has been going for some time now … ‘Going Broke-ism’ does not take place in a straight line. There are giddy periods when the sun peeps out from behind the clouds of gloom and doom. People remove themselves from their bunkers and stretch out … they race to the ‘dealer’ and buy a new GM SUV or giant pickup truck. By doing so they revive the American Dream, elevate GDP while at the same time absolutely assuring the burial of the same GDP.
It appears that the inability of the large banks to evict non- paying homeowners is contributing to an apparent economic turnaround. Perhaps there is such a thing as a free lunch after all!
Economist Steve Keen has noted that changes in the rates of deleveraging effect aggregate demand:
For a long time I’ve focused on the contribution that the change in debt makes to aggregate demand, in the relation that “aggregate demand equals the sum of GDP plus the change in debt”. An obvious extension of that was that “change in aggregate demand equals change in GDP plus acceleration in the level of debt”—which would imply that change in unemployment is driven by changes in the rate of growth of debt.
Changes in the rate bad loans are recognized and charged off will effect how GDP is perceived. Cutting the rate of deleveraging even against static GDP is ‘good news’. Credit along with its cousin ‘money’ has velocity, too!
The chart below shows my confirmation of the relationship with the data on the annual change in unemployment in the USA and the annual rate of acceleration of private debt since 1955. The correlation is -0.67: a staggering correlation of a first and a second order variable over such a period, and across both booms and busts.The two dotted red lines labelled “S” and “E” show when the NBER thinks this recession started and ended, and they neatly coincide with turning points in the credit impulse—an indicator that the NBER is not even aware of, let alone one that it considers when attempting to date recessions.
Superficially, one might think that since the credit impulse does indicate when unemployment is going to rise or fall, then the current data implies that the recession is indeed over—even if the NBER doesn’t understand the actual causal dynamics at play.
But the chart also shows that there has never been a turndown in credit like this one—the peak rate of deceleration of debt was over 25 percent, versus a mere minus 6 percent in the deep recession of the 1970s. And though the rate of acceleration of debt has the most direct impact on employment, ultimately all three factors—the level of debt (compared to GDP), its rate of change, and whether that rate of change is increasing or decreasing—must be taken into account.
What Professor Keen is suggesting is that when credit appears to expand alongside GDP it registers as a gain in GDP. Since the US has been experiencing a de- facto foreclosure moratorium because of the ‘Robo- signer’ flap and the mass of defective mortgage documents, the rate of economy- wide deleveraging has slowed. The credit impulse appears to be accelerating. That many homeowners have free possession of their houses and can use what would be mortgage payments for other purposes is good for the economy!
Bad times are good times, right? Keep in mind that one or both of two things will take place. Foreclosures will increase once clearance is obtained from the authorities or the authorities will balk and banks will fall insolvent due to increasing mortgage- related costs. In either case there will be a — perhaps dramatic — increase in deleveraging. Right now it looks as if the banks will take the hit. Sorry banks, no more bailouts!
If foreclosures increase there will be more pressure on the real estate sector and banks will fail due to impaired balance sheets. If the banks fail outright ‘homeowner’ occupants will receive more free rent but within declining, squatter- filled neighborhoods as is becoming the case in many areas of the country right now. Boarded up banks will rot on every corner.
This is what is inevitable without managed restructuring. Restructuring that takes place all by itself is chaotic or uncontrolled deflation.
Everywhere you look the deflation narrative is replacing the progress version. America’s greatest growth industry is poverty. The same is true in China. For every Chinese lifted out of the mire in its rush to modernize there are others driven into poverty somewhere else in China or in another part of the world. Modernity is all about cost shifting. Economies are ways to manage surpluses. As these increase so do the costs of managing them. Eventually the costs are greater than the value of the surpluses themselves.
At this point there is nowhere to shift the costs, nobody willing or able to accept them. Attempts to increase surpluses by means of ‘growth’ simply add to the excess costs, instead.
In America the surplus of ‘luxury’ housing incurred an and self- feeding unmanageable cost of (required) mortgage debt. The cost of the debt renders the housing industry insolvent. In China, the cost of the surplus of foreign currency reserves is hyper- inflation. Right now the ability of China’s finance elite to manage its reserve surplus is questionable. Since the excess cost relation to surplus is an economic law the answer to the question is already answered.
Inflation is the footprint of progress until it is morphed by foolish policy into the hyper- variety. We have in America hyper- inflation in the finance economy, the consequence of lending excesses. This excess is now being shipped overseas via the dollar carry trade. American foolish policy is mirrored by Chinese foolish policy: they refuse to reduce the surplus but rather shift costs to its citizens in the form of a massively bloated property bubble and rising prices.
It does not matter what the Chinese or their American counterparts choose to do on the periphery of economic policy making. Without reducing the surplus the outcome will be the rise of management costs to levels greater than the value of the surplus itself. This is Steve from Virginia’s ‘First Law of Economics’.
The cost of America’s (and the world’s) surplus of automobiles — our way of measuring wealth and well- being — is Peak Oil and ruinous deflation. The cost of America’s dollar surplus is the bankruptcy of finance. The cost of China’s manufacturing surplus capacity is ruinous pollution and the decline and fall of Chinese agriculture … leading to starvation and famine. All forms of great wealth — surplus — are variations on the theme of King Midas. The cost of Spain’s 16th century surplus of Western Hemisphere gold was ruinous wars, inflation then the loss of Spanish wealth and influence and ultimately its empire. The cost of the American empire is ruinous to us as was the Soviet’s to them which turned out to be collapse of that empire.
Small — and surplus free — is indeed beautiful.
In China the entire country is in the grip of hyper- inflation as the banking system feeds sterilized ‘hot’ dollars into the banking sector and thence into the pockets of Chinese citizens. With little for them to buy the costs for what they do buy is skyrocketing. China sez 4% but the situation the the reality is much higher: This hyper- inflation is the cost of managing the massive and increasing dollar surplus. Steps China takes to manage the surplus such as raising interest rates perversely makes the surplus grow by way of the dollar carry trade.
Officially, China’s consumer price inflation topped out at 3.3 percent in July from the year before—a 21-month high. The government says the spike is a one-off caused by crop damage in recent flooding. Other costs, they say, such as cars, mobile-phone bills, and clothing, are actually falling, and price increases should slow as the economy cools. At an Aug. 12 press conference, Pan Jiancheng, a deputy director in the statistics bureau, announced that the inflationary threat was “overhyped.”Many consumers, investors, analysts, and academics disagree. “There has been a jump in prices that isn’t reflected in the numbers,” says Chinese Academy of Social Sciences economist Yu Yongding, who formerly served as an adviser to China’s central bank. Michael Pettis, a finance professor at Peking University, wonders how a country that grew 10.3 percent last quarter and is seeing upward pressure on wages could register inflation of only a few percentage points. Another sign of rising prices: Multinationals in China expect to hike wages an average of 8.4 percent this year, according to human resources consultant Hewitt Associates (HEW). Ordinary Chinese, meanwhile don’t see the steep jumps in their housing, education, and medical expenses reflected in the official stats. “Inflation could well be 6 percent now for most people in China,” says Pettis.
Keep in mind a baseline growth figure of 10.3% would indicate an inflation baseline of 10.3% with inflation driven by increases in money supply being added to that baseline. In other words, growth in goods and services would increase money supply by 10.3% with hot- money additions and F/X- related inflation added to that. If Pettis’ 6% is used the ‘corrected’ rate of (hyper-) inflation would 16.3% per year.
Hyper- inflation is an exponential function. We don’t know the doubling time but the rate would be 16% now, then 32%, then 64%, 130%, etc. The doubling period shrinks as the rate increases as well since the rate- time ratio is an outcome of transaction velocity or the quantity of (apparent) money. This is a self- reinforcing phenomenon.
Comparison between U.S. and China from January 2008 to June 2010In China,M2 money growth was 61 percent from January 2008 to June 2010. And M2 of the dollar grew at 14 percent during the same period. Why should a currency appreciate when it is being printed in faster speed than another one? It is true that China’s GDP grew faster than the U.S. GDP.
But even after adjusting for GDP growth, the spread between M2 growth and GDP in China was 42 percent, versus the spread of 19 percent in US. Using this measure, shouldn’t the yuan be devalued by 23 percent relative to the dollar?
Good question, right? Seems like the only folks who believe the yuan is over- valued are the Chinese, Albert Edward @ Societe Generale and myself. I have to give Edwards great credit for foresight whereby he sees both the forests and individual trees. This is by way of Zero Hedge:
With everyone and their grandmother screeching that it is about time for China to inflate the renminbi, despite that such an action would be economic and social suicide for the world’s most populous country, SocGen’s Albert Edwards once again stalks out the Black Swan in left field and posits the contrarian view de jour: China will aggressively devalue the yuan following a deep 2010 downturn coupled with escalating trade wars. As Edwards says: “I think the next 18 months will see major ructions in the financial markets. The consequences of a double-dip back into recession next year require some lateral thinking. If the carry trade unwind results in a turbo-charged dollar, any collapse in the China economic bubble will be doubly destructive to commodity prices. A surging dollar, coupled with China moving into sustained trade deficit through 2010, could prompt the Chinese authorities to acquiesce to US pressure for a more flexible exchange rate. But why does no-one expect a yuan devaluation?”
The yuan is both — over- and undervalued. It is undervalued to the degree that China is the target for capital flows the same way the French franc and the US dollar were undervalued in the period leading up to the Great Depression. Speculators flooded into the franc- and dollar denominated investments for the same reasons they flood into the yuan today. The expected (wanted) upward revaluation would produce a speculative foreign exchange return.
At the same the yuan is overvalued because there is a structural imbalance between what China can produce against what the rest of the world can consume. China’s mercantilism renders its currency overvalued the same way the UK’s mercantile economy rendered sterling overvalued during the same pre- Depression period. China’s is a huge economy. Its currency manifests characteristics of both conditions.
Along with inflation, there is a shift of funds from Chinese depositors and savers into the F/X accounts of the dollar carry- traders. This is this cross- border thievery that economists such as Michael Hudson rant about. It’s a form of looting.
The obvious question is, what if these speculators are wrong over the longer term? They usually are!
Deflation will have dollars as more valuable and harder to come by. America can manufacture them but the rest of the world cannot. As deflation manifests itself the short- dollar carry trade will vanish and speculators who cannot unwind positions will be ruined. The dollar carry trade is another Bernanke Bubble. At some point it will deflate. Both the dollars and the pegged Chinese yuan will be more valuable. The cost of the Chinese dollar surplus will be shifted from China’s citizens to China’s management elite. Chinese deflation will intensify and China’s version of the USA waste- based economy will collapse as its real estate bubble evaporates.
If the Chinese cut the peg to the dollar, inflation in China will intensify even further. China’s establishment will loot its citizens and blame the mess on the Americans and Bernanke. China will be able to import commodities like food and fuel with dollars, but citizens will be in a race with the devil, unable to afford these goods. China will be locked into a death spiral, dependent upon its shrinking dollar reserves but with a similarly shrinking export market as ‘hard’ dollars will not be in circulation in the rest of the world, only inflated non- dollar currencies. If China shifts its mercantile efforts to other currencies and markets the same inflationary dynamic will take hold. China has manufacturing overcapacity as it over- invested in the wrong sector the same way Americans over- invested wrongly in wasteful consumption. Both are now and will continue to choke on foolish investments.
China will ultimately become more like Argentina, its trade surplus will vanish. Without customers its manufacturing capacity will rust into obsolescence. China’s currency reserves will disappear. It will be just another poor country.
China needs to shrink its dollar surplus now rather than wait for circumstances to do it. China’s dollars are the anvil that will take its economy to the bottom of the ocean. The best way is to repatriate dollars by purchasing some ‘future’ in the US, which is what investors in this country are failing to do. By future, I don’t mean the tech variety which is a scam.
The Chinese could open China- America Development Banks in all fifty states and recycle dollar funding into the US in the form of lower interest loans to start small non- industrial businesses. Small business in the US is on the ropes. China could support businesses with vendor financing in reverse where China banks would offer a market for US goods and services along with loans at a level that is not now available.
Chinese dollar capital would support alternative economic priorities that escape the FIRE cycle which has the big supporting the gigantic — with their implied massive, unsupportable costs. Chinese capital in the US could support a million new organic farmers which in turn would support thousand of now- disappearing US towns. This would create demand for Chinese as well as American goods. China could invest in US rail transport, transit, alternative energy, anti- pollution and other businesses whose products would be useful in China’s economy. Dollars would be repatriated to the US for value rather than waste. Instead of interest Chinese banks would receive credits for the purchase of US exports which in turn would be used to balance US/China trade. This is Michael Hudson:
What then should China should it do with its buildup of excess reserves, if not recycle its inflows into their bonds? Four possibilities have been suggested: (1) to revalue the renminbi, (2) to flood China’s economy with credit (as Japan did after the Plaza Accord of 1985), (3) to buy foreign resources and assets, and (4) to use excess dollars to buy back foreign investments in China, given US reluctance to permit Chinese investment in America’s own most promising economic sectors.
Banking and agriculture, public transit and conservation are not ‘promising sectors’. The establishment would ignore the effort. At the same time, China would reduce its currency surplus. China throwing its ‘poisoned dollars’ into the ocean would be remunerative to the Chinese! Sending funds to the US for credits would be even more sensible! It would create an alternative credit cycle, break the stranglehold of US banks and credit on US citizens, would increase appreciation of the other and make US- China exchange more meaningful.
On the downside, it would put the ‘China as a global menace’ industry under pressure.
Doing this both policy makers and economists must be more realistic and look past interest rates and other trivia. There are a lot of very smart people who are trying to make sense of what it going on. Almost none of these appreciate the role of energy in the ‘Moderne’ economy. I’d like to see Michael Pettis discuss energy and how it relates to the Chinese economy. Cheap coal — in the form of products that embed it — is China’s greatest export. What happens when the cost of China’s coal surplus aggregates to the point where it is unsupportable? Don’t misunderstand, Professor Pettis is a brilliant economist, he seems to miss the big picture. Pettis does not answer the energy issues, neither do most other analysts or economists. By their actions both US and Chinese policy makers are content to ignore these issues hoping they will go away.
Even if China’s current account and trade imbalances vanished tomorrow with the US and the rest of the world the Chinese would still be poised at the edge of the same abyss they are right now. This is also true of the US and the rest of the OECD. The world has lived far beyond its finance and resource means. Now the bill has come due.
EDIT:
Hi Ben …
As to your first question, the idea is to have distributed investments rather than the usual asset purchases that form bubbles (a surplus). Investing ‘small’ would not create bubbles.
Banks today don’t ‘incubate’ small businesses, that job has been ceded to venture capitalists. This model needs a fairly high growth rate and is hostage to the industrialization fad. The China- America banks would fill the role of VC’s on the smaller scale. It would allow the incubation of businesses that combine American creativity and craft with a chance at very large market exposures. I can see a lot of possibilities such as skill exchanges.
If China decided to enter banking in the US the outcome would be very exciting. If China committed a fraction of their dollar capital the China- America bank would be one of the largest banks in the country. Aiming to bank toward the American middle class — a target for US banksters — the Chinese could turn banking on its head the same way China manufacturers have turned production upside down.
Bank capital could also do larger scale investments whose returns do not appeal to ordinary VC’s such as city rail transit, organic agriculture, artisan foods, energy- sustainability programs, etc. The Chinese are already involved with this sort of thing in China, I think the Chinese would find enthusiastic participants here in this country.
As for the dynamic of the now … China responded to the 2008 crisis by printing money and forcing its banking system to lend. The outcome was a ‘Keynesian’ stimulus that is — compared to the scale of the US stimulus — about three times as large. Add to this cheap dollars and a Chinese mechanism to turn dollars into China currency the inflation table was set.
The end of the recession had the Chinese in a massively expanding asset bubble in real estate with another in raw materials. Fueling these bubbles was the bank credit, ‘black market’ credit from Chinese ‘special development interests’ (mostly municipalities) and various mafias. It is likely that most if not all of the Chinese elites are heavily invested in these bubbles; it would be absurd if they were not.
Since all bubbles burst at some point the issue is what happens next now that the bubbles have reached the ‘max’. The Chinese government honchos will not let themselves go down the toilet. The central bank will print and print some more. It is China, not America, that is producing excess currency and putting it into circulation. China needs hyper- inflation to bail out its government elites. This is one of the features of the ‘Great Hyperinflations’ that have happened elsewhere such as in Weimar in the 1920’s. Debts were repaid with worthless money and creditors were ruined along with savers (usually ordinary citizens with little to spend on).
Hyperinflation is amplified by Bernanke’s ZIRP which feeds a dollar carry- trade to China and elsewhere. There are also high levels of inflation in Brazil and other developing countries for the same reasons.
China inflation is the new ‘It Gurl’ along with austerity in the West. I don’t think China can or wants to control it. China bank rates would have to rise to a Volckeresque +20% to stifle China inflation. This won’t happen, the elites won’t allow it. Deflation in China would ruin the elites and represent a loss of prestige.
Inflation can be disguised as it is already. Rates are ??? Much of China’s business is transacted on various black markets. Inflation will ruin people the China government doesn’t like very much along with enriching the elite. At the same time, hyperinflation will increase the value of dollars and Treasuries held by China. The elites have access to lots of dollars, gold and Treasuries. They will thrive in a hyperinflationary context while the Chinese ‘little people’ will be devastated.
Who cares about them, right? The elites will blame everything on Obama and Bernanke.
Meanwhile, when fuel prices drop back to $70- ish look for a large helping of deflation in the US from multiple sources: State/muni government risk, Eurozone risk and default, bank failure due to mortgage securities overhang, etc. Keep in mind, depressions are class warfare and Irish have started bank runs against the EU- IMF zombie Irish banks.
The Depression has officially started.