Donnerstag, Dezember 02, 2010

It Takes A Government...

There's a lot going on: outright fraud in securitization, with companies claiming that they didn't need to actually follow the letter of the law, since no one was paying attention; bond markets behaving in ways never seen before; failing economies that are too big to fail; banks so heavily leveraged that there can be no creative destruction ala Schumpeter (desperately needed, but being blocked by those with too much to lose) and at least two major bubbles that no one wants to see burst.

The last shall be first: two bubbles. Gold and China, and they are inter-related. The Chinese who can are buying up gold like never before - hence the gold bubble -  and for very, very good reason. China itself is a bubble.

Don't believe me?

Consider this:: as I've said time and time again, a cardinal, deadly sin of economics is the misallocation of capital.

Great portions of the Chinese economy are currently working without price information. See this here by Megan McArdle:

When you're in China, it's easy to get caught up in the constant extolling of the benefits of (modified) central planning,  After all, the Shanghai-Hangzhou train, which I rode, is awesome, and it's certainly true that the market probably wouldn't have provided it.  The Chinese argue that the new high speed rail network is critical not merely to move the population around, but to free up the existing railbed for more freight traffic.

On the other hand, there are great dangers to being able to point at an infrastructure problem like this and say: "Make it so."  We interviewed someone at the rail ministry, and initially I was going to ask him the normal financial questions you ask someone planning a major capital expansion in the United States: capital costs, cost-effectiveness, and so forth.  The answers are more often than not the fever dreams of the most optimistic consultant they could find, but at least there is some tether to reality: the head of the agency doesn't actually want to be fired because his budget overruns just ate the money allocated for children's health care.

In China, I was stumped as to how you'd even ask that question. These projects don't have to go to the market for loans; the government directs the state-owned banks to lend to them, at interest rates decided by the state.  There's no opportunity cost to the money, since it's not like the rail ministry would otherwise be building a chain of noodle shops.  And the ridership projections are vetted by the same people who want to build 16,000 km of high-speed rail.

Prices are really useful.  But in whole large sectors of the Chinese economy, particularly the  banking sector, the government sets those prices.  This means huge information loss, and the concomitant possibility that there is a vast misallocation of resources.

Understand, please, that China is not a market economy: it remains a controlled economy, one where prices continue to be made meaningless. It is first and foremost a government-owned economy with some privatization (but don't you dare think about behaving in ways that The Party doesn't like!) and a mercantilist attitude that exploits the openness of foreign markets to destroy competition and assimilate technologies in order for The Party to survive. It is, of course, not entirely that simple, but this remains the core of the Chinese political economy. They, The Party (which, of course, in its current incarnation is nothing but a collection of apparatchniks and thugs), is riding a wave of economic expansion and growth, one that almost literally has to grow at 8% a year in order to cover all the mistakes, errors and incompetence of The Party in order to keep peasants coming to the cities and entering the industrial workforce under conditions that should outrage, but don't because they are kept carefully hidden.

Further (same source):

To get a really catastrophic misallocation of resources, it seems to take a government; corporations can only screw things up on an artisinal scale.  For that matter, it's worth noting that our government has spent the last seven decades trying to keep the price of housing low, and that much of that intervention, such as the creation of mortgage securitization, ultimately significantly contributed to the crisis.

It's worth remembering that at the time they were built, all those useless houses looked like prosperity.  So too, massive mispricing in China may look pretty sweet--unless a hiccup suddenly leaves the government with a hell of an expensive white elephant.  Or lots of them. As anyone who has contemplated purchasing a luxury car will know, just because something is really awesome, doesn't mean it's a good idea, economically speaking.  Buying without knowing the price is dangerous no matter where you are.

This is what is facing us now: far too many True Believers in the Chinese economy, convinced that it will continue to expand at 8%+, coupled with the Chinese themselves, buying gold like it is going out of style.

If prices were accurate, you wouldn't have that: the uncertainties of missing prices (or, more exactly, the intuitive knowledge that capital is being misallocated right and left, largely because the Chinese government cannot bear to have someone point out that the Emperor has no clothes.

It really does take a government for really catastrophic misallocation of resources: this is happening in China today. We don't know if China can afford a HS rail network (not only for the reasons that Megan put forward in that link) as we don't know what it will cost and whether that will be an investment that really will pay back.

Especially when you consider that the Chinese are aiming at a vast expansion of inner-China flights, which is in direct competition to HS rain. In other wards, the left hand doesn't know what the right hand has done, is doing, and plans to do.

When China falls, it will fall very, very hard. Communist countries always do when The Party tries to hold onto power far too long. This is going to be a major catastrophe, an epic fail. It really does take a government to do that.

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