Category Archives: Economics

Japan and the Economics of the American Empire

Excerpt from Chalmers Johnson‘s excellent Blowback, written 18 months before september 11th, and stated that some middle easter blowback (CIA euphemism for anti-US results of US foreign policy and covert operations) was a near certainty. Blowback also predicted much of the 2008 economic collapse, though post 2008 adjustments have simply prolonged the problem rather than confronting the cause.

During the Cold War the Soviet Union lost any number of friends and potential allies by forever hectoring them about Marxism and the stages of economic growth they would have to go through in order ever to hope to live like Russians. Such Marxist rigidity clearly benefited the American side in the superpower face-off of that era. Ideological arrogance turned many countries, like Tanzania and Egypt, against their Soviet economic advisers, and overbearing Soviet behavior contributed heavily to the Sino-Soviet dispute. Unfortunately, in the post–Cold War era it is the United States that is exhibiting a capitalist version of such heavy-handedness and arrogance.


Ideology—that is, the doctrines, opinions, or way of thinking of an individual, a class, a nation, or an empire—is as tricky a substance to use in international conflicts as poison gas. It, too, has a tendency to blow back onto the party releasing it. During the late 1950s, in the depths of the Cold War, many Americans began to suspect that the Soviet Union was actually a third-rate economy; but it still had the world’s most alluring ideology, a body of thought capable of attracting more people in the Third World than the “possessive individualism” (to use the philosopher C. B. Macpherson’s term) espoused by the United States. Soviet intellectual appeals were built around the ideas of Karl Marx—indubitably a man of the West and properly buried in Highgate Cemetery, London—which attracted even the most chauvinistic people on earth, the Chinese. Marxism-Leninism, as espoused by the Soviet Union, provided explanations for the inequities of colonialism, a model of economic development based on the achievements of Russia under Stalin, and the promise of world peace when all nations had passed beyond imperialism, which was the “final stage of capitalism.”


Part of what gave Soviet ideology such power to convince whole peoples in the Third World was the way it assimilated and invoked the single most uncontested ideology of our century, that of science. It claimed to rest not on the hopes of idealistic reformers but on the logic of “scientific socialism.” The Soviets insisted that they were acting in accordance with laws of human development discovered by their patron saints, Marx and Lenin. By contrast, the ideology of the “free world” looked at best like a rationalization of the privileges enjoyed by Americans because of their exceptional geography and history.


Not surprisingly, American leaders came to feel that somehow they had to match the ideological claims of communism in what they saw as a great global battle for the souls of earth’s contested majority. Nowhere did this need seem more acutely necessary than in East Asia, where Communist regimes had come to power in China, North Korea, and Vietnam despite the fact that Marx’s analysis of class conflict in industrializing societies bore only the faintest relation to the actual conditions in any of these countries. At the time, communism was also an active competitor in every other country of the region. Asians were attracted to it precisely because it claimed to be based on science—the ingredient that seemed to undergird the industrial and military might of their European, American, and Japanese colonizers—and because the example of the Soviet Union held out the hope of a solution that might someday be within their own revolutionary grasp.


The American response, never expressly articulated but based on the total mobilization of the American people for the Cold War by President John F. Kennedy and other leaders, was twofold. First, we would do everything in our considerable power to turn Japan into a capitalist alternative to mainland China, a model and a showcase of what Asians might expect if they threw in their lot with the Americans instead of the Communists. Second, academic economics as taught in most American universities was subtly transformed into a fighting ideology of the “West.” From each of these transformations would come fateful consequences for the American empire after its competition with the Soviet Union ended. Because most Americans never understood either policy to be a strategy for pursuing the Cold War, they took both Japan’s achievements and the wealth of the West to be evidence of an ineluctable destiny that made the United States a singularly appropriate model for the rest of the world. Any doubts raised about these propositions were seen as undermining the pretensions of the American empire. Thus, what began as tactical responses to temporary, often illusory or misleadingly interpreted Soviet “advantages” ended up as ideological articles of faith for the “sole superpower” of the post–Cold War world.


From approximately 1950 to 1975, the United States treated Japan as a beloved ward, indulging its every economic need and proudly patronizing it as a star capitalist pupil. The United States sponsored Japan’s entry into many international institutions, like the United Nations and the Organization for Economic Cooperation and Development, well before a post–World War II global consensus in favor of Japan had developed. It also transferred crucial technologies to the Japanese on virtually concessionary terms and opened its markets to Japanese products while tolerating Japan’s protection of its own domestic market. It even supported the Japanese side in all claims by individual American firms that they had been damaged by Japanese competitors. In addition, the United States allowed Japan to retain an artificially undervalued currency in order to give its exports a price advantage for well over a decade longer than it did any of the rebuilt European economies.


We proclaimed Japan a democracy and a model of what free markets could achieve while simultaneously helping to rig both its economic and political systems. We used the CIA to finance the ruling party and engaged in all manner of dirty tricks to divide and discredit domestic socialists.1 In this process there was much self-deception. For far too long America’s leading officials insisted that Japan could never be an economic competitor of the United States’. President Eisenhower’s secretary of state John Foster Dulles was, for example, convinced that while the Japanese might be able to sell shirts, pajamas, “and perhaps cocktail napkins” to the American market, little else was possible for them.2 Americans did not wake up to Japan’s competitive challenge until their steel, consumer electronics, robotics, automotive, camera, and semiconductor industries were virtually extinct or fighting for their lives.


After the “security treaty riots” of 1960, when a Japanese mass movement tried to prevent the signing of a treaty that would perpetuate the basing of American troops in Japan and Okinawa, the United States moved its campaign to portray Japan as a model democracy into high gear. It appointed as ambassador the well-known Harvard historian of Japan Edwin O. Reischauer, who was married to a Japanese woman from a distinguished political family. His job was to repair the damage to the image of Japanese-American amity caused by the 1960 riots, which to many Asians appeared to be a Japanese equivalent to the Budapest uprising of 1956. Reischauer was to “reopen a dialogue” with the alienated Japanese left while shoring up the conservative Liberal Democratic Party, its aging rightists from prewar and wartime governments now screened from public view while it emphasized economic growth over democracy.


Perhaps Reischauer’s most influential step was to endorse in his own extensive writings and speeches of the time a movement among American academic specialists to rewrite the history of modern Japan as a case study of successful “modernization.” So-called modernization theory flourished in the United States during the 1960s just as the Japanese economy “took off” (to use that famous term of the modernization theorists), achieving double-digit growth rates. This new approach to Japan traced the country’s course of development from the Meiji Restoration of 1868, which was Japan’s debut as a unified nation rather than a collection of feudal states. It contrasted Japan’s achievement of great-power status with the dependency and susceptibility to colonialism of the rest of Asia, particularly China. It stressed how the initial authoritarianism of the Meiji oligarchs evolved into a toleration of political parties during the 1920s, producing at least the possibility of parliamentary democracy. The theory drew attention to how the “liberal” 1920s, although ultimately destroyed by reaction and militarism after 1931, provided precedents for reform that many Japanese leaders seized upon when genuine democratization got under way during the American occupation.


Japan emerged from this stirring tale of political and economic development as an exemplary nation, the only country in Asia that avoided being colonized. The fact that it did so by joining the Western colonialists in victimizing the other countries of Asia was underemphasized in such accounts. Japan’s kuroi tanima, or “dark valley,” from 1931 to 1945, in which it warred with China and the United States, was explained away as due to a unique concatenation of international factors—the Great Depression, the closing of European and American colonies to Japanese exports, Japan’s fear of bolshevism, and American isolationism. What actually went on in the “dark valley,” from the rape of Nanking to the Bataan Death March, was incidental to the tale of economic growth and political consolidation and best forgotten, since Japan’s aggression was now understood to be but a temporary sidestep on a long march toward modernization. The emperor of Japan, who had reigned since 1926 and presided over much military aggression and brutality, emerged as a simple marine biologist and pacifist who had opposed the war from the beginning and had actually brought it to an end in 1945 through his own decisive action. It was said that he was a man of few words in view of the fact that from the end of the war to his death in 1989 he was never again allowed to utter many in public.


The American public, like its policy elites never very well informed about Japan to begin with, bought this rosy picture of that country as the chief bulwark against communism in Asia. John Dower and a few American academic specialists argued that modernization theory was incomplete and that Japan’s militarism had domestic roots every bit as deep as its commitment to modernity, but they were easily ignored.3 Japan was now entrenched in American consciousness as a full-fledged democratic ally with a system rooted in free-market capitalism and certain eventually to “converge” with the United States as a liberal, consumer-based state.


To be sure, there were occasional “misunderstandings” as one nation’s capitalists sought competitive advantage over the other. In dealing with such “unfortunate” developments, the task of diplomacy and the mission of the American embassy in Tokyo became not to champion American interests but to ameliorate the conflict itself, usually to Japan’s advantage. Nothing seriously wrong could come of such policies, it was argued, because, as modernization theory taught, the two societies were on the same developmental path toward common economic ends.


The second aspect of the ideological challenge to the Soviet Union was the development and propagation of an American economic ideology that might counter the promise of Marxism—what today we call “neoclassical economics,” which has gained an intellectual status in American economic activities and governmental affairs similar to that of Marxism-Leninism in the former USSR. Needless to say, Soviet citizens never understood Marxism-Leninism as an ideology until after it had collapsed, just as Americans like to think (or pretend) that their economics is a branch of science, not a fighting doctrine to defend and advance their interests against those of others. They may consider most economists to be untrustworthy witch doctors, but they regard the tenets of a laissez-faire economy—with its cutthroat competition, casino stock exchange, massive inequalities of wealth, and a minor, regulatory role for government—as self-evident truths.


Until the late 1950s, academic economics remained one of the social sciences, like anthropology, sociology, and political science—a non-experimental, often speculative investigation into the ways individuals, families, firms, markets, industries, and national economies behaved under different conditions and influences. It was concerned with full employment, price stability, growth, public finance, labor relations, and similar socioeconomic subjects. After it became the chief ideological counterweight to Marxism-Leninism during the Cold War, its practitioners tried to extract it from the social sciences and re-create it as a hard science.


Its propositions were now expressed less in words than in simultaneous equations, the old ideas of Adam Smith reappearing as fully mathematized axioms, increasingly divorced from empirical research. Its data were said to be “stylized facts,” and economists set out to demonstrate through deductive reasoning expressed in mathematical formulas that resources could be allocated efficiently only through an unfettered market. By now all these terms (“resources,” “efficiency,” “markets”) had been transformed into abstractions, not unlike the abstract formulations (“the proletariat,” “the bourgeoisie,” “class conflict”) of its Soviet opponents. English-speaking economics became such a “hard science” that in 1969 the central bank of Sweden started giving Nobel Prizes to its adepts, virtually all of them American academicians. This ensured that virtually all aspiring economists would in the future try to do so-called theoretical economics—that is, the algebraic modeling of markets—rather than old-fashioned empirical and inductive research into real-world economies.


Economics split from the social sciences and took up a new position somewhere close to mathematics. Economists were now endlessly called upon by governmental bodies to testify that the American economy was unmatchable, even if it sometimes behaved badly because of overspending liberals, pork-barrel politics, or greedy monopolists. Alternatives to it were understood to be either converging with it or destined to fail. Economics no longer studied the economy; it spoke ex cathedra about what was orthodox and what was heresy. Meanwhile, empirical research on economic phenomena migrated to business schools, commercial think tanks, and the other social sciences.


Unquestionably, after the first two decades of the Cold War, in a purely dichotomous choice between an economy based on Marxism-Leninism and one based on free-market capitalism—as exemplified by the economies of the Soviet Union and the United States—most people around the world would have chosen the free market. But in East Asia, at the height of the Sino-Soviet dispute and the American war in Vietnam, neither ideology was working out according to either superpower’s script. The Chinese were discrediting forever whatever attractiveness might have remained in the forced-draft economic achievements of the Soviet model. Through bungling, megalomania, and deep ideological confusion about what Marxism and the Soviet experience taught, the Chinese Communist Party managed to kill thirty million of its own citizens and then, in a paroxysm of mutual blame, came close to destroying its unmatchable cultural legacy in the so-called Cultural Revolution. Today this period is recognized—even in China—as a monumental disaster, but at the time many Americans, from idealistic leftist students to presidents and other political leaders, failing to understand what was happening, retained a sentimental attraction to Mao Zedong and Zhou Enlai, the mismanagers of the Chinese revolution.


The truly surprising development in East Asia, however, was that America’s “non-Communist” satellites, protectorates, and dependencies were starting to get rich and to compete with their superpower benefactor. All of this was camouflaged by the Cold War itself, so that the enrichment of East Asia occurred almost surreptitiously. The year-in, year-out record-breaking growth rates of such previously poor places as Japan, South Korea, and Taiwan were not precisely what American elites had expected, but they were explained away as nothing more than confirmations—even overconfirmations—of officially espoused free-market ideology and so were greeted with parental pride.


If the capitalist economies of East Asia were starting to perform better than the United States itself, this anomaly was usually attributed to mysterious Japanese or Asian cultural or even spiritual factors or to complacency on the part of American managers and workers. By the time the Western world awoke to what had actually happened, economic growth in East Asia was self-sustaining and unstoppable by external actions (although many Asians thought this was exactly what the United States was attempting when its policies toward the area led to the meltdown of 1997). The enrichment of East Asia under the cover of the Cold War was surely the most important, least analyzed development in world politics during the second half of the twentieth century. It remains to this day intellectually indigestible in the United States.


The fundamental problem is not simply that in the Cold War era Japan attained a $5 trillion economy—although that alone was an unexpected competitive challenge to American economic preeminence—but how it did so. It had found a third way between the socialist displacement of the market advocated by Soviet theorists and an uncritical reliance on the market advocated by American theorists. The Japanese had invented a different kind of capitalism—something no defender of the American empire could accept. It was therefore assumed either that the Japanese were cheating (and all that we needed to compete successfully against them was a “level playing field”) or that they must be headed for a collapse similar to the one that had overtaken the USSR.


In turning neo-classical economic theory into a fighting ideology, American ideologues encountered one element of capitalist thought that they could not express in abstract, seemingly “scientific” mathematical terms. This was the set of institutions through which competitive market relationships actually produce their benefits. Institutions are the concrete, more-or-less enduring relationships through which people work, save, invest, and earn a living—such things as stock exchanges, banks, labor unions, corporations, safety nets, families, inheritance rules, and tax systems. This is the realm of the legal, political, and social order, where many considerations that govern the economy other than efficiency contend for primacy. For economic theorists institutions are “black boxes,” entities that receive and transmit economic stimuli but are themselves unaffected by economic theory.


In attempting to forge a fully numerical, scientific-looking model of the capitalist economy for purposes of the Cold War, Western ideologues simply assumed that the institutions of modern capitalism must be those that existed in the United States in the late Eisenhower era. This meant that savings were typically moved from the saver to industry through a capital market (such as the New York Stock Exchange) rather than, for example, through the banking system. They assumed that industrial-labor conflicts were settled by interminable strikes, and not by, for example, offering some workers career job security; and they assumed that the whole purpose of an economy was to serve the short-term interests of consumers, instead of some overarching goal such as the wealth and power of the nation as a whole.


These American assumptions were almost identical to the Soviet assumption that the institutions of “socialism” must be those that existed in the USSR during, say, the Khrushchev era. Neither side ever produced an ideological model to sell to others that could be divorced from their own country. Because of this inability to express the institutions of either socialism or capitalism in some culturally neutral—or at least more varied—way, it is understandable that many observers simply reduced the claims of Marxist-Leninist ideology to the USSR and those of free-market capitalism to the United States.


In finding a third way, Japan’s postwar economic “miracle” reinvented not economic theory but the institutions of modern capitalism so that they would produce utterly different outcomes from those imagined in the American model. Given Japan’s history of catch-up industrialization, its overarching need to avoid the victimization and colonialism to which every other area of East Asia had succumbed, its virtual dearth of raw materials, its dependence on manufacturing and international trade to sustain its large population, and its overwhelming defeat in World War II, it could not ever have become a clone of the United States. Its postwar planners and technocrats instead organized a capitalist economy intended to serve the interests of producers over consumers. They forced Japan’s citizens to save by providing little in the way of a safety net; they encouraged labor harmony regardless of what it did to individual rights; and they built industries based on the highest possible human input rather than simply on some naturally given comparative advantage, such as cheap labor or proximity to a large market like China’s. Their goal was to enrich Japan, if not necessarily the Japanese themselves. They viewed all economic transactions as strategic: theirs was to be an economy organized for war but now directed toward ostensibly peaceful competition with other countries.


Since the 1950s, the United States had seen the entire world in Cold War terms. This meant that Japan was far more important as an anti-Communist ally than as a potential economic competitor. In order to keep U.S. troops and bases in Japan, the Americans provided open access to their market and the government pressured private American firms to relinquish ownership rights to technologies being transferred to Japan. As Japanese trade and industrial bureaucrats took advantage of this deal, trade disputes became inevitable. From the “dollar blouses” that flooded into the United States during the Eisenhower era to the textile disputes of the Kennedy and Nixon administrations, complaints about the costs of “alliance” with Japan became a permanent feature of Washington politics. They also produced a lucrative new field for former government officials turned lobbyists, whom the Japanese hired in increasing numbers to ameliorate or paper over the disputes. Even though Washington remained more or less ignorant of how the government in Tokyo actually worked, the government in Tokyo took a life-or-death interest in Washington’s role in regulating the American economy. Japanese officials also did everything in their power to maintain the artificial separation between trade and defense that the U.S. government had invented and to see that the Pentagon was happy with its facilities.


This artificial separation between trade and defense has been a peculiar characteristic of the half-century-long American hegemony over Japan. Official guardians of the Japanese-American Security Treaty and their academic supporters have maintained an impenetrable firewall between what they call, using the Japanese euphemism, “trade friction” and the basing of one hundred thousand American troops in Japan and South Korea. There was no reason why these two aspects of the Japanese-American relationship should been dealt with as if they were separate matters except that, had they not been, the actual nature of the relationship would have been far easier to grasp.


Until the 1980s, the United States officially ignored all evidence that this compartmentalization of its massive military establishment and its growing trade deficits with Japan was going to be very costly. From about 1968 on, trade deficits began to rise just as the hollowing out of certain industries that the Japanese government had targeted became more visible. U.S. officials then consulted with their Japanese counterparts about these problems and accepted fig-leaf agreements that offered the pretense of remedies to distressed American businesses and communities. With the exception of President Nixon’s 1971 decision to force an ending to Japan’s artificially undervalued exchange, nothing else of significance was done.


During the 1980s, however, pressures for action of some sort markedly increased. The Japanese economy, now a major competitor, was starting to erode the industrial foundations of the United States. Moreover, the Cold War was settling into its final Reaganesque rituals. Despite inflated CIA estimates of Soviet strength, it became increasingly clear to many, even before the rise to power of Mikhail Gorbachev, that the two sides were starting to accommodate each other and that the threat of a superpower war was declining. In this context, a new way of thinking developed about Japan itself and about the nature of America’s relationships with newly rich Asia. Business Week dubbed it “revisionism” and wrote:


No less than a fundamental rethinking of Japan is now under way at the highest levels of the U.S. government, business, and academia. The standard rules of the free market, according to the new school, simply won’t work in Japan. . . . Some people call the new thinking “revisionism,” departing as it does from the orthodox view that Japan will eventually become a U.S.-style consumer-driven society.4


The Japanese, who had been very proud of their “developmental state” and its guided economy and who readily wrote about it for domestic consumption, suddenly became concerned when American revisionists, myself included, began saying that “leveling the playing field” was not the issue, since the two economies were different in such fundamental ways. It was one thing for Japan and its lobbyists to parry complaints about their country’s closed markets and the numerous barriers it raised against foreign products ranging from automobiles and semiconductors to grapefruit and rice. It was quite another for Americans to claim that they were playing by entirely different rules. Accusations that the “revisionists” were Japan bashers or racists rose quickly to the surface.


Meanwhile, a number of Japanese politicians and industrialists added insult to injury by claiming that the trade deficit resulted from the laziness of American workers or resorted to racism by pointing to the racially mixed nature of the workforce while characterizing American minorities as indisciplined and ineducable. In 1989, a prominent Japanese politician, Shintaro Ishihara, and the president of Sony, Akio Morita, cowrote a book, The Japan That Can Say “No,” in which they suggested that their country should not share Japanese-developed technologies that the Americans regarded as of national security significance unless the Americans reined in their critiques. In 1998, Ishihara, angry about an economy that seemed to be heading into decline, wrote a sequel, The Japan That Can Say “No” Again, suggesting a halt in investment in U.S. government securities to teach a lesson to Americans who had pushed Japan to open its economy. These views made him sufficiently popular that in 1999 he was elected mayor of Tokyo.


Nonetheless, the American government continued its typical Cold War style of doing business into the early 1990s. In 1988, for example, State Department and Pentagon leaders proposed transferring to Japan the technology of the F-16 fighter aircraft in order to allow the Japanese to build their own fighter, the FS-X. A huge controversy erupted over why the Japanese did not simply buy the F-16 fighters they needed from the manufacturer, thereby helping to balance the trade deficit and keep manufacturing in the United States. One State Department official, Kevin Kearns, who was in Tokyo at the time the FSX deal was negotiated, agreed with the critics and wrote in the Foreign Service Journal, “As long as the Chrysanthemum Club [of pro-Japanese American officials] continues to skew the policy process in our government and paid Japanese lobbyists and academics-for-hire continue to influence disproportionately the treatment of Japan in the public realm, the United States will continue its approach to Japan in the same tired, self-defeating way.”5 Following these remarks, Deputy Secretary of State Lawrence Eagleburger publicly denounced Kearns and in February 1990 forced his resignation from the State Department. The Bush administration then transferred the F-16 technology to Japan.


In an equally telling incident in 1990, the Matsushita Electric Company of Japan bought MCA Inc., the giant Hollywood-based entertainment conglomerate, for $7.5 billion, one of the biggest purchases ever of an American company by a foreign firm. This was less than a year after Sony had acquired Columbia Pictures for $3.4 billion and Newsweek had run a cover showing Columbia’s torch-bearing female icon wearing a kimono.6 In addition to by-then-widespread worries about Japanese capital invading the United States, there was the further complication that MCA owned a lucrative concession that serviced visitors to Yosemite National Park. In order to avoid the public relations embarrassment of having a Japanese company own part of a national park, the Department of the Interior suggested that Matsushita donate the concession to the park service. The Japanese, however, did not want to let it go and instead hired an elite corps of Washington lobbyists, lawyers, and public relations specialists to escort their purchase past congressional and government critics.


Leading the Matsushita team was former U.S. trade representative Robert Strauss. According to the Washington Post, he was paid $8 million for successfully brokering the deal and seeing to its public relations aspects, including getting the Department of the Interior to back off. When asked by reporters why he was being paid such an enormous fee for a minimal amount of work, Strauss nonchalantly replied, “I don’t work by the hour anymore. I don’t do windows.”7 This remark greatly puzzled the Japanese, although they were pleased enough with what their largesse had bought them. They concluded that Washington was as corrupt as Jakarta or Seoul and that anything could be had if the price was right. Rather than devoting attention to the potential pitfalls of their own brand of capitalism, the Japanese in this instance followed a distinctly American path and convinced themselves that they were invincible, while the United States was in a terminal decline. They therefore marched steadily toward their own decade-long economic downfall.


These alarms and diversions were also effective in turning American attention away from the most distinctive trait of Japan’s type of capitalism—namely, the major role given to governmental industrial policy and its role in a capitalist economy. Industrial policy refers to the attempt by the government to nurture particular strategic industries that are thought to be needed by an economy for reasons of national security, export competitiveness, or growth potential.8 As a result, most Americans failed to grasp how crucially Japan’s industrial policy depended on its political and military relationship with the United States and on access to its vast market. Nor did they understand that the Japanese were investing the huge trade profits in American Treasury securities that were, in turn, helping to finance America’s huge debts and making the American financial system critically dependent on Japanese savings. This growing dependency made American officials reluctant to criticize the Japanese in any way. Even when they did so, the Japanese rationalized such criticism as meant only for U.S. domestic consumption.


What Americans, including the revisionists, failed to see was that the Japanese economy, still devoted to exporting a vast array of ever more sophisticated and technologically advanced manufactured goods primarily to the American market, was generating an industrial overcapacity that would eventually threaten the health of the world economy. Moreover, as much of Asia began to emulate the Japanese form of capitalism or become offshore manufacturing platforms for Japanese corporations, this overcapacity threatened to reach crisis proportions. The crisis came to a head in 1997 and has been a continuing feature of the international economy ever since.


Political developments helped precipitate the crisis. In 1992, the Americans elected Bill Clinton on a slogan of “It’s the economy, stupid,” and in 1993, the Liberal Democratic Party in Japan, no longer needed as a bulwark against communism, simply collapsed of its own corruption and redundancy.


The Clinton administration did experiment briefly with policies advocated by the revisionists, including managed trade. The new administration even toyed with convincing the Japanese to join in helping manage Japanese-American trade, but its heart was never in it. The actual work was left to the usual array of Washington lawyers and economists, who had no East Asian knowledge or experience whatsoever, with the easily predictable outcome that the Japanese, much more experienced and better informed than their American adversaries, simply ran circles around them.


Using their huge leverage over American debt financing and Clinton’s need for the appearance of domestic economic prosperity in order to be reelected in 1996, the Japanese got the Americans to back down on most trade issues. The administration covered its tracks by claiming that it could not allow economic disputes to interfere with security and military matters. The difficulty was that except for the bellicose statements and deployments of the United States itself, peace was breaking out in East Asia. In 1992, for example, China recognized South Korea; that same year the government of the Philippines asked the U.S. Navy to leave the major base it had long occupied at Subic Bay. Still, the U.S. government claimed to see threats from North Korea and China, and the Japanese went along, doing whatever they could to satisfy the Pentagon.


In 1993, the Liberal Democratic Party lost its majority in the Japanese Diet for the first time in thirty-eight years. Increasingly irrelevant to Japan’s need to reinvigorate its economy and assume control over its foreign policy, it was not voted out of office but simply disintegrated. At first, a popular coalition government formed among the many new parties in the Diet. It seemed that a long overdue political realignment might be at hand. As it turned out, the Socialist Party, long feared by the United States because of its advocacy of “neutralism,” was so beguiled to be in office that it ultimately abandoned everything it had ever claimed to stand for and forged a cynical coalition with the LDP to control parliament. In the end, all the LDP’s loss of power revealed was that the party system itself had largely been postwar window dressing. In 1997, the LDP returned to power and resumed its stewardship over Japan’s old Cold War relationship with the United States.


At least, though, the rise to power in the 1993-97 interregnum of nonmainstream LDP and opposition party leaders opened up an important debate over how and why the country had become so rich and yet had such an ineffective elected government. Bureaucratic insiders as well as intellectuals and academics began publicly to acknowledge and elaborate on the very points the American revisionists had made. New York Times correspondent James Sterngold reported from Tokyo, “Five years ago, some Western critics were derided by the Japanese establishment as wrong—and probably racist—for declaring that Japanese policy was set by bureaucrats, not politicians, and that Japanese politics was often corrupt. . . . Suddenly, expressions and criticism previously regarded as blasphemous when uttered by ‘revisionists’ and ‘Japan bashers’ are spoken with a surprising matter-of-factness.”9 In the process they opened up whole new perspectives for viewing the interlocking Japanese governmental, social, and economic systems. They affirmed that a corps of unelected elite bureaucrats actually governed the country under a façade of democracy. They laid out the ways in which, working within a Cold War framework and guided by their government, the major corporations had invested in productive capacity many times greater than domestic demand could possibly absorb, thereby becoming totally dependent on continued sales to the American and Asian markets. They detailed the methods of the cartels, of restrictive licensing practices, of the underdeveloped system of judicial review, and of myriad other “nontariff barriers” to trade that kept American and European corporate penetration of the domestic market to a minimum.


One impetus for such new, self-critical attitudes could be found in the changed economic atmosphere. Following a binge of big-ticket investments at the end of the 1980s and a bubble of real estate speculation that accompanied newfound wealth, the economy began to falter. After eight years of stagnation, in 1998 it finally plunged into real recession. In an ironic twist, American ideologists used these developments to argue as always that American free-market capitalism was the globe’s one and only path to success. However, they now incorporated revisionist analyses without acknowledgment into their critiques of the Japanese economy. For example, the Wall Street Journal’s Paul Gigot had long maintained that Japan’s economy operated just like the U.S. model. “Japan’s miracle, like Britain’s and America’s before it,” he wrote in 1986, “was largely the product of creativity and enterprise by individuals and their businesses.”10 A decade later, in a column entitled “The Great Japan Debate Is Over: Guess Who Won?,” he could be found deriding Japan’s “model of bureaucratic-led economic growth,” as distinguished from “American-style capitalism.” His new point: the revisionists may have been right about how Japan worked but they were wrong to think it was a success. To the extent that the Japanese economy might ever stage a comeback, Gigot argued in a fashion typical of his colleagues, it would have to do business “in a framework that more resembles the American model.”11 Put another way, these economic ideologues found convincing proof in Japan’s economic fate that a hegemonic America would continue to dictate the rules of international commerce into the distant future, even if that hegemony were disguised with catchphrases like “globalization.”


As the Cold War receded into history, the United States, rather than dissolving its Cold War arrangements, insisted on strengthening them as part of a renewed commitment to global hegemony. Japan was supposed to remain a satellite of the United States, whether anyone dared use that term or not. Meanwhile, annual American trade deficits with Japan soared. American manufacturing continued to be hollowed out, while a vast manufacturing overcapacity was generated in Japan and its Southeast Asian subsidiaries. Capital transfers from Japan to the United States generated huge gains for financiers and produced an illusion of prosperity in the United States, but in 1997, it all started to unravel. The most severe economic crisis since the Great Depression hit the East Asian economies and began to spread around the world.

Each year approximately ten thousand American troops descend on Thailand for a joint military exercise called Cobra Gold. The military part of these visits is largely make-work for the American and Thai staffs, but the troops love Cobra Gold because of the sex. According to the newspaper Pacific Stars and Stripes, some three thousand prostitutes wait for the sailors and marines at the South Pattaya waterfront, close to Utapao air base. An equal number of young Thai girls from the country-side, many of whom have been raped and then impressed into the “sex industry,” are available downtown in Bangkok’s Patpang district. They are virtually all infected with AIDS, but the condom-equipped American forces seem not to worry. At the time of the 1997 war games, just before the economic crisis broke, sex with a Thai prostitute cost around fifteen hundred Thai baht, or sixty dollars at its then pegged rate of twenty-five baht to one U.S. dollar. By the time of the next year’s Cobra Gold the price had been more than halved.1 This is just one of many market benefits Americans gained through their rollback operation against the “Asian model” of capitalism.

The global economic crisis that began in Thailand in July 1997 had two causes. First, the built-in contradictions of the American satellite system in East Asia had heightened to such a degree that the system itself unexpectedly began to splinter and threatened to blow apart. Second, the United States, relieved of the prudence imposed on it by the Cold War, when any American misstep was chalked up as a Soviet gain, launched a campaign to force the rest of the world to adopt its form of capitalism. This effort went under the rubric of “globalization.” As these two complex undertakings—perpetuating Cold War structures after they had lost their purpose and trying to “globalize” countries that thought they had invented a different kind of capitalism—played themselves out around the world, they threatened a worldwide collapse of demand and a new depression. Whatever happens, the crisis probably signaled the beginning of the end of the American empire and a shift to a tripolar world in which the United States, Europe, and East Asia simultaneously share power and compete for it.

During the Cold War, the Communists routinely charged that the United States used the Marshall Plan for rebuilding wartorn Europe and subsequent economic aid programs to advance the interests of American companies and to keep the Third World dependent on the First. According to the Communist theory of economic colonialism, capitalist states enforce an inherently discriminatory division of labor on less developed countries by selling them manufactured goods and buying from them only raw materials, an extremely profitable arrangement for capitalists in advanced countries and one that certainly keeps underdeveloped countries underdeveloped. This is why revolutionary movements in underdeveloped countries want either to overthrow the capitalist order or to industrialize their economies as fast as possible.

Such economic colonialism has long existed in many aspects of America’s relations with Latin America. During the Cold War, the United States wrapped this system of dependency in the rhetoric of anticommunism, labeling elected leaders Communists if they seemed to endanger American corporate interests, as in Guatemala in 1954, and ordering the CIA to overthrow them. Campaigns against the influence of Fidel Castro, for instance, often proved of great usefulness to American companies south of the border. But this pattern of relationships did not cause the global economic crisis of the late 1990s.

The fundamental structural cause was the way the United States for more than forty years won and retained the loyalty of its East Asian satellites. These non-Communist countries accepted the American deal as offered and worked hard at “export-led growth,” primarily to the American market. If the Japanese led this movement, behind them were three ranks of followers: first, the “newly industrialized countries” of South Korea, Taiwan, Hong Kong, and Singapore; then, the late developers of Southeast Asia, Malaysia, Indonesia, Thailand, and the Philippines; and finally, China, at present the world’s fastest-growing economy. The Japanese found this so-called flying-geese pattern appealing. They were flattered to be the lead goose and the inspiration for those that followed. The leaders of each of these countries assumed that their economic destination—Los Angeles (and from there the rest of the American market)—was a permanent feature of the international environment; and so long as the Cold War existed, it was as permanent as anything ever is in interstate relations.

Over time, however, this pattern produced gross overinvestment and excess capacity in East Asia, the world’s largest trade deficits in the United States, and a lack of even an approximation of supply-and-demand equilibrium across the Pacific. Contrary to Communist analyses of how neocolonialism should work, these terms proved surprisingly costly to the imperial power. They cost American jobs, destroyed manufacturing industries, and blunted the hopes of minorities and women trying to escape from poverty.

Judith Stein, a professor of history at the City College of New York, has detailed how the de facto U.S. industrial policy of sacrificing American workers to pay for its empire devastated African-American households in Birmingham, Alabama, and Pittsburgh, Pennsylvania. This is, of course, but another form of blowback. She writes, “At the outset of the Cold War, reconstructing or creating steel industries abroad was a keystone of U.S. strategic policy, and encouraging steel imports became a tool for maintaining vital alliances. The nation’s leaders by and large ignored the resulting conflict between Cold War and domestic goals. Reminiscing about elite thinking in that era, former Federal Reserve Board chairman Paul A. Volcker recalled that ‘the strength and prosperity of the American economy was too evident to engender concern about the costs.’ ”2 Moreover, American economic ideologues always dominated what debate there was, couching the problem in terms of protectionism versus internationalism, never in terms of prosperity for whites versus poverty for blacks. The true costs to the United States should be measured in terms of crime statistics, ruined inner cities, and drug addiction, as well as trade deficits.

U.S. officials did finally start to negotiate more or less seriously with the Japanese and the other “miracle economies” to open their markets to American goods. But the attempt always collided with the security relationship. In order to level the economic playing field, the United States would have had to level the security playing field as well, and this it remains unwilling to do.

In East Asia, to create industries that could export to the American market, design the right products, and achieve competitive prices and levels of quality, governmental industrial policies became the norm. Japan was the regional pioneer in creating model collaborative relationships between government and industry. In part, it drew on its history as one of the world’s most successful late industrializers and on its wartime production system, in which the government and the huge zaibatsu, or corporate combines, had worked together to produce the weapons that Japan needed. After the onset of the Cold War, the Americans did very little to prevent the Japanese from re-creating the combines (now called keiretsu) and the legal structure that supported them, largely because occupation officials either failed to recognize what was happening or were blind to its implications.

To base a capitalist economy mainly on export sales rather than domestic demand, however, ultimately subverts the function of the unfettered world market to reconcile and bring into balance supply and demand. Instead of producing what the people of a particular economy can actually use, East Asian export regimes thrived on foreign demand artificially engineered by an imperialist power. In East Asia during the Cold War, the strategy worked so long as the American economy remained overwhelmingly larger than the economies of its dependencies and so long as only Japan and perhaps one or two smaller countries pursued this strategy. But by the 1980s the Japanese economy had become twice the size of both Germanies. Anything it did affected not just the American but the global economy. Moreover, virtually everyone else in East Asia (and potentially every underdeveloped country on earth) had some knowledge of how to create such a miracle economy and many were trying to duplicate Japanese-style high-speed growth. An overcapacity for products oriented to the American market (or products needed to further expand export-oriented economies) became overwhelming. There were too many factories turning out athletic shoes, automobiles, television sets, semiconductors, petrochemicals, steel, and ships for too few buyers. The current global demand for automobiles, for example, seems to have peaked at around 50 million vehicles at a moment when capacity has already grown to 70 million. To make matters worse, as a result of the global economic crisis, auto sales in Southeast Asia fell from 1.3 million in 1997 to 450,000 in 1998.

This is not to say that all the barefoot peoples of the world who might like to wear athletic shoes or all the relatively poor people who might someday be able to afford a television set or an automobile are satisfied. But for now they are too poor to be customers. The current overcapacity in East Asia has created intense competition among American and European multinational corporations. Their answer has been to lower costs by moving as much of their manufacturing as possible to places where skilled workers are paid very little. These poorly paid workers in places like Vietnam, Indonesia, and China cannot consume what they produce, while middle- and lower-class consumers back in the United States and Europe cannot buy much more either because their markets are saturated or their incomes are stagnant or falling. The underlying danger is a structural collapse of demand leading to recession and ultimately to something like the Great Depression. As the economic journalist William Greider has put it in his book One World, Ready or Not, “Shipping high-wage jobs to low-wage economies has obvious, immediate economic benefits. But, roughly speaking, it also replaces high-wage consumers with low-wage ones. That exchange is debilitating for the entire system.”3 The only answer is to create new demand by paying poor people more for their work. But the political authorities capable of enacting and enforcing rules to enlarge demand could not do so even if they wanted to because “globalization” has placed the matter beyond their control.

A crisis of oversupply was inevitable given the passage of time and the unwillingness of imperial America to reform its system of satellites. Even in the late 1990s, the American economy continued to serve as the consumer of last resort for the enormous manufacturing capacity of all of East Asia, although doing so produced trade deficits that cumulatively transferred trillions of dollars from the United States to Asia. This caused an actual decline in the household incomes of the bottom tenth of American families, whose real incomes fell by 13 percent between 1973 and 1995. It was only in 1997 that a weak link snapped—not, ironically, in trade, but finance—and threatened to bring the system down.

The financial systems of all the high-growth East Asian economies were based on encouraging exceptionally high domestic household savings as the main source of capital for industrial growth. Such savings were achieved by discouraging consumption through the high domestic pricing of consumer goods (which, of course, also led to charges of “dumping” of normally priced goods when they were sent abroad). To save in such a context was a patriotic act, but it was also a matter of survival in societies that provided little in the way of a social safety net for times of emergencies, and in which housing often had to be bought outright or in which interest payments on mortgages was not treated favorably as a tax deduction.

East Asian governments collected these savings in banks affiliated with industrial combines or in government savings institutions such as post offices. In organizing their economies, they had chosen not to rely primarily on stock exchanges to raise the capital their export industries needed. Instead they found it much more effective to guide the investment of the savings in these banks to the industries the governments wanted to develop. In East Asia, ostensibly private banks thus became partners in business enterprises and industrial groups, not independent creditors concerned first and foremost with the profitability of a company or the success of a loan. These banks in effect followed government orders and felt secure so long as they did so.

Superficially, corporations in most East Asian countries looked like their American or European equivalents, but in this case appearances were indeed deceptive. As the American corporate raider T. Boone Pickens discovered when he tried to buy a small Japanese company that made auto headlights, a significant block of shares was held by the Toyota Motor Company. The firm he wanted to acquire was part of the automaker’s keiretsu, or conglomerate of cooperating firms and banks. Although Pickens acquired what in the United States would have been a controlling interest in the company, Toyota blocked his takeover and prevented him from naming his own directors and corporate officers. The fact that Pickens was able to buy the shares at all was a fluke in Japanese corporate governance, the result of a single disgruntled stockholder. Until very recently Japanese corporations were “owned” entirely by one another in elaborate cross-share-holding deals designed to keep people like Pickens out and to keep the enterprise working for the country rather than for the profits of shareholders. The sale of shares was not a way to raise capital, and the people who held them were uninterested in the risks or profits that the company’s operations entailed.

This was actually a brilliant system. Oxfam, the British development and relief agency, maintains that the Cold War East Asian economies achieved “the fastest reduction in poverty for the greatest number of people in history.”4 But the stability of any East Asian economy depended on its keeping its financial system closed—that is, under national control and supervision. Once opened up to the rest of the world, the financial structures of the East Asian developmental states were extremely vulnerable to attack by foreign capital and international financial speculators. The industrial policy system produced corporations in which the burden of debt was five times greater than the value of the shareholders’ investments, whereas these so-called debt-to-equity ratios for U.S. firms are less than one to one. East Asian corporations operating with such large burdens of debt were normally indifferent to the price of their equity shares. Instead, they serviced these debts at their banks with income from foreign sales. When they were unable to repay their loans, the banks themselves very quickly veered toward bankruptcy. The whole system depended on continuous growth of revenue from export sales.

East Asian bankers are no stupider or more corrupt than those elsewhere. It is just that the industrial policies of the systems within which they operate put the profitability of a loan very near the bottom of the criteria they use for making an investment decision. Instead, these bankers focus on enlarging productive capacity, achieving larger market shares, accumulating assets, and having large balance sheets. It is true that from a purely Western perspective, they should not have offered many of the loans they made. To us it seems insane to ignore commercial criteria such as profitability. But for a Korean banker, it was more important to support an affiliated company that was building cars for the U.S. market than to question whether the company was making prudent investment decisions. That was part of the logic of being a banker in a satellite country within America’s hegemonic order in East Asia.

Then, without warning, that order changed. Perhaps the first important blow to the East Asian model of capitalism came in 1971, when President Nixon abolished the Bretton Woods system of fixed exchange rates, created by the United Nations Monetary and Financial Conference in the summer of 1944 at Bretton Woods, New Hampshire. The treaties that resulted from Bretton Woods were the most important efforts of the victorious Allies of World War II to create a better global financial system than the one that existed in the 1930s. The Allies intended to prevent a recurrence of the protectionism and competitive devaluations of national currencies that had deepened the Great Depression and fueled the rise of Nazism. To do these things, the Bretton Woods conference established a system of fixed exchange rates among the world’s currencies. It also created the International Monetary Fund, to help countries whose economic conditions forced them to alter the value of their currencies, and the World Bank, to help finance postwar rebuilding. The value of every currency was tied to the value of the U.S. dollar, which was in turn backed by the U.S. government’s guarantee that it would convert dollars into gold on demand.

Nixon decided to end the Bretton Woods system because the Vietnam War had imposed such excessive expenditures on the United States that it was hemorrhaging money. He concluded that the government could no longer afford to exchange its currency for a fixed value of gold. A more effective answer would have been to end the Vietnam War and balance the federal budget. Instead, what actually occurred was that the dollar and other currencies were allowed to “float”—that is, to be converted into other currencies at whatever rate the market determined.

The historian, business executive, and novelist John Ralston Saul described Nixon’s action as “perhaps the single most destructive act of the postwar world. The West was returned to the monetary barbarism and instability of the 19th century.”5 Floating exchange rates introduced a major element of instability into the international trading system. They stimulated the growth of so-called finance capitalism—which refers to making money from trading stocks, bonds, currencies, and other forms of securities as well as lending money to companies, governments, and consumers rather than manufacturing products and selling them at prices determined by unfettered markets. Finance capitalism, as its name implies, means making money by manipulating money, not trying to achieve a balance between the producers and consumers of goods. On the contrary, finance capitalism aggravates the problems of equilibrium within and among capitalist economies in order to profit from the discrepancies. During the nineteenth century the appearance, and then dominance, of finance capitalism was widely recognized as a defect of improperly regulated capitalist systems. Theorists from Adam Smith to John Hobson observed that capitalists do not really like being capitalists. They would much rather be monopolists, rentiers, inside traders, or usurers or in some other way achieve an unfair advantage that might allow them to profit more easily from the mental and physical work of others. Smith and Hobson both believed that finance capitalism produced the pathologies of the global economy they called mercantilism and imperialism: that is, true economic exploitation of others rather than mutually beneficial exchanges among economic actors.

Opponents of capitalism, such as Marxists, viewed such problems as inescapable and the ultimate reason capitalist systems must sooner or later implode. Supporters of capitalism, such as Smith and Hobson, thought that its problems could be solved by imposing social controls on the monetary system, as did the Bretton Woods agreement. As they saw it, lack of such controls led to the maldistribution of purchasing power. Too few rich people and too many poor people resulted in an insufficient demand for goods and services. The “excess capital” thus generated had to find some place to go. In the maturing capitalist countries of the nineteenth century, financiers pressured their governments to create colonies in which they could invest and obtain profits of a sort no longer available to them at home. The nineteenth-century theorists believed this was the root cause of imperialism and that its specific antidote was the use of state power to raise the ability of the domestic public to consume. After the United States ended the Bretton Woods system, these kinds of problems once again returned to haunt the world.

In the 1980s, when Japanese trade with the United States began seriously to damage the American economy, the leaders of both countries chose to deal with the problem by manipulating exchange rates. This could be done by having the central banks of each country work in concert buying and selling dollars and yen. In a meeting of finance ministers at the Plaza Hotel in New York City in 1985, the United States and Japan agreed in the Plaza Accord to force down the value of the dollar and force up the value of the yen, thereby making American products cheaper on international markets and Japanese goods more expensive. The low (that is, inexpensive) dollar lasted for a decade.

The Plaza Accord was intended to ameliorate the United States’ huge trade deficits with Japan, but altering exchange rates affects only prices, and price competitiveness and price advantages were not the cause of the deficits. The accord was based on good classroom economic theory, but it ignored the realities of how the Japanese economy was actually organized and its dependence on sales to the American market. The accord was, as a result, the root cause of the major catastrophes that befell East Asia’s economies over the succeeding fifteen years.

Once the high yen–low dollar regime was in place, the U.S. government assumed that the trade imbalance would correct itself. The United States did nothing to end Japan’s barriers against imports and still permitted Japan to export into its market anything and everything it could sell there. Japan reacted to the high yen by putting its industrial policy system into high gear in order to lower costs so it could continue its export-led growth, even at a disadvantageously high exchange rate. The Japanese Ministry of Finance also lowered domestic interest rates to make capital virtually free and encouraged industrial groups to invest more vigorously than they had ever done before. The result was fantastic industrial overcapacity and a “bubble economy,” in which the prices of such things as real estate lost any relationship to underlying values. Business leaders proudly announced on American television that a square meter of the Ginza was worth more than all of Seattle. Ultimately, huge debts accumulated and the Japanese banks were stuck with at least $600 billion in “nonperforming” loans that threatened to bankrupt the entire banking system.

By 1995, the contradictions were starting to come to a head. Japan still had a huge surplus of savings, which it exported to the United States by investing in U.S. Treasury bonds, thereby helping fund America’s debts and keep its domestic interest rates low. And yet Japan itself was simultaneously facing the possibility of the collapse of several of its bankrupt banks. Financial leaders said to the Americans that they needed relief from the high yen in order to increase Japan’s exports. They hoped to solve their problems in the traditional way, via more export-led growth. Eisuke Sakakibara, then Japan’s vice minister for international affairs in the Ministry of Finance, readily acknowledges that he intervened with Washington to lower the value of the yen and admits to his “inadvertent role in precipitating one of the 20th century’s greatest economic crises.”6 The United States went along with this; facing reelection in 1996, Bill Clinton certainly did not want Japanese capital called home to prop up Japanese banks at that moment. As a result, between 1995 and 1997 the U.S. Treasury and the Bank of Japan engineered a “reverse Plaza Accord”—which led to a 60 percent fall of the yen against the dollar.

However, in the wake of the Plaza Accord, many newly developing Southeast Asian economies had by then “pegged” their currencies to the low dollar, establishing official rates at which businesses and countries around the world could exchange Southeast Asian currencies for dollars. So long as the dollar remained cheap, this gave them a price advantage over competitors, including Japan, and made the region very attractive to foreign investors because of its rapidly expanding exports. It also encouraged reckless lending by domestic banks, since pegged exchange rates seemed to protect them from the unpredictability of currency fluctuations. During the early 1990s, all of the East Asian countries other than Japan grew at explosive rates. Then the “reverse Plaza Accord” brought disaster. Suddenly, their exports became far more expensive than Japan’s. Export growth in second-tier countries like South Korea, Thailand, Indonesia, Malaysia, and the Philippines went from 30 percent a year in early 1995 to zero by mid-1996.7

Certain developments in the advanced industrial democracies only compounded these problems. Some of their capitalists had spent the post–Plaza Accord decade developing “financial instruments” that enabled them to bet on whether global currencies would rise or fall. They had also accumulated huge pools of capital, partly because aging populations led to the exceptional growth of pension funds, which had to be invested somewhere. Mutual funds within the United States alone grew from about $1 trillion in the early 1980s to $4.5 trillion by the mid-1990s. These massive pools of capital could have catastrophic effects on the value of a foreign currency if transferred in and then suddenly out of a target country. Fast-developing computer and telecommunications technologies radically lowered transaction costs while increasing the speed and precision with which finance capitalists could transfer money and manipulate currencies on a global scale. The managers who controlled these funds began to encourage investment anywhere on earth under the rubric of “globalization,” an esoteric term for what in the nineteenth century was simply called imperialism. They argued that excess capital should be allowed to flow freely in and out of any and all countries. Some economists argued that the free flow of capital was the same thing as the free flow of goods, despite mountainous evidence to the contrary.

Capital flows to developing nations in Asia and Latin America jumped from about $50 billion a year before the end of the Cold War to $300 billion a year by the mid-1990s. From 1992 to 1996, Indonesia, Malaysia, Thailand, and the Philippines experienced money and credit growth rates of 25 percent to 30 percent a year. During this same period South Korea, Thailand, and Indonesia invested nearly 40 percent of their gross domestic product in new productive capacity as well as in hotels and office buildings; the comparable figure for European nations was only 20 percent and even less for the United States. In 1996, Asia was the destination for half of all global foreign investment, European and Japanese as well as American. On the American side, by 1997 Citibank held about $22 billion in local currency loans in East Asia, about $20 billion in securities, and $8 billion in dollar loans; Morgan Bank had $19 billion in Asian securities and $6 billion in dollar loans; and Chase had $4 billion in local currency loans, $15 billion in Asian securities, and $6 billion in dollar loans.8

Although they did not speak out at the time, a number of famous financiers and economists have since pointed out the dangers of what is called “hot money” or “gypsy capital.” George Soros, one of the world’s richest financiers and head of a large “hedge fund” located in the Netherlands Antilles, asserted that “financial markets, far from tending toward equilibrium, are inherently unstable,” and he warned against the folly of continuing down the path of deregulating the financial services industry.9 Jagdish Bhagwati, one of free trade’s most passionate supporters and a former adviser to the director-general of the General Agreement on Tariffs and Trade, argued that the idea of free trade had been “hijacked by the proponents of capital mobility.” He claimed that there was a new “Wall Street–Treasury complex,” comparable to the military-industrial complex, which contributes little to the global economy but profits enormously from pretending that it does. The East Asian economies did not really need hot money from abroad, since in most cases they saved enough themselves to finance their own growth. Bhagwati has also pointed out that an unregulated financial system can with relative ease become divorced from the productive system it is supposed to serve and so be unnaturally predisposed to “panics and manias.”10

There was as well a less financial ingredient in the disaster-in-the-making. Without particularly thinking about it or sponsoring any public debate on the subject, the U.S. government built its future global policies on the main military elements of its Cold War policies. It expanded NATO to include the former Soviet satellites of the Czech Republic, Hungary, and Poland; it reinforced its East Asian alliances; and it committed itself to ensuring access to Persian Gulf oil for itself and its allies. The Gulf War of 1991 was the first demonstration of this commitment. Eschewing a “peace dividend,” which it might have directed toward its own industrial and social infrastructure, the United States also kept its Cold War–sized defense budgets in the $270 billion range while seeking to reorient its military focus from the possibility of war with a more or less equivalent enemy to imperial policing chores everywhere on earth.

With hegemony established on military terms and the American public more or less unaware of what its government was doing, government officials, economic theorists, and members of the Wall Street–Treasury complex launched an astonishingly ambitious, even megalomaniacal attempt to make the rest of the world adopt American economic institutions and norms. One could argue that the project reflected the last great expression of eighteenth-century Enlightenment rationalism, as idealistic and utopian as the paradise of pure communism that Marx envisioned; or one could conclude that having defeated the Fascists and the Communists, the United States now sought to defeat its last remaining rivals for global dominance: the nations of East Asia that had used the conditions of the Cold War to enrich themselves. In the latter view, U.S. interests lay not in globalization but in bringing increasingly self-confident competitors to their knees.

In any event, buoyed by what the apologist for America Francis Fukuyama has called the “end of history”—the belief that with the end of the Cold War all alternatives to the American economic system had been discredited—American leaders became hubristic. Although there is no evidence that Washington hatched a conspiracy to extend the scope of its global hegemony, a sense of moral superiority on the part of some and of opportunism on the part of others more than sufficed to create a similar effect.

Their efforts came in two strategic phases. From about 1992 to 1997, the United States led an ideological campaign to open up the economies of the world to free trade and the free flow of capital across national borders. Concretely this meant attempting to curb governmental influence, particularly any supervisory role over commerce in all “free-market democracies.” Where this effort was successful (notably in South Korea), it had the effect of softening up the former developmental states, leaving them significantly more defenseless in the international marketplace.

Beginning in July 1997, the United States then brought the massive weight of unconstrained global capital to bear on them. Whether the U.S. government did this by inadvertence or design is at present impossible to say. But at least no one can claim that America’s leadership did not know about the size and strength of the hedge funds located in offshore tax havens and about the incredible profits they were making from speculative attacks on vulnerable currencies. In 1994, for example, David W. Mullins, former Harvard Business School professor and vice chairman of the Federal Reserve Board, went from being a deputy of Reserve Board chairman Alan Greenspan to a position as a director of Long-Term Capital Management (LTCM), a huge hedge fund with its headquarters in Greenwich, Connecticut, but its money safely stashed in the Cayman Islands, beyond the reach of tax authorities. In 1998, after the conditions it helped bring about had almost bankrupted the fund, the New York Federal Reserve Bank arranged a $3.65 billion cash bailout to save the company—as good an example of pure “crony capitalism” as any ever attributed to the high-growth economies of East Asia. In fact, when the bailout came to light, a number of Asian publications cynically recalled how the New York Times had editorialized only months earlier that in Asia “collusive practices were not only tolerated, they were encouraged” and that “the United States needs to reiterate the importance of full transparency by companies and financial institutions.”11 After the LTCM bailout, Martin Mayer, one of the most respected writers on the American financial system, observed that “the Fed [Federal Reserve Board] for all its talk of ‘transparency’ has made the fastest growing area of banking totally opaque, even to the supervisors themselves.”12

In order to make it intellectually respectable for the smaller Asian economies to swallow all the money the United States, Japan, and other advanced countries were offering them, the U.S. government threw its weight behind the Asia-Pacific Economic Cooperation forum (APEC), an organization the Australians had launched at a meeting of trade ministers in Canberra in November 1989. The forum did not, however, take off until November 1993, when President Clinton decided to attend an APEC meeting in Seattle and turned it into an Asia-Pacific summit of leaders from all the major East Asian nations. The Seattle meeting also produced APEC’s first “Economic Vision Statement”: “The progressive development of a community of Asia-Pacific economies with free and open trade and investment [italics added].” Under American leadership, APEC became the leading organization promoting globalization in East Asia. At annual meetings in different Pacific Rim countries, it insistently propagandized that the Asian “tiger economies” open up to global market forces, in accordance with the most advanced (American) theorizing about capitalist economies and in order to not be left behind as mere developmental states.

The November 1994 APEC meeting in Bogor, Indonesia, committed the participants to free trade and investment in the Pacific by 2010 for developed countries and by 2020 for developing countries, such as China and Indonesia. In 1995, at Osaka, APEC members agreed to unilaterally open their economies rather than attempt to negotiate a treaty like the North American Free Trade Agreement, which would have generated too much resistance in many of the member nations. Nothing much happened at Manila in 1996—except for a visit by the leaders to the old U.S. naval base at Subic Bay, now cleaned up of its prostitutes and turned into a free-trade and development zone. At Vancouver in November 1997, with the Asian financial crisis already under way, the United States pushed for the rapid removal of tariffs and nontariff barriers to trade in fifteen different sectors of economic activity. At Kuala Lumpur in November 1998, APEC finally came unglued. The prime minister of Malaysia, Mahathir Mohamad, had only a few months earlier reimposed capital controls over his economy to insulate it from gypsy capital, for which Vice President Al Gore openly denounced him, encouraging the people of Malaysia to overthrow him. The meeting ended in rancor, with Japan taking the lead in scuttling any further market-opening schemes for the time being. Its Ministry of Foreign Affairs declared that the United States was possessed by an “evil spirit” and accused it of endangering the region’s fragile economic condition by pushing market-opening measures down the throats of countries too weak to open their borders further.13 Malaysia and the United States did not even bother to attend the 1999 APEC meeting of trade ministers in Auckland, New Zealand.

The shock that brought this edifice crashing to the ground started in the summer of 1997, when some foreign financiers discovered that they had lent huge sums to companies in East Asia with unimaginably large debts and, by Western standards, very low levels of shareholder investment. They feared that other lenders, particularly the hedge funds, would make or had already made the same discovery. They knew that if all of them started to reduce their risks, the aggregate effect would be to force local governments to de-peg their currencies from the dollar and devalue them. Since this would raise the loan burdens of even the most expertly managed companies, they too would have to rush to buy dollars before the price went out of sight, thereby helping to drive the value of any domestic currency even lower.

The countries that had followed recent American economic advice most closely were most seriously devastated. They had opened up their economies to unrestricted capital flows without understanding the need to regulate the exposure of their own banks and firms. They did not ensure that borrowers in their countries invested the money they acquired from abroad in projects that would pay adequate returns or that actually constituted collateral for the loans. The foreign economists who advised them did not stress the institutional and legal structures needed to operate in the world of American-style laissez faire. No one warned them that if they raised their interest rates in order to slow inflation, foreign money would pour into their countries, attracted by high returns, whereas if they lowered interest rates in order to prevent a recession, it would provoke an immediate flight of foreign capital. They did not know that unrestricted capital flows had put them in an impossible position. What took place in East Asia was a clash between two forms of capitalism: the American system, disciplined by the need to produce profits, and the Asian form, disciplined by the need to produce growth through export sales.

The International Monetary Fund entered this picture and turned a financial panic into a crisis of the underlying economic systems. As already mentioned, the Bretton Woods conference of 1944 had created the IMF to service the system of fixed exchange rates that lasted until the “Nixon shocks” of 1971. It survived its loss of mission in 1971 to become, in the economist Robert Kuttner’s words, “the premier instrument of deflation, as well as the most powerful unaccountable institution in the world.”14 The IMF is essentially a covert arm of the U.S. Treasury, yet beyond congressional oversight because it is formally an international organization. Its voting rules ensure that it is dominated by the United States and its allies. India and China have fewer votes in the IMF, for example, than the Netherlands. As the prominent Harvard economist Jeffrey Sachs puts its, “Not unlike the days when the British Empire placed senior officials directly into the Egyptian and Ottoman [and also the Chinese] financial ministries, the IMF is insinuated into the inner sanctums of nearly 75 developing country governments around the world—countries with a combined population of some 1.4 billion.”15

In 1997, the IMF roared into a panic-stricken Asia, promising to supply $17 billion to Bangkok, $40 billion to Jakarta, and $57 billion to Seoul. In return, however, it demanded the imposition of austerity budgets and high interest rates, as well as fire sales of debt-ridden local businesses to foreign bargain hunters. It claimed that these measures would restore economic health to the “Asian tigers” and also turn them into “open” Anglo-American-type capitalist economies. At an earlier meeting at Manila in November 1997 called to deal with the crisis, Japan and Taiwan had offered to put up $100 billion to help their fellow Asians, but the U.S. Treasury’s assistant secretary, Lawrence Summers, denounced the idea as a threat to the monopoly of the IMF over international financial crises, and it was killed. He did not want Japan taking the lead, because Japan would not have imposed the IMF’s conditions on the Asian recipients and that was as important to the U.S. government as restoring them to economic health.16

In Indonesia, when the government ended its dollar peg and let the currency float, the rupiah fell from about 2,300 to 3,000 to the dollar but then stabilized. At that point, with almost no empirical knowledge of Indonesia itself, the IMF ordered the closure of several banks in a system that has no deposit insurance. This elicited runs on deposits at all other banks. The wealthy Chinese community began to move its money out of Indonesia to Singapore and beyond, and the country was politically destabilized, leading ultimately to the overthrow of President Suharto. All Indonesian companies with dollar liabilities rushed to sell rupiahs and buy dollars. Equities instantly lost 55 percent of their value and the currency, 60 percent. The rupiah ended up trading at 15,000 to one U.S. dollar. David Hale, chief economist of the Zurich Insurance Group, wrote at the time, “It is difficult, if not impossible, to find examples of real exchange rate depreciations comparable to the one which has overtaken the rupiah since mid-1997.” He suggested that a proper comparison might be with the hyperinflation that hit the German mark in 1923.17

By the time the IMF was finished with Indonesia, over a thousand shopkeepers were dead (most of them Chinese), 20 percent of the population was unemployed, and a hundred million people—half the population—were living on less than one dollar a day. William Pfaff characterized the IMF’s actions as “an episode in a reckless attempt to remake the world economy, with destructive cultural and social consequences that could prove as momentous as those of 19th-century colonialism.”18 Only Japan, China, and Taiwan escaped the IMF juggernaut in East Asia. Japan kept aloof even when the Americans publicly rebuked it for failing to absorb more exports from the stricken countries, for the Japanese knew that the Americans would not actually do anything as long as the marines were still comfortably housed in Okinawa. China remained largely untouched because its currency is not freely convertible and it had paid no attention to APEC calls for deregulation of capital flows. And Taiwan survived because it had been slow in removing its financial barriers. It also maintains a relatively low ratio of investment to gross domestic product, is shifting further toward a service economy whose capital needs are less, and has maintained export diversity—unlike, for example, Korea’s overconcentration in products such as semiconductors destined for the American market. Foreign holdings of Taiwanese currency are negligible because its peculiar political status makes it unattractive to the hedge funds. Thus, it has been able to offer some of its own huge foreign currency holdings to help bail out countries in Southeast Asia.

After the big investors had pulled their money out of East Asia and left the area in deep recession, they turned to Russia. They calculated that there was little or no risk in buying Russian state bonds paying 12 percent interest because the Western world would not let a former superpower armed with nuclear weapons default. But the situation was further gone in Russia than these investors imagined, and so, in August 1998, the Russians defaulted on the interest payments (they still owe foreign investors perhaps $200 billion). If Russia does not repay these loans, it will be the largest default in history. These developments so scared the finance capitalists that they started pulling their money in from all over the world, threatening even well-run economies that had implemented all the economists’ nostrums on how to get rich like the North Americans. The Brazilian economy was so destabilized that in mid-November 1998 the IMF had to put together a $42 billion “precautionary package” to shore it up. Needless to say, the IMF has also helped plunge millions of poor Brazilians deeper into poverty. In order to meet the IMF’s austerity requirements, the Brazilian government even had to cancel a $250 million pilot project to save the Amazon rain forest. The result was that other countries withdrew their matching funds for the Amazon, and the degradation of an area that contributes 20 percent of the globe’s fresh-water supply resumed.19

In speeches in Russia and East Asia during the second half of 1998, President Clinton warned the peoples of these areas not to “backslide” and urged them to open their nations even further to American-style laissez-faire capitalism. But he had lost his audience. By now his listeners understood that the cause of their misery could not also be its cure. Many remembered that the Great Depression started as a financial panic then made worse by deflationary policies similar to those prescribed by the IMF in 1997 and 1998 for East Asia, Russia, and Brazil. The result in the early 1930s was a general collapse of purchasing power. That has not happened so far this time, largely because the United States went on a consumption binge and provided virtually all growth in demand for the excess output of the world. Can American “shop till we drop” be sustained indefinitely? No one knows.

The economic crisis at the end of the century had its origins in an American project to open up and make over the economies of its satellites and dependencies in East Asia. Its purpose was both to diminish them as competitors and to assert the primacy of the United States as the globe’s hegemonic power. Superficially it can be said to have succeeded. The globalization campaign significantly reduced the economic power and capitalist independence of at least some of the United States’ “tiger” competitors—even if, as with Russia and Brazil, the crisis could not be kept within the bounds of East Asia. This was, from a rather narrow point of view, a major American imperial success.

Despite such immediate results, however, the campaign against Asian-style capitalism (and the possibility that America’s satellite states in the area might gain independent political clout as well) was ill-founded and included serious blowback consequences. The United States failed to acknowledge that East Asian success had depended to a considerable extent on preferential, Cold War–based exports to the American market. By cloaking its campaign in the rhetoric of market opening and deregulation instead of the need to reform outdated Cold War arrangements, the United States both destroyed the credibility of its economic ideology and betrayed its Cold War supporters. The impoverishment and humiliation of huge populations from Indonesia to South Korea was itself blowback enough, even if the blowback for the time being spared ordinary Americans. But if and when the stricken economies recover, they will almost certainly start to seek leadership elsewhere than from the United States. At a bare minimum, they will try to protect themselves from ever again being smothered by the American embrace. In short, by refusing to reform its Cold War structures and instead insisting that other peoples emulate the American way, the United States gave itself an unnecessary, possibly terminal case of imperial overstretch. Instead of forestalling global instability, it helped make such instability inevitable.

The triumphalist rhetoric of American leaders basking in their economy’s “stellar performance” has also alarmed foreigners. When Alan Greenspan asserted to Congress that the crisis meant the world was moving toward “the Western form of free market capitalism,” almost no one thought that was either true, possible, or desirable. Economics has not displaced culture and history, regardless of the self-evaluation of the economics profession. Many leaders in East Asia know that globalization and the crisis that followed actually produced only pain for their people, with almost no discernible gains.20 Globalization seems to boil down to the spread of poverty to every country except the United States.

Clearly on the defensive, Richard N. Haass and Robert E. Litan, directors respectively of foreign policy and of economic studies at the Brookings Institution in Washington, lamented, “In some quarters [globalization] is seen as having caused the rapid flows of investment that moved in and out of countries as investor sentiment changed and were behind the Mexican [1995] and Asian financial crises.” But to them this would be a wrong conclusion. To accept it would be to “abandon America’s commitment to the spread of markets and democracy around the world at precisely the moment these ideas are ascendant.”21 But whether such ideas are actually ascendant is, thanks to the crisis, now in doubt, and such doubts are generating more blowback. The duties of “lone superpower” produced military overstretch; globalization led to economic overstretch; and both are contributing to an endemic crisis of blowback.


China CPI – Follow the Wet Market

HKTDC(香港易发局)sourced an Hong Kong Economic Journal EJ Insight(信报)article about measuring predicting Chinese inflation. See Article.

There are eight major categories in the CPI basket. They are food, clothes, tobacco and liquor, health and personal care goods, home appliances and maintenance, housing costs (mostly rentals), transport and communication, and expenses on entertainment, education and culture.

Influence in the CPI is dwarfed by food, which accounts for one third of the CPI.

If we follow the trend of food prices, we can feel the pulse of the CPI movement.

  • Prices of pork are on a downward trend in the past few months. This is because pork prices have been on a high level in the past two years, prompting many individual raisers to keep more pigs. And these pigs hit the market since the Spring Festival, greatly boosting supply and which will continue to cause a retail price drop.

  • Prices of vegetables also declined. Take cole for example. During the Spring Festival, a kilogram of cole, a widely-consumed vegetable in China, cost 12 yuan. It now costs 3 yuan per kilogram in Beijing. If you are a smart shopper, you can easily get a bargain of 2 yuan a kilogram.

  • The reason for the price decline is pretty much the same as in the case of pork. Warm weather has lifted northern China from the months-long chill and locally-grown vegetables have begun flooding the market, thereby pulling down prices. Apart from that, the government’s effort to subsidize farmers in their seed and fertilizer purchases has helped slash farming costs, benefiting end consumers as well.

  • The downtrend of pork and vegetable prices will persist for sometime, pulling down the CPI.

  • But the prices of some food items are going up and this is likely to offset the drop in the prices of pork and vegetables. Cooking oil saw the biggest prices increase as major edible oil producers raised their prices in March, citing costs of labor and raw materials.

Chinese Real-Estate Bubble Pops Day₀

I spent quite a bit of time writing about the Chinese Real-Estate bubble in 2009-2010. Back in 2005, the bubble (based on affordability ratios) was already evident, but post Gov’t stimulus boondoggle, the bubble turned into a super-bubble. Sometime in late 2010, I had written everything that I really had to say about it, and since there’s no equivalent of Chinese-CDS that I could find to buy and make some cash on the impending real-estate meltdown, I could only sit back, think about other things, and wait for the inevitable.

Some of the things I wrote:

Most interesting notes from two years ago?

This is exactly what China needs to worry about – when the debt is unwound, what will keep the brakes on the descent.


The 2009 “Expand Domestic Consumption” (扩大内需) policy of China has been a newspaper success around the world, however, I’m inclined to think the result will be exactly what was experienced in Japan: “succeeded only in inflating the national debt”.

So here we are. The music has stopped. Let’s see who sits down, and who doesn’t. In the long run, this is a very good thing for the Chinese economy. Every day earlier means less mis-allocated resources to re-allocate.

Conspiracy Theory:

Could the technocrats have planned this all along, as a way to force wealthy Chinese to provide financing to develop new housing for the rest of the nations citizens, and crash the market enabling those less affluent citizens to buy up the houses at effectively subsidized prices?

Chinese Income Gap – Problem?

If you spend any amount of time in any of China’s cities, it will not take long to notice that there are MANY WEALTHY PEOPLE and MORE POOR PEOPLE. China obviously has a massive population – so you get a chance to see more people in a short period of time that almost anywhere else.

Western strategists continually write about Rural vs Urban China, often writing about these in terms of Rich vs Poor China. Then they equate the current rural condition with Mao’s peasant led rebellion that founded the People’s Republic of China back in 1949.

For whatever reason, pundits are always looking at the LAST PROBLEM, and when they don’t have a deep understanding of the situation, pundits like to make analogies to Chinese history.

I have two contentions:

  1. WE FOCUS ON THE WRONG GAP: China does have a rich poor gap that must be improved – but it’s not the rural/urban or even the rich/poor gap. It’s the middle class/rich gap.
  2. CHINESE HISTORY ISN’T SPECIAL: China’s history is almost meaningless in trying to understand modern China. What’s happening on the ground today in China has as little in common with the Mao era as the Civil War does with modern America.

Today there was an article in StratFor (Strategic Forecasting) that focuses on the gap between China’s rich and poor. The article is titled: China Political Memo: A Growing Gap Between the People and the Elite.

A recent survey conducted at several top universities in China, including Peking University (PKU) and Tsinghua University, shows that the percentage of rural students enrolled at those institutions has dramatically declined over the past two decades. At PKU the percentage dropped from more than 30 percent in the 1990s to about 10 percent today. The numbers are similar at Tsinghua and other more selective Chinese universities. The most obvious reasons for this decline include China’s rapid rate of urbanization and the increasing number of job opportunities available to the rural population. Still, the decline is a worrisome sign that opportunities for China’s rural population to attain higher social status may be narrowing. The survey findings also reinforce an already evident trend: that social mobility in China is not as fluid as the country’s economic development might suggest.

Good. We’re focused on social mobility. Educational institutions are a big part of social mobility – especially access to the most elite institutions.

You can read the original China Daily article: Rural Students Deserve Better.

The rural Chinese population has been experiencing severe brain-drain for the last 30 years. In 1982, China was 20% urban, and only 26% urban by 1990. Today, China is over 50% urban. By 2035, it’s expected to be 70% urban.

Based on the numbers given in 1990 and today – the admission numbers should probably be closer to 15%. But that’s without factoring in the “brain drain” that has already happened in the country side. The smartest, the most ambitious, the most motivated have long since left this pre-industrial farming communities, and the ones that are born onto these farms try to get out as fast as possible.

So – it’s not a black and white issue – from an efficiency standpoint – to say that more farm students should be enrolled then are already being enrolled.

On the other hand, unrelated changes such as improving the legal system, tax system, and real estate market would probably do more to strengthen the country. How much does the unreliable legal system do to keep people from working with those outside of their network?

In any society, even an ideal one, social stratification is inevitable. But for a modern society to prosper and grow it must minimize barriers to economic advancement. Otherwise, gaps will widen among the social strata, creating potential resentment and instability at the lower levels. In China, the traditional path to a better life was the imperial examination system (ke ju), which began in the 7th century during the Sui dynasty and was open to anyone who demonstrated sufficient intelligence and drive, regardless of social status. Ke ju selected the most promising administrators for the state bureaucracy. As such, it served for centuries as a portal through which smart and hard-working youth could become part of China’s political class. This transformation could greatly change the life not only of the individual aspirant, but also his entire family. Cancellation of the imperial examination system in 1905, during the Qing dynasty, cut off this mode of access. In the 1950s, the division between the people and the ruling elite was reinforced with the introduction of the hukou system, a resident-identification program that created an official division between rural and urban dwellers.

This is a typical example of bias #2 – Chinese History isn’t special. What does the “imperial examination system” have to do with modern China? The exams could be taken by male adults, and the last exam was given in 1905 – meaning that the test taker had to be born before 1890. The imperial exams were a test. “Gaokao” was a test. The SAT is also a test. Why would we assume that “Gaokao” has more connection to the imperial exams than it does to the SAT?

The biggest beneficiaries of the system have been urban dwellers, who have greater access to employment, social welfare, education, medical care and housing than their rural counterparts. Despite years of campaigning by the state for hukou reform and a more equitable distribution of benefits, little has been achieved. If anything the disparity seems to be widening, which makes the findings of the recent university survey all the more troubling.

Of course the industrialized (ie. urban dwellers) are the beneficiaries of modern China – because they are more productive in the urban environment. Their farming jobs are easily replaced with the capital equipment used on American farms – equipment that allows 1% of Americans to work in agriculture.

One of the few portals left for upwardly mobile youth in China is the college entrance examinations (known as gao kao). The gao kao system is intensely competitive, allowing qualified applicants regardless of pedigree an opportunity to enter a university (usually in an urban area), earn a degree and find a well-paying job. While the system falls short in many ways — stipulating, for example, lower quotas for rural applicants than their urban counterparts and thereby further widening the gap — it remains the most efficient path toward the elite class, both politically and economically. And this, much like the imperial examinations once did, helps to anchor stability and, to some extent, secures the power of the elite class. While an expanding educational system was once seen as a great leveler of modern China, a growing imbalance in the distribution of resources between the country’s rising middle class and their less privileged rural counterparts is making it harder for rural youth to move upward. College tuition and fees are becoming less affordable. Many of the top universities choose students based on their acquired specialties — for example, music or technology — which wealthy students are better able to develop. This hurts rural students, who are more likely to have attained high scores through hard work. Meanwhile, many selections are based on personal networks, which further impedes poor students. The result is a narrowing of options for rural youth, the brightest of whom may not have enough money or the right connections to get into the top schools. Barriers are also being raised by the increasingly close connections between China’s political elite and business elite, both urban based. As it becomes harder for China’s rural population to break through these barriers, it could lead to growing grievances over inequality and intensifying social unrest — Beijing’s greatest fear. Therefore, Beijing may need to work to increase access, creating opportunities for the country’s massive rural population.

Yes, it’s sad anytime someone is under-utilized. In 1982, 75% of Mainland Chinese were subsistence farmers. Today it’s less than 50%. Seems reasonable to believe that the 50% that are still subsistence farmers are probably not much better off than they were in 1982 – because they are no more productive than they were in 1982. However, if they want, then can go get a job in an urban area. They can work in the factory, and their kids can get a shot at really integrating into that urban area. Unless the government makes a mess of inflation – there was 100% inflation leading up to the 1989/6/4 incident – the farmers will be fine. They know their future awaits them in the city when their time comes. If not them personally, their children or grandchildren.

The bigger problem is that the wealthy/elite are very entrenched, and getting more entrenched by the second. The far more interesting survey for Tsinghua and PKU would be: what is your parents net worth? or what bureaucracy do your parents run?Knowing how relationships and favors work throughout China, I would be very pleasantly surprised if these numbers were anything like a representative (meritocratic) representation of urban China.

The Chinese Middle class has average incomes around $10,000 USD/year. Meanwhile, China has more than 1.11 MILLION households with net worth over $1,000,000 USD. Houses in most urban areas of China can not be purchased by the “middle class” with the current middle class income:home price ratio.

It’s not the barrier between the poor and the middle class that China needs to worry about – this is a barrier that the motivated can easily overcome. It’s the barrier between middle class and wealthy that they need to worry about — because the smart, ambitious, but frustrated — those are the ones you’ve got to worry about.

Emerging Market Myths

Interesting SeekingAlpha article pointing out credit expansion as an often overlooked factor in developing market growth, and that when credit expansion stops, developing markets may stop developing.

It is almost taken for granted that many emerging markets will continue to experience higher growth rates than more established countries including the United States, the U.K., and most of the countries in Western Europe. However, it is usually assumed to be the result of a superior educational system, a more coherent set of cultural values, high population growth, vast natural resources, and numerous other factors–all of which are almost completely irrelevant to the issue of economic vibrancy. Let’s focus on the single most important feature of emerging markets, which is the availability of credit. Developed markets have enjoyed relatively easy and plentiful access to credit in numerous forms for decades or longer–mortgages, credit cards, auto loans, installment payments, low money down payments, government-guaranteed borrowing, and numerous related institutions. In sharp contrast, much of the rest of the world was on a cash-only basis until just twenty or thirty years ago (or even less, in some ‘frontier’ countries including Colombia, Mongolia, and Uganda). If you live in an all-cash economy which suddenly begins to use credit, there will be an immediate surge in spending–and which will create a domino expansionary effect. When someone borrows money, that money quickly finds its way into the real economy. Over time, as that loan has to be repaid, this will have a gradual drag on the economy over a period of several years or more. However, the immediate impact is invariably positive. In any nation where most of the GDP growth is caused through the expansion of local businesses, as in China and India, the fact that many millions of people will suddenly have access to credit will almost certainly create double-digit increases in annual revenue for many sectors of the economy. This higher rate of growth can only continue as long as credit continues to become more readily available to an ever-increasing segment of the total population. Eventually, as in the developed world, a point of saturation begins to be approached. There are still those who do not have access to credit, but they will eventually consist primarily of those who are not creditworthy due to their limited personal circumstances, or the minority of those who simply refuse to borrow money under any circumstances. Once this saturation point is reached, further credit expansion slows dramatically. This has the immediate effect of causing lower rates of economic growth. In the longer run, the reality of widespread loans having to be repaid will have an even more negative effect on the economy, especially during times of recession when assets become less valuable, while loans are not diminished in magnitude. In relative terms, then, the loan-to-asset ratio of much of the population will dangerously increase.

The author makes a good point, especially scary if you consider many emerging markets drastically (100%!) under report their public debt numbers, but credit expansion isn’t the only reason for growth in Asia. The more important, and more real story is productivity growth.

China has a good educational system, stable government, and talented, hard working citizens. No reason Chinese labor should be priced at 20% of USA labor, especially when Chinese blue collar labor is MORE PRODUCTIVE than US blue collar labor in many situations (environmental regulations, employee obedience).

Real-estate prices in China are already adjusted for 10-20 years from now when those prices hit parity, but still many medium/long businesses opportunities selling to the chinese consumer, particularly: Agriculture, Finance, Retail, Medicine, Health & Fitness.

The Most Interesting Company in China

In the USA, when you first interact with someone, you assume you are relatively trustworthy and that they are who they say they are, unless they give you some reason to be suspicious. In China, the default stance is that you are always suspicious and you only believe someone is who they say they are, and can deliver what they say they can deliver after they’ve given you reason to believe them. In other words:

  • In the USA, innocent until proven guilty
  • In China, guilty until proven innocent

China is an extremely low trust environment. As Fukuyama argues, Trust is an economic lubricant, reducing the cost of transactions and enabling cooperation.

Yet, in this ultra low trust environment, companies still have to offer financing terms to their business partners. The result, is that collecting the outstanding cash is very difficult, many payments are unable to be collected, and companies are often uncertain of their overall financial position. From Dec 1st until Chinese New Year, many Chinese companies are focused on collecting outstanding accounts. Books are typically closed on (Lunar) Chinese New Year.

They don’t have much penetration yet, but Dun & Bradstreet (DNB) has partnered with Huaxia Bank to expand into China. (Huaxia is 20% owned by Deutsche Bank).


Every Chinese company having a D&B number would be a big step forward for businesses, and with Web 2.0 technologies, D&B should be able to leverage the Chinese business community to get an early read on which companies are growing, which are struggling, and who you can trust to pay on time – if ever.

Note the D&B/Huaxia JV started in Dec 2006, more than a year after Deutsche Bank acquired a 20% stake in Huaxia, yet it doesn’t seem to be getting a lot of traction yet. Probably not ideal to structure this sort of thing as a JV – since it’s not in the business of actually granting credit, just acting as an information service, and since D&B is a strong global brand that can quickly earn trust in China, it’s probably better structured as just a Foreign Enterprise, ideally selling stakes in that enterprise to each of the biggest Chinese banks. That way you’ve got government support, access to proprietary government information, but you have the free market incentives necessary to succeed anywhere.

It’s already been nearly 4 years, and the JV may need to be restructured, but D&B has the potential to have a huge impact on China – an impact on society far beyond what consumer goods companies can hope for.

Dollar Peg: Bad Business For China

Price is what you pay. Value is what you get.

Warren Buffet

Beijing regularly complains about the “safety of it’s dollar reserves”. This political posturing makes for nice headlines and helps aggregate soft power, but your response should just be to laugh at Beijing’s naiveté and move on to the next story.

Beijing should keep some foreign currency reserves, which help to stabilize the domestic currency and encourage foreign investment. However, if Beijing did not manipulate the value of the Yuan, Beijing’s dollar reserves would not have risen to the ridiculous levels that we see now.

Today, the Chinese economy is structured to do one thing very well: make products for export. Manufacturing is a notoriously cost conscious business, and as costs in China rise, the government doesn’t want to see factories relocate en-masse to Vietnam, the Philippines, or other lower cost regions. Under normal circumstances, currencies trade a lot like stocks, prices go up and down relative to each other every day. However, every day the Chinese Yuan is worth the same amount of US Dollars. For almost 2 years, it’s been pegged at about $1.00 USD = ¥6.83 Yuan.

Trading Dollars for Yuan.

China didn’t pass a law saying that each dollar is worth 6.83 Yuan. Nobody will be tortured, jailed or executed for trading Dollars for Yuan at another rate. Instead, China’s central bank, The People’s Bank of China (PBoC), has created a policy that no matter what, they will sell you ¥6.83 Yuan for each $1.00 USD. The value of the Yuan is less than ¥6.83. Perhaps the value is ¥6.8, perhaps it’s ¥6.0, it might even be ¥5.0 or ¥4.0 for each $1 USD. However, since the PBoC is willing to sell Yuan at such a discounted price, they have a monopoly on the market. There’s no free exchange market for the Yuan, so nobody, including the PBoC can figure out exactly what the value of the Yuan should be, but the price is set by the PBoC.

Trading Yuan for Dollars

Selling Yuan is a little different story. If you have Yuan, and you want to sell them for Dollars, the PBoC doesn’t make life easy for you. Yuan sellers have to register with the PBoC and request foreign exchange. The PBoC has the choice on whether or not the Yuan sale will be permitted. For anyone investing in China, this is a very important fact to be aware of – one that I expect will bite a lot of foreign investors if the Chinese Real-Estate market bubble were to pop.

Since the PBoC is willing to give you such a great price when you sell dollars and buy Yuan, there is automatically an inward flow into Yuan, in spite of the risk that the PBoC may not let you convert Yuan back into dollars when you want to take your money back out.

If you torture the data long enough, it will confess.

Ronald Coase

The Big Pile of Dollars

As long as the PBoC keeps the peg, all of the dollar reserves that are acquired are valued by the PBoC at the price that the PBoC paid, even though the value is less than the price paid. Everybody knows that the PBoC is selling Yuan very cheap, so even more people buy Yuan (or other Chinese assets) with the intention of selling them back as soon as the price of the Yuan rises to match it’s value. Combine this with the fact that the Chinese economy is designed to produce exports, and you’ve got a recipe to up with a lot of dollars.

The PBoC has an account full of dollars corresponding to all of the Yuan, Yuan valued exports, and Yuan assets that China has sold to the rest of the world. This pile of dollars is massive and grows quickly. Since some interest on this money is better than no interest at all, the PBoC lends a lot of these dollars back to the US Federal Government, helping to finance both annual deficits and the overall debt, and pushing down interest rates.

Losses: Real or Realized

If the actual value of the Yuan in dollar terms was ¥6.70, but the PBoC’s currently pegged rate were ¥6.80, then every single time the PBoC trades a Dollar for a Yuan, it would be loosing ¥0.10 Yuan for every dollar traded. The bigger the gap between the rate that the PBoC is willing to pay for Dollars, and the the value of the Yuan, the bigger the loss on each trade. Central Banks are funded by Tax payers, so money loosing policies like this are not unheard of.

Every day for several years, the PBoC has been paying top dollar to buy dollars, even though the Dollar has been going down relative to other currencies (Euro, Yen).

(In case you didn’t notice, the flat line, least changed against the dollar, is the Chinese Yuan)

The PBoC re-values the Yuan, either by allow it’s price to be set by the market, just like the Dollar, the Euro and the Yen, or by raising the price the PBoC sells Yuan (perhaps only 6.0 Yuan for each dollar instead of 6.8 today).

THE CATCH, is that even though the PBoC is loosing money every time it buys dollars, from an accounting perspective it doesn’t look like a loss. It’s not until the price of the Yuan increases, the loss will finally look like a loss, a huge loss, to every accountant on the planet.

After the smoke clears

Someday, the PBoC will stop operating as the discount Yuan seller, thereby slowing down their accumulation of dollars, and correspondingly reducing demand for interest payments on their big pile of dollars. Less demand for dollar interest, means that the price of financing debt is going to go up. You’re not going to have many more chances to get a 30-year fixed mortgage at 5% — it was 12% in 1985.

The rising Yuan could be extremely dangerous for the Chinese economy, because there isn’t any other sector that could replace China’s manufacturing jobs. Though there are many well educated and talented Chinese entrepreneurs, the unpredictable regulatory and legal framework make investment in any R&D very high risk. Without further political reform, China appears to be stuck at the bottom of the value chain, in the Manufacturing department.

The Internet Bubble – Popped – 10 Years Ago Today

BBC put together an interesting review of Internet stock bubble, that ended on March 10, 2000.

February 2000:

David: If your not a media stock, dot-com stock or a telecom stock, valuations are very low.

BBC: So what you’re saying David is that it’s really the result of this asset bubble. In other words, the actual stock market value of these companies was way out of line, compared to their potential to earn money.

David: Right, and I think that was fairly widely known. In our consciousness, it was just way out of whack. But, every day you heeded it, or you got left behind. These things were going up by the day, they were going up by the rate of warp seed, regardless of whether they had earnings or not.

BBC: Though you though it was all a bit ridiculous, you still felt you had to keep recommending these dot-com shares to your clients.

David: Looks, this seems kinda ridiculous, maybe we should look at pulling back on the aggressiveness of your styles, because they had all of the proof they needed – in their track record. It was fabulous. And it was very difficult to convince them of any other type of approach to what they were doing. I think it was quite difficult to tell clients to pull back, when every month they were making another 5-10%.

The Internet stock bubble was a classic stock market speculative bubble. The 2007 subprime crisis is a bubble in credit and the price of money. The discussions people were having about Internet Stocks in February 2000 sure sound a lot like discussions about the Chinese Real-Estate market.

They had all of the proof they needed – in their track record.

Christian Science Monitor weights in on China bubble

Gordon Chang, author of “The Coming Collapse of China“, published in 2001. The book predicted the China would collapse by around 2005, or perhaps as late as 2010. He predicts that widespread unemployment, government corruption, inefficient state owned enterprises, and a lack of leadership would lead to the undoing. Publishers Weekly comments:

His invocations of the “power of the Chinese people,” or of an imaginary individual who will one day “end the Chinese state as it now exists,” read more like political soap opera than judicious analyses.

One of the Amazon commenters summarized Mr Chang’s POV as:

“The Coming Collapse of China” is an angry book written by the son of a man who “left China before the end of the Second World War and [the son] grew up hearing him say that Mao Zedong’s regime would have to fall.” The son returned to China to work as a lawyer in Shanghai. When he wrote this book – his first – it was a polemic in which he pounded away at the evils of Communism and predicted that Jiang Zemin’s regime would have to fall.

The Christian Science Monitor published Mr Chang’s “China: the world’s next great economic crash” article in the Opinion section this week. The truth is probably somewhere in between the current China Euphoria (rise of China is story of decade) and Mr. Chang’s China Collapse POV. For the record, I’m optimistic that China will be in a very strong position by 2050, with living standards in the largest cities (Beijing, Shanghai, Guangzhou) at parity with Taipei and Hong Kong. However there is a massive asset bubble in China that is hurting all but the wealthiest 0.5% (85% of families can’t afford basic housing). 40% of local gov’t revenues come from land sales (Professor Chovanec) and current GDP growth is fueled by real estate development.

The following is an [objective?] look at the current China situation:

Beijing, ignoring advice from Washington and other capitals, did not in the boom times try to restructure its economy to favor consumption. Instead, the Chinese government sought to take maximum advantage of then-surging foreign demand. The role of consumption, therefore declined – falling from a historical average of 60 percent of the economy to about 30 percent last year. No country has a lower rate.

To make up for slumping demand abroad and sluggish consumer spending at home, the State Council, the central government’s cabinet, announced a stimulus plan in November 2008. Beijing originally said it would spend $586 billion through 2010. In the first full year of the program however, it has directly and through state banks disbursed about $1.1 trillion in stimulus funds.

The plan, not surprisingly, is creating gross domestic product, but growth is an artificial “sugar high.” For one thing, Beijing’s stimulus spending last year was around a quarter of the total economy. Now, perhaps as much as 95 percent of China’s growth is attributable to state investment, as a Chinese analyst noted recently.

Despite the massive state spending, the country’s economy is not particularly robust. Power consumption statistics, a crucial indicator of economic activity, show the economy expanding at only two-thirds the announced rate.

Moreover, essentially flat consumer prices last year belie official reports of roaring retail sales. So does the full-year 11.2 percent decline in imports, another sign of sluggish domestic demand. And if the economy is really growing by double digits, why is Beijing insisting on continuing its stimulus?

New York Times columnist Thomas Friedman, however, thinks none of this will be a problem. Arguing that China is not the next Enron, he gives this advice to Mr. Chanos: “Never short a country with $2 trillion in foreign currency reserves.”

Yet Beijing’s record-setting reserves – now $2.4 trillion – are essentially unusable for this purpose. Why? China’s leaders need local currency, the renminbi, to deal with domestic needs. If they convert reserves into renminbi, they will cause the currency to zoom up in value and choke off the critical export sector. Foreign reserves have only limited uses in domestic crises.

Second, the state’s stimulus plan is taking the nation in the wrong direction. It is favoring large state enterprises over small and medium-sized private firms, and state financial institutions are diverting credit to state-sponsored infrastructure. Over the past three decades, China’s economy has expanded at an average annual rate of 9.9 percent because of the private sector, but now Beijing is renationalizing the economy with state cash.

Third, Beijing’s flooding of state enterprises with government cash will undermine their competitiveness, as a similar tide of money severely damaged Japan’s corporations during the bubble years.

Japanese managers discovered they could make more money managing cash than from anything else, and they therefore neglected their underlying businesses. Essentially the same thing is happening in China.

The Biggest Peg: Chinese Yuan and Sterilization Bonds

Jeffrey Frankel, of Harvard University wrote “On the Renminbi”, concerning the RMB/USD peg as the view looked from 2005, just after the first minor devaluation (2.1%) of the RMB. When one currency is pegged to another, the value will typically be pegged too high, or too low. If pegged too high, there will be a run on the currency, just like an old fashioned bank run, but in this case it’s the nations central bank. If pegged too low, the currency will be undervalued. Hot money will arrive in anticipation of the eventual revaluation. Central Bankers must try to get the excess cash out of the system, primarily through Sterilization Bonds.

We have already mentioned that a balance of payments surplus implies that the reserve component of the monetary base is increasing. Some expansion in the monetary policy may be entirely appropriate, especially in an economy with strong long-term growth. But in an economy that is in danger of overheating, the central bank may wish to sterilize the inflow, so as to prevent expansion in the overall money supply.

If the money supply expands, you will create inflation and may also create asset bubbles which [mis]allocate resources from productive efficient. Recently these misallocations have expanded global housing markets and propped up global stock markets.

Sterilization can be a good response to an inflow, for a period of time. It can help the country maintain its exchange rate target without abandoning a target for the money supply or interest rate. But it can become increasingly difficult over time, especially if traditional barriers to capital flows have been gradually eroded. One problem is that it just prolongs the balance of payments disequilibrium, because it by-passes the automatic mechanism of adjustment that reserve flows provide under the monetary approach to the balance of payments. Another potential problem is the quasi-fiscal deficit: if the central bank has to pay high interest rates to get domestic residents voluntarily to absorb “sterilization bonds,” while receiving low interest rates on its reserves of US treasury securities, then it is running a deficit.

Under normal circumstances, Sterilization Bonds would require chinese state banks to purchase bonds from the government, reducing the size of the money supply (because money is handed back to the government). However, in China all foreign currencies collected at state banks are immediately surrendered to the central bank. I believe this policy removes the typical need for “Sterilization”.

Some governments are able to force their bonds down the throats of their banks without paying market interest rates, a form of financial repression; but this just weakens the balance sheets of banks and raises the odds of a banking crisis somewhere down the road.

With the banks all being owned by the Gov’t, this is the case here…

One disadvantage of a balance of payments surplus, on the other hand, is that the reserves, which are typically held in the form of US Treasury bills and bonds and other dollar securities, pay a low rate of return. Interest rates on US treasury bills are low because the market is so liquid and because default is assumed to be very unlikely — and also, during the period 2001-2004, because the Federal Reserve has held short-term interest rates well below normal historical levels. The Chinese authorities have evidently already diversified out of Treasury bills, into agency bonds and other longer term securities, which will probably help the yield somewhat. But it is more likely than not that the dollar will depreciate over the next ten years (not necessarily in the short run), in light of the large US trade deficit, which would reduce even further the return to holding dollar securities. (Diversification into the euro or other currencies has evidently not yet gone far.)

The low interest rates associated with this giant pool of money helped sow the seeds for the global financial crisis. Basically, there is too much money in RMB and not enough good USD investments, yet the Fed set interest rates too low. The result was Chinese bankers buying Fannie, Freddie and boatloads of mortgaged backed securities.

These points are drawn largely from the experience of emerging markets such as Colombia and Korea in the early 1990s. Those countries were able to sterilize capital inflows only for a year or two, before it became too difficult, due to high interest rates on the sterilization bonds and the prolongation of strong capital inflows (as in standard macro models). Chinese officials may be correct that their case is somewhat different, due to a financial system that is less open and less market-oriented.

See the “surrender” policy for dealing with foreign currency.

The capital inflow has consisted largely of Chinese citizens bringing capital flight money back home, speculating on a revaluation, and so far the authorities have not had to pay high interest rates locally to sterilize it. But they may find it increasingly difficult to sterilize further inflows.

The “inflows” are all the Chinese expatriate class returning home story was probably true when this story started, however the size of the bubble today and “Rise of China” being the most read story of the decade indicate the story has been stretched quite a ways now. Interesting that speculators always have a million reasons why it’s different this time and how other people are speculating, but not them and it’s not widespread.

Either way, if this gap is real, better to address it through appreciation than inflation.

But I doubt this is the policy that the CCP will peruse, despite how logical it may be and how much it may benefit the average citizen.

Google Taking Stand Against Chinese Censorship

Caing reported that it’s going online. Now, the guys at google have decided to stop self-censoring, even if it means pulling their operations out of China! Full source (blocked by GFW)

These attacks and the surveillance they have uncovered–combined with the attempts over the past year to further limit free speech on the web–have led us to conclude that we should review the feasibility of our business operations in China. We have decided we are no longer willing to continue censoring our results on, and so over the next few weeks we will be discussing with the Chinese government the basis on which we could operate an unfiltered search engine within the law, if at all. We recognize that this may well mean having to shut down, and potentially our offices in China.

In Mainland Chinese culture, the person with slightly more authority in a situation routinely strong-arms the weaker party, and the weaker party generally goes along with the situation, saying “没办法 – No [other] method”. Google is another recent example 1st worlders of saying “No, are civilized and don’t agree with mafia negociation tactics”. Great job guys! Hope to see an explosion of cases like this in 2010!

The CCP has been using 8% annual GDP growth as the metric of success for years, but has lost sight of WHY 8% GDP growth has been the objective – and the bureaucrats have figured out how to manipulate GDP growth during the bubble years, the same way managers in American firms figured out how to manipulate stock prices in the 60s/70s. The resulting american conglomerate boom didn’t create long term shareholder value any more than the central planners focus on unproductive GDP will create long term financial benefit.

Deng Xiaoping made massive steps forward in Chinese reform by simply getting the gov’t out of the way, and with his support Zhao Ziyang and Zhu Rongji were able to go further. Chinese reform has been in exercise in gradualism, and this gradualism has avoid many undoable mistakes. However, we are left asking who are the reformers today? Wen Jiabao seems to generally came deeply about the welfare of the people, but without a free press and an independent judiciary, I think corruption will eat away at the efficiency of the Chinese economy and prevent mainlanders from reaching living standards of their brethren in Taiwan and Hong Kong.

China Bubble? Jim Rogers “No”. Jim Chanos “Yes”.

The mainstream financial press has recently started picking up on the idea of weather or not “China” is a bubble. Longtime China bull Jim Rogers is quoted as saying: “I find it interesting that people who couldn’t spell China 10 years ago are now experts on China… China is not in a bubble.”

Rogers’ partner George Soros got famous shorting sterling. Meanwhile, Jim Chanos got famous shorting Enron. Chanos noticed that Enron had a very low return on Capital Investment (only 6-7%/year) and is seeing the same low return on invested capital here in China.

The first day I ever came to Shanghai, it was for a lunch invitation with Rogers. I fell in love with the place, and though it took a few months to get here, I plan to stay in Shanghai. Bubble or not. That first day in Shanghai, standing with Rogers on top of the Ritz Carlton, he explained to me the madness of the Shanghai real-estate bubble, and moreover, the world wide real-estate bubble. So there you go: “Rogers, China real-estate Bubble: Yes”.

Listen, Rogers is saying that “There is no commodities bubble”. Rogers has a huge amount invested in this, and if central banks keep printing money, they keep proving Rogers right. When China’s real-estate bubble pops, some commodities will take a short term hit, but the macro trend is that the USD is being devalued.

Chanos isn’t saying that he doesn’t think that China has a bright future, he is said the GDP numbers are “massively inflated by under-depreciating a very, very, very shaky capital asset base.” Chanos’ critics say that China’s different because there’s no leverage here, but that’s not true. The market is leverage by multiple layers of ownership each using existing property as collateral. Not unlike the structured leverage in Dubai, but completely different from the leveraging the the US property market.

Most interesting is that many in the US are vehemently opposed to government involvement in the economy, yet those same people are bullish on the China market because the Chinese Technocrats can “fine tune” the economy at their will. These are the same all powerful technocrats that drop dead regularly bingeing with the hostesses at KTV.

Here’s the relevant China situation, as it stands today, summed up quickly: 1. Everybody in China was dirt poor from 1949-1977 because the gov’t prevented private enterprise (basically the same as North Korea today) 2. In 1977, Deng Xiaoping created the first Special Economic Zone in Shenzhen, beginning the growth of China. 3. In the late 90s, Clinton arranged for China to enter the WTO, speeding up foreign direct investment 4. More investment more, higher efficiency factories and foreign exchange reserves soared 5. The gov’t invested (25%?) these foreign exchange reserves into infrastructure, creating hopes of a modern, industrialized, first world China at some point in the future. 6. The owners of the factories, the beneficiaries of the infrastructure projects earned private profits, and had to invest these profits – due to lack of investment options, most chose to invest in luxury real-estate, pushing up prices to current levels. 7. In ’07, the Global Economic Crisis came and China still had enough foreign reserves to weather the crisis, not only offsetting the drop in exports, but preserving the lucky “8%” GDP “growth”. 8. Throughout ’08/’09, Due to high real-estate prices and weakened global trade and investment options, even more money has been poured into Chinese Real-Estate

Things to remember. The Technocrat “Central Planners” have never had a good track record. We’re all aware of the disasters of Communist Central Planning of Russia, Cuba and the Closed China. In the 80s though, American’s talked about the magic of the METI (Ministry of Economy, Trade and Industry) explaining how America couldn’t compete with Japan’s centrally planned capitalism. That infatuation ended around when American’s bought Rockefeller Center back from Japanese investors for half the price.

Personally, I’m very long on the Chinese entrepreneurs and the Chinese people. In the next 50 years, I hope that most of them are able to join us Americans, and our allies in Japan and Europe in first world living standards – they’ve already done so in Hong Kong and Taiwan and it seems to be a great thing for all of us. Meanwhile, I’m very bearish on bureaucrats everywhere, and nowhere more so than where the bureaucrats are living in a giant bubble – and feeding the bubble for their own benefit.

Caijing’s Hu Shuli is Back in Action!

Hu Shuli 胡舒立, founder of Caijing Magazine stepped down back in November. Hu Shuli is known to have backing from the CCP Standing Committee, enabling her to safely report on policy, corruption, law and human rights from a relatively independent perspective. Her situation is quite unique in China.

In September last year, Hu Shuli started stepping away from Caijing due to editorial constraints that were starting to impact the magazine. The scope of coverage started tightening in July, not due to editorial, but due to the magazine’s chief investor (Wang Boming 王波明) calling for caution. The All-China Federation of Industry and Commerce/中华全国工商业联合会, the party-led organization of businessmen that holds the magazine’s publishing license. Desk editors told reporters they wouldn’t be running any politically controversial stories — indefinitely. The move was related to the general restrictions of all forms surrounding the Oct 1st, 60 year anniversary of the CCP.

There are some things that even Caijing would have never been able to report on…

The untouchables are known among foreign media as “the three T’s and one F”: Tiananmen, Tibet, Taiwan, and the Falun Gong. Jeremy Goldkorn, who runs a Web site about Chinese media called, adds, “You don’t directly criticize central government and top leaders, and you don’t question their legitimacy. You can criticize lower-down officials, specific actions, and talk about local problems.”

Our worries seem to be over. This wasn’t a long term crackdown on transparency. It was only only an admission of frailty in preparation for the 60th anniversary military parade.

Hu Shuli 胡舒立 is back in action at Caing 新世纪周刊! Here’s the post at Caing: 胡舒立的团队和新闻职业共同体

Leverage and the Chinese Property Bubble

A “bubble” is a sustained but temporary major misalignment between perceptions of value (momentarily reflected in market prices) and actual underlying value (eventually reflected in actual cash flows over time). In this sense, it is primarily a psychological phenomenon, caused by unrealistically high expectations of profit and/or underestimation of risk. I stress the words “sustained” and “major” because minor misalignments are taking place — and being corrected — constantly, which is what markets are all about. If all of us knew what returns would actually be over time, we wouldn’t even need markets — or entrepreneurs — in the first place. But there are times — we call them bubbles — when these misalignments persist and feed on themselves until, somewhere down the road, the market loses faith and valuations suddenly come crashing back to reality in one fell blow.

Some economic bubbles that we’ve experienced:

Non-leveraged bubbles are still bubbles, but fortunately their ends are not as dramatic and there effects are not as long lasting as leveraged (credit boom) bubbles. Frederic Mishkin pointed out this distinction in the Financial Times (Not all bubbles present a risk to the economy [FT subscription required]).

Like the start of the Internet Industry, there were also bubbles at the start of the Automotive, Radio and Television revolutions. Each one changed our life. Each time, too much speculative capital chases too few good assets. Additionally, the excess supply of capital creates an excess supply of assets that can be purchased.

The common thread in these three bubbles is over-excited investors putting money into a relatively new product, financial scheme, or industry that seems, given its limited track record, to offer a sure-fire path to riches but whose real risks and rewards they do not yet fully comprehend. Funding those investments via debt is not a necessary ingredient.

I have not yet been able to find a lot of 3rd party sources covering real-estate leverage in China, for now I’ll quote Prof. Chovanec on the subject (Leverage and China’s Property Market).

According to current rules, Chinese developers must use their own capital to secure land. Once they do so, banks will lend them 65% of the money they need for construction and related development costs, with the land pledged as collateral. But saying developers must use “their own capital” to buy the land is a bit misleading.

Residential Sector: Developers build and offload projects rapidly to buyers, half of whom are paying cash.

  • Many developers do raise such funds by listing on the domestic or Hong Kong stock exchanges
  • Many bring in private equity investors.
  • I’ve also seem them raise it in the form of debt
    • Parent company take out loans and then inject the funds as capital into a real estate subsidiary. (most common)
    • Issuing high-yield bonds (if they’re listed)
    • By taking on loans at multiple layers of holding companies, a developer can leverage up considerably to cover his “capital” commitment to the banks.
    • It’s very hard to quantify the extent of this exposure, due to the indirect way many of these loans were raised and channeled into real estate.
  • Approximately 50% of all residential purchases in China today are financed with mortgages
  • China’s mortgage market is relatively small — about 10% of GDP, compared to 48% for Hong Kong.

Commercial sector, developers are building properties mainly to hold and lease. That means they are raising debt — both from banks and subordinated creditors — and they are not deleveraging.

  • Many commercial buildings sit nearly or completely empty
  • Where does the cashflow to pay the loans on the property come from?
    • Does the bank care, or is it happy rolling over the loan because the (supposed) value of the collateral has risen?
  • This is the Dubai story all over again — multiple layers of leverage, no tenants, no cash flow.

Credit vs Collateral

  • In the West, banks usually make commercial loans to businesses based on an evaluation of their expected profits and cash flows — will they earn enough to repay?
  • In China, as in many developing markets where banks’ technical skills are not so sophisticated, most business loans are made on the basis of collateral — are there assets the bank can seize if the loan goes bad?
    • Asset Chinese banks like most as collateral is real estate
    • Therefore SOEs enjoy both preferential access to land AND lion’s share of bank loans in China
  • Nobody is really arguing that Chinese banks are over-leveraged.
  • It’s their clients, the developers and SOEs, that are leveraged up on real estate.
  • It’s loans to those clients, should property take a tumble, that would hit the banks as losses.

Even the Police Dept is Building Houses!

Cash Rich SOEs Pushing Real Estate Bubble Ever Higher

The National Audit Office data shows that 25 central ministries are involved in real estate violations, worth billions of yuan. Among them, unlisted assets of 51.6917 million yuan from the Ministry of Foreign Affairs have gone into purchasing real estate. The Ministry of Agriculture has developed commercial housing, acting beyond its authority, and has submitted false reports on housing subsidies. In 2008, a real estate rental service center under the Ministry of Finance took in rental income of 5.3193 million yuan. The Ministry of Public Security has approved construction projects worth 422 million yuan, utterly exceeding its authority. Other data show that among 136 central enterprises under the State-owned Assets Supervision Administration Commission, about 70% of the companies are involved in real estate, among which 16 firms are primarily based in the property industry, including Poly, Sino-Ocean, and China Resources, while more than 80 outside firms have business in real estate. Among the top ten highest priced land purchases in major cities in the first half of this year, 60% were gobbled up by SOEs.

Yes, that is 25 central ministries that have been caught speculating in the real-estate market.

  • What is the Ministry of Agriculture doing building houses?
  • And the Police Department (called “Public Security” here) is in the construction business too?

The government here is just as “asleep at the wheel” as the OFHEO was when regulating Fannie-May and Freedie-Mac.

The Office of Federal Housing Enterprise Oversight (OFHEO) was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises — the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).