November 01, 2011

China points to Weimar exit

Keynes's collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff," --- Hyman Minsky.

The Middle Kingdom will face problems somewhat similar to US and most EU economies .It will manage because its population is hardworking and the govt exercises enough control unlike free hand to greedy banksters and corporate houses in US , a policy New Delhi's IMF pensioners have followed . Indians have caught up by holding Formula One Indian Grand Prix on October 30, 2011,fastest car racing , hosting heavy metal band Metallica and Lady Gaga .

It is time to patch up with China , whose GDP is 3 times India's , but the former wants stability ,But idoitic Arnab Goswamis and Maaroofs indulge in hard talk ( which will only pleases their masters in Mumbai and Wall Street ).They know so little about international affairs .No wonder Head of Press Council Justice Katju holds Indian media in such low esteem as I always have since long.

Hope the article below helps better understanding of international situation

China points to Weimar exit
By Martin Hutchinson ASIA TIMES 2 NOVEMBER,2011

I have written in the past that while Keynesian stimulus spending made no sense whatever for Western countries whose budgets were substantially in deficit before the 2008-09 recession began, it was more justifiable in China, with a substantial budget surplus at the start of the recession. However it now appears I was wrong.

Far from rescuing their economy by Keynesian stimulus, the Chinese regime overdid it, even by the most demented Keynesian standards. Rather than financing spending directly, they encouraged the state-owned banks to go on a lending spree. The result was an astonishing surge in bank lending, 42% of gross domestic product (GDP) in 2009 and 2010 and 37% in 2011, around US$2.8 trillion annually.

The result has also been galloping inflation and a banking system now truly close to collapse. Mao Zedong tried for 30 to destroy

the entrepreneurial Chinese economy; where he failed, John Maynard Keynes may have succeeded from the grave.

Keynesians will object that their recommendation in times of recession was for heavy doses of government spending, not bank loans. However that won't wash. When the great majority of the banking system is controlled by the government, and a high proportion of the loans is going to infrastructure projects sponsored by government departments, government-owned companies and local governments, it's absurd to claim this to have been something other than classic Keynesian stimulus.

The only difference is in the financing, which was less directly inflationary than the Weimar/Keynes approach of printing the money, but more damaging to what remains of the Chinese banking system.

The projects financed by the stimulus were the usual mix of the moderately useful, the thoroughly corrupt and the staggeringly inappropriate that you'd expect from recession-driven stimulus. China has the enormous advantage over the United States that it treats environmentalists with the contempt that they generally deserve.

While this produces some environmental monstrosities like the Three Gorges hydroelectric dam, it allows China to construct infrastructure at a staggering speed and with great efficiency. Thus while the United States got very little for its US$800 billion of stimulus, China has got a gleaming new high-speed rail service (albeit with corruption and shoddy construction making it pretty life-threatening to ride on) lots of new toll roads that few people use and some entirely empty but very impressive office complexes.

As with other Keynesian stimulus, the problem here is one of malinvestment, in the Austrian economic sense. The high-speed railroad is probably not worth what it cost, but certainly has some substantial economic value. The roads have less economic value because their tolls are so high that it may well be a decade before China's people can afford to use them. The empty office complexes will in some case have value, giving room for expansion as Chinese economic growth continues, but in other cases will have been built in the wrong place or to the wrong scale.

Midtown Manhattan's Empire State Building, completed in 1931, stood largely empty for a decade, but eventually paid off well for its long-suffering investors as the local economy soared. Detroit's Renaissance Center, completed in the much more benign economic environment of 1977, has been a boondoggle ever since it was opened, in the middle of blighted downtown Detroit. In China's case, since much of the investment was wasted, either partially or totally, it can be expected to drag on the economy for many years to come.

Officially, China's consumer price index rose at only a 6.3% annual rate in the third quarter. That's slightly below the People's Bank of China benchmark interest rate of 6.56% - which appears to indicate a monetary policy that by recent US interest rates is positively restrained.

However, two factors suggest this apparent moderation is an illusion. First, the "free market" interbank interest rate is far below the People's Bank of China policy rate, at an average of 1.62% in August, while even the one-year deposit rate is only 3%. Second, the GDP deflator, a more accurate (because more complex and difficult to fudge) measure of inflation than the CPI, rose by 10.3% in the third quarter. The two figures taken together suggest a real interest rate close to minus 9%, equivalent to that prevailing in Dubai in early 2008, before its real-estate bubble burst.

You'd think that, with China's third-quarter growth rate still 9.1% and inflation a real threat, the Chinese authorities would be tightening monetary policy, at least gradually. Not a bit of it. Premier Wen Jiabao on October 25 warned against tightening credit conditions, urged credit support for small companies and suggested that price controls should be used to control inflation.

Make no mistake, the forces leading to a Chinese crash are strong. If we assume that around half of the bank credits extended in the last three years are economically justified arms-length deals, a generous assumption, then the excess extension of credit has been around $1.4 trillion annually, 21% of GDP in 2009 and 2010, dropping to 18.5% of GDP in 2011.

Thus, through bank-directed financing, China has been running as big an effective budget deficit in cash terms as in the United States, which has an economy more than double the size. Greece has not got close to a budget deficit of 20% of GDP, and the United States only did so in 1944, in the depths of World War II. Like everything else in China, their Keynesian stimulus has been much bigger - and looks likely to have correspondingly more adverse long-term consequences.

Chinese policy errors may be exacerbated by trade considerations. With true inflation at least 10% and the yuan up over 5% against the dollar in the last year, even legendary Chinese productivity increases may be stretched to remain competitive. A Boston Consulting Group study recently suggested that several of the sectors which the US has "outsourced" to China in recent years may return to the United States, as China is becoming uncompetitive.

Even more dangerous for the Middle Kingdom is competition from Vietnam, India and even parts of Africa, as the collapse in barriers due to globalization spreads global sourcing further into the world's impoverished hinterlands. China's trade surplus in the first nine months of 2011 fell 10.6% from a year earlier to only $106 billion - less than 3% of China's GDP. Since exports still represent 38% of China's GDP, a swing into substantial deficit seems likely.

Faced by a trade deficit and a gigantic bad debts problem in its banking system, China is likely once again to attempt financial repression - keeping deposit rates far below inflation while lending rates remain high, thereby allowing the banks to recapitalize themselves through jumbo profits on new lending.

Britain took the same approach in the 1950s and 1960s, keeping interest rates low and inflation relatively high (albeit suppressed from time to time by price controls) thereby successfully working down the massive World War II debt at the cost of impoverishing savers who, like my Great Aunt Nan, unwisely invested their life savings in supposedly risk-free government bonds.

Like Britain in 1945-79, China has tight exchange controls that allow her to oppress her citizens in this way. Foreign governments that were truly concerned with the Chinese government's oppression of its people would demand that these controls be lifted forthwith, thus both remedying a major human rights abuse and forcing the government to face up to the banking system's current difficulties.

This is unlikely, and judging by Wen Jiabao's remarks China has no intention of tackling its inflation problem anytime soon, other than by draconian government controls that will further destabilize the economy. It's possible that this will lead to depression but more likely, given the Chinese penchant for rapid money creation (M2 money supply was up 19.2% in the year to August) that the increasing distortions in the economy will cause inflation to accelerate from a trot into a wild gallop.

There's a precedent for China's current approach, with a mass of controls and rampant money printing to disguise a yawning budget deficit - and it's Weimar Germany in 1919-23. That ended in 1 trillion percent inflation and economic collapse. It also wiped out the savings of the middle classes (something very likely under China's current policies) and thereby led to the rise of Adolf Hitler a decade later.

Sixty-five years after his death, Maynard Keynes has a lot to answer for. Not only are the failed stimulus policies, massive deficits and renewed economic crisis due largely to misguided application of his theories, but so also are the monetary errors, in China and throughout the world, derived at least in part from his ignorance and insouciance about the effect of interest rates.

However China's government, faced with not even a recession but simply a slowdown in activity caused by external factors, appears to have applied Keynesian theories with unprecedented vigor, such that even those on the left who bemoan the inadequacy of the 2009-10 US stimulus should be satisfied. Regrettably, if China descends into Weimar inflation and their response is international aggression, the rest of us will have to pay the price.

Martin Hutchinson is the author of Great Conservatives(Academica Press, 2005) - details can be found on the website - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on, Great Conservatives only in a Kindle edition,Alchemists of Loss in both Kindle and print editions.

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