China a Kleptocracy at the Brink?

       Wow! I just finished reading the most unflattering piece about China I've ever read. Krugman linked to it. Krugman does tend to be something of a China basher but if you read the article it's very compelling.

       "I have no idea whether this John Hempton piece on China is at all right, but it’s a terrific read, and provides food for thought."

        Neither do I.

       "Hempton basically argues that China has turned financial repression — controlled interest rates on deposits, which ensure a negative real rate of return — into a giant engine of kleptocracy. The banks extract rent from depositors, transfer those rents on to state-owned enterprises in the form of cheap loans, and then the Party elite essentially embezzles the money. Underlying the whole system is a high savings rate that Hempton attributes to the one-child policy."

       "Actually, if he’s right about the demographic underpinnings, there’s a time bomb lurking in the system quite aside from his concerns about inflation running too hot or too cold: eventually, and as I understand it fairly soon, those older Chinese who have been frantically saving because they don’t expect enough grandchildren to support them will become net dissavers, pulling money out of the banks to live on. And then, if his basic story is right, the whole system implodes."

     "I like this story; I’m curious to know what people who actually know something about China think."

       http://krugman.blogs.nytimes.com/2012/06/11/financial-repression-chinese-style/

        I too would be curious. The picture that Hempton draws couldn't be more stark. Is he guilty of being uncharitable? Again those who know are welcome to elaborate.

        He makes the point that any agricultural economy that makes the conversion over to a modern industrial economy grows like gangbusters at first. In addition he argues that the later a country industrializes the faster will be its initial growth as the technological infrastructure will be firmer:

        "Every economy that has moved peasants to an export-orientated manufacturing economy has had rapid economic growth. Great Britain industrialized at about 1 percent per annum. It was slow because all the technology needed to be invented for the first time. During the 19th Century US economic growth – once started – ran about twice the rate of the UK. They copied the technology which was faster than inventing it. Later economies (eg Japan, Malaysia, Thailand, Korea) went later and faster. As a general rule the later you industrialized the faster you went – as the ease of copying went up. In the globalized internet age copying foreign manufacturing techniques and seeking global markets is easier than ever – so China is growing faster than any prior economy."

          Of course Japan until the early 70s was growing at a comparable rate to China-12, 14, as much as 16 percent. Then came the oil shocks and Japan never grew in double digits again-over night they fell from 16 percent growth rate to 3.

        "This fast economic growth – which would happen in a more open economy – is creating the fuel for the Chinese kleptocracy."

          Interestingly what drives the high Chinese savings rate is not so much a cultural preference to save but the one child policy. As there is no welfare-no Social Security, neither-the only means of support for many lower middle class and poor Chinese are their children-however the one child policy makes this impossible.

        The "kleptocracy" benefits by a negative interest rate on deposits for all the captive savers. High inflation leads to riots as this eats into the already negative interest rates.

        "Bank deposits rates are regulated. You can't get much different from 1 percent in a bank deposit. Life insurance contracts (a huge savings mechanism) are just rebadged bank deposits – attractive because the regulated rate is slightly higher."

      http://brontecapital.blogspot.com/2012/06/macroeconomics-of-chinese-kleptocracy.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+BronteCapital+%28Bronte+Capital%29

     "This is a lousy savings mechanism because inflation has been between 6 and 8 percent (but is now lower than that and is falling fast). At almost all times (except during the height of the GFC) the inflation rate has been higher – often substantially higher – than the regulated bank deposit (or life insurance contract) rate."

     "In other words real returns for bank accounts are consistently negative – sometimes sharply negative."

     "Most Chinese savings however are not invested in see-through apartment buildings. Bank deposits still dominate. The Chinese banks are the finest deposit franchises in human history. They can borrow huge amounts at ex-ante negative real returns."

      "And those deposits are mostly lent to State Owned enterprises."

      "The SOEs are the center of the Chinese kleptocracy. If you manage your way up the Communist Party of China and you play your politics really well may wind up senior in some State Owned Enterprise. This is your opportunity to loot on a scale unprecedented in human history."

       So the twin threats are inflation that gets so high that the people riot as their savings get bitten into even more deeply. But right now the real fear of the PRC is that inflation gives way to deflation or even low inflation. This will take away all the benefit of the deposits that the "kleptocracy" benefits from. As Krugman also points out, there could be major dissaving soon."

     It is widely argued that China's government will have to adjust soon. If there's truth in this it may be a lot sooner than is realized.