Revisiting “A China Prediction”

…there’s going to be a reckoning, and the funny thing is that reckoning is going to begin in China and then eventually spread to the rest of the world. Whether it will happen in close proximity to the end of the COVID-19 pandemic remains to be seen, but there is definitely a short term correction and a longer term debt cycle deleveraging that are being put off by these policies. At some point, it will no longer be able to be kept at bay.

-cafebedouin, “A China Prediction: A Debt Deleveraging in a Decade.” cafebedouin.org

Today might be the day. Look for news on Evergrande and whether that will send China into recession. It probably won’t be Lehman Brothers, but it’s not going to be trivial. This comment seems about right to me:

“It won’t be a financial crisis, but a controlled burn of the world’s 2nd largest economy.”

-Kent Willard quoted in Adam Tooze, “Adam Tooze’s Top Links: Is Evergrande “China’s Lehman moment”? (#21)” adamtooze.substack.com. September 19, 2021.

A China Prediction: A Debt Deleveraging in a Decade

“What happens when torrid monetary and fiscal reflation in the West meets tighter credit and evaporating liquidity in China?

We will find out soon enough who calls the shots for world inflation in a globalised economy dominated by cross-border capital flows. We will also find out whether these two colliding forces moderate each other, or set off the sort of wild ructions in currency, commodity, and bond markets that make hedge funds salivate.”

-Ambrose Evans-Pritchard, “The world’s reflation party may be spoilt by China hitting the brakes.” The Telegraph. May 27, 2021.

There’s an interesting dynamic at play with coverage like the above. What most people miss, because they have attention spans of this quarter or this year, is that China has been doing torrid monetary and fiscal reflation for years, and the attendant moral hazard of having free money guaranteed by the government is starting to show how much systemic risk is hidden from view in China.

If you look at a standard breakdown of debt to GDP, like this one from Trading Economics, China looks to be in a very good position relative to the rest of the world. For China, the ratio is 66.8%, below India’s 69.6%. For the United States, it’s 108%. Now, consider this table from SPGlobal’s March report: Local Government Debt 2021: China’s Dominance Overshadows Borrowing Capacity In Other Emerging Markets.

Notice how much China’s subnational borrowing is compared to India’s? This explains why China’s national borrowing looks so good relative to other “developing” countries. They are, once again, cooking the books.

China has been doing torrid monetary inflation for years, but keeping it off the national books and putting it onto local government debt. And, it has been long understood that local government debt, partnerships and so forth were essentially backed by the national government, which means they are essentially national debt. If those numbers were added to reflect this reality, China’s debt to GDP would be worse than the United States.

So, they’ve reached the point of moral hazard, where they have to decide whether they are going to allow for defaults, bankruptcies and the restructuring of debt. To their credit, they are making some inroads on this front, but articles like the one above are hilarious because it fundamentally misunderstands this central point. China is slowing down because they have been using these policies for decades, whereas Western governments quantitative easing and other measures of pushing liquidity into markets were done in response to the 2008 financial crisis. Like China, Western markets have grown dependent on this influx of cash.

But, obviously, there’s going to be a reckoning, and the funny thing is that reckoning is going to begin in China and then eventually spread to the rest of the world. Whether it will happen in close proximity to the end of the COVID-19 pandemic remains to be seen, but there is definitely a short term correction and a longer term debt cycle deleveraging that are being put off by these policies. At some point, it will no longer be able to be kept at bay. If you want more detail, Ray Dalio’s talk on How The Economic Machine Works is a good point of reference.

Conversations on Political Economy

Capitalist: Capitalism provides for the most efficient allocation of resources, wealth creation and individual choice. It’s the best economic system we’ve got.

State Socialist: There are other values than efficiency, prosperity and choice. Capitalism tends toward oligarchy and monopoly. As industries concentrate and gain economies of scale, wealth creation is concentrated for the benefit of society’s elite, and non-elite individual choice declines, and over a long enough time period, with limited or no competition, resources are not allocated efficiently. State socialism solves these problems.

Capitalist: State socialism is inefficient. There are few incentives and options to create wealth, and it limits individual choice. State socialism tends toward dictatorships and state monopolies. When the state takes over an industry, it benefits elite government officials rather than society as a whole. Bureaucracy and corruption lead to a squandering of resources, and kills individual initiative.

Small Socialist: Small socialist enterprises — such as employee ownership, cooperatives, and collective ownership — solve both the problems of Capitalism and State Socialism at the cost of economies of scale. Decision-making is distributed across the industry or enterprise. Employees and/or customers are also owners and have incentives aligned with the business. What’s not to like?

Capitalist: Without economies of scale, small socialists remain small. Some industries cannot exist without economies of scale. In others, it is impossible to compete with capitalist or state enterprises without them. Small socialists will stay small, with all the poverty that entails. Capitalism solves this problem.

State Socialist: Small socialists also have the problem of capitalists, except it concentrates power into decision-makers hands. They, in-turn, have incentives to collude to extract benefits for themselves or for their industry at the expense of the enterprise or society as a whole. Good stewards and state ownership solves this problem.

[Continue, ad infinitum and adding in small capitalist, communist, anarchist, fascist, etc.]

Discussions of political economy are ultimately discussions of what you value and which system you believe is most likely to give it to you. See also: Revolution for One.

Kondratiev Waves & Social Unrest

“In the United States, 50-year instability spikes occurred around 1870, 1920 and 1970, so another could be due around 2020. We are also entering a dip in the so-called Kondratiev wave, which traces 40-60-year economic-growth cycles. This could mean that future recessions will be severe. In addition, the next decade will see a rapid growth in the number of people in their twenties, like the youth bulge that accompanied the turbulence of the 1960s and 1970s. All these cycles look set to peak in the years around 2020.”

-Peter Turchin, “Political instability may be a contributor in the coming decade.” Nature 463, 608 (2010). https://doi.org/10.1038/463608a

“What does it mean for the current wave of protests and riots? The nature of such dynamical processes is such that it can subside tomorrow, or escalate; either outcome is possible. A spark landing even in abundant fuel can either go out, or grow to a conflagration.

What is much more certain is that the deep structural drivers for instability continue to operate unabated. Worse, the Covid-19 pandemic exacerbated several of these instability drivers. This means that even after the current wave of indignation, caused by the killing of George Floyd, subsides, there will be other triggers that will continue to spark more fires—as long as the structural forces, undermining the stability of our society, continue to provide abundant fuel for them.

-Peter Turchin, “2020.” Clio Dynamica on PeterTurchin.com. June 1, 2020.

Harvard’s Reinhart and Rogoff Say This Time Really Is Different

“And you want to talk about a negative productivity shock, too. The biggest positive productivity shock we’ve had over the last 40 years has been globalization together with technology. And I think if you take away the globalization, you probably take away some of the technology. So that affects not just trade, but movements and people. And then there are the socio-political ramifications. I liken the incident we’re in to The Wizard of Oz, where Dorothy got sucked up in the tornado with her house, and it’s spinning around, and you don’t know where it will come down. That’s where our social, political, economic system is at the moment. There’s a lot of uncertainty, and it’s probably not in the pro-growth direction.”

-Simon Kennedy, “Harvard’s Reinhart and Rogoff Say This Time Really Is Different.” Bloomberg. May 18, 2020.

Probably the best thing I’ve read on the financial implications of the coronavirus pandemic. If you have any interest in GDP, the economy, etc., this is worth reading in full.

Knowledge of the Future

“…there are (a) facts, (b) informed extrapolations from analogies to other viruses and (c) opinion or speculation.

…if you’re experiencing something that has never been seen before, you simply can’t say you know how it’ll turn out.

…There’s no algorithm for deciding whether to favor life for a few (or for thousands) versus economic improvement for millions.”

-Howard Marks, “Knowledge of the Future.” Oaktree Capital. April 14, 2020.

Interesting throughout.

Capitalism vs. Price Gouging

Open Question: When does capitalism become price gouging?

Strikes me that price gouging is during acute events where people with means cannot buy what they want, i.e., the price mechanism breaks badly enough that it impacts society-at-large rather than a minority. But, so long as it’s impacts a minority or is an plausibly deniable externality, it’s merely capitalism as designed.

Weitzman’s The Noah’s Ark Problem

“The “Noah’s Ark Problem” is intended to be an allegory or parable that renders a vivid image of the core problem of maximizing diversity under a budget constraint. What is treated here is actually not the most general form of the underlying mathematical problem. Some slight generalizations are possible, but they would come at the expense of diluting a crisp version of the basic paradigm. Noah knows that a flood is coming. There are n existing species/libraries, indexed i = 1, 2,… , n. Using the same notation as before, the set of all n species/libraries is denoted S. An Ark is available to help save some species/libraries. In a world of unlimited resources, the entire set S might be saved. Unfortunately, Noah’s Ark has a limited capacity of B. In the Bible, B is given as 300 x 50 x 30 = 450,000 cubits. More generally, B stands for the total size of the budget available for biodiversity preservation. In either case, Noah, or society, must face the central problem of choice. A basic choice question must be answered. Which species/libraries are to be afforded more protection-and which less-when there are not enough resources around to fully protect everything? I present here the simplest way that I know to model the analytical essence of this choice problem. ” The ‘Noah’s Ark Problem’ is a parable intended to be a kind of canonical form of the simplest possible way of representing how best to preserve biodiversity under a limited budget constraint…

…The solution of the Noah’s Ark Problem is always “extreme” in the following sense. Noah, or the conservation authorities that he symbolizes, should be concentrating all their resources on maximal protection of some selected species/libraries, even at the expense of exposing all remaining species/libraries to minimal protection…

…The ranking formula (29) encourages the conservation authorities to focus on four fundamental ingredients when choosing priorities: Di = distinctiveness of i = how unique or different is i; Ui = direct utility of i = how much we like or value i per se; APi = by how much can the survivability of i actually be improved; Ci = how much does it cost to improve the survivability of i. I am not intending here to argue that it is easy in practice to quantify the above four variables and combine them routinely into the ranking formula (29) that defines Ri. The real world is more than a match for any model. The essential worth of this kind of research is to suggest a framework or way of thinking about biodiversity preservation, and to indicate how it might be backed by a rigorous underlying formulation.

-Martin L. Weitzman, “The Noah’s Ark Problem.” Econometrica, Vol. 66, No. 6 (November, 1998), 1279-1298.

RIP, Martin Weitzman. I cannot remember another paper with this much math in it that was still accessible to a lay reader like me. Also, it strikes me that this theoretical model could be applied in other areas of life, such as friendships.

Brahmin Left vs. Merchant Right: Rising Inequality and the Changing Structure of Political Conflict

Conclusions

Globalisation/migration (domestic vs external inequality) and educational expansion (education vs property inequality) have created new multi-dimensional conflicts about inequality, leading to the collapse of the postwar left-vs-right party system.

Why didn’t democracy reduce inequality?

Because multi-dimensional coalitions are complicated.

Without a strong egalitarian-internationalist platform, it’s difficult to have the low-education, low-income voters from all origins vote for the same party.

Racism/nativism & higher education = powerful forces dividing the poor if there’s no strong uniting platform.

-Thomas Piketty, “Brahmin Left vs. Merchant Right: Rising Inequality and the Changing Structure of Political Conflict.” EHESS & Paris School of Economics Sciences Po, January 24 2019

h/t Boing Boing, which provides a nice overview. Open Question: Am I a member of the Brahmin Left?