How can China’s economy end up like Japan’s?


Why are we worried it may turn into another Japan?
Factors such as high debt-to-GDP ratio, the speed at which it built up, an enormous amount of government money spent on propping up the stock market ($200 billion), bad loans, financial frauds, and capital outflow are all engendering a concern for a financial crisis. There are many reasons why we may not be in for a crisis (explained here), but if not crisis, the real concern is that China’s economy may end up like that of Japan.

What happened in Japan?
In the 1990s, banks in Japan liberally lent to real estate projects based on wildly speculative land values. At one point, a park in Tokyo was meant to have the same value as an entire state in the U.S. (or something like that). Then the bubble burst in 1991 with land and stock prices spiralling down. However, banks did not call in bad loans and kept them on the books as if nothing was wrong (on the orders of the banking regulator), and the central bank pumped Japanese banks with liquidity. That prevented the financial system from a comprehensive collapse. But there was nothing to do about the bad debts, which in turn limited banks’ ability to make new loans to worthy businesses. Corporations on their part spent all the little profit they made paying down debt rather than investing in new projects (that is usually how an economy grows). So the economy was literally stagnant.

How bad is China’s situation?
So notwithstanding a financial crisis, we are concerned that China might indeed face a similar fate. But it’s worth noting that they narrowly avoided a lost decade in 1997 by transferring bad loans to asset management companies, and funnelling liquidity into banks from the Treasury. Then, unproductive SOEs were ruthlessly shut down (what the premier Zhu Rongji is known for, and the current premier Li Keqiang is being compared to) and people were allowed own and sell houses (this is when the People get the sweet taste of capitalism for the first time since 1945). The economy took off, and so corporations made enough to pay down all the debt.

Of course, the situation now is different: growth rates are expected to dither and fall below 6%. And although the quality of lending is better, it is huge in absolute terms: 260% by some estimates, which in itself is not that bad since i) US and Japan have a higher ratio ii)has enough income and assets to pay down. But still it’s concerning. The way to reduce debt-to-GDP ratio is obviously to reduce credit, but that comes at the expense of growth. For political reasons, the CCP cannot afford to slow growth and if you slow growth then people are not able to pay back their debt.

Much of the information here was taken from Arthur Kroeber’s China’s Economy: What Everyone Needs to Know

If you didn’t have time to read about the South China Sea, here’s a summary.

southchinaseaThe ruling by the Permanent Court of Arbitration at the Hague was much stronger than expected. Almost all points under contention were ruled in favour of the Philippines. This surely will have some consequences not just for the way China conducts itself in the region but also for China’s soft power which, for all its money, has been and still will be a crucial part of the country’s efforts to forge more ties in the world.

Two key points of the ruling:

1. There is no legal basis for China’s historic claims within the Nine-dash line.

2. The Philippines reserves its traditional rights on the Scarborough Island, and any Chinese land reclamations and blocking of fishing and oil-exploration activities violate Philippino sovereignty.

Here is a really great summary on the verdict:

The immediate response by China has been to reject the verdict, as expected, and indeed it is doubtful as to whether the ruling could fundamentally undermine what China has been doing or claiming within the so-called nine-dash line. Some have even argued China has followed a tradition of “Great Powers” ignoring international ruling on maritime disputes. But the South China Sea involves keen interest of multiple parties, including the U.S. and a third of global trade passes through this area. So now there are legitimate grounds on which to scrutinise any action that China takes in this body of water going forward.

What China will do next depends on whether hardliners or moderates in Zhongnanhai gain the upper hand. Hardliners would probably see in continued militarisation of the South China Sea an apposite response. Moderates, on the other hand, are concerned that would push regional neighbours further into America’s embrace.

Many analysts are turning towards the view that in denting China’s long-held ambition of becoming a maritime power, the Hague ruling would have emboldened the hawks. Indeed, it is hard to find any representation of moderate sentiments in the Standing Committee of the Politburo, and by now it can be said with confidence that Xi has monopolised power crystallised consensus around his China Dream platform.

Taylor Fravel’s breakdown on why China wants South China Sea so badly sums it up nicely:

Here are a few things that analysts here and there have predicted China might do in response should hard-liners come to dominate the agenda:

1. Declare Air Defense Identification Zone. China did that in the East China Sea and most countries simply ignored it by dispatching jets into the zone. But with landing strips and various other airforce facilities based in the South China Sea, its ability to enforce ADIZ in the South China Sea should be taken more seriously.

2. Withdraw from UNCLOS. (maybe even set up its own international tribunal?)

3. Continued industrial-scale land reclamation and continued deployment tolerance of the activities of the militia, the so-called Little Blue Men on Scarborough Shoal, around which the Philippines reserves traditional rights to undertake fishing activities, the ruling has declared.

Another immediate flashpoint is Mischief Reef, part of the Spratley’s island scatter, which the ruling had declared legally belongs to the Philippines. Yet, Chinese landing strips and air facilities the size of football fields are already in place there.

There is optimism that bilateral negotiations are still viable between China and the Philippines, which wisely chose not to crow about the ruling. The new Philippine president Duterte is expected to be different from President Aquino who has actively and publicly strengthened ties with the US. Duterte’s priorities are state-led infrastructure projects and economic reforms, and any foreign policy decision will be made in consideration of this (despite the fact that he claimed he will water-ski to Scarborough and plant a national flag). That means existing ties with U.S. will not likely shrivel. But given the ruling, the Philippines is in good position to extract economic concessions in some form of investments or trade deals.

With ASEAN and the EU too spineless to stand up against flagrant defiance of international law, what will affect how China acts in the long-run is U.S. policy, which so far has preferred to respond to China’s salami-slicing strategy of incremental gains. As many have pointed out, the onus is on the U.S. to prove its commitment to regional allies. But so far, pronouncements on Asia-Pacific by the more likely candidate hasn’t been so reassuring, though it isn’t a guarantee of things to come. Those in favour of action by US, has called for active naming-and-shaming, though that might backfire given America’s own track record of observing international rulings: Nicaragua); resumption of freedom-of-navigation operation, public condemnation of the militia. While governments figure out what they want to do, for now, the losers of this ruling are KFC and Apple in China.

Adolf Schicklgruber, the Fuhrer?

Adolf Hitler’s father was called Alois. And he was known as Alois “Schicklgruber” for the first forty years of his life. That was the maiden name of his mother, since his father Johann Hiedler, a miller, never legitimized Alois as his own son. In fact he had abandoned him aged ten when his mother Maria Ann Schicklgruber passed away. Then thirty years later, Johann turned up aged eighty four to claim Alois. For some reason his name had modified slightly to “Hitler”. Historians speculate that Alois, out of guilt, wanted to help his son gain a share of an inheritance from an uncle. 

In any case, the story continues thusly in William Shirer’s classic work, The Rise and Fall of the Third Reich:

There are many weird twists of fate in the strange life of Adolf Hitler, but none more odd than this one which took place thirteen years before his birth. Had the eight-four-year-old wandering miller not made his unexpected reappearance to recognize the paternity of his thirty-nine-year-old son nearly thirty years after he death of his mother, Adolf Hitler would have been born Adolf Schicklgruber.

There may not be much or anything in a name, but I have heard Germans speculate whether Hitler could have become the master of Germany had he been known to the world as Schicklgruber. It has a slightly comic sound as it rolls off the tongue of a South German. Can one imagine the frenzied German masses acclaiming a Schicklgruber with their thunderous “Heils”? “Heil Schicklgruber!”? Not onl
y “Heil Hitler” used as a Wagnerian, pagan-like chant by the multitude in the mystic pageantry of the massive Nazi rallies, but it became the obligatory form of greeting between Germans during the Third Reich, even on the telephone, where it replaced “Hello.”

Heil Schicklgruber!

Panama Papers didn’t happen in China

Chinese censors must be one of the most efficient and effectively managed state institutions around the world. As soon as posts related to Panama papers began to be circulated, they were at work. According to Baidu, Panama Papers do not exist.


Among the Chinese high-level officials to be implicated in this 2.6TB leak from Mossack Fonseca were 2 members of the 7 Standing Committee of the Politburo, one of them being Liu Yunshan 刘云山, the propaganda chief himself, as well as president Xi Jinping. So the stakes were quite high and the range of censorship equally extensive (the word for “brother-in-law” was reported to be included in the “sensitive” list, or got “404ed” 被404了 since it was the name of Xi Jinping’s brother-in-law, Deng Jiagui 邓家贵.) 

Just as the Russian propaganda machine portrayed it as part of an “information war” against Putin, China’s Global Times called it “a new means for ideology-allied Western nations to strike a blow to non-Western political elites”. Besides the “Western plot” card, as the China Digital Times noted, the week that Panama Papers were released coincided with news of assault on a woman at a Beijing hotel and the non-intervention of the bystanders, which for the latter reason attracted a flurry of views and moralizing comments about the state of Chinese society etc. etc.–it was enough to distract. The confidence with which the spokesman of the Ministry of Foreign Affairs repeatedly no-commented questions related to Panama was also notable.

However tempting it is to imagine the damage this may have on the legitimacy of Chinese leadership, I would argue it was limited, if not negligible. In 2012, when Bloomberg and NYT reported on the former Premier Wen Jiabao 温家宝’s wealth, there were no uprisings. 

To many people in China, as this Economist article rightly points out, high-level corruption is neither news nor a compelling reason to lose faith in the leadership. The Chinese middle class which that widely-quoted study on the relationship between GDP per capita (threshold being USD 6,000) and democratization (and of course the end of history thesis) had hoped would become the next agents of change, were for the large part unmoved. Admittedly, that idea would have appeared more persuasive at the height of American power before 2008 when capitalism and democracy seemed to partner up well. 

Of course, calling for an outright regime change or endorsing democratization in public have unequivocally become unpopular since Tiananmen.  That is not to say the Chinese middle class has no political consciousness, which would be a grand generalization on a group of more than 100 million people. In fact, the quesiton of how to make China a better place is something almost everyone obsesses about. But, more and more are less convinced by the merits of democracy as an effective mode of governance (Trump). Additionally, some of my Chinese friends (who are mostly the children of the middle class) have lamented how many Chinese millennials are less concerned about such matters than by the latest trend in Korean hair style. Though it’s hard to say without a comprehensive survey, the argument has been made that much of the middle class, in part out of a sense of powerlessness to effect any meaningful change themselves, are more concerned about their daily lives.

There is an interesting comparison to be made with Russia, another authoritarian country whose leader has been a central cast to this episode through the proxy of a cellist called Sergei. Similar to China, not much shit was given in Russia (Andrey Kostin, head of a state bank that allegedly involved” called the idea of Putin’s involvement “bullshit”). “Corruption is seen as a fact of life, and the sense that there’s nothing we can do about it is pervasive,” editor of the journal Counterpoint Maria Lipman told the Economist. 

Corruption in China, however, is not a fact of life. In fact, the campaign to rid its system of graft has been one of the most enduring and intense ones to take place since the communist takeover. If you talk to a cab driver in Beijing, my go-to source for the “average Chinese Joe”, many of them will tell you it’s all to settle political scores. Yet the same people also believe the anti-corruption campaign is genuinely having an impact, nevermind whether it will be rooted it out once and for all–the Xi administration remains one of the more popular governments in the world according to a survey. So, it is rather odd that there should be very little reaction to all of this, especially when Xi Jinping’s relative was on the client list of the same law firm that Gu Kailai, the wife of Bo Xilai, Xi’s arch enemy, and the poster child of the bad boys’ club in China.


In this instance, however, I was personally more curious as to how this news would be received at a time when discontent appears to be brewing within Chinese society and the political circle in regards to more oppression of the freedom of speech and media, and the increasing influence of Xi Jinping. But that idea itself, that the oppression of the freedom of speech or the increasing hold on power of Xi can impair Chinese society, has also not gained such wide currency either. Such developments are often taken with a positivist attitude; so people are less judgmental. It seems more apparent that authoritarian politics, not corruption, is taken as a fact of life in China. Due to such circumstances, along with other factors, contradictions of an authoritarian regime in relation to corruption come under less scrutiny, especially if the economy is doing relatively OK. 

But we also mustn’t forget the achievements of China’s propaganda apparatus. When such episodes like Panama Papers strike, media blackouts and the forestallments of anything vaguely civil society-esque  (remember the five feminists who were arrested for protesting about women’s rights) have obviously played a great role in pre-empting sentiments adverse to the incumbent government. The former gives the impression to the masses that it is not an important issue (or that it doesn’t exist). The latter prevents more active citizens from making it into one. Both have seen an uptick under Mr. Xi, and together with the recent memory of Tiananmen, these make for a powerful propaganda package that keeps potential dissent on the side of caution. 

Such control of media and public opinion, I believe, was the main factor behind the extraordinary difference in reaction to the cruise ship sinking in China and South Korea. In both countries, a cruise ship sank, the leading crew members survived but hundreds died. In China, the official pronouncement that it was a natural disaster was taken at face value and discussions were wrapped up within the week. In Korea, it was a to begin a long period of intense political firestorm, and still continues to be one of the major reasons for the strikingly low ratings of the current Park administration. 

Briefing: financial scams in China, why so many?

Scams in China’s finance industry is a trend I think will continue for a long time. Quartz has done this great compilation of financial scandals in China:

Here are a few highlights:

E Zubao and other P2P financing platforms—at least $11 billion

Fanya Metal Exchange—about $6 billion

MMM social financial network—beyond calculation

Zhuoda Group—about $1.6 billion

GSM Financial Group—about %6.2 billion

And it also discusses why these schemes succeed, or why investors keep falling for them:

First off, opportunities in real estate and of course the stock market seem dubious, and new financial companies, especially peer-2-peer lending firms present an attractive alternative.

But of course, while rule of law has much to catch up on this new and upcoming industry, presenting a great opportunity for crooks with a bit of brains to come in and attract innocent investors looking for swift gains.

Indeed, many of these firms lie beyond the scope of supervision. P2P lending platforms often go beyond their normal role as sole information brokers and provide services and products that only licensed banks or lending companies offer. Many of them are not even registered with the State Administration for Industry and Commerce.

And investors will just go for these seemingly shady companies for really quite simple reasons: i)friends recommended it,

ii)just believed in their marketing campaign promising incredibly high returns (in some cases, people know it’s a ponzi scheme but still go for it confident they can get out with some gains before it all collapses),

iii)some famous investor spoke well of it (eg.,

iv) some local government has backed them like in the case of Fanya. People just expect the government will have their back once things go south. Nothing more than the trusting soul of man under authoritarianism.

v)And another unique feature on mainland:


Put these all together: it’s a lack of experience in investments. Mainland has arrived to capitalism late and so investing habits are also in its teenage years. So all of this will take time to develop, but it will also require reform on all fronts, law, regulation, supervision, general education, and availability of information etc. But most importantly, my view is that it is the enforcement of law, as always, they can make most difference in the short-term.

深夜的经济学|Late night economics: what did the People’s Bank of China do to the offshore RMB market?

The background:

China has two currency rates. One is onshore, which trades within a narrow band dictated by a central bank daily rate (the yuan is allowed to rise and fall by 2% of this fixed rate). The other is offshore, where the yuan floats freely and serves as an indicator of what markets think about the Chinese economy.

Since last August, when the PBoC declared a change to how it fixes daily yuan rates, which they say reflects market value, the yuan was expectedly devalued. But it was depreciating at much quicker pace than people had anticipated.

Caixin’s details on the change:
The new method, which officials said better reflects market value, links the daily rate to the currency’s closing price for the previous trading session. The fixing is a reference the central bank provides to interbank forex market traders based on the perceived value of the yuan. It is a mid-point from which daily spot trading prices for the yuan are allowed to deviate by 2 percent in either direction.

Dreading further depreciation of the yuan, those with offshore yuan holdings started selling. Then you had speculators who sought profit from the weakening yuan by short-selling their yuan holdings, and the gap between onshore and offshore yuan widened to a record. (Besides the fact that offshore is free floated and onshore isn’t, the fact that capital can’t come out freely from mainland once in, has contributed to the widening gap).

Details on short-selling CNH (offshore RMB in Hong Kong):
Known as “carry trading,” it has become popular practice for speculators to swap borrowed offshore yuan for dollars, then rebuy RMB when it has depreciated, pay off the loan and keep the remainder. Only made possible since August when the RMB started depreciating.

All this had led offshore RMB to become significantly more devalued than onshore RMB, with the gap widening to over 1,300 basis points (in November it was about 300).

What the PBoC has done is to stop short-sellers by raising the interest rate at which they can borrow CNH. It has done so by selling its massive foreign exchange reserves and buying up offshore RMB through state-owned banks in Hong Kong. Hibor (Hong Kong Inter-bank Offered Rate) went to record highs of 66.8% on January 12.

The RMB has now stabilized at 6.58 against the dollar.

But the move has not been without costs. Countering short-selling in such a manner reduced FOREX reserves, which last year shrank for the first time by 500 billion USD to 3.3 trillion. At a time when, Chinese companies are still saddled with 1.53 trillion dollars in foreign debt, most of which are also short-term.

But as China’s economic transition continues (as well as the ups&downs of the stock market), the expectation is further depreciation, and that means more intervention of that nature is likely.