Streetwise Professor

January 14, 2014

So How Would This Be Different Than Revealing Our Breaking Enigma or JN-25 in WWII?

Filed under: China,History,Military,Politics,Russia — The Professor @ 11:53 pm

The most recent Snowden revelation, courtesy of the NYT-go figure-is that the NSA has used trade craft and high technology to penetrate offline computers.

Note  the headline and the first couple of paragraphs, which are oh-so-vague about just what computers are penetrated.  It could be yours!!!!!!

Not really.

And look at this, from the first paragraph: the NSA’s actions “also create a digital highway for launching cyberattacks”.   The targets of said attacks are not named, leaving it for suggestible minds to conclude that the NSA is targeting the innocent.  The insinuation–a NYT speciality–is that the intent of the NSA action is aggressive, and therefore somehow illegitimate.

You have to read four paragraphs into the story to find this:

The radio frequency technology has helped solve one of the biggest problems facing American intelligence agencies for years: getting into computers that adversaries, and some American partners, have tried to make impervious to spying or cyberattack. In most cases, the radio frequency hardware must be physically inserted by a spy, a manufacturer or an unwitting user.

The N.S.A. calls its efforts more an act of “active defense” against foreign cyberattacks than a tool to go on the offensive.

So we are attempting to penetrate the computers of “adversaries.”  Like China and Russia.  Good of the NYT to acknowledge we actually have adversaries.

But of course, what the left hand giveth, the lefter hand must take away.  The very next sentence:

But when Chinese attackers place similar software on the computer systems of American companies or government agencies, American officials have protested, often at the presidential level.

And you thought moral equivalence was dead!

If you read the article carefully, you will conclude-despite the efforts of reporters David Sanger and Thom Shanker to obfuscate-that the NSA is engaged in defending the United States against malign countries that have long waged asymmetric combat against us, and which could be military adversaries in open conflict in the future.  Not likely, but possibly.

Shocking, I know, that an entity called the National Security Agency would be engaged in such outrageous efforts to defend US national security.  The nerve.

Look, the NSA and other intelligence agencies spend boatloads of money.  This is actually something that is worth paying for.

And just how, exactly, does this revelation advance the interests of the privacy of US citizens, which I though was Eddie Snowden’s big concern?  Hell, how does it advance the interests of privacy of private citizens of China and Russia, for that matter?  This is directed at the governments of those countries.

Can we just get over the pretense that Snowden is a whisteblower concerned about privacy issues?  That’s just the candy coating on a huge poison pill–an information operation directed against the United States.  This whisteblower persona gives Snowden immunity from scrutiny, and from behind this cover he lobs info bomb after info bomb against US national interests, compromising extremely sensitive operations intended to protect the US against nations that bear it very, very ill will.

Imagine if during WWII, prior to June 4, 1942,  someone had revealed the the US had broken the Japanese JN-25 Code.  Or if someone had disclosed the Ultra secret–that Britain and the US had broken the Enigma cipher.  I really can’t find any meaningful distinction between those hypotheticals, and the reality of what Edward Snowden–and the New York Times–has done, and will be continuing to do.

Update: The article mentions submarines, but it doesn’t draw the best submarine analogy.  During the Cold War, the US Navy’s submarine force engaged in highly clandestine, dangerous, imaginative and largely successful efforts to penetrate Soviet communications.  For instance, US subs tapped underwater telephone cables in Soviet harbors. (Read the book Blind Man’s Bluff for the details.) This was of vital importance during the Cold War.  What the NSA is doing now with Chinese and Russian computers is not different, in any material way.

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July 25, 2013

The Michael Jackson Economy: Cold Turkey or Hair of the Dog?

In 2009 I called China the “Michael Jackson economy,” meaning that it was kept going by artificial stimulants, but that inevitably their cumulative effects would cause  serious, and perhaps fatal problems.  They mask the effect of the underlying ailment, and have severe side effects.   China responded to the 2008 financial crisis by engaging in massive stimulus, and has inflated credit bubbles whenever growth stuttered in the past several years.  Moreover, allocation of credit and investment in the economy is subject to substantial direct and indirect government control.  Local governments invest massive amounts in infrastructure and housing projects, and the banking system is tilted to direct credit to large state enterprises that invest primarily in heavy industry-steel manufacture and shipbuilding, for instance.

This “investment” can prop up GDP statistics, but they are recorded at cost, not value.  (I recommend this David Henderson piece about the perversity of GDP fetishism, and how GDP can grossly mis-measure well-being.)

If the investments are ill-conceived, they will not pay for themselves in the future, and economic output and consumption will suffer.  And investments guided primarily by the visible hand in an authoritarian state are almost certainly ill-conceived.  They are driven by considerations like political connections, prestige, and the imperative to maintain employment in existing enterprises and regions to buy labor-and political-peace.  This latter effect is particularly deleterious, as it means that rather than there being a natural corrective mechanism for past mistakes, mistakes tend to be self-perpetuating.

The Wall Street Journal has a fascinating article about one major malinvestment that fits this story almost perfectly.  Yes, it is likely an extreme case, but there are enough similar stories to suggest that that the malivinestment problem in China is severe.  Moreover, the bloated fraction of investment to GDP, and the falling delta between changes in credit and changes in income provide some quantitative support for these anecdotes.  Add in the dodginess of Chinese economic data, and there is serious reason to believe that China is heading for a very rocky period.  When the interactions with the financial system are considered, the prospects look even more dire: when the investments don’t generate sufficient return to pay back the loans, realistic outcomes range from a Japan-like zombie-fication of the banks to a full-blown financial crisis.

China’s new premier is promising 7+ percent GDP growth.  That could be the problem: the only way to get it is to double down on the artificial stimulants, thereby exacerbating the malinvestment problem.  Living with lower GDP growth, and permitting Chinese businesses and individuals to reallocate resources to those that generate value rather than statistics, would be far preferable in the short, medium, and especially long run.

A major adjustment is needed, but I would have little confidence in the Party and the system that created the mess in the first place to manage this adjustment effectively or efficiently.  The political economy suggests that incumbent industries, firms, and interests, all of which have strong political influence, will disproportionately influence government economic policy.  This impedes adjustment, and substantially increases the odds of zombie-fication, of the financial system and entire industries.  China could use some creative destruction, but I do not believe this is politically feasible.

China is one of those few matters on which Krugman and I agree.  Krugman mentions that this could be bad for commodity prices, and that would definitely be true if China goes cold turkey and stops trying to perpetuate its old growth model.  That will lead to a substantial decline in the demand for commodities such as industrial metals, iron ore, coal, and oil.  But if the political economy story is correct, it will attempt to support the existing commodity-intensive structure of production and delay the adjustment process.  In the event, commodity prices will likely fall, because a reprise of 2009′s extreme dosage of stimulants is likely infeasible.  But government attempts to cushion the adjustment process will cushion the impact on commodity prices too.

But it is true that the course of commodity prices will depend crucially on how the Chinese government handles the painful withdrawal from its past stimulus binge.  Cold turkey would be very bearish (how’s that for a mixed metaphor!?!) Hair of the dog far less so.  This implies that a crucial fundamental in commodity markets in coming months and even years, and perhaps the crucial fundamental, will be Chinese politics.

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July 1, 2013

Deleveraging is Devilish Hard: Just Ask the PBOC

Filed under: China,Economics,Financial Crisis II — The Professor @ 8:19 pm

The WSJ has a very long and interesting article about the PBOC’s ham-fisted handling of the liquidity crunch of the past weeks.  The central bank was trying to send a signal that it wanted to restrain credit growth, especially in the shadow banking sector, but things got out of hand:

Since early June, the PBOC has sought to force Chinese banks to redirect their lending away from shadow bankers—a mélange of trust companies, pawnbrokers, leasing companies and others—whose lending is putting further stress on an economy already slowing, economists say.

To achieve this, the central bank withheld cash from the interbank market, essentially twisting the arms of traditional bankers to force them to change their lending practices.

On June 20, China’s leaders feared the credit squeeze was getting out of hand. Overnight interest rates at which banks borrow from each other spiked to as high as 30% that day. A rumor circulating in Shanghai that Bank of China had defaulted on an interbank payment was given more credence when a Chinese newspaper, the 21st Century Business Herald, reported the alleged default on its website around 6 p.m. According to the newspaper, Bank of China defaulted during that afternoon, “deferring transactions for half an hour due to a fund shortage.”

But shadow banks are holding a large amount of assets.  How are those assets going to be funded?  Does the PBOC want banks to bring them on their balance sheets?  Really?  If not, where will they go?  Another reason that the PBOC’s crackdown was not credible last month, and hence will be unlikely to have disciplinary effects going forward.

Deleveraging is hard, because leverage funds assets.  To reduce leverage, you have to reduce the assets, or find equity to finance them.  How?  Dump them, leading to fire sales and substantial declines in asset prices that spill over and harm the balance sheets of banks and other institutions?  If not, where is the equity going to come from to hold these assets?

The PBOC is probably right in its diagnosis that China is over-leveraged and that the leverage is particularly fragile.  But making the diagnosis is one thing.  Finding the cure is something different altogether.  The PBOC has found that cutting off funding to shadow banking isn’t feasible, because the assets it holds have to go somewhere.  And if a lot of those assets are bad-which is likely the case here-it’s truly a challenge.  Extend and pretend is the path of least resistance, meaning that the problem is deferred, and likely to matastasize. Meaning that even the most clever central banker is likely to find it very difficult to wean the financial system off cheap credit.  There is a path dependence here that makes that task very, very difficult.  So it’s likely that we haven’t read the last story about a liquidity crisis in China.

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June 27, 2013

Did the PBOC Blink? Uhm, Yes.

Filed under: China,Economics,Financial Crisis II,Politics — The Professor @ 6:36 pm

The WSJ’s ChinaRealTime blog asks that question.  The answer is fairly obvious.

Recall about a week ago that China was experiencing an acute liquidity shortage, resulting in the spiking of repo rates to 25 percent intraday.  The PBOC remained aloof.  Then it intervened, providing liquidity and making soothing noises.  Interbank rates (SHIBOR) and repo came back down, though they still remained at elevated levels.

The narrative is that the PBOC was trying to teach banks and shadow banks (trust companies, marketers of wealth management products and the like) a lesson: cut down on the extension of dodgy credit, or else!

But as I noted in my post last week, the PBOC was in a bind.  It could refuse to supply liquidity, and watch the system blow up.  Or it could supply liquidity, and undermine the credibility of its “or else” threat.  Not surprisingly, PBOC chose the latter course.

The ultimate result is likely to be quite different than the PBOC had hoped for.  Banks and shadow banks will likely conclude that the PBOC will always come to the rescue.  The “or else!” threat is incredible.

Meaning that Chinese credit will continue to grow, and the ultimate reckoning-which must occur-has been merely delayed.

I have read some reports questioning where money invested in WMPs will go at the end of the quarter, when they mature.  Well that’s the problem, isn’t it?  If the WMPs can’t roll over, if the money invested in them goes somewhere else, the rather dicey assets they hold can’t be funded, with the following consequences: (a) some WMPs will default, (b) others will call on the (implicit) liquidity puts extended by banks, thereby communicating the contagion to the banks, and/or (c) WMPs will dump assets on the market, depressing prices, with deleterious consequences for others holding similar assets.

The PBOC is riding the tiger. Its relenting at the last minute makes it clear that it is loath to dismount.  Market participants will note this, and respond accordingly.  Meaning that the supposed teaching moment will not provide the lesson that the PBOC intended.  It will instead convince market participants that they will be rescued if it looks like the system is about to crack.

Again: the reckoning with China’s extreme financial imbalances and malinvestment has merely been deferred.

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June 20, 2013

Crisis=Danger+Opportunity? The PBOC Seems to Think So

Filed under: China,Economics,Financial crisis,Financial Crisis II,Politics,Regulation — The Professor @ 8:30 am

I have written for some time about my doubts about the sustainability of Chinese growth (driven by massive credit expansion that is delivering progressively less and less bang for the renminbi), and my concerns about the stability of the Chinese financial system, especially the shadow banking system.  So far these prognostications have not been realized, but events over the last few days relate directly to these doubts and concerns.

Specifically, China is in the grips of a full-blown liquidity crisis, with overnight repo rates approaching 30 percent, and one week rates well over 10 percent.  The Chinese yield curve has become steeply inverted, which is never a good sign.  The word “panic” is being bandied about quite freely.

News accounts make it seem that the liquidity shortage is the deliberate  policy of the People’s Bank of China.  Indeed, these accounts suggest that the PBOC is withholding liquidity from the market precisely because it too believes that credit-fueled growth is unsustainable, and that the banking and shadow banking sectors have over expanded and need to be cut down to size:

China’s interbank funding costs surged again on Thursday, with the two shortest-term rates hitting record highs, as the central bank again ignored market pressure to inject funds into the market, despite fresh evidence that the economy is slowing.

The People’s Bank of China (PBOC) told the market that it would not conduct repo business in its regular open market operations on Thursday, frustrating widespread expectations that it would use reverse repos to inject cash to ease an acute market squeeze over the last two weeks.

. . . .

“The central bank appears to be determined to force banks and other financial institutions, such as funds, brokerages and asset managers, to de-leverage,” said a trader at a major Chinese state-owned bank in Shanghai.

“That hardline stance suits the recent government policy of clamping down on non-essential businesses by financial institutions, such as shadow banking, wealth management, trust operations and even arbitrage.”

Yes, deleveraging is probably a good idea: the economy had become over leveraged as the result of previous stimulus policies that fed a credit boom. The question is: how to deleverage?  Quite often system-wide deleveraging is a chaotic process, beset with externalities.  Companies that can’t fund dump assets in fire sales, which puts pressure on other institutions holding the same or similar assets: they often join the fire sale stampede.  Institutions start hoarding credit and liquidity, which drives up rates and puts yet further pressure on financial institutions.

In other words, system-wide deleveraging often occurs through a financial panic that causes massive economic damage.  Usually central banks try to stem this process by flooding the system with liquidity.  Bizarrely, China, it appears, seems to be trying to start the process by starving the system of liquidity.  Central banking with Chinese characteristics, as it were.

One interpretation is that the PBOC has found that jawboning and other less drastic policies have failed to stem the growth in credit and shadow banking, so it feels obliged to take stern measures to curb these activities.  But this is a dangerous way to do it, and I am not sure that it is the optimal strategy in the game between the PBOC and other market participants.

Let’s say the PBOC relents and says “You’ve been warned: don’t let it happen again.”  Many market participants will infer that the PBOC’s threats are not credible, and that it will supply liquidity if the system appears on the verge of failure.  The will therefore have little incentive to curb their activities, viewing the PBOC as a paper tiger.  The economy will continue to be over leveraged.

Conversely, let’s say to demonstrate its credibility the PBOC sticks to its guns and refuses to supply liquidity: then there is a risk of a full-blown panic and crisis-and right now.

China is having an episode not unlike the one that hit world markets in August, 2007, when funding markets signaled the onset of the crisis, with the difference being-and it is a big difference-that this appears to be a crisis of choice, and one that could morph from onset to a Lehman moment in days or weeks, not months.

Perhaps the PBOC believes that the situation is so dire that a purgative crisis now is preferable to a worse one that chooses its own time to appear.  If so, it has no one else to blame.  If China’s financial system was hurtling down the road too rapidly, it was because the PBOC (and the Chinese government) had jammed down the accelerator with its credit-driven stimulus measures.  Now it is responding by jamming on the brakes.  A policy of alternating extremes seldom works out well.

There is an apocryphal belief that in Chinese the word “crisis” is represented by the characters for “danger” and “opportunity”.  (JFK is responsible for popularizing this belief.) The most charitable interpretation of the PBOC’s starving the market of liquidity is that it doesn’t view that belief as apocryphal, but as gospel.  That it is running a great danger to seize an opportunity to put the Chinese financial system on a firmer foundation.

Maybe.  But that suggests a conceit on the behalf of policymakers: it presumes that once a panic is sparked, they can control it, and the panic will make financiers more prudent in the future by putting the fear of God into them today.

That’s a very, very risky bet that has a very, very high probability of turning out very, very badly.

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February 18, 2013

Rosneft: Supermajor Wannabe

Filed under: China,Commodities,Economics,Energy,Politics,Russia — The Professor @ 2:13 pm

Rosneft is scrambling to finance its acquisition of TNK-BP.  The means it is resorting to speak volumes about the gulf between its aspirations to be a supermajor and reality, and also about the risks that lenders perceive in dealing with Russia (and perhaps Rosneft specifically).

Rosneft is raising $10 billion through an oil pre-pay deal with Vitol and Glencore.  Rosneft agreed to sell the oil forward, with deliveries starting this year, and Vitol and Glencore used those contracts as collateral for loans for $10 billion.  The money goes from the banks, through Vitol and Glencore, and then on to Rosneft which will use it to pay AAR and BP.  The use of oil to secure the Rosneft-Vitol/Glencore deal is interesting.   Rosneft cannot borrow the money on its own promise to repay: it did borrow $15 billion from banks on that basis, but individual banks were not willing to take more than $1 billion in exposure to the Russian company: that limited appetite for Rosneft credit risk (which given its asset base is driven by political and legal risk) is quite telling.

Rosneft has to use prepays-a kind of financing usually extended to less creditworthy commodity traders, producers, or processors-to get additional funds.  Big commodity houses like Vitol and Glencore frequently use prepays and offtake agreements to provide funding to smaller producers and refiners.  It’s not the way real supermajors secure credit.

Oil is particularly useful as collateral, because if Rosneft tries to renege on its commitment to the Swiss houses (as it might be tempted to do if oil prices spike well above the agreed price), it will have a difficult time selling the oil as anything it tries to sell would be subject to seizure.  It’s a lot easier to seize oil in tankers or in storage facilities in Rotterdam to collect on a debt than it would be to try to seize a refinery in Russia.

Rosneft is also going back to the China well.  It has approached CNPC for $25-$30 billion dollars, again backed by sales of oil at fixed prices.  It originally denied it was in talks with CNPC, but this appears to be a “meaning of is” thing.  It might not have been in talks right at the instant that the Reuters reporter called them last week, but today Igor Sechin is in Beijing talking to the Chinese about a deal.  That’s not the kind of thing that is stitched up over a weekend.

This is a reprise of a $25 billion loan from CNPC and the China Development Bank to Rosneft and Transneft to fund construction of a pipeline extension to China negotiated at the depths of the crisis in 2009.  As I predicted at the time, that deal soon unleashed conflict between the Chinese and the Russians over the price of the oil that the Russians sold to secure the loan, and the transportation cost. The battle raged for several years, until the Russians agreed to sell the oil at a $1.50/bbl discount to the price they charged other customers buying off the ESPO pipeline.

Again, doing a large loan secured by oil, especially with a counterparty with whom the Russians have had numerous pricing disputes (they still haven’t negotiated a price in a gas deal that was first inked in 2006), is hardly the mark of a supermajor.

I fully expect that any new deal with China will spark future price disputes.

The quite evident limits on Rosneft’s borrowing capacity will constrain its ambitions to expand production in Russia, especially in offshore projects in the Arctic.  Hence, it will be very reliant on JVs with companies like Exxon who will no doubt drive very hard bargains.

The means that Rosneft must resort to in order to finance its purchase of TNK-BP says a lot.  It can’t borrow agains the assets it is acquiring, or its other assets.  Beyond the $15 billion syndicated loan, the only thing that lenders feel comfortable lending against is the oil that Rosneft must sell.  That’s the way middling-to-marginal commodity firms get funding, not supermajors.

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February 5, 2013

Hard Landing-Deferred and Made Harder Still?

Filed under: China,Commodities,Economics,Financial Crisis II,Politics — The Professor @ 10:01 pm

Last year there were concerns about a “hard landing” in China.  Those fears have dissipated with 7.8 percent growth in the fourth quarter.  Now there is widespread optimism that China’s growth will continue inexorably: the recent spike in iron ore prices (which had plunged when concerns about the Chinese economy were most acute) is a very visible sign of that.

But . . .

It appears that this rebound is the result of another dose of stimulants, notably an injection of credit.  Which (a la Michael Jackson) gives less of a lift each time it is applied.  Now it takes about 3 RMB of credit to generate a RMB of GDP growth.  Moreover, this application of stimulus has deepened the investment-dependence of the Chinese economy, and delayed its transition to a more balanced, natural system.  Furthermore, to the extent that the projects funded by this debt don’t generate sufficient returns, the borrowers will not be able to repay; this risks a solvency crisis, and of course, a liquidity crisis that can break out when lenders are solvent, but at elevated risk of becoming insolvent.

A few articles in the last few days suggest that the optimistic turn may be quite overdone, and that there are dangers lurking beneath the sea of debt.  Chinese banks are rolling over local government debt that was used to fund stimulus spending.   Chinese heavy manufacturing enterprises are becoming increasingly indebted, and are staying afloat with borrowing.  The shadow banking system is growing and mutating.

The Chinese economy is still largely centrally planned.  Not directly, but through subsidies and especially through subsidized credit.  Admittedly, my priors are that centrally planned economies are doomed to difficulty, even though they can produce spurts of measured growth.  With sufficient coercive powers, such governments can keep things going for quite a while.  But there’s a point when they can’t.  I wouldn’t be surprised if China is approaching that point.  In other words, the further injection of credit may have just deferred the hard landing . . . and made it all the harder.

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October 14, 2012

A Bear in the China Shop

Filed under: China,Economics,Energy,Financial crisis,Politics,Regulation — The Professor @ 2:15 pm

I have long been a bear on China.  Prior to 2008 because of the shakiness of its banking system; post-Crisis, because of my deep skepticism about the effects of the huge stimulus program-including its impact on the banking system, or more properly, the shadow banking system.

I am not alone.  The Bank of China is warning about the country’s shadow banks:

A senior Chinese banking executive has warned against the proliferation of off-book wealth management products, comparing some to a Ponzi scheme in a rare official acknowledgement of the risks they pose to the Chinese banking system.

China must “tackle” shadow banking, particularly the short term investment vehicles known as wealth management products, Xiao Gang, the chairman of the board of Bank of China, one of the top four state-owned banks, wrote in an op-ed in the English-language China Daily on Friday.

“Unsurprisingly, although Chinese banks’ non-performing loans are at a low level of 0.9 percent, the potential risks are worse than the official data suggest,” Xiao wrote, adding that a problem could come as indebted borrowers face cash flow problems or enter default, straining the banking system.

“The music may stop when investors lose confidence and reduce their buying or withdraw from WMPs,” he said, referring to wealth management products.

He warned of a mismatch between short-term products and the longer underlying projects they fund, adding that in some cases the products are not tied to any specific project and that in others new products may be issued to pay off maturing products and avoid a liquidity squeeze.

“To some extent, this is fundamentally a Ponzi scheme.”

Xiao’s op-ed is in line with similar warnings issued by outsiders, particularly the Fitch Ratings agency whose China banking analyst Charlene Chu has long warned of a maturity mis-match and the threat to the Chinese banking system of products with various terms and interest rates.

Moreover, there is a widespread belief among investors in these products that banks are offering liquidity puts:

Although the products are technically more risky than deposits, most investors believe they are backed by the banks’ implicit guarantee and they are marketed aggressively in bank branches nationwide. Xiao acknowledged this perception posed a risk for banks’ bottom line.

“The rollover of a large share of WMPs could weigh heavily on formal banks’ reputations, because many investors firmly believe that banks won’t close down and they can always get their money back,” Xiao said.

In June, People’s Bank of China vice governor Liu Shiyu said many banks are not transparent enough about the risks wealth management products carry.

“China’s shadow banking system is complex, with a close yet opaque relationship to the regular banking system and the real economy,” Xiao concluded by saying.

“It must be tackled with care and sufficient flexibility, but it must be tackled nonetheless.”

Recall that the movement of SIVs back onto bank balance sheets was a major channel by which problems in the shadow banking sector were communicated to US banks.

These “wealth management” products grew up as a direct result of the intervention of the supposedly wise direction of the Chinese state.  It wanted to restrict bank lending that had been stoked by the 2009 stimulus, in a step-on-the-gas-whoops-step-on-the-brakes maneuver so common to attempts to “fine tune” economies.  The bank credit was basically redirected to the informal sector.

I’m sure it will work out swell.

For more background on the crazy-quilt Chinese banking sector, and all its fragility, this is a decent source.

Another reason for my bearishness is my innate skepticism-based on long experience-of state efforts to guide resource allocation.  Case in point: China has gone all out to promote investment in renewables, and has been awarded with huge losses:

hina in recent years established global dominance in renewable energy, its solar panel and wind turbine factories forcing many foreign rivals out of business and its policy makers hailed by environmentalists around the world as visionaries.

But now China’s strategy is in disarray. Though worldwide demand for solar panels and wind turbines has grown rapidly over the last five years, China’s manufacturing capacity has soared even faster, creating enormous oversupply and a ferocious price war.

The result is a looming financial disaster, not only for manufacturers but for state-owned banks that financed factories with approximately $18 billion in low-rate loans and for municipal and provincial governments that provided loan guarantees and sold manufacturers valuable land at deeply discounted prices.

China’s biggest solar panel makers are suffering losses of up to $1 for every $3 of sales this year, as panel prices have fallen by three-fourths since 2008. Even though the cost ofsolar power has fallen, it still remains triple the price of coal-generated power in China, requiring substantial subsidies through a tax imposed on industrial users of electricity to cover the higher cost of renewable energy.

The outcome has left even the architects of China’s renewable energy strategy feeling frustrated and eager to see many businesses shut down, so the most efficient companies may be salvageable financially.

Well played.  Remind me again why should we compete by throwing good dollars after bad renmibi?

(As an aside, to illustrate the absurdity of subsidy politics, Solyndra is suing Chinese solar panel makers for predatory pricing.  Predatory pricing suits are almost always meritless.)

A substantial fraction of measured Chinese growth in the recent past has been accounted for by investment.  But the relevant question is whether this investment is going to pay dividends, or whether it has been misdirected into white elephants.  The solar (and wind) experience suggests the latter.  Historical experience with politicized investment suggests the latter.  The influence of corruption and the political influence of the elite on the investment prices also suggests the latter.  I’m going with the latter.

The WSJ has a long piece on a Chinese economist who is similarly skeptical about the ability of the Chinese state to direct investment:

Mr. Zhang’s academic colleagues were all praise for the “China Model,” but in 2009 he was giving speeches entitled “Bury Keynesianism.” Then a top administrator at Peking University, where he now teaches economics, he argued that since the financial crisis was caused by easy money, it couldn’t be solved by the same. “The current economy is like a drug addict, and the prescription from the doctor is morphine, so the final result will be much worse,” he said.

. . . .

Ultimately, Beijing’s stimulus fed a false investment boom that stoked asset bubbles—then the morphine wore off while the government tightened. Officials claim the economy grew at 7.6% year-on-year between April and June this year. Skeptics think the real number is closer to 4%. (One London research house says 1%.) Meanwhile, industries dominated or favored by the state, such as steel or solar power, are idling from overcapacity. Countless sheets of copper are reportedly stacked in warehouses, blocking doorways and exemplifying Hayek’s notion of “malinvestment.”

It’s actually worse than merely Hayekian/Austrian malinvestment, IMO.  That arises from decisions made on the basis of false price signals that result from monetary stimulus.  That is surely present in China in spades.  But there is also a good deal of state-directed investment, or investment channeled to state enterprises, or investment influenced by corrupt and connected members of the elite.

A good analysis of these issues is to be found at Michael Pettis’s blog, including examples like this post.  He aims the following, trenchant questions at China bulls:

  1. How much debt is there whose real cost exceeds the economic value created by the debt, which sector of the economy will pay for the excess, and what is the mechanism that will ensure the necessary wealth transfer?
  2. What projects can we identify that will allow hundreds of billions of dollars, or even trillions of dollars, of investment whose wealth creation in the short and medium term will exceed the real cost of the debt, and what is the mechanism for ensuring that these investments will get made?
  3. What mechanism can be implemented to increase the growth rate of household consumption?

All very good questions.  China’s recent GDP growth has really been driven by what are properly considered costs: the amount of money invested.  The relevant issue is the value produced by those investments.  Given the state domination of the process of making these investments-either directly, or via distortions of the price system through monetary stimulus and financial repression that distorts interest rates-I am dubious, in the extreme, that these investments will pay.

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