More on the one-child policy's legacy

From the Quartz article yesterday:

In a study questioning the government’s claim that the one-child policy was responsible for preventing 400 million births, Feng Wang of the Brookings-Tsinghua Center called the rule “the most extreme example of state intervention in human reproduction in the modern era.” He added:

History will also likely view this policy as a very costly blunder, born of the legacy of a political system that planned population numbers in the same way that it planned the production of goods. It showcases the impact of a policymaking process that, in the absence of public deliberations, transparency, debate, and accountability, can do permanent harm to the members of a society.

Needless to say, the one-child policy has been a lightning rod for criticism of the communist dictatorship. It's quite a shame that such baby-killing horrors as the ones recounted here have been a regular occurrence in mainland China until practically this very day (if even relatively rare as a percentage of the total population).

On the other hand, whether it prevented 400 million extra births or only 200 million (as this article mentions as a lower estimate), there's no question that my fellow millennials got a living standard boost from all the missing siblings. True, this improvement was bought at the price of a rapidly aging population, but the declining workforce over the next couple of decades won't be such a disaster for China given that automation is likely to more than compensate for the loss of human labor. In fact, Chinese demographers and economists back in the 1980s were already incorporating increased usage of robots necessitated by a smaller workforce into their projections, so it's not accurate to say that Beijing was completely blindsided by the precipitous plunge in the fertility rate (now well below the replacement level of 2.1 children per woman).

This article assessing the impacts of ending the one-child policy quotes one economic expert as saying that decreased demand - not insufficient supply - is the main threat posed by graying populations. But at only $8,000, China's per capita GDP is still very low compared to Japan and South Korea, meaning it doesn't really need more people to significantly boost demand at this juncture, anyway. With widespread adoption of technological advances and further productivity gains, low-workforce China is actually set for some pretty healthy growth for the next couple of decades, if only its leaders get reforms right. And this also means that now is the time to start incentivizing two-child families, so that when China finally reaches high-income status 20 to 30 years hence, its young population won't be so thin.

Overall, the one-child policy will probably be remembered as an unfortunate method which nonetheless helped achieve what economic development alone would have mostly accomplished as a natural matter of course anyway.

One day, the hundreds of millions of my fellow millennials who were victims of the one-child era will be honored in a national memorial thanking their sacrifice of blood and soul to build 21st century Chinese civilization.

One child policy reversal: too little, too late?

During deliberations for the just-completed Fifth Plenum of the CPC 18th Party Congress, which laid out the 13th five-year plan (2016-2020), China has at long last scrapped the one-child policy completely; to some, this is all but admitting the mistake of putting the nation on a path to senility before first-world prosperity.

Having lost two younger siblings to the one-child policy in the early 1980s, this is a rather personal issue for myself - not to mention all mainland-born Chinese millennials of the so-called "little emperor" generation of spoiled brats and neurotically self-centered introverts.

The social effects of the one-child policy are tremendous in both scope and duration: not only must China grapple with a declining workforce at a far lower income level than Japan was at when it grayed in the 1990s, it is also facing the time bomb of a surplus of 40 million extra men of marrying age in the coming decade.

This second phenomenon casts a long shadow over the government's hopes of turning the economy around from investment to consumption. Research has already shown that ferocious young male competition for a constricted pool of brides contributes to the high savings rate in China (i.e. saving for a home purchase) - thus crimping the consumer spending Beijing so desperately needs to transition the economy in the coming years.

But a more obvious - and serious - problem is that the lopsided gender balance only prolongs the depopulation crisis. Let's say the rising generation of a society consists of 120 males and only 100 females as a result of disproportionate aborting of female fetuses, which is exactly what has happened in China for decades, leading to just such a breeding male-female ratio. If this young population had not been subjected to such a skewed abortion gender imbalance, perhaps it would be 40 more females and 20 more males, for a total of 140 each. And so even though the total young population is 220 as opposed to 280, or 21.4 percent less on account of the abortions, the total potential future families among this population is 28.6 percent less - 100 versus 140 (i.e. the number of females).

Such grim prospects for the rising generation in China explain why it has even been suggested that wives take multiple husbands.

To be continued...

Militarization of the South China Sea just got a big boost

At least one source is saying that the destroyer USS Lansen was shadowed by two similar Chinese warships during its just-concluded "freedom of navigation" exercise around the Chinese-held Spratlys in the South China Sea.

If so, this would represent a potentially major escalation of the militarization of some of the world's most crucial waters. Unfortunately, neither Washington, which has promised to make these FON exercises a regular event, nor Beijing, which has staked much domestic credibility on its nationalistic claims to the South China Sea, would appear to have much room for compromise.

By sending two missile destroyers, including one of its most modern "Type 052C" boats, to pursue the USS Lansen, the PLA Navy effectively said: "Just one destroyer doesn't intimidate us...we are a Great Power, and if you want to make an impression, you should be prepared to deploy great force at great risk and cost, but even then, don't expect any free lunches here in our local pond."

Alas, nobody can seriously have expected America to stand idly by, at least not indefinitely, while China pretty much made a mockery of its credibility as enforcer of fairness on the high seas; but now that a challenge has been made - and apparently met in kind - it could be the start of a slippery slope.

At the very least, Pentagon planners should be carefully considering the nature, scale, and persistence of the exercises it must execute to change Chinese calculations in America's favor; the worst Washington can do now is unwittingly accelerate the PLA's militarization of the Spratlys by posing enough of a threat to give Beijing the pretext, but not enough to actually push back.

In the overall context of US-China relations, this is the most visible and potentially most dramatic test of strength...it could set the tone for every other aspect of the bilateral relationship, and along with it, the larger arena of Sino-US strategic competition in not only the Asia-Pacific, but increasingly worldwide.

Will the US Navy be compelled to beef up its forces and exercises in the South China Sea? How will the PLA Navy respond? Will it reach the point where Washington must go well beyond regular navigational freedom postures and dispatch a full carrier strike group, prompting Beijing to seal off the Spratlys zone for anti-ship missile tests? A scary thought...but strategists on both sides of the Pacific had better be drawing up their South China Sea endgames right about now.

RMB SDR inclusion now likely

In what would be a breathtaking coup for Beijing after a tumultuous year which has all but sealed China's centrality to the global economy in often not-so-encouraging ways, the IMF now appears set to recommend the RMB to be included in the Special Drawing Rights (SDR) reserve currency basket in late November.

China's weekend decision to scrap deposit rate ceilings, though it is unlikely to have much impact on the real economy, was nonetheless one of the key remaining technical hurdles to clear for the yuan's reserve currency status.

Still, this change of fortune is rather surprising in light of no indications of significant progress in the overall liberalization of China's capital account; Chinese equity and debt markets haven't lately become more open to foreigners, nor have foreign equity and debt markets become more open to Chinese. Perhaps there's more going on behind the scenes than made public, but if that were so, even the most optimistic assessments of China's financial liberalization don't expect a full capital account opening anytime soon; the IMF could well be following the UK's lead in buckling to intensive Chinese lobbying that's hard to resist given how much the global recovery's continuation depends on Beijing.

There's no question that the 800-lb. gorilla among uncertainties in global finance is the valuation of the RMB: I have noted earlier that developed economies' dread of deflation gives Beijing tremendous leverage through their ultimate control of the yuan's exchange rate. It would now appear that the G-7 is completely sold on Beijing's insistence that, for their own wealthy societies' sake, they must concede initiative to China on the pace and nature of the yuan's increased role in global trade and finance.

Some Western analysis, like this recent MarketWatch article, are bullish on PBOC's ability to maintain the strong exchange rate without rapidly burning through its remaining $3.51 trillion in forex reserves, a prospect that seemed very plausible in the wake of August's $93.9 billion drop in the reserves.

Others have begun to look at the problem more holistically, suggesting that the RMB is actually already reacting in lockstep with smaller regional Asian currencies as opposed to merely obeying PBOC diktats.

Whatever the truth of the present situation - and again, it's most likely there's a degree of truth to each contradictory viewpoint - RMB inclusion in the SDR will send a powerful signal: China largely controls its own destiny, and just like its WTO obligations, it won't have to satisfy every Western requirement, or even a compelling majority of them, to get most of the benefits of the existing framework. Such is the power of the resurgent Middle Kingdom...

Bond market illiquidity: a sign of the times (read: deflation threat)

Nearly three weeks ago Bloomberg reported on a study trumpeting that there really hasn't been a liquidity crisis in the corporate bond market, after all. Unfortunately, the headline, "It's Official: There's No Bond Liquidity Crisis", is a lot rosier than the actual assessment laid out in the article. The concluding sentence really sums it all up:

The bond market may be deeply troubled, and may face a rocky road ahead. But the problems have less to do with the mechanics of each debt trade and more with years and years of monetary stimulus and the ensuing lopsided demand to buy credit.

This is pretty much saying, "Yeah, things are really just fine and dandy, because aside from the fact that the whole world has changed what with all the QE and money printing since 2009, everything's still pretty normal and as expected."

Now everyone knows that abnormally low interest rates and multiple rounds of QE in the G-7 since the financial crisis has led to an explosion of debt issuance worldwide; this past summer, the shockwaves emanating from China's stock market crash, economic slowdown, and currency devaluation exacerbated the tensions in the debt (i.e. credit) markets, which since at least mid-2014 had been grappling with a steady hemorrhaging of liquidity owing to the sheer supply glut of bond instruments.

This is a sign of the times: in recent months, Western regulators have begun resorting to rather extraordinary measures to keep the bond bubble from nastily popping. I can't seem to find the articles via Google now, but not too long ago I saw some headline about new limits on bond trading; earlier this year I read about proposals to restrict traders' access to daily bond quotes to reduce volatility.

Bloomberg notes from the study in question:

Their findings show credit markets are actually evolving. And everything seems fine. Maybe even better than it was before the 2008 financial Armageddon, which prompted Wall Street banks to shrink and stop acting like hedge funds.

Now, actual hedge funds and others are stepping in and making markets, even as big banks pull back. Yes, companies can’t seem to sell enough corporate debt and yes, this means trading has failed to keep pace with debt issuance.

As a counterpoint, the banks aren't terribly happy about their reduced role. Just two and a half months ago they were complaining that much of the bond market's liquidity squeeze can be blamed on post-crisis regulation which has constrained their traditional market-making function.

As usual, it's most likely there is a good deal of truth to both sides of the issue.

Back to China, the big elephant in the room...the present state of the global bond market goes a very long way to explaining just how grave is the fear of deflation of asset values in the rich developed nations. It's why, as the cartoon in my last post showed, Xi Jinping could leave the UK with Dave Cameron and George Osborne ecstatic about losing their underwear.

So my next post, hopefully before the markets open Monday, will touch the issue of China's latest interest rate and reserve ratio cuts, the removal of the cap on deposit rates, and consequent likely inclusion in the IMF's reserve currency basket, the SDR (Special Drawing Rights).

What China bears are really up against

The signing of over $60 billion worth of deals during Xi Jinping's visit to the UK, including the much-anticipated nuclear power agreement that has critics wondering how a major Western economy could entrust such sensitive strategic assets to a communist dictatorship, has left the following impression of David Cameron and George Osborne.

Actual facts and events like this are perhaps the most telling gauge of just how bad things are with China's supposedly crashing economy.

Financial Times explains why, in addition to other bubbles of late, China has probably experienced a "bear bubble" as well.

If financial services powerhouse Britain is in any way a bellwether for where America is headed (some food for thought, given how much more central financial services have become to our own economy since the crisis, as well), then Xi's UK trip gives Beijing something to aspire to in terms of just how warm and fuzzy its relations with Washington could one day be...once the ruling class here, as in London, falls all over itself to please its mandarin-apparatchik counterpart.

Financial services grows 16% YoY: big support for offical 6.9% growth

China's financial services sector grew a torrid 16.1 percent in the supposedly disastrous third quarter, according to Dow Jones. This goes a long way to explaining the overall 8.6 percent growth in services and makes the official 6.9 percent GDP increase in 3Q more credible.

Of course, China bashers will be all over this supposedly fake or fudged figure, but it's actually pretty easy to believe. These two paragraphs are the key:

While the benchmark Shanghai Composite Index tumbled to 2850.71, its lowest point in the collapse reached on August 26, trading volume also fell 25 per cent in the third quarter from a quarter earlier, according to data provider Wind Information Co. 

HSBC economist Ma Xiaoping said an accelerated increase in bank credit likely aided the financial sector's stronger performance and "may have offset some impact from market volatility." 

So we have reputable international industry sources saying that the financial sector didn't quite plunge into the abyss, after all. A 25 percent contraction in trading volume would still put such volume at a considerably higher level from the same period a year earlier; the increase in bank credit is rather substantial in the official stats:

The growth of outstanding bank loans also picked up in the third quarter to 15.4 per cent from a year earlier, up 1.6 percentage points in the second quarter and 2.13 percentage points from same period last year, according to official data. In September, Chinese banks issued the highest amount of new credit on record for the month. 

Further data confirming a pickup in the real estate sector, if even somewhat slower than in 2Q, would also bolster the case for continued impressive growth: real estate remains a substantially bigger chunk of the economy than equities.

So now, the Gordon Chang's and Jim Chanos's of the world must make the case that sector data is being fudged all across the board, not simply in bits and pieces that leave glaring holes and inconsistencies.

Their next exercise should really be to determine the rate of electricity output growth related to the financial services industry: but it makes one wonder how childish their math skills are if they equate a 1 percent electricity growth to a 1 percent finance sector growth. I mean, one can easily see that even if all the additional stock trades compared to last year translates to a 10 percent increase in electricity consumption by stock-related servers and other electronics, this wouldn't do much to pull up the overall national consumption growth if far more energy-intensive sectors like manufacturing are exhibiting flat or negative growth.

That being said, it's true that the 5 or 6 percent growth in manufacturing - still a massive sector - doesn't square with stagnant or contracting electricity usage. Something to look into more carefully, IMHO...Chinese factories should be getting more efficient over time, and perhaps one year is a long enough time frame to notice some improvement; if so, the low electric growth could actually be another good sign, considering how notoriously wasteful of productive inputs Chinese factories were not too long ago.

China 3Q GDP comes in at 6.9 percent

Bloomberg: 6.9 pct growth slowest since financial crisis but eases fears of significant slowdown

This was probably the only politically acceptable figure for Beijing to report for the July thru September quarter...it was such a tumultuous period for global perceptions of China that an otherwise relatively unremarkable if downbeat (by Chinese standards) quarter acquired a profound significance for market sentiment on every continent. This 6.9 percent was the only "not too hot, not too cold" figure that would tell the world, "we know 7 percent is out of reach, but we're holding up pretty well nonetheless since we eked out something above the 6.8 percent international consensus estimate."

There's no question that the headline GDP figure is as much political as economic; on the other hand, it's wrong to think, as the China "perma-bears" all but assume, that it's simply fabricated by old-fashioned communist apparatchiks tasked with hiding a giant Potemkin village.

Gordon Chang, author of the 2001 book The Coming Collapse of China, has been foremost among the China bears for years; he was at it again in a video in which he repeats his recent claim that China is currently growing at barely 1 to 2 percent.

Chang is a good barometer of China skepticism. Although China's economy is nearly 10 times bigger than it was when he claimed back in 2001 that it would collapse within the decade - thus putting a dent on his credibility - in fact some of the most critical systemic problems China faces have not changed in 14 years.

Even if Chang is correct about 1 to 2 percent growth currently, that may only be because - as even he admits in the interview - that past years of rapid expansion understated actual growth, meaning that present growth is being generated from a larger base than previously thought. An AP article notes as much:

"Beijing is measuring a 2015 economy using a 20-year-old framework," said Daniel H. Rosen and Beibei Bao of Rhodium Group, a research firm, in a report in September.

The government didn't collect data on thriving service industries until 2005. Once it did that, the official size of China's economy abruptly increased by 17 percent, propelling it past Italy as the sixth-largest.

In their report, Rosen and Bao said Chinese data still fail to reflect the true value of real estate, retailing and other service industries, as well as of research and development.

Rosen and Bao suggest China's antiquated system might hide the fact that its economy, due to overtake the United States as No. 1 in the next decade, is at least $1 trillion bigger than reported.

IMHO, China and its communist regime are not on the brink of collapse...if anything, an actual GDP growth of only 1 to 4 percent at this time could be a sign of remarkable strength and resilience, given that there are few signs of a significant uptick in social unrest.

That being said, Gordon is still right that the RMB remains significantly overvalued...he mentions a potential devaluation of 10 percent in the near future, which is far below the 30 to 50 percent I personally believe possible. And this is where I take most issue with his reasoning: given that the RMB is so ridiculously overpriced against the dollar, this massive deflationary threat to the global economy and especially to the advanced economies like the US gives Beijing tremendous leverage.

It's a topic I'll return to at some point in future...Chimerica is double-edged in nature and just as Washington constricts Beijing's freedom of action, so does Beijing constrict Washington's.

Xi Jinping vs. Li Keqiang: the Emperor and his Master Wonk

The Economist reiterates the now popular assertion that Premier Li Keqiang is the weakest Chinese Premier in decades. Notably:

Mr Li’s problem, however, is not so much incompetence as impotence. He is officially ranked second in the party hierarchy, but it is ever more apparent that Mr Xi largely excludes him from day-to-day decision-making on economic policy. That is a striking change of fortune for a man once thought to be a possible candidate for the role that was eventually filled by Mr Xi, who took over as China’s leader in 2012.

On the other hand, Mr. Li continues in his role as overseer of such crucial strategic initiatives as the overhaul of the Chinese financial sector.

Of course, if you're a liberal (whether Western or Chinese), then along with the authors of the Economist, it's probably a big letdown that Li has been marginalized. As a realist, though, I'm more willing to accept the obvious: unless China democratizes right now, its only alternative path of development at this juncture inevitably requires Xi the strongman to take economic authority away from Li the thoughtful technocrat.

The Economist piece, even though it concludes that Xi Jinping has consciously determined that his own strong personal leadership is China's best hope to push through difficult reforms - i.e. that usurping much of the prime minister's authority is unavoidable - nonetheless still demonstrates the liberal tendency to understate the degree to which China's economic reforms are really part and parcel of, and subsidiary to, Xi's larger mission to overhaul the CPC as an effective ruling party.

So yes, the Economist is right to point out that Xi really has a very full plate now - having to keep an eye on the economy even as his signature anti-corruption campaign continues - but even if things like the summer stock market bailout weren't directly related to the anti-graft crusade, in the end they're not at all separate concerns for Xi.

So in other words, Li is really just the Emperor's Master Wonk adviser in the current period of systemic crisis management. His consultation and expertise are needed all the time, not least to render accurate situation reports to the throne room and to ensure that the Emperor's edicts don't inadvertently screw up the public welfare; at this stage in the game, though, he's just not the guy who'll be making actual decisions.

Will China become more like us, or will we become more like them?

The Guardian just ran a good article about China's financial and economic reform prospects by one of the co-chairs of Gavekal Dragonomics, a nice wonky research outfit specializing on China or, perhaps more accurately, "Chimerica".

The musing that concludes the article is somewhat shocking:

The world has learned since 2008 how dangerously financial expectations can interact with policy blunders, turning modest economic problems into major catastrophes, first in the US and then in the eurozone. It would be ironic if China’s Communist leaders turned out to have a better understanding of capitalism’s reflexive interactions among finance, the real economy, and government than western devotees of free markets.

I personally don't underestimate Xi Jinping's and Li Keqiang's grasp of macroeconomics; I think theirs is a deeper and more nuanced understanding of this complex topic and discipline than most Western experts, largely because they deal with the very pressing reality of managing a massive system on a daily basis.

Seven years after the global financial crisis, many free-market fundamentalists here in America are still largely in denial of what happened; of course, the steadily heating-up election season will only amplify their angry voices decrying the evils of "statism" and "overregulation", even as they insist more defiantly than ever that all we need is to get rid of the federal government, and then the inherently superior creativity and ingenuity of the American people will be unleashed yet again to prove that "freedom" is what makes any country genuinely great.

Thankfully, blind ideology is finally being phased out: a Donald Trump presidency, if anything, will actually bolster the role of government, not undermine it. We're actually going to become more like China and Russia, not vice versa: soon we'll be punishing our own private companies and individuals for doing whatever they want to maximize short-term profits at the expense of long-term national security and sovereignty, i.e. hiring illegal immigrants and moving factories and jobs overseas.

The voodoo-economics assertion that American businesses would be more patriotic and pro-American if only we didn't have such high corporate taxes sounds pretty neat, but it's also ludicrous: I mean, it's really news to us that China's been giving our companies so much free lunch.

So the great convergence - the marriage of China and America into Chimerica - looks set to happen one way or another. Liberals in China wish they'd be more like us; conservatives here wish we were more like them. Who said the perfect match has to be made in Heaven and not Hell?

Some inflation basics

Back in first or second quarter of 2015, China posted year-on-year GDP growth of 5.8 percent in nominal currency terms. However, because inflation was at -1.2 percent (negative inflation, i.e. actual deflation), the rate of real GDP growth was 5.8 minus -1.2 percent, or 7.0 percent.

The basic formula, then, is this:

Real GDP growth rate = Nominal GDP growth rate - Inflation rate
OR
Real GDP growth rate + Inflation rate = Nominal GDP growth rate

To illustrate with a bare-bones example, let's say our economy produces only widgets, and our GDP is generated by purchasing them. In the first year, Y1, we produce 100 widgets and purchase them for $1.00 apiece, generating a GDP of $100, which also represents our economy's money supply. In the next year, Y2, real output grows to 107 widgets, and to purchase all of them at the same price of $1.00 each - that is, to maintain zero price inflation - we increase the money supply by $7 to $107, which is also our Y2 GDP. At this zero inflation, both nominal GDP growth and real GDP growth are the same, 7 percent.

If we want to generate some inflation, we simply increase the money supply by more than the $7 needed to absorb the growth in widgets to purchase. Let's say we increase the money supply by $10 instead of $7. Then our Y2 GDP is $110, or a 10 percent nominal GDP growth over Y1's $100. But since only $7 of that $10 is necessary to purchase all Y2 widget production at the constant price of $1.00 each, the other $3 is an inflated addition. So this is 3 percent inflation: $3 have been added to the original money supply of $100 that's over and above what's needed for price stability; the other $7 was legitimately added for price stability, and hence represents the real GDP growth of 7 percent over the base GDP/money supply of $100. So our real GDP growth of 7 percent ($7/$100) plus the 3 percent ($3/$100) inflation gives us the 10 percent nominal GDP growth ($10/$100).

On the flip side, deflation happens if we don't add enough to the money supply to maintain the unit price for widgets in Y2. Let's say we only add $5 to the money supply, meaning a nominal GDP growth of 5 percent: this leaves us $2 short of the $7 increase needed to purchase all 107 widgets in Y2 at a constant $1.00 price. So instead of an inflated addition to the money supply over and above the price equilibrium, we get a constriction of the money supply below that level: a relative contraction of $2, or 2 percent ($2/$100) deflation. Then our nominal GDP growth of 5 percent minus our inflation rate of -2 percent yields us our real GDP growth (same as before) of 7 percent.

This last calculation is much like the first I made above for China's quarterly GDP earlier this year: low nominal growth minus negative inflation (deflation) for a higher real growth. Needless to say, this only happens in tight monetary environments often characterized by considerable overcapacity, which China suffered from in 2014 and 2015.