Stimulus and Protectionism

“Whenever someone starts talking about 'fair competition' or indeed, about 'fairness' in general, it is time to keep a sharp eye on your wallet, for it is about to be picked.”

― Murray N. Rothbard

The global economy has been struggling, to say the least, since the Global Financial Crises of 2008. When the financial crises occurred US and Europe started a process of monetary stimulus, an experiment with ‘zero bound’. The Chinese saw demand destruction like never before, 25% of their exports vanished and 25m migrant workers had to come back home. This prospect of instability made Chinese government embark on an unprecedented fixed asset expansion program to maintain demand and employment. This were funded by bank loans, by the same banks controlled by the government.

Gross Capital Formation (US$ bn)	2000	2008	2015	2008-2015	CAGR 2000 – 2015	CAGR 2000 - 2008	CAGR 2008 – 2015
China	367	1,127	4,553	22,074	18.3%	15.0%	22.1%
US	2,077	3,233	3,299	24,109	3.1%	5.7%	0.3%
Euro Area	1,599	2,603	2,588	22,365	3.3%	6.3%	-0.1%
Japan	1,022	988	1,042	8,657	0.1%	-0.4%	0.8%
World	7,266	12,427	19,215	128,038	6.7%	6.9%	6.4%
% of World
China	5%	9%	24%	17%

Source: World Bank

While this expansion was taking place, it is interesting to see how household final consumption shaped up during the same period.

Household Final Consumption (US$ bn)	2000	2008	2015	2008-2015	CAGR 2000 – 2015	CAGR 2000 - 2008	CAGR 2008 – 2015
China	568	1,660	4,251	23,295	14.4%	14.4%	14.4%
US	6,792	10,014	12,284	87,311	4.0%	5.0%	3.0%
Euro Area	3,673	7,833	6,367	58,226	3.7%	9.9%	-2.9%
Japan	2,674	2,826	2,416	24,479	-0.7%	0.7%	-2.2%
World	20,203	36,446	42,608	3,25,058	5.1%	7.7%	2.3%
% of World
China	3%	5%	10%	7%

Source: World Bank

So, the critical questions anyone would ask:

• Why are the Chinese who have only 7% of Household Final Consumption spending 17% of the Global Capital Formation post 2008?
• Why has global demand not expanded at a faster pace despite so much central bank stimulus globally with Capital Formation expanding 6% but demand only 2%?

When the Global Financial Crises struck, the Chinese government seeing the retrenchment of demand embarked on massive capital asset formation, the fixed asset formation expanded faster than before 2008 to the point where it spending more than Euro a rea or US. This capital expansion did rescue the global economy initially. The expansion had two elements. The first was in capacity building in different industries (a significant proportion was related to construction) to the extent there is overcapacity in excess of 30% in sectors like iron and steel, glass, cement, aluminium, solar panel, and power generation equipment. China exports US$2.3trn worth of goods around the world with electronic equipment and machinery making up almost half of it. By some estimates, Chinese has the capability to export another US$2trn globally given its overcapacity. The second part is in property, China has invested since 1998 more than 15% of GDP in property or something like 40% of Gross Capital Formation. By 2025, they plan to move 600m people to urban centres, like building all the cities of Europe in less than a generation. Property investment creates income for local provinces and municipalities (it is also their main source) which then use this income to for their pet expansion programs, industry incentivisation and employment generation programs. Thus, increasing property prices every year helps not only the wealth effect of the populace but also ensures larger and larger availability of money for the provincial governments. Politics is intricately linked to economics.

While this was happening at one end of the globe, the other end was busy providing financial stimulus. But this created no jobs as Chinese overcapacity swallowed whatever excess demand that was created at whatever price. Of course, demand growth was impacted by declining population and aging. With lack of jobs, there could never be any meaningful and sustainable expansion in consumption. The financial stimulus consequently, instead of working in its traditional ways helped expand financial asset prices – stocks, bonds, property, wine, art or fur. We have, therefore, seen inequality grow across the globe.

We've used up a lot of bullets. And we talk about stimulus. But the truth is, we're running a federal deficit that's 9 percent of GDP. That is stimulative as all get out. It's more stimulative than any policy we've followed since World War II.  - Warren Buffett

China may propound itself to be virtue of free market world. It is hardly for the reason of political stability (e.g. global media or internet access), overcapacity and local capability development in key industries. For example, as Dr Balding points out:

• An average Chinese tariff rate of 3.4% compared to the US rate of 2.6%. China maintains a 9.9% average rate for other WTO members while the US has a 2.5% weighted average for WTO members;
• China maintains a long “negatives” list of industries in which foreigners simply cannot invest. This includes such high tech national security industries as cotton.  Even now, most investors require a Chinese joint venture partner and are simply prohibited from having a wholly owned Chinese subsidiary;
• China continues to restrict international capital flows despite joining the IMF SDR and promoting RMB internationalization.  Excluding flows within China controlled territory, the RMB ranks below the Danish krone for international payments and transactions.   

This brings us to today’s fork:

• The Chinese desperately want access to the global markets especially the US (>25% of global demand) while keeping its demand to itself to sustain industry and employment;
• One Belt One Road is as much an economic manifestation of this as it is geopolitical;
• Investment is done with Chinese money and conditionality’s such that the construction activities are taken up by Chinese companies (nothing unusual here, JICA or EXIM does the similar);
• The monies lent unless it gives an adequate economic return may leave high levels of debt in emerging countries i.e. Venezuela where the decline in oil prices have put US$18bn of China financing at risk or like Sri Lanka where high levels of debt have resulted in 80% of a port being handed over to China; 
• Given the deterioration of the Chinese economy (overcapacity and high levels of debt), Chinese people are sending their savings abroad parking in real estate or acquiring companies at high valuations, this is putting pressure on the RMB (devaluation expectations run as high as 30-40% if the central bank stops intervening):
• Almost till 2013, China had bought US$ to maintain the low value of the currency but now despite the massive current account surplus the outflow is unprecedented causing continuous haemorrhaging of the currency reserves;
• Politicians globally, whether they understand this or are just seeing implications in their home markets, are responding with rising protectionist sentiment in Europe and the US, Trump is just an extreme version of this sentiment.

It is clear that this will not end well. Low rates have created a world of high debt and overvaluation, retracement of both is detrimental for economic progress and the overcapacity China has created may take over a decade to clear out. Continuing issues of Eurozone and Middle-East and global aging make things only worse. None of the parties involved seem to be able or willing to normalize their paths on their own, which likely means a crisis that sparks the adjustment.

Take your pick…

What we know?

The next 10-15 years will engender the next cycle of big change. The pressure of the 4 aspects below have been playing at the seams and they will come to a head increasingly in the next few years and the world political order will need to manage or will be forced to bear the consequences:

• Rapidity of scientific change;
• Population increase and aging;
• Excessive global leverage and imbalance;
• Climate change.

There is enormous bureaucracy built around governance and sophistication in economic supply-chains now. But the uncertainty that looms ahead is unprecedented. The post-ideology world that we had moved into once the Soviet empire fell is now taking a turn larger creating a mutation that we shall only witness and not fully control.

 

Science and the beauty of it all

Physics has been all too important in modern man’s life and I cannot even emphasize how much. And, in this age of wonderful discovery the most important has been the Second Law of Thermodynamics.

It’s the Second Law of Thermodynamics: Sooner or later everything turns to shit. That’s my phrasing, not the Encyclopedia Britannica. - Sally, In Woody Allen’s Husbands And Wives (1992)

 

Did you know? What are they surfing on their ____? It’s a pad, it’s a phone, It’s a laptop, It’s a TV…

Today approximately thirty corporations control 90 percent of world Internet traffic; Google alone manages an estimated 20 percent of the Internet’s content through websites, storage, and enterprise apps. ISPs, the current backbone of the Internet, prefer self-management and self-regulation to heavy state involvement. Furthermore, the publicly accessible Web is but a small fraction of the total Internet. The Dark Web of anonymous Torencrypted networks and Bitcoin transactions, the Deep Web of unindexed pages, corporate intranets, and other publicly unsearchable databases make up the vast majority of the Internet’s content.

 

For those wanting to think deeper in the new year!!!

Schrödinger's cat is a thought experiment, sometimes described as a paradox, devised by Austrian physicist Erwin Schrödinger in 1935. A cat is placed in a steel box along with a Geiger counter, a vial of poison, a hammer, and a radioactive substance. When the radioactive substance decays, the Geiger detects it and triggers the hammer to release the poison, which subsequently kills the cat. The radioactive decay is a random process, and there is no way to predict when it will happen. Physicists say the atom exists in a state known as a superposition—both decayed and not decayed at the same time. The scenario presents a cat that may be simultaneously both alive and dead, a state known as a quantum superposition, as a result of being linked to a random subatomic event that may or may not occur - Erwin Schrödinger, is famed for a number of important contributions to physics, especially the Schrödinger equation, for which he received the Nobel Prize in Physics in 1933

 

Excesses of the past

Money, Money everywhere not a drop to Recap. Even with the unprecedented liquidity infusions by ECB the banking crises will come to head…leave alone high levels of unemployment and immigration issues

Goldman Sachs estimates bail-out of Monte Dei Paschi will need Eur38 billion. And, this is just one bank. Italians have raised Eur20 billion for the bank bailout fund. Add, Eur 200 billion Italian investors have invested in junior (sub-debt) of these banks.

 

U2 remember - Unprecedented and Unsustainable!!

China's share of global consumption - Aluminium: 54%, Copper: 48%, Zinc: 46%, Steel: 45%, Rice: 30%, Gold: 23%, Wheat: 17%, Oil: 12%, Gas: 6%

 

We are sure!!

Man has for too long forsaken ability to accept change for rationality and certainty. Especially, the diplomatic community!! A beam called “Trump” just struck them.

“Western man has tried for too many centuries to fool himself that he lives in a rational world. No. There's a story about a man who, while walking along the street, was almost hit on the head and killed by an enormous falling beam. This was his moment of realization that he did not live in a rational world but a world in which men's lives can be cut off by a random blow on the head, and the discovery shook him so deeply that he was impelled to leave his wife and children, who were the major part of his old, rational world. My own response to the wild unpredictability of the universe has been to write stories, to play the piano, to read, listen to music, look at paintings - not that the world may become explainable and reasonable but that I may rejoice in the freedom which unaccountability gives us.” - Madeleine L'Engle, A Circle of Quiet

 

Beware asking for a revolution to achieve a state of perfection. If something scares all autocratic regimes is an overthrow where no counter balance exists. And, they have seen the Russians after 1991 and the Arab Spring…

“If mankind were to resolve to agree in no institution of government until every part of it had been adjusted to the most exact standard of perfection, society would soon become a general scene of anarchy and the world a desert.” - Hamilton

 

Economics and supply-chains

With the world population and productivity rising since World War II and fiat currency providing unlimited power to central banks to expand the monetary base, Keynes postulates of government intervention to smoothen business cycle were embraced and worked until 2008…the limitation of debt became clear but not how to turn the clock back…Of course people brushed up on Hyman Minsky’s works. He had talked about the accumulation of debt by the private sector in causing a crisis, problem of insolvent debt and the Knightian uncertainty (risk that is immeasurable and incalculable).    

From World War II onward, fixed capital formation rose like a west-to-east wave from under 20 percent of GDP to over 30 percent. Germany’s 1950s Wirtschaftswunder (economic miracle), Japan’s 1960s 9 percent growth rates, the “Asian Tigers” of the 1970s and 1980s (South Korea, Taiwan, Singapore, and Hong Kong), and then China starting in the 1990s, where it topped 40 percent of GDP and powered sustained growth of close to 10 percent for the past three decades. China embraced Keynes like nobody’s business. - Dr Parag Khanna

 

God forbid if a comet from space were to land in Almeria!!

The two hundred square kilometers of greenhouses in Almería in southern Spain, where up to half of Europe’s annual demand for fresh fruits and vegetables is grown, is unmistakable, especially as sunlight reflects off their plastic roofs.

 

We are literally moving mountains...

Maersk Triple-E that sets sail from Shanghai bound for Rotterdam can carry its full capacity of 36,000 Nissan cars, 180 million Apple iPads, 110 million pairs of Nike shoes—or some combination…

 

Mankind - Beauty and the beast

Maybe not the next 30-40 years but surely thereafter at a greater pace large scale migration can become a reality…unlike that we have seen in known history. Welcome to the age of climate change…

In the current century, closer to the equator became more than those towards the cold poles. But soon may require mass migrations, as equator and tropical population is hit by increasing temperatures, drought, and rising sea levels. Canada and Russia could become massive agricultural powerhouses producing most of the subsistence crops needing people to help their agriculture and feed the global population.

 

Mankind is capable of great good but at times gates of hell can be opened…

On 28 September 1918, in preparation for the final push through the German defensive line, British artillery unleashed 1 million shells in a single, continuous day-long barrage –11 shells per second for 24 hours.

As Lloyd Blankfein, chairman of Goldman Sachs, pointed out in 2009: ‘In January 2008, there were 12 triple A-rated companies in the world. At the same time, there were 64,000 structured finance instruments … rated triple A.’ In short, what the market demanded the innovative financial sector duly supplied.

 

These young people, they just don’t learn…

Four-fifths of all civil wars since 1970 have occurred in countries with a median age below twenty-five, precisely the Arab world’s demographic profile.

 

Wheels of change turn slowly but by the time change comes the great resource of energy and climate change may push things on the edge in the Middle-East...

How dreadful are the curses which Mohammedanism lays on its votaries! Besides the fanatical frenzy, which is as dangerous in a man as hydrophobia in a dog, there is this fearful fatalistic apathy. The effects are apparent in many countries. Improvident habits, slovenly systems of agriculture, sluggish methods of commerce, and insecurity of property exist wherever the followers of the Prophet rule or live. A degraded sensualism deprives this life of its grace and refinement; the next of its dignity and sanctity. The fact that in Mohammedan law every woman must belong to some man as his absolute property – either as a child, a wife, or a concubine – must delay the final extinction of slavery until the faith of Islam has ceased to be a great power among men. Thousands become the brave and loyal soldiers of the faith: all know how to die but the influence of the religion paralyses the social development of those who follow it. No stronger retrograde force exists in the world. Far from being moribund, Mohammedanism is a militant and proselytizing faith. It has already spread throughout Central Africa, raising fearless warriors at every step; and were it not that Christianity is sheltered in the strong arms of science, the science against which it had vainly struggled, the civilisation of modern Europe might fall, as fell the civilisation of ancient Rome. - Winston S. Churchill, The River War

 

Feeling Futuristic

Some people can just think too far ahead. Senor Cortés forestalled some of the great strategists of our time (Mackinder, Mahan or Spykman) and Europeans fought over control of the Mediterranean and the road to the Indian Ocean, then Americans over the Caribbean we still fight over the issue…South China Sea!!

Spanish conquistador Hernán Cortés made an equally extravagant claim in 1524: “He who controls the passage between the oceans may consider himself master of the world.”

 

The American’s ignored a golden rule after 9/11, now as America provokes hope better sense may prevail on China.

Never start a land war in Asia but never get involved in a trade war with a current account surplus.

                                                                _________________________

Hope that this random walk conjures the picture of decade of great change that we are about to step into…

 

And, finally the new year!

I hope that in this year to come, you make mistakes. Because if you are making mistakes, then you are making new things, trying new things, learning, living, pushing yourself, changing yourself, changing your world. You're doing things you've never done before, and more importantly, you're doing something - Neil Gaiman