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A question for Ben Bernanke at today's press conference:
• In 2005 at your confirmation hearings, you said there was no housing bubble
• In 2007, you said the subprime fallout was likely to be contained
• In 2008, you said you didn't expect a recession
• In 2009, you said the Fed would not monetize US government debt
• In 2010, you said inflation was too low
Question: Are we supposed to laugh or cry?
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The brilliant, provocative, and slightly mad GMU economist and blogger Tyler Cowen wrote his New York Times column about why the Euro zone is headed for breakup. I get the sense an editor read the column, spit out his coffee, and smacked a headline on it that buried the sensational implications, which may be prompting calls from Euro-mandarins to Sulzbergers as we speak.
Here is why the Euro is ultimately doomed:
Suppose the US and Canada have divergent economies, but separate currencies. Both countries make cars. Canada is (purely hypothetically) a poorly performing economy, with poorly educated, unproductive workers, inept management, high taxes, inefficient government regulation and services, resulting in low quality, expensive cars. Canada will have a hard time selling its cars internally and exporting them to the US, while the US will export cars. As consumers buy fewer Canadian cars and investors have little reason to invest there, the Canadian dollar will tend to decline vs. the US dollar. But as the CAD declines, Canadian cars will start to get cheaper relative to US cars in both countries, allowing more to be sold. Poor productivity growth leaves Canadians with a lower relative standard of living as imports get expensive, but they can still sell some cars, and the adjustment in the currency cushions the impact on production and the domestic economy.
Now suppose the two places we're talking about are Michigan and Alabama, which share a currency and a common Federal government. Alabama's car manufacturers do well, Michigan's do poorly. Michigan can't devalue its currency, since it shares the USD with Alabama. Its auto sector shrinks. People are laid off from Michigan car factories, and some of them move to Alabama, where car workers are in demand. The overall US economy is doing no better or worse than before, and as Alabama booms, taxes are generated, and help the Federal government pay for unemployment benefits, retraining, pension benefit guarantees, social security as older workers retire, and other help for Michigan. There is no currency cushion, but labor mobility and transfer payments cushion the adjustment.
Now let's go back to the first Canadian example, and suppose the US and Canada shared a currency. Canada can't devalue, so its cars remain uncompetitive and manufacturing shrinks. Workers lose jobs, but can't easily move to the US due to language and cultural barriers. Canada's unemployment rate goes up, tax receipts decline and the Canadians have to borrow to pay unemployment benefits and cut services. They start to run deficits and eventually they're on the brink of default. They turn to the US for help. US taxpayers feel they did everything right, so why should they bail out those lazy Canadians? Canadian taxpayers feel like those hegemonic Americans are telling them what to do, and running a currency and interest rate policy that impoverishes Canadians.
When the 'North American dollar' (NAD) status quo becomes politically unsustainable, one of two things can happen. 1) The Canadians go back to the CAD, which depreciates sharply, making it impossible to pay back USD debts. They default on sovereign debt. They institute capital controls which make it impossible for their companies to pay back 'North American dollars', and rewrite the rules so foreign debtholders can't take the assets in bankruptcy.
Or 2) the US goes back on the USD and Canada stays on the NAD, which depreciates sharply. Now the Canadians can pay back their debts in cheap NADs, and there is no need for a messy default.
Either way, any poor suckers who end up with Canadian assets and US liabilities get taken to the cleaners, including banks which will be busted and have to be taken over by the government or get massive bailouts.
Substitute EUR for NAD, Greek drachmas, Irish punts and Portuguese escudos for CADs, deutschemarks for USDs, and you get the picture. The fundamental problem is that Europe's monetary integration is too far ahead of the economic, social and political integration. Perhaps a bailout will be arranged this time, but the next one may be politically impossible. Unless the political and economic integration catches up, a sufficiently big crisis will inevitably rip up the Euro zone. Either a hard core centered in Germany will secede from the Euro, which seems less damaging and therefore more likely, or some peripheral countries will undergo Latin American style political and economic upheavals.
Either way, it will be a huge mess. The massive banks are already somewhat crippled by huge home mortgage losses; they have hard-to-disentangle cross-border operations; and there are a multitude of governments and regulators who coordinate with great difficulty.
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I have been reading the poor reviews of Atlas Shrugged. I feel almost disappointed that it is by collective consensus a steaming turd. I would welcome a thoughtful movie about an interesting thought experiment, and I think the country could use a rare substantive debate about the size and role of government.
I like the libertarian ideal of as much economic and personal freedom as possible, consistent with the equal liberty of others.
Nevertheless, people who believe in Libertarianism or Objectivism as a practical political ideology are a bit wacko.
Communists made the unfortunate claim that the individual doesn't matter, everything is the collective. Individual property is illegitimate, every speech or action is good or bad depending on its impact on the collective. It was a terrible, harmful corruption of an ideal of equality to say individuals don't matter, only the group matters.
Libertarians make the opposite claim, that individual rights and liberty are all that matters. This reaction to a profound error leads to another profound error.
There's a part of The Fountainhead where the talented architect Roark makes a deal that he'll design housing for the masses, if it will be built exactly as he designs it. The guy he makes the deal with can't deliver the goods, and through the political process lots of changes get made. Roark blows up the building, and in his trial says that he had the complete right to dynamite it because it would not have existed without him and it had already been destroyed by the additions made by losers, and he's acquitted.
What about the investors who paid for the building? What about the other professionals who worked on the building, engineers and electricians and engineers, did they have an equal claim to destroy it? What about the people who might have been sheltered happily in the building, blissfully unaware of what might have been? Was Roark trampling on their right to realize themselves by destroying the group's creation? Isn't it distinctly possible that Roark's great design was an evolution of other great masters he learned from? Perhaps they might have marveled at his brilliance, but might some of them have also felt a desire to blow it up as a bastardization of their own work?
Communism failed because we humans like to own stuff, express ourselves creatively and realize ourselves as individuals. Libertarianism is equally wrong, because we do almost everything worth doing as groups, and group identity (and the politics that go with it) are genetically hardwired into us. Anybody who's been to a stadium knows we're tribal. The fashion industry and organized religion have viable business models based on our desire, not just to distinguish ourselves individually, but express our affiliations and seek meaning in our lives as part of a larger group.
These are complementary aspects of ourselves. We're individuals, and we're interdependent. Any practical 'ism' has to balance these two.
Somebody said that conservatives want government to be like your father telling you how to behave, liberals want government to be like your mother clothing and feeding you and taking care of you, and libertarians are like children throwing a tantrum and running away from their mother and father so they can eat more ice cream.
Keynes said that every government action is a tradeoff between liberty, efficiency and fairness. I would say that if you think fairness or equality is all that matters, you're a communist. If you think that all that matters is efficiency in the pursuit of economic growth (or any other goal like the success of a race or the word of God), then you're a fascist. And if you think liberty is all that matters, you're a libertarian, and as wrong as the first two.
The maximum liberty consistent with the equal liberty of others: I'm with you up to there. When you start saying the group has no right to compel anyone and restrict their liberty, that all human behavior should be based on voluntary cooperation, and all taxation and regulation are illegitimate taking by force, you're an extremist.
The idea that a modern society could function at a high level without a strong and sometimes intrusive state is wrong. There are laws against things we all agree are immoral, like violence and theft. There are also laws like traffic rules and property zoning, that solve coordination problems. Then there are government activities around public goods like roads, subways, defense, and I think public health (pollution, food safety, medical care) and education fall into those categories.
It is very true that there can be a fine line into paternalism, ignoring market incentives, overreaching beyond the area government can be effective, and favoring politically privileged groups. But to be against vaccination requirements, or airliner safety regulations and inspections, or collective action by common agreement against other threats is madness. To think unfettered freedom can solve all problems seems like magical thinking. It seems more likely to give rise to feudalism and mafia rule, as the strongest abuse their power, and people accept rules that entrench powerful interests as a substitute for chaos.
Fortunately, these guys have no chance of forming a successful movement. How could you organize collective action by people who don't believe in collective action?
Let me say at the outset that I am bullish on gold in the long run. US demographics, politics, debt levels, harder-to-extract energy, peaking of globalization's labor supply shock: all these point to inflation in the long run. And central bankers have not exactly covered themselves in glory lately.
That being said, going back on the gold standard makes exactly as much sense as going back to horses and buggies.
Here's why. Gold enthusiasts point out that a good suit cost about an ounce of gold in Roman times, Revolutionary times, and (at least until the recent bull market) modern times.
An observation, and then a question. From Roman times until the early 1800s, growth was low, then both populations and per-capita GDPs soared. Q: If the world was still on the gold standard, would gold be worth more, or less than it is?
The answer is, a hell of a lot more. The dollars people now hold would need to be gold equivalents, and gold demand would be far higher. Back of the envelope estimates: since 1820 world real GDP has gone up by a factor of something like 60. The world's inventory of gold has gone up 15 times (from the oft-quoted saw that 90% of the world's gold has been mined since 1848).
Therefore, if the relationship of gold supply to real GDP had stayed the same, the price of the suit in gold would have had to have drop to about 1/4.
Simple math: if the amount of gold added to the world's inventory is something like 1.5% a year, and if world real GDP grows at a 2.5% rate, prices have to fall 1% annually to keep the amount of gold relative to nominal GDP the same.
In a modern economy, price deflation is death. Suppose you're an investor and an entrepreneur comes to you with a proposal to build a factory, and the business plan shows next year the factory will cost 1% less to build, and the products will sell 1% cheaper. Why build a factory today if you can get a 1% a year increase in purchasing power just by keeping gold in your mattress? You would need a very big or very certain return to lend it out or invest it.
The upshot is, under the gold standard fewer factories will be built, real interest rates will be higher, and entrepreneurs and established companies are not going to get access to the cheap capital which generates high rates of growth. Falling prices and strong growth tend to be mutually exclusive. (Inflation and taxes force entrepreneurs to invest, take risks, and basically run to stay in place - as long as they're not so high and unpredictable they defeat the purpose of running.)
When you get strong growth globally and a fixed amount of gold, you end up with not enough money to go around, and a banking crisis. People don't cut prices and wages when times are good. In fact behavioral economics (and long experience) shows they avoid doing so even when times are bad. Growing GDP and fixed money supply means interest rates go up. Banks get creative about trying to lend as much as possible with limited capital. Eventually, the countries that are losing gold suffer bank runs and financial panic. They might devalue their currency, screwing the people who hold it, exactly as the gold-standard advocates hope to avoid. Planet-wide the supply of gold is fixed, so the panics roll around from country to country, until depression brings economic activity and prices back in line with the gold supply that can support them. (To true gold afficionados, this is a feature, not a bug.)
I was once at a dinner honoring Paul Volcker, and a bolder acquaintance asked him what he thought about Ron Paul and the gold standard. His answer was in the old days, the gold standard was a millstone around central bankers' necks and they were quite glad to be rid of it.
The crux is, you need a certain amount of money, determined by the size of the economy, and the price level, and the technical efficiency with which you can use it for transactions. Too much money, you get inflation. Too little, you get high interest rates, panic and depression. In a fiat money system, the central bank decides how much money there should be. In a gold standard, the amount is fixed, except for mining. The gold standard is like having a hard core central banker who grows reserves according to an ultra-strict rule.
Consider these monetary regimes: 1) a fiat system where central bankers determine the money supply; 2) a strict monetary growth rule where money is allowed to grow in line with GDP; 3) a commodity basket regime, where monetary growth is managed to keep the price of the basket relatively constant over time; 4) a gold standard, where the basket is reduced to 1, and the supply of money grows in line with the quantity of gold, not the price.
The utter pointlessness of the gold standard argument is seen by the fact that a typical response to a panic, or war, was to suspend convertibility, provide paper liquidity, and then later go back on the gold standard at a devalued rate. If you do this often enough, it's not very different from never being on the gold standard in the first place. It's a fiat currency, intermittently managed to keep it in line with gold as long as times are good.
Under the less hardcore monetary regimes like 2) and 3), in extremis, bankers can adjust the parameters of the monetary rule. When push comes to shove, bankers always do what they want. It follows that in the long run, whatever anyone decides, the supply of money ultimately depends on the judgment of central bankers. Even the great Volcker went back from 2) to 1).
Far from being persuaded by people who think the gold standard is the only stable system, it seems clear to me that a flexible economy needs a flexible currency and fiat money is the only stable equilibrium.
The US dollar might totter as it is seen as a less reliable store of value, but the Fed always just has to go up the ladder of target credibility (and pay the economic piper) to restore it. The only thing the USA has to do to keep the fiat money system going is 1) not disappear from the face of the earth and 2) go up the hard-money ladder quickly enough to avoid hyperinflation.
In other words, not completely screw up.
In the next few years or maybe decades, I suspect there will be ample opportunity to screw up. The US will be less important in the world economy, the dollar will be less acceptable, everyone already has too many, and for various reasons alluded to above, we will move down the credibility ladder, closer to Argentina than Switzerland. So I'm a dollar bear and a gold bull. But if you think fiat currencies are going away, then you have succumbed to gold buggery.
You might be a gold bug... if you think 'manipulation' is keeping the price of precious metals low; if you think yellow metal is the only way to own gold because ETFs and futures etc. are backed by nonexistent inventories (warehouses and auditors notwithstanding); if you chart stocks by their value in gold as a measure of ontological reality instead of a thought experiment; if you deflate anything by the monetary base; if you think inflation and taxation are theft and represent the worst possible outcome in an economy, but if all the banks had been allowed to collapse in an old-style panic, the effect would have been good for the soul in the long run.
From The Reformed Broker, some other signs you might be a gold bug.
1. The cloud. Transition from a PC-centric world to a mobile/cloud-centric world. Microsoft is the new IBM. Google is the new Microsoft. Apple is the new Apple - innovative, iconoclastic, beloved by early adopters, but not necessarily the mass market solution because they are expensive, closed, loathed by carriers/OEMs. But smartphones are still a niche market, when everyone needs a smartphone, and they have a choice of an almost free Android vs. an iPhone, I wouldn't bet on the iPhone, especially internationally.
Subtrends
- infrastructure as a service (go to Amazon or Rackspace and order 100 virtual servers in their data center in a public or private cloud for you to set up and administer as you wish)
- platform as a service ; get a full stack for a Web application, Linux, Apache, Mysql or a NoSQL database, PHP or Ruby on Rails, roll out 100 web servers with your application
- software as a service - buy an application delivered over the Web, like Salesforce.com, or Google Office
- anything as a service
- migrate anything to mobile (social, location-based) devices and apps
- 4G networks
2. Social knowledge / Digital culture. All knowledge is becoming universally available, interactive, and social. When I was a kid, a book was a treasure... now you go on your iPad or Kindle and every book you could want is at your fingertips. The medium is the message, and knowledge is now collaborative, everything is a conversation. You comment in the online PHP manual and it is updated, or you comment on a news story, your comment is upvoted, and the author revises with a correction or clarification. All information is social, shared and discussed via Facebook and Twitter, and social news aggregators like Reddit. The mobile/cloud might be the more tangible and investable transition, but digital culture is pretty earth-shattering, really a second Gutenberg revolution.
- social apps; location-based apps
- decline of traditional media, rise of blogs, news aggregators
3. The Internet of objects.. Everything online, tracked, and controlled over the Internet. Google just paid a ton of money for a flight tracking company. Package tracking is mainstream, ADT advertises that they let you see and control your home over the Internet. 1m mainframes -> 10m minicomputers -> few hundred million PCs -> few billion mobile phones -> 10s of billions of devices. Still very early.
- RFID, mobile phone readable bar codes
- IPv6
4. Privacy/security. As everything goes digital, we have to reinvent privacy and security technologies and social conventions. I loathe Facebook because they act completely oblivious to the privacy implications of their actions, every day they make public information that harms their users, and they take the miraculously open and anonymous Internet, and turn it into a private platform where everyone is tracked, and your personal information is turned into their private property. The law and technology will need to evolve, unlike the early days of the Internet the security and political complex is not going to be behind the curve, and the trends don't look good.
- Facebook
- Google/China
- Integrating security in hardware - Intel/McAfee
Sub trends that fit into multiple/all categories
- Big data - making sense of the ridiculous large amounts of 'data exhaust' of all our daily activities
- Database marketing, online marketing
Further reading/mostly stolen from:
Ray Ozzie's outgoing Halloween Memo
Discussion by Don Dodge of Google
McKinsey's top trends.
China's remarkable growth continues - China has apparently now passed the US in industrial production, with the world GDP title in its sights (see previous post).
So how incredibly fortunate it is that the USA retains its commanding lead in the services sector! Clearly, future opportunities will abound in such sectors as retail and food services, debt collection, and of course government and related services. Based on recent government initiatives, the medical and military service fields seem particularly well positioned. We owe a huge debt of gratitude to all our heroes who serve overseas, in present and future military adventures, declared and otherwise. But those also serve who merely wait at home, for where would our GDP be without imputed rent on owner occupied housing? The fortitude of our world-beating service providers and consumers makes my eyes well up. I can't help whistling a few bars of John Philip Sousa as I suppress the urge to chant "USA! USA!"
And yet there is one corner of the services sector, where we imagined we were invulnerable, but now find China surpassing the USA and emerging as world-beaters: bank shenanigans.
I just read the remarkable book Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise, by Carl E. Walter and Fraser J. T. Howie, and think it's worth a quick summary.
After the 1978 liberalization, banks expanded lending liberally to real estate ventures in the Special Economic Zones, moving their franchise beyond lending to state owned enterprises. As it turned out, the tropical island of Hainan did not have the anticipated potential that had enabled 20,000 real estate companies to flourish. And the backing of the rock solid Chinese government apparently did not extend to ensuring that state-owned enterprises (SOEs) which experienced the downside of the free (or freer) markets actually made good on the loans made to them at the behest of patriotic duty and the party.
Hence, after some years of pursuing hope as a strategy and delaying recognition of non-performing loans (NPLs) and inadequate capital, a bailout of banks was deemed necessary and desirable. And where else to look but at the bastion of capitalism, the USA and its experience with massive leverage, the RTC, off-balance sheet entities and delayed recognition of losses and 'too-big-to-fail'? The restructuring of the banks took shape in multiple steps.
Step 1: in 1998 reserve ratios were reduced. This freed up room on balance sheets, which the banks used to buy a special 7.2% bond issue from the MOF.
Step 2: the MOF simultaneously turned around and bought 7.2% bank bonds which the banks booked as long-term capital. Presto, capital ratios were miraculously replenished!
Step 3: a good-bank, bad-bank strategy similar to the RTC. For each of the 4 big banks, an 'asset-management company' (AMC) was created. The AMCs were initially capitalized by $1B in loans (all figures USD) from the MOF.
However, there was apparently some political difficulty in shelling out the large sums needed to capitalize the AMCs in a way that would have enabled them to take the necessary volume of NPLs off the books. Where to get the rest of the cash but from the banks themselves? The banks then loaned $105b to the AMCs to enable them to purchase bad loans at full face value. By this unusual and creative expedient, the banks swapped the NPLs for bonds backed by the AMC's assets, which were the NPLs themselves, enhanced by the undoubtedly fully reassuring state backing of said AMCs. The central bank kicked in additional financing of $75b in loans to the AMCs to buy additional NPLs.
Step 4: Conveniently ignoring the fact that the NPL problem was still there, swept under the rug with the AMCs, take the banks public. If you wondered why Hank Paulson spent so much time in China, it was to find collections of state assets that could be cleaned up, repackaged as national champions, and sold as future world-beaters and proxies for China's amazing growth. With that kind of action, you couldn't keep Paulson and other investment bankers away with a stick. 3 of the 4 big banks went public, the straggler, Agricultural Bank of China, didn't make it until 2010.
But Western style finance turned out in 2009 to be somewhat less robust than met the eye. As Chinese exports cratered in the financial crisis, it was imperative to keep the economy going. The state called on the banks to lend, and on industry and local government to step up with investment projects. In their patriotic duty, banks rose to the task, enabling governments to seize land from farmers and build apartments, not to mention high speed rail, and any other pet project local politicians fancied. In 2009, banks grew their loan book 30+% - BOC over 40%. Many of the projects were half-baked, premature, or possibly tainted with corruption, and it seems likely that they may not yield cash flow for some time, if ever.
Which leads us to today.
The 4 big banks are the lynchpin of the financial system, as of 2009 controlling 43% of financial assets. Bond markets are immature and consist largely in banks floating bonds at politically determined interest rates that they themselves hold to maturity, essentially loans by another name. Stock markets are similarly immature, with slivers of SOEs held by the public investors, which have no influence or control rights.
The state still owns majority stakes in the banks and retains control, with management appointed by the party. Loans are still politically mandated, along with appropriately modest interest rates as befits projects backed by the government (whose power and strong credit somehow does not always guarantee that these loans are repaid on time)
The more reform-minded officials hoped at the outset that the AMCs would be wound down, the losses would be recognized, by the state guarantors if necessary. Publicly held banks would move toward international accounting and credit standards, and over time the financial markets would mature. And as it turned out, the AMCs were not wound down, when the initial bonds came due, they were simply rolled over.
For now, the banks are reporting record profits, and low NPL ratios. This a mathematical artifact, since the massive volume recent-vintage loans isn't yet seasoned enough to go sour. The banks still sport huge market caps and pay large dividends. One might question the wisdom of a hefty dividend, since rapid economic growth in China means rapid bank loan growth, necessitating an equity base that grows in parallel. Even with prudent lending and without paying fat dividends, the banks would need to periodically come to the market to refresh equity capital.
A future restructuring seems in the cards, it's just a matter of how long it takes for an NPL problem to emerge, how big it gets, how long it is swept under the table.
As long as China's economic performance continues and the country retains its vast FX reserves, the country clearly has the wherewithal to weather significant storms. The question is simply who will bear how much of the losses: the central government through the AMC guarantees, the local depositors who have no other outlet for savings and receive below-inflation returns, or the shareholders.
What's clear is the first-rank market caps of the banks (ICBC is the biggest bank in the world by market cap) are not related to their performance. They simply reflect investors' estimation of the likelihood they will continue to receive the dividends, and desire for an exposure to a proxy for Chinese growth. Dividend reduction would be a loss of face and future access to capital. The GITIC insolvency ended up in losses for creditors who thought they had state backing. If the political winds blow against continued liberalization, it's not impossible that a bank's management might be purged and required to make public self-criticism, and shareholders might have to take a haircut. (Some days, purging and public self-criticism, not to mention the ultimate price of execution for corrupt managers, would seem like management practices Western finance could benefit from)
What's also clear is that China's world-class manufacturing has not been accompanied by world-class financial markets. China's economy is not in a process of continuous liberalization toward free market capitalism. It reflects the highly selective application of market incentives in a politicized, state-centric economy. Minority equity investors will get whatever returns the political winds blow their way. In the Chinese stock market, control is not for sale, there are no mechanisms to bring stock returns in line with economics, which are in any case totally dependent on the political winds.
To paraphrase what someone said about George Steinbrenner, there is nothing quite as junior as being China's junior partner.
Further reading:
Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise, by Carl E. Walter and Fraser J. T. Howie
Wall Street Journal book review of Red Capitalism, reviewed by Edward Chancellor
Forbes: China Banks' Illusory Earnings.
FT Alphaville: China's useless banks.
A few years old, but new to me: an interesting perspective from Yegor Gaidar, reformist economist of the post-Gorbachev era.
• Collectivisation and urbanization left the Soviet Union with a grain shortfall. Rather than reform the agricultural sector, they paid for food with oil exports.
• In the 1985, the Saudis decided they would no longer act as swing producer and forgo exports while other members of OPEC cheated. The Saudis started a price war and broke up the cartel. Oil went briefly under $10 a barrel and Soviet oil revenue dried up.
• At first the Soviets paid for food with foreign reserves, then they borrowed. But then they began to reach the limits of their credit.
• Part of Gorbachev's reforms were with the idea of becoming a country the West would lend to, even provide state guarantees in exchange for reform.
That didn't work out too well. As Brzezinski later said, the Soviet Union could be an empire or a democracy, but not both. Once they showed weakness, everyone wanted out.
In the post-war period period (possibly throughout the dynasties), truth has been relative in China, while power has been absolute.
Today's propaganda and censorship can be shockingly ham-handed. Foreign websites are routinely blocked. While the policies change, unaccessible sites on my recent visit seemed to include YouTube, most social media platforms like Facebook and Twitter, and blogging platforms like Blogger, WordPress. Seemingly odd sites like Picasa for photo sharing were blocked. Other social media sites like Reddit were available, maybe they just not popular enough yet, and as every site goes social, you can't block everything. Google and Gmail have seemed mostly accessible but occasionally not - no way to tell if it was a problem on my end, Google's end, or government interference, but Google complained that it was the government and I am inclined to take them at their word.
I had not prepared for the eventuality of no Facebook, but was able set up a VPN connection in no time that fully circumvented the restrictions (securitales.com). VPNs have also been blocked in the past. I tend to think the rapid circumvention is not ineptitude, but security agencies keep some VPNs open to keep an eye on users, and they may be either technically compromised or in cahoots with the security forces.
(An aside on Google - Google moved its site offshore, complaining of ham-handed interference and Chinese attempts to hack them and gain access to dissident accounts. I'm sure they also felt they would be unable to crack the market beyond their share of 30% or so and the upside of staying was limited. The government appoints national champions they can work with, and this seems to be Baidu. Baidu has no problem indexing MP3s, something Google can't do. (Ironically, Google got in big intellectual property trouble in China over Google Books.) Google itself doesn't trust the Chinese and restricted local engineers' access to source code. And of course, there's the usual culture gap - local competitors have been more nimble and better with the Chinese writing system.)
To foreigners and English speakers this kind of censorship seems like a pretty big deal. But it's highly unclear if Chinese speakers really find it that intrusive, since censorship is highly effective on local publishers, so the need for crude blocking tools is less noticeable.
Local media are pressured and harassed if they step out of line. The case of the investigative magazine Caijin is highly instructive. Despite a finely tuned ear and pen and highly placed government supporters, they were eventually hamstrung and the real reporters replaced with government stooges. (An excellent longer read). Reporters Without Borders ranks China 171st of 178 countries on its press freedom index, between Yemen and Sudan.
Reportedly, broadband availability is high, even in rural areas (if expensive), and about 1/3 of the population is using the Internet. Mobile phones are ubiquitous.
The rate of change is stunning and I cannot really imagine what the generation gap must be like. Grandparents might have experienced civil war, revolution, turmoil of the Mao era, and now an incredible modern world. Parents worked hard to build modern China. Children have access to pop-culture riches parents could never have dreamed of.
The urban-rural divide is gaping. Guangdong in the south near Hong Kong and the huge Yangtze river delta from Shanghai inland have the bulk of the industry. The little I saw of countryside from train windows was decent houses but pretty small plots, solar water heaters but not big combines (of course anecdotes are not data and regional variations must be huge).
Within the cities, the wealth gap feels more or less Latin American, the destitute next to high-end luxury stores and gleaming vanity office projects. The official numbers show much less inequality, but have little credibility.
The hukou system, forcing people to register in their home towns and get permission to move, is one burden. China understandably seeks to limit massive influx into the cities leading to giant slums and an even bigger informal economy. But the numerous migrants who do make the journey are illegal aliens in their own country, unable to access education for their children, medical care and other services unless they go back to their home. This results in children left with grandparents, homeschooled, or not in school. The more or less universal literacy rate is a huge achievement and the necessary precondition for all of China's other achievements, but progress may have stopped since the 90s.
The one child policy doesn't apply to everyone and is unevenly enforced when it does. It has reduced fertility to 1.8% vs. a replacement rate of 2.1%. It may have prevented 400m births, and one can hardly blame authorities for recoiling at the implications of that kind of population growth. There is a shortage of women nationally, with 118 boys born for every 100 girls, but in some villages it can be as high as 140. North Korean women have been known to be trafficked and sold as wives. Stories of pressured abortions and sterilizations are commonplace. The rate of female suicide has been reported to be the highest in the world. It seems likely that the policy will be relaxed eventually. If for no other reason, this will happen because while current demographics are highly favorable for growth and savings, if trends continue, the dependency ratio is set to rise dramatically, putting pressure on improved living standards, and the population will then decline. (Low fertility takes a long time to reduce fast population growth - at first the cohort dying off is smaller than the fertile one)
Corruption and land grabs are a continuing problem. All land still belongs to the state, but you can get long-term rights. Decentralization has left provinces scrambling for money, especially the poorer ones. Requests to the central government for financial help are not necessarily heard, nor a ticket to political success. Rapid growth makes it a great business for local authorities and developers to grab land from farmers, build factories and apartments, and share the booty. In theory, compensation is offered for landgrabs, in practice it is at best below market rates. At worst, you get your utilities shut off and goons harass and beat you until you leave. If you dissent, Chinese courts have a conviction rate of 99%. And the CCP can still send you to labor camps for no reason whatsoever, although it happens much less frequently.
Three corruption scandals: the massive AIDS outbreak after villagers were strongly incentivized by the state to sell blood; two were executed for adulterating baby food by adding an inedible nitrogen-rich compound to make protein content appear higher in tests, officially killing 6 and sickening 294,000 ; and Chongqing trials showcased the nexus between corruption, politics, and the underworld. These also highlight the current government's aggressive response when corruption crosses a line and threatens social stability, and a very limited check and balance in the form of a thin strain of activism and press freedom which is not fully stamped out.
The diminishing safety net and land grabs have left some worse off than before. Dislocation has increased, even as roads and railroads tie the country closer together. Between heavy-handed state direction of the economy, censorship, the hukou system, and the one-child policy, corruption, it would be stunning if there was not a lot of latent dissatisfaction. But directionally, the improvement in most people's living conditions vs. their parents is equally stunning. The Chinese people have suffered so much that things still look pretty good. They have had zero indigenous experience with liberal democracy and it is a foreign and shocking concept to the overwhelming majority of people. Since Tienanmen, it's clear the CCP will do whatever it takes to hold on to power. That resistance to reform (and all of Chinese history) presents a choice between submission to a strong central authority, or chaos and destruction of the progress China has made toward unity, wealth, and global respect. These facts, together with state control of media and the harsh reaction to any dissent, explain the lack of pressure for liberalization. However, the Hong Kong experience with civil liberties (despite the complete lack of democracy under either the British or the mainland), and increasing travel and Internet access, cannot help changing that equation on a generational time scale.
In 2012, China will get new leaders. I don't have anything brilliant to say about this, so I'll return to it if I do in the future. However, the new leader Xe (pronounce 'She') is associated with the Shanghai clique brought to power after Tienanmen and responsible for the top-down industrial policy and FDI focus. But he is also ex-governor of Zhejiang, which is the province south of Shanghai with a far higher rate of indigenous entrepreneurship and non-salary income than Shanghai and other neighboring provinces. He is also a 'princeling', the son of a man who was appointed Guangdong ex-governor, and seems to have had a privileged career. But after his farther was purged in the Cultural Revolution, Xe was sent down to work on rural farms, where he spent seven years, finally able to go to university after Mao's death. The number two, Li, is a member of the 'Youth League clique', the perhaps somewhat more ideologically and rurally focused faction of current leader Hu. While I have little insight, the focus may be on reducing export dependence and increasing domestic consumption, if anything stepping back from market reforms towards international standards of accounting and corporate governance, never mind political liberalization.
The Chinese have made a deal with the devil (or the CCP anyway): stay out of politics, don't challenge the absolute authority of the CCP, and you can do more or less what you want. The trains will run on time (and will be new high speed trains). The Communists fundamentally underestimated the ability of capitalist democracies to evolve. Could we be making the same mistake with China? A deeply mysterious process has enabled a highly competent succession of leaders to emerge and hand off power peacefully for 30 years. Western style democracy and capitalism often do no better. But they have proven the ability to self correct their worst excesses. The political will that enables China to get things done, even when they cause massive dislocation, does not appear to allow for similar checks and balances.
Some of China's small neighbors have experienced effective dictatorial leadership that over time moved countries closer to true liberal democracy - Korea and Taiwan come to mind. It's possible China is following the same path 20 years behind them. It also seems possible that ineffective, kleptocratic leadership could come to power - Russia comes to mind too. China has experienced rapid change and tumultuous upheavals, and they do not appear to be over.
Fellow travelers: Zhou, Mao and 2 revolutionaries I never heard of in Shaanxi, 1937
I spent most of March in Asia and trying to figure out China. To understand the present, you have to understand the past, so I turned to The Search For Modern China, by Jonathan Spence of Yale, which seems to be standard fare for undergrad history surveys. It was a great start, although I wished he had given his analysis of the whys as well as the who, what, when, where, despite the political sensitivities when talking about modern China.
Here is a quick summary mixed with a few conclusions and speculations.
The history of China seems to be a cycle of a strong leader and faction taking over the country, ruling it for generations as a dynasty, then decaying, and eventually getting supplanted by a new dynasty (or a period of civil war and chaos) when they get too weak and corrupt to centrally manage a huge country,
China is a big country, the size of the United States, but 4+ times the population, ie North America plus Western Europe plus most of Latin America. The populated areas are easy to get around through the river systems and flat plains, so anyone who took over would strategically want control all the way to the oceans in the east, mountains in the southwest, and vast deserts in the northwest in order to be safe from internal and external enemies. To the north, fertile land and the reach of the Han people peter out, so a wall may have seemed like a good idea. To lead China, so vast and diverse, is to be a very strong leader, or a very insecure one, or both.
Despite the vast size, and language and cultural differences which are similar to the differences between Italy and Britain, uniting China seems to have been regarded as a desirable thing, as the somewhat fluidly defined 'Han' people seem to have forged a common political and cultural identity for a large part of recorded history. In this they are similar to Indians, who have possibly even more vast language, cultural, and also racial and caste divisions, and yet share a common identity as Indians.
The Ming Dynasty (1368-1644) built the Forbidden City and the Great Wall. Their peak is seen as a time when China seemed to lead the world. But they weakened and turned inward, burning all their ships, and restricting contacts with foreigners who came near.
In 1644 the Ming fell to invaders from Manchuria who took up residence in the Forbidden City and appointed themselves the Qing (pronounced Ching) dynasty. The Mings and previous emperors had generally been content to make the Koreans, Vietnamese, Tibetans and others into 'tributary states' who were under Chinese influence but not ruled from Beijing. But the Manchus, already an ethnic minority ruling the Han, didn't feel inhibited from incorporating additional ethnic groups and extended the borders of China proper into Tibet, Mongolia, and Central Asia. In today's Chinese schoolbooks, the 'tributary state' distinction is glossed over, and historical maps show that Tibet and Central Asian Xinjiang have always been part of China. (In the now disputed Ryuku islands, people sometimes paid tribute to both China and Japan. When the Middle Kingdom's ships were sighted, the locals would hide signs of the Japanese and pay the necessary respect and tribute until the Chinese were back over the horizon.) The current 'Han-ification' of Tibet and Xinjian seems unrelated to any strategic or economic benefit (perhaps there is some mineral potential), and more a matter of pride in restoring the maximum extent of the Qing empire.
While the Mings were turning inward and decaying, Europe entered a turbulent but dynamic phase, took the inventions of gunpowder, paper and printing which originated in China, and took them to a new level. It is interesting to speculate on why Europeans explored the world and improved technology and China did not, but certainly intense competition between rival states provided strong evolutionary incentives, and the Christian schism led to questioning and upending of traditional relationships. Central control, Confucian conservatism, and the challenges of empire may have played a role in China in not encouraging too much individual and creative thinking (and possibly the current CCP feels the same, wanting educated technocrats who don't seek too much change).
Starting from the 1500s, Europeans became big explorers and traders with China. The Portuguese were tolerated at Macau from the 1500s after they did the Mings a favor and killed off local pirates. The British wanted porcelain, silk, tea, and spices, but the Chinese were highly resistant to any imports. This was highly inconvenient, and had major economic repercussions as British gold and silver were used up to buy Chinese goods, leading to tight money. It led the East India Company to an intensive program to grow tea in India using seeds imported from China (ironically, after heroic efforts they found local Indian varieties like Darjeeling grew better and where quite marketable). It also led to growing opium in India and trading it with China, which successfully stopped the outflow of gold and silver.
China now had a problem with opium addiction and balance of payments, and tried to stamp out the opium trade. In 1839, the crafty and competitive independent traders who had entered China after Britain ended the East India Company's China trade monopoly managed to successfully maneuver Britain to war with China, in order to open trade in opium and other products. A half-hearted defense of Britain: there were politicians whose initial reaction was, if China doesn't want opium, don't sell them opium. However, they were no match for the opium traders' ability to stoke political support through judicious application of funds and newspaper propaganda, and their ability to goad the nonplussed Chinese into attacks on persons and property which the British felt 'must not stand', as they say today.
Humiliation ensued for the Chinese, the ceding of Hong Kong island to the British, and the start of a cycle which would continue for the next 90 years. Western commercial exploitation would expand until it met Chinese resistance, which would be a pretext for further military humiliation, taking more land and commercial rights.
Even the colonies got infrastructure to the extent it served commercial exploitation, and legal and institutional frameworks. The Chinese got opium, the sacking of their palaces, removal of antiquities, and 'extraterritoriality', where foreigners were not subject to Chinese law. (In defense of the West, the Chinese did not have a remarkably transparent legal system and had developed a habit of summarily executing accused Westerners.)
In street markets in Hong Kong, vendors display a fish and cleverly chop out and sell pieces in such a way as to inhumanely keep the fish alive and fresh as long as possible. That's how the the French, Americans, Germans, and Japanese carved up China. The amazing thing is that the Qing dynasty actually survived as long as 1911 despite their own ineptitude, conflicts with foreigners, and internal rebellion. In one bizarre episode, a pseudo-Christian religious movement, the Taiping Rebellion held Nanking and surrounding areas for 11 years, until the Western powers helped clean them out after they threatened Shanghai. What regime can survive if it can't keep foreigners and weird cults taking over parts of its heartland?
In the early 1900s the Qing attempted to reform in the direction of constitutional monarchy, but the result was unrest and they were forced out - a lesson surely not lost on 20th and 21st century leaders. But it is sometimes easy to get rid of the old order but not easy to build a new one - the Nationalist government under Sun Yat-sen quickly lost control, and provinces split off under their own leaders and generals/warlords. In 1919 China suffered another disastrous humiliation, when despite sending hundreds of thousands of laborers to Europe to free up Allied troops for fighting duty, and having believed they had a deal for the return of German concessions and industries, the Allies instead gave them to the Japanese in some sharp dealing.
A period of intellectual self-searching followed. The Communist Party was founded in 1922. It received much support from the Soviet Union, and many members studied abroad, in Russia as well as other countries - Deng Xiaoping studied in Paris and Moscow. The Communists allied with Sun Yat-sen and the Nationalists to try to create a united China free from foreign domination. However, Sun Yat-sen died in 1925, and Chiang Kai-Shek, a virulently anti-Communist military leader, took over. After the Nationalists and Communists cooperated to bring a large area under Nationalist control, they predictably fell out. The Nationalists were able to expel the Communists from most of the areas they controlled.
Chiang was brutal, inept, and corrupt. He ascended to leadership through assassination, allying with warlords and underworld figures, and a convenient marriage into Sun Yat-sen's family. On one occasion, the Nationalists broke a Shanghai strike by calling a meeting of the strikers, parading the strike leaders on stage, and shooting them in front of strikers. Nor was he the best friend of commercial interests, targeting them for funds he was perpetually short of.
Chiang followed a strategy of appeasing the Japanese and trying to annihilate the Communists and unite the country. The Communists retreated to an enclave they ruled as the Jianxi Soviet. Chiang encircled them and their survival there appeared in doubt. 100,000 of them broke out, abandoning women, children, and the infirm, and fled Chiang's pursuing army for over a year, losing 90% of their number. Chiang had them encircled again in Shaanxi. But in the meantime the Japanese were becoming increasingly aggressive. In the 'Xian Incident' of 1936 some of Chiang's allies arrested/kidnapped Chiang and pressured him to stop fighting the Communists and unite against the Japanese. After he did, he was soundly defeated and bottled up in Chungqing, and the Japanese used it as an excuse to take over more of China.
The US assisted Chiang unofficially before Pearl Harbor and officially after, but little was accomplished beyond pinning down a Japanese army. Chiang drafted something like 14m conscripts, 10% of whom died of malnutrition and disease before combat, and an additional 34% deserted. Westerners reported conscripts with distended bellies being led to the front lines tied together like chain gangs. Meanwhile, without US assistance, Mao emerged as the Communist leader, and was able to consolidate and effectively govern the small backwaters under Communist control, and resist the Japanese. The US considered giving assistance to Mao, it went all the way to Roosevelt, but Chiang nixed the idea. Of course, all the old China hands involved in those discussions ended up purged and disgraced as Reds in the McCarthy era.
After the Japanese defeat, the US tried to facilitate national reconciliation, sending Marshall to China, but it was a nonstarter for Chiang and would undoubtedly have been a tactical maneuver for Mao. The US sensibly decided to cut Chiang loose. Inevitably, the economy and currency collapsed, as did the defense against Mao. The Nationalists fled and holed up in Taiwan.
After the Communist takeover, while there was violence against landowners and redistribution of land, they appear to have been fairly enlightened at first. When the Korean War broke out, Mao agreed to a military alliance with the USSR and they fought the US and Koreans. Although China initially routed the 'UN forces', and occupied Seoul, the US rallied, and despite losing about 50,000 dead, the Chinese lost an untold multiple of that number.
Still, in 1957 the Communists had reason to feel proud of what they accomplished and Mao made a speech soliciting increased openness and freedom of speech in the 'Hundred Flowers' campaign. When the resulting criticism of the Communists was harsh and hit a bit close to home, a pivot to an 'Anti-Rightist' campaign resulted in all the critics going to jail, labor camps and re-education - a bit of a rope-a-dope, planned or otherwise, to curb dissent. By the time Mao's speech was published, it had been conveniently edited to invite only constructive criticism.
Realizing after failing to prevail in Korea that there was some catching up to do, Mao launched a campaign called the 'Great Leap Forward,' involving full collectivization, massive industrial investment, and, inexplicably, small local 'backyard steel furnaces'. Having learned their lesson of the 'Hundred Flowers', local leaders did not voice any misgivings they may have had, but competed to report immense crops and steel production. The result was a large quantity of useless poor quality steel, massive resource misallocation, and exports of grain while the country endured famine in which tens of millions died.
The brief alliance with the Soviets fell apart. Possibly Mao thought Khruschev was a sellout with his notions of peaceful co-existence with the West and repudiation of Stalin. Possibly the Russians thought Mao was a loose cannon who would not toe Moscow's line, and they ultimately reneged on helping China build the atomic bomb. (Blueprints shredded by expelled Russian advisers were reassembled and reportedly speeded up China's 1964 nuclear test.)
Mao's influence initially waned after the disastrous Great Leap Forward and the more pragmatic technocrats such as Deng tried to get things back on track. However, from 1966, Mao and a faction of hangers-on and enablers pushed back in the form of the Cultural Revolution, urging grass roots radical Communism and attacks on technocrats as elitist capitalist roaders. The radicals got out of control, and ended up killing intellectuals, sending those most capable of rebuilding China to labor camps, destroying much of the cultural heritage Westerners hadn't carted off, and gutting all of the institutions from universities to courts to financial and economic management.
Mao appears to have been a great mass campaigner, but when his time came to govern, all he seemed to know how to do was mass campaigns, eventually against his own revolution. In leading the revolution, he was aided by an instinct for survival and ruthlessness, but also a sure-footed common touch for the needs and aspirations of rural China. In power, he ruthlessly betrayed the peasants in the push for collectivization and industrialization, purged former allies and critics, and ended up out of touch and surrounded by people who told him what he wanted to hear. In a bizarre and ironic twist, the Cultural Revolution destroyed China's institutions, taught a generation of youth to think independently and skeptically of the top leaders, and created a blank slate to rebuild, helping pave the way for modern China.
After Mao died in 1976, the country was a shambles. He had appointed a successor, but Mao's political legacy unsurprisingly faded pretty quickly once he died, and Deng, a leader of the pragmatists and technocrats was able to take over and consolidate power. He started the 'Four Modernizations' (economy, agriculture, technology, and defense), let farmers keep some of what they produced, let people start small enterprises, and launched greater capitalist experiments in the 'Special Economic Zones.' As a sop to conservatives, they were initially limited to 'bird cage' provinces where they could be managed isolated from the rest of the socialist enterprise.
In the 80s, rural China made huge strides in poverty reduction. Many of China's most dynamic enterprises came out of rural China due to grass roots reform. The SEZs were also successful but massive urban change took a long time to take off. In 1989, amid economic difficulties, protests grew for 'the fifth modernization' (political freedom), followed by the Tienanmen massacre. It's instructive that a month of massive urban democracy demonstrations did not bring about much national revolt in the countryside; In fact, after local military were reluctant to intervene, Deng called up rural provincial troops who snuffed out the protests.
After 1989, the reformer Zhao Ziyang was purged and the 'Shanghai Clique', focused on industrial policy and urban development, was brought to power. The focus shifted from grass roots reform to foreign direct investment, state owned enterprises, export-driven growth, industrialization and urbanization. Western banks like Goldman Sachs were brought in to take sketchy and fragmented state-owned assets like 'China Mobile' and turn them into listed 'national champions' theoretically subject to international standards and market discipline. While these policies have been undeniably successful, rural China has suffered from the focus on urban development and top-down industrial policy, diminished subsidies and higher taxes, and corrupt leadership. Illiteracy has actually increased as tuition fees rose, parents migrated for better opportunities or because they had no choice, and kids had opportunities to go to work. Post-1989 rural stagnation is ironic, since rural support helped bring the CCP to power and remain there after Tiananmen.
The post 2009 financial crisis has brought a new, still unclear phase. Faced with a steep drop in exports, China undertook a massive stimulus to build infrastructure, and promised to take steps to reduce reliance on exports and boost domestic consumption. Less promisingly, the financial crisis reduced the prestige of 'international' accounting standards and market discipline, and banks and state owned enterprises were subjected to Party mandates to keep the economy going. As the world economy has recovered, China has been overheating. But the stimulus projects like huge railway and residential construction seem unlikely to pay off with actual cash flows, which will lead to stress on an immature, politicized corporate and financial system.
After 60-plus years, China has in large measure achieved unity, global respect, economic strength, and lifted most of the country out of extreme poverty. As a dynasty, it's a very respectable showing after a quick start and a very rocky consolidation period. Someone who was born in 1930 has experienced an almost unbelievable amount of tumult and change. That rapid change has resulted in tremendous dislocations, social stress, and weak institutions. There is no shortage of ambition or political will to take tough steps. But desire for real liberalization is absent. Since the CCP went all-in in 1989 and drew a hard line on political liberalization, the apparent choice then becomes accepting a strong ruler, or risking a return to the chaos that preceded 1949.
The question becomes how far this dynasty can grow before it outpaces the ability of strong central rulers to stay on top of it, and weak governance, corruption, and frustrated desires of the population lead to decay and unrest. China has seen change and tumult postwar Westerners can barely imagine. And of course, since China is now at the center of massively unbalanced patterns of trade, finance, investment and consumption, whatever happens next will have a huge impact around the world.
Possible further reading:
The Search for Modern China, Jonathan D. Spence
China and Europe, 1500-2000 and beyond: What is Modern?, Ken Pomeranz and Bin Wong, Columbia University
Mao Zedong and China's Revolutions: A Brief History with Documents, Timothy Cheek
The Private Life of Chairman Mao: The Memoirs of Mao's Personal Physician Dr. Li Zhisui, Dr. Li Zhisui
Prisoner of the State: The Secret Journal of Premier Zhao Ziyang, Zhao Ziyang (Author), Adi Ignatius (Editor)
Red Star over China: The Classic Account of the Birth of Chinese Communism, Edgar Snow
China Road: A Journey into the Future of a Rising Power, Rob Gifford
