DAS KAPITAL: ‘Moral Hazard’, What’s Really Going On in China – By Charles Hugh Smith

Source – oftwominds.com

  • “…All three factors inflated a debt-asset-speculative bubble of profound proportions, and President Xi grasped what the clueless Federal Reserve and other western central banks have not: Either pop the bubble when you still have some control over it or let it expand and pop when you’ve lost all control..Control is something the CCP and Xi want to retain, regardless of the cost to the nouveaux riche, the parasitic elites, the aspirational middle class and even the Party regulars who have supped too often and too gloriously at the corruption / moral hazard trough”

What’s Really Going On in China – By Charles Hugh Smith

Losses will be taken and sacrifices enforced on those who don’t understand the Chinese state will no longer absorb the losses of speculative excess.

Let’s start by stipulating that no one outside President Xi’s inner circle really knows what’s going on in China, and so my comments here are systemic observations, not claims of insider knowledge.

Many western observers have noted the centrality of Marxist-Leninist-Maoist doctrine in President Xi’s writings. This is somewhat akin to invoking America’s Founding Fathers to support one’s current policies: if you’re trying to modify state policy in China, you have to explain it in the context of the Chinese Communist Party’s history and doctrines. Never mind if the ideals were not met; what’s important is establishing continuity and resonance with the history of China, the core doctrines of Chinese Communism and the CCP’s leadership based on those doctrines.

That said, we should be careful not to read too much into doctrinal evocations such as common prosperity, which are useful conceptual anchors and slogans but not the full story.

What’s actually happening in China isn’t Marxist or Capitalist–it’s plain old non-ideological human greed, hubris and magical thinking manifesting as moral hazard running amok.. Moral hazard— the separation of risk and consequence, as speculators make increasingly risky bets because they know any losses will be covered by the state–is effectively the new State Religion in China: everyone is absolutely confident that every punter, especially all the rich, powerful, well-connected speculators–will be bailed out by the central government.

Greed knows no bounds when a speculator is insulated from risk, for people have an insatiable appetite for risky bets when the gains will be theirs to keep but any losses will be covered by the government.

This is the fundamental story of Evergrande: the implicit backstop of the Chinese government enabled near-infinite moral hazard which then fueled an explosion of debt-funded speculation with essentially zero connection to real-world risks, sales, return on capital, etc.

Both the U.S. and China have been a utopian Paradises of moral hazard for the past 30 years. In the U.S., the Federal Reserve would bail out any losses / declines in the debt-asset bubble orgy.

In China, the implicit policy was that the structural losses in state-owned enterprises (SOEs) and the speculative excesses of rapid development would be tolerated as long as real growth in employment, wages, profits and lifestyles was strong. Creating vast amounts of debt-money was necessary to support growth, and that it also supported speculative excesses was accepted as part of the price of explosive progress, much like environmental damage.

After 30 years, the equation in China has changed: debt in the official banking sector and in the informal shadow-banking sector has soared along with purely speculative excesses while “good growth” has stagnated. That’s the problem with incentivizing moral hazard: the profits from speculation, corruption and fraud far outweigh the puny profits earned by legitimate enterprises. So where do you put the borrowed billions? In Evergrande and other conglomerates of speculation.

Something else changed in 30 years of rapid development: inequality skyrocketed, and since inequality and corruption are mutually-reinforcing, corruption also reached new heights as inequality skyrocketed.

A third factor emerged after 30 years of touting technology and speculation: the power of Chinese Big Tech and financiers began encroaching on the control of the Communist Party.

All three factors inflated a debt-asset-speculative bubble of profound proportions, and President Xi grasped what the clueless Federal Reserve and other western central banks have not: Either pop the bubble when you still have some control over it or let it expand and pop when you’ve lost all control.

In systems terms, when risk and fragility reach unstable levels in tightly-bound systems, there’s no controlling the supernova-like implosion of the system.

Xi observed the skyrocketing power of Big Tech, moral-hazard-incentivized financiers and cryptocurrencies and concluded that the state must move decisively to crush these rivals, regardless of cost. This separates China from the American state, which is incapable of enforcing any sacrifices, limits or costs on the parasitic elite which dominates its economy and political order.

Xi saw the danger of Big Tech and financiers being able to buy whatever influence they needed from corrupt CCP and state officials, and he realized that this is the crucial moment in history: either crush Big Tech and the financiers / speculators or risk losing control to their interests.

Control is something the CCP and Xi want to retain, regardless of the cost to the nouveaux riche, the parasitic elites, the aspirational middle class and even the Party regulars who have supped too often and too gloriously at the corruption / moral hazard trough.

Losses will be taken and sacrifices enforced on those who don’t understand the Chinese state will no longer absorb the losses of speculative excess. Those who don’t understand the reign of parasitic private-sector elites and excessively corrupt party officials in China is over might profitably ponder this Chinese proverb: “Whoever gets mixed up with garbage will be eaten by pigs.”


https://www.oftwominds.com/blog.html

Related…

Evergrande bubble popped in time: no Lehman moment – By David P. Goldman

China stage-managed crisis for investment & social goals; US should’ve done similarly before 2008 Lehman shock

Equity markets on September 22 and 23 turned in their strongest two-day performance since last May, as fears of contagion from China’s Evergrande real estate giant faded.

Far from a Lehman moment, the Evergrande crisis was a preemptive popping of a bubble – the sort of action that US authorities might have been wise to take in 2004 before the collapse of the US housing market nearly took down the global banking system.

Chinese authorities won’t bail out Evergrande, which with nearly 2 trillion yuan (US $430 billion) in liabilities is the biggest source of risky real estate credit in the world.

A 17% rise in Evergrande’s battered equity price in Hong Kong trading Thursday indicates that the company has a chance of survival in much-shrunken form – although without government help. The Chinese government will underwrite Evergrande’s existing obligations to home buyers, but nothing more.

The Evergrande crisis will accomplish a set of objectives, senior Chinese officials told Asia Times.

First, it will stop the growth of dangerous leverage in the property sector, an objective that Chinese regulators signaled in 2020 with “red lines” for developer leverage and curbs on lending to the property sector. “It’s dangerous to pop a bubble,” one official said, “but even more dangerous not to.”

Second, it will bring down home prices, in keeping with the government’s theme of “common prosperity” and more equitable distribution of rewards. Soaring home prices, particularly in coastal cities and Beijing, have put home ownership outside the reach of lower-income Chinese.

Third, it will suppress inflation by reducing speculative building and demand for iron, copper, cement and other raw materials.

Fourth, it will help drain the political swamp in Chinese local governments, whose finances have depended on property sales. The cozy relationship between local officials and property developers encourages corruption and inhibits the central government’s efforts to modernize the tax system. “The real estate bubble arose through corruption,” one official commented.

Fifth – and most important – it will shift capital allocation toward high-productivity industries like manufacturing and away from construction, an inherently low-productivity occupation.

Real estate now contributes a full quarter of China’s GDP, a distortion that could be justified in prior years by the need to house the 600 million Chinese who migrated to cities from the countryside over a 30-year period. Real estate, though, has been the investment of choice for Chinese households, whose direct and indirect investments make up barely 8 percent of household assets, compared to the mid-30% range in the United States.

China’s expansive monetary policy after 2017 incited an acceleration of loans to the property sector. During 2017-2019, total property lending exceeded credit to the manufacturing sector for the first time. The People’s Bank of China’s curbs on property lending capped the outstanding volume of real estate loans during the past year, while lending to industry rose rapidly.

Union Bank of Switzerland economist Wang Tao sketched out the likely disposition of Evergrande in a Sept. 21 article published by Caixin Daily:

Property delivery is the most important: Among Evergrande’s stakeholders (i.e., homebuyers, suppliers, and banks including bond investors), homebuyers are the most important from the point of view of social stability, and hence project delivery and paying suppliers’ payables will be prioritized.

Segregation of project companies from the group: Next, the key is to materialize the asset value and ensure the cash generated from asset disposal will flow to suppliers. We think a possible scenario is the segregation of Evergrande’s project companies away from the rest of the group. Cash flow from project companies would need to be put into a custodian account, with local government supervision, to ensure that cash inflow from property and land sales will be used for construction and supplier payables only, aiming to restore the confidence of homebuyers in its properties. At the same time, the project companies may also pay suppliers with properties.

Debt restructuring: At the group level, the banks and bond investors would need to undergo a debt restructuring and bear the loss from a haircut. We expect a debt restructuring (i.e., a haircut on debts and extension of debt) will be needed.

Equity investors in Evergrande and other property companies will lose most if not all of their stakes, and banks and bondholders will take a “haircut” – a negotiated reduction in their outstanding principal and interest. But the damage to China’s banking system will be limited, and the central bank will stand ready to provide liquidity where required.

It isn’t clear how far the pain will extend to China’s property sector. In April, more than half of China’s property development companies met the central bank’s “red line” criteria for leverage, including a cap of net debt at 100% of equity. Evergrande failed the test.

Chinese media are now reporting the details of Evergrande’s overreach, including vast amounts of hidden off-balance-sheet leverage and exorbitant expenditures on prestige items such as the company’s Guangzhou Evergrande football club, which was led to international victories by some of Europe’s highest-price coaches.

China has suffered from the same leveling-off of productivity (measured in the above chart by so-called “total factor productivity,” or the combined productivity of labor and capital) that affects the industrial nations.

The great conundrum in productivity measurement lies in the failure of the Information Technology sector to raise productivity in the rest of the economy. Rather than radiating productivity, the largest Internet companies in the West have earned rents as consumer monopolies. That is an outcome that China is trying to avoid, through anti-monopoly measures in the consumer Internet space.

 In China’s case, that’s the result of allocating the lion’s share of capital to an inherently low-productivity sector, namely property. With an aging population, China needs high productivity growth to fund a pension and health system and support an increasing number of dependent elderly with a stagnating or shrinking workforce.

The message to the market from Chinese policymakers in the Evergrande crisis is that capital will flow to high-productivity sectors. Although large-capitalization internet stocks like Alibaba and Tencent have had a terrible year to date, the stealth performer in Chinese stocks is the CSI 500 Index, driven by strong performance among smaller industrial companies.

Markets appear to have gotten the message. China has lanced a boil that threatened the health of the economy and – despite some intermittent pain – will be better off for it.

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