Tales of the Great Chinese Construction Boom (and the Coming Bust)

Mike Shedlock of the Mish's Global Economic Trend Analysis blog passes on an amazing story about the excesses of the Great Chinese Construction Boom. The story is from an American sculptor who regularly lives long periods in China.

I have been exchanging emails with Bill Hopen, a sculptor who frequently travels to China, often for months at a time. Bill writes ....

I've been to China a lot Mish, spent many months at a time there for the last eight years. China is already in a massive overcapacity real estate bubble. They are building three apartments for everyone that is lived in. Most apartments are empty and those that are rented do not come close to paying the interest on the loan.

There are huge department stores with products loaded on the shelves and staff everywhere and no one is shopping! Staff outnumbers customers five to one. It's surreal. They are ready, waiting for a great wave of shopping to come, but no wave is coming.

Eventually this "borrow and build" economy will be a pop heard round the world. China runs on construction, build build build, but there is no reason for that many places and spaces and big mall businesses with no consumers.

[...]

My comments were about apartments in Shanghai. Middle class folks (e.g. a doctor makes about $20,000 a year) will often buy one apartment one to live in and one as "investment". Sound familiar? The extras are mostly empty, or renting for much less than 6% interest on the money to buy the unit.

We rented a luxury two floor roof top terrace apartment (20th floor) in a gated compound with gardens, sculpture, playgrounds, walkways, waterfalls, bamboo fish ponds, fountains, and underground parking for $800 a month! The apartment is fully and nicely furnished with beds HDTV, kitchen dishes...everything.

The guy we rented from said he would sell it for $650,000. This was a normal price judging from many "bargain" offers in the windows of many area Realtors.

The typical real estate secured interest rate was 6 to 6 1/2%, so that's at least $36,000 interest per year, yet we were able to negotiate a rent of $800! And there were lots of apartments available. People would approach us with incredible deals. You could tell they were hurting, had bought extra apartments and were struggling with paying the mortgages, and were desperate for any help from any rent they could get.

This is an amazingly clear description of a financial system gone seriously bad. If this is indeed an accurate description of the state of the Chinese real estate market, I would imagine that it would be much more broadly discussed in mainstream media. Are the members of the mainstream media so fearful of annoying the Chinese central government that they are keeping it all hushed up?

The Chinese upper classes have been indeed getting their hands on increasing amounts of money. But I have a strong hunch, that when their liabilities are taken into account, there hasn't been enough increase in the number of actually wealthy people to sustain the amazing rate of construction in China.

There is a large number of people with cash to command for a while. This is easy to observe. The total amount of wealth is huge. There is an assumption of a more or less even spread of the assets along a part of the population.

Widespread construction is started, for it seems that there are a lot of reasonably wealthy prospective buyers. But people's personal balance sheets are actually quite opaque. Only later is it found out, that almost all of the actual net wealth is actually concentrated in a very few and select hands, as often is the case with these Ponzi-like me too-exercises. The net wealth of the rest is zero, or even worse.

Once everybody and their best friends have taken their maximum dose of debt, there is no more cash to command. This point, it seems, can be reached very suddenly. If the wealth is in the hands of a select few, there is naturally no drive for large scale construction of expensive assets, for those few can only make use of a very limited number. A single person can only make use of a certain limited number of personal accommodations. The same goes for all kinds of financial and economic planning that has been going on on the basis of completely wrong assumptions.

Next step: Complete chaos.

Micro-Protectionism in Japan

Wow. Protectionism is spreading to a whole new level in Japan, according to Times Online:

Its electronic gadgetry is gathering dust on the shelves of high street stores, nobody is buying new fridges and the mountain of unsold plasma televisions is growing by the day.

However, in desperation, Panasonic has hit on the perfect counter-attack against the consumer slump: it has ordered every member of staff to go out and buy £1,000 of Panasonic products.

Toyota and Fujitsu have announced similar campaigns. The next step must be to start paying salaries in plasma TVs. Barter economy, here we come. :-)

Hey, maybe it's not such a bad idea after all. Imagine high level management being compensated with tons of company products. What better way is there to make them concentrate on the quality of the products than having to personally sell them for cash in the market? :)

I never knew that protectionism could be a microeconomic issue.

A Covert Mea Culpa from Mankiw?

Greg Mankiw writes sensibly about not judging a president for “treating a single patient”. He then goes on to reference his own record as the chief economic adviser of a president:

Now some people may be tempted to read the above commentary and call it self-serving. After all, the economy looks pretty bad right now, so maybe I am trying to excuse President Bush and, indirectly, myself as one of his economic advisers.

Not so. If you want to judge presidents and their economic advisers by outcomes, that would be all to my benefit. I arrived in Washington to head the CEA in February 2003 and left in February 2005. (Harvard has a two-year rule for faculty leave). During that time, the economy grew at a healthy annualized rate of 3.6 percent, and the unemployment rate fell half a percentage point. As judged by outcomes, I look pretty good! But I will be the first to admit that this argument is deeply silly.

Hmm. Those two years happen to coincide with the hottest period of growth for the housing/credit bubble. His policy advice led the president to adopt a position of minimal regulation. And this happened in the presence of incredibly loose monetary policy (largest sustained downward deviation from the Taylor rule in near history). This is the period that gave us the infamous 2-28 ARM.

I'm all for judging Mankiw (negatively) on his (bad) policy advice, instead of the temporary growth of a bubble. At least he seems to be a person of some intellectual honesty in pointing this out himself.

Update: The subprime teaser rate ARMs have been in existence long before 2003. However, the time period was an era of rapidly growing subprime ARM utilization and increasingly predatory lending practices.

A Pound of Manufacturing Base, Please

Dean Baker writes about the strength of the pound as the cause of a weak manufacturing base in Britain:

The British Pound, like the U.S. dollar, had been seriously over-valued in recent years. That is why it had been running a large trade deficit.

[...]

In most contexts reporters are able to understand the relationship between higher prices and demand, but for some reason in the context of trade, they discuss the topic as though there is no relationship. Hence in an article on the falling British pound, the NYT tells readers that Britain's prosperity over the last decade "camouflaged a steadily weakening manufacturing base."

Of course, the prosperity did not just "camouflage" a weakening manufacturing base, to a large extent, the prosperity was directly related to the weakening manufacturing base (except for the laid-off manufacturing workers).

The over-valued pound allowed the British to buy imported goods at lower prices than their own industry could produce them. However, this led to a large current account deficit which could not be sustained indefinitely.

I both agree and disagree with this view. It is stupid of NYT to speak of Britain's “prosperity”.

In the case of “prosperity” (= access to liquidity) being directly related to a weakening manufacturing base, I would go even further. In a limited sense, the temporary “prosperity” is both directly and indirectly caused by diminishing assets, including the manufacturing base.

Liquidation of capital, like industrial machinery, is an easy and short-sighted way of getting hold of currency to spend on imported consumer goods. It's a simple case of eating your seed crop. You can get fat for a short while on such consumption. Until you run out.

This temporary “prosperity” is just a loan from the future. Most of these inter-temporal fund transfers are actual loans, but a liquidation of productive capital for the purposes of consumption is a loan from the future in an equally real sense. One might also ultimately need to liquidate assets to pay off a loan in the end, with identical results.

That's the way trade deficits go and ever will. You get more than you give at one time. Later you have to reciprocate. And you just might have some regrets when the time comes. (Just ask Icelanders.)

No current account deficit can ever be sustainable (in the sense of having less than infinite zero crossings in infinite time). Unfortunately there is no upper bound on the time span and the magnitude of a single era of imbalance. For the purposes of fairness, we should strive to keep them at less than a generation. (OK, I'm guessing. I don't have the mathematical proof for these claims.)

In what comes to the expensive pound as a cause for manufacturing weakness, I seriously object. I do agree that the pound has been too expensive, and that it does encourage eating into capital.

But how could the value of the pound be the ultimate cause of anything? Prices are like weightless particles, always at the mercy of external pressures. One has to search for the real cause from the factors that affect supply and demand, of which the price is merely a shadow.

When a price is “wrong” it is most certainly caused by a lack of information.

Overly high flexibility of credit is the key here. Loss of income and wealth due to eating into assets is too easily “camouflaged” by excess credit. Inefficiencies in the foreign exchange, like the pound being too expensive, are merely a symptom of such blindness.

Without credit, all overconsumption would be immediately reflected as a loss of assets. Credit has a way of complicating the process, but the fundamental effect is still there. More consumptions results in less assets later on. This can not be escaped.

These price distortions, which do exist, have an unfortunate reinforcing effect on the original cause by further encouraging people to eat into their assets. A high price encourages activity that decreases the underlying value, like over-construction. With credit as a disguise, this decrease in real value is not necessarily recognized by the market participants. The relative price is thus further increased. This is especially true in a mental environment where the “market is always right,” which encourages price-inelasticity.

In a sense it is even rational, to a degree, to eat into assets when the price is good. But the human mind is too biased for the near term and against the long term to ever make these kinds of trade-offs rationally. People do get greedy and they definitely do get regrets. (I know from personal experience.) Humans are not adapted to easy credit. It's an unnatural state of affairs.

“The over-valued pound allowed...” sounds quite too much like the pound has a will of its own. It is much more honest to just say that somebody overpaid. The British sold (or pledged) too much of what they had (or will earn) and used the proceeds for consumption. Now they have little left. The buyers (of the pound and ultimately British assets) probably overpaid because of a false sense of value generated by a seemingly insatiable demand from the very same Brits who are now impoverished.

Now everybody has regrets: The British, for having to pay for their past consumption from diminished income, and their trading partners, for receiving less from the British than they expected in return for the consumer goods provided earlier.

I think I have written this before but its worth repeating: Oversized credit facilities are to the economy like pulling a heavy trailer with a bungee cord.

In what comes to a reform of the existing credit system, a downturn is not the time to start making radical restrictions. These things have to be taken carefully, in a regulatory, a monetary and a fiscal sense. It's like fishing. Give it some slack when it's kicking, reel it in when the coming is good.

Unfortunately, in the US, the EMU, the UK and Japan, all three means, the monetary, the regulatory and the fiscal, are pretty much exhausted, due to giving up too much line in easy times. Deregulation has been taken to the limit, monetary policy is at the zero bound, and government deficits are already huge. The spool is approaching empty, and the line is in danger of snapping.

Whatever slack is given now, the most important thing is to start reeling in as soon as the situation improves. People really have to be dragged into austerity kicking and screaming. Otherwise the spool will get empty and the line will snap. (OK, enough bad fishing analogies. Anybody know if Keynes was a sports-fisher?)

A Crude Contango. What? Why?

Crude oil prices in the futures markets are currently so much higher than spot prices that big investment houses are hiring oil tankers just to keep crude oil in storage for a few months and cashing in the price difference.

Bloomberg reports of Morgan Stanley, among others, hiring more vessels.

Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.

[...]

Frontline Ltd., the world’s biggest owner of supertankers, said Jan. 14 about 80 million barrels of crude oil are being stored in tankers, the most in 20 years. A purchaser could buy oil now, keep it for months at sea and fetch better prices by selling futures that are higher than the spot price.

[...]

Phibro LLC, Citigroup’s commodities trading unit, has the 1 million-barrel carrier Ice Transporter stationed off north Scotland and also hired the supertanker Ashna to store. Shell, Europe’s largest oil company, booked two supertankers.

“From a tanker owner’s perspective, this is a little gift from heaven,” Finn Engelsen, managing director of Lorentzen & Stemoco AS, an Oslo-based shipbroker and consultant, said by phone from Oslo today.

For the shipbrokers and shipping companies this is clearly a perfect deal. But what is the status of the tanker crews? I guess they have it easy being harbour-bound.

But seriously, who on earth are the counterparties that are buying these expensive futures? Can't they see that there is a huge build-up of crude in storarge that is going to push the spot price even lower in the future? Has price discovery completely broken down in such an intensely followed market? How about that. We really do live in interesting times.

US Official: Suspect in a Guantánamo Trial Case Was Tortured

Finally an outspoken Bush administration official has said it straight. In an interview with Bob Woodward in the Washington Post, Susan J. Crawford, who is in charge of the military commissions for trying terrorism suspects, says that US has tortured a detainee in Guantánamo Bay. (Thanks to Andy Worthington for the link.)

The top Bush administration official in charge of deciding whether to bring Guantanamo Bay detainees to trial has concluded that the U.S. military tortured a Saudi national who allegedly planned to participate in the Sept. 11, 2001, attacks, interrogating him with techniques that included sustained isolation, sleep deprivation, nudity and prolonged exposure to cold, leaving him in a "life-threatening condition."

[...]

The interrogation, portions of which have been previously described by other news organizations, including The Washington Post, was so intense that Qahtani had to be hospitalized twice at Guantanamo with bradycardia, a condition in which the heart rate falls below 60 beats a minute and which in extreme cases can lead to heart failure and death. At one point Qahtani's heart rate dropped to 35 beats per minute, the record shows.

Sleep deprivation alone is a very serious method of torture, as any person with experience of severe insomnia knows very well. Sleep deprivation over several days is enough to drive a person insane. Added to other forms of mental and physical hardship it is simply devastating.

God bless you, Ms. Crawford, but why didn't you speak out before the last week of the outgoing administration? You have, after all, been in charge of the military commissions since February 2007. Were there any specific threats made against speaking out?

This is a clear signal for the incoming US authorities to start examining possible war crimes by administration officials during the 7 past years of war against terror.

Unfortunately the interview also contains some serious bullshit.

The Qahtani case underscores the challenges facing the incoming Obama administration as it seeks to close the controversial detention facility at Guantanamo Bay, Cuba, including the dilemmas posed by individuals considered too dangerous to release but whose legal status is uncertain.

[...]

"There's no doubt in my mind he would've been on one of those planes had he gained access to the country in August 2001," Crawford said of Qahtani, who remains detained at Guantanamo. "He's a muscle hijacker. . . . He's a very dangerous man. What do you do with him now if you don't charge him and try him? I would be hesitant to say, 'Let him go.' "

If someone's legal status is uncertain, he should be released. Nobody is "too dangerous to release". That is just hyperbole. If there is reasonable suspicion of malicious intent, the person can be subjected to intensified surveillance after release. Other persons with similar intent outside of the radar screens of US intelligence—and they do exist—are much, much more dangerous. Already identified suspects, even if released because of a lack of evidence, are the least of the problems. (I've heard of hijacking planes or cars or other vehicles, but a muscle hijacker? Is that like jumping to somebody's back and saying, "to Havana, pronto!"?)

Anyway, the war on terror(ism)—an inane euphemism though it is—was supposed to be a struggle between ideas. Ms. Crawford and other US authorities are clearly missing the forest for the trees by focusing so heavily on specific individuals. There is a very fitting Finnish proverb ("ei sota yhtä miestä kaipaa"), which roughly means that no single man is needed in a war. (Everybody is needed, but nobody is irreplaceable.)

It is quite simple really. All detainees should be either tried or released. If some doubt remains of the guilt a suspect, one should keep an eye out after release. One might even find his way to some co-conspirators.

Nicholas Kristof Is Dreaming of Sweatshops

New York Times columnist Nicholas Kristof has just discovered that a sweatshop employment is not the bottom of the scale of poverty:

Talk to these families in the dump, and a job in a sweatshop is a cherished dream, an escalator out of poverty, the kind of gauzy if probably unrealistic ambition that parents everywhere often have for their children.

[...]

I’m glad that many Americans are repulsed by the idea of importing products made by barely paid, barely legal workers in dangerous factories. Yet sweatshops are only a symptom of poverty, not a cause, and banning them closes off one route out of poverty. At a time of tremendous economic distress and protectionist pressures, there’s a special danger that tighter labor standards will be used as an excuse to curb trade.

What Mr. Kristof forgets is that there will always be relative differences in income. If the Cambodian sweatshop workers would get a proper paycheck, they would be able to employ the people now living in garbage dumps at better service sector jobs, like restaurants etc.

There will always be a part of the population that will be left outside of the employment in factories. The level of poverty of the people who live in the margins of society is more a reflection of the level of disposable income of the population in general.

If the people who work in sweatshops were not offered a very small but safe income from abroad, they would most probably engage in riskier, but potentially more rewarding activities, like farming. They would trade with each other, and everybody would have a chance for accumulation of capital. Instead, they merely subsist on food imported from countries with heavy export subsidies, while the rest of the economy gains nothing.

Whole populations of poor people can be kept in sweatshop conditions by paying them just enough to keep them away from the risks associated with independent economic action, but still not quite enough for any meaningful accumulation of capital.

Mr. Kristof is correct in his notion that absolute limits on minimum wages can result in activities moving to relatively more advanced locations. The focus should be on increasing the overall level of pay in underpaid industries, like garments. Thus, any criteria in labour standards should be defined on a relative local basis, to determine a level of pay that provides enough disposable income for the development of the local economy.

Economically marginal people in a sweatshop-based economy live in true squalor, just as Mr. Kristof has noticed. But such poverty is so complete exactly because of the lack of disposable income in the economic mainstream.