Is China a Bubble?

We've been hearing for several years now about China's massive growth and off-the-charts savings rates. But I've seen a few things recently that have made me start to question these.

First, I heard an economics nobel laureate say that China's household savings rate is not very different from the rest of Asia; their high national savings rate is largely accounted for by corporate savings, namely retained earnings. Now, retained earnings are profits that are not paid out as dividends, or more precisely, reported profits that are not paid out as dividends. What if those reported profits aren't quite on the up and up?

Second, China's banking system has been pretty weak for a while. It's riddled with non-performing loans that do not get written off. So who knows about the real state of the system?

And then third, the Wall Street Journal today published this article, which details the massive debt crunch that is facing Chinese universities. One excerpt:

China is suffering from a higher-education equivalent of the global credit bubble. On government orders, China's universities -- most of which are state-controlled -- boosted enrollment by up to 30% a year, year after year for most of this decade, and built vast new campuses. Financing was considered a cinch: New students would mean more tuition to pay off the loans that funded the expansion. But those plans were wildly optimistic, leaving hundreds of universities across China crippled by debt...

In impoverished Anhui province, 50 universities owe $1.2 billion to banks, according to Zhao Han, who is vice president of the Hefei University of Technology in Anhui. Mr. Zhao, who is a government adviser with access to the financial figures, says some schools have debt payments that equal half of their tuition revenues.

This is classic, CLASSIC bubble stuff.

It's a far cry from three snippets to calling a bubble, but this is something I'll look into for future posts.

Tin Cans...

...are 10-20% of the materials cost of canned food, according to the Wall Street Journal. And that's not even real tin, just tin plated! Which begs the question: tin-plated WHAT?

Econ 101, Revisited

I've always been slightly bothered by the old Econ 101 equation:

(1) Y = C + I + G + X - M

and its counterpart:

(2) 0 = (I - S) + (G - T) + (X - M)

The thing that's gnawed at me is how exactly it is that savings (a decision not to spend) gets magically channeled into investment (e.g., an active decision to build a factory). Part of the answer is that if I save and don't spend, someone else must have dis-saved. But what if I chop down a tree for some firewood, sell the firewood, and save the money? I saved, but the person who bought the firewood and put it in his garage didn't dis-save! It's hard to call that investment.

Savings are really a claim on future consumption, and you can have this in three ways:

1. Ownership of the actual means of production. That corresponds to investment.
2. Ownership of the goods you want to consume. That's inventory accumulation.
3. Cash dollars. These are the portion of future production against which there are explicit claims. The government can create these dollars, which are not really liabilities of the government per se but rather of the society as a whole -- it is everyone in the society that must redeem the dollars, not just the government. Cash dollars are like goodwill in accounting -- they are a recognition today of value that will be created in the future.
   

All this points to a slight revision of the above. Equation (1) needs to have inventory accumulation (call it N) added to it. And equation (2) needs to be adjusted for cases when the government prints additional money (call monetary growth J).

So we have

(1*) Y = C + I + G + X - M + N

and

(3) G - T = J - SG

where SG is government savings, or more precisely change in publicly held government debt. The new equation (2), adjusted for money growth and inventories, then becomes:

(2*) 0 = (I + N - S) + (J - SG) + (X - M)

Personally, I find this formulation more satisfying, because there's no "magic" about how savings gets transformed into investment; inventories and money provide some wiggle room.

There's much more to be said here about the implications of expanding the money supply. But that is material for another post.

The Fed Marks to Market

Nice post from Zero Hedge suggesting write-downs to come.

http://zerohedge.blogspot.com/2009/04/fed-reports-over-30-loss-on-bear.html

This chart is from the IMF Global Stability Report -- it shows European banks are continuing to create securitized assets, even though they can't sell them, because they are eligible collateral at central banks. Should we be afraid, or are these high-quality assets written with good underwriting standards, given the tight credit environment?