Patrick Chovanec is one of my favorite China analysts (along with Michael Pettis). He has worked as chief of staff for John Boehner in Washington DC and has also worked in the financial industry (private equity in the US and China). He is currently a professor of finance at Tsinghua Univ. in Beijing. I’ve met him many times on my trips to Beijing and I think very highly of him. Following is the original version of his op/ed in today’s Wall Street Journal. The paragraph I've put in bold was cut out of the version that finally printed in the paper due to space constraints.
The article highlights the flawed logic in the China bulls who argued the Beijing model would supplant the Washington consensus model that prevailed until the global credit crisis of 2008.
it should be noted that Obamanomics embraces some fundamental concepts underlying the Beijing model, that puts government in a co-leadership role with private enterprise. The “you didn’t build that” quote highlights Obama’s view (reinforced in his recent convention speech) that the federal government must play a decisive role in shaping our economic future. As Chovanec's editorial points out in his editorial, the Chinese model is one that superficially seemed to be robust, but that we are increasingly seeing as fundamentally bankrupt, like the government subsidized green energy sector in China.
Government may lead a superficially successful economic boom as we’ve seen many times in history before including with Japan in the 1980’s. Japan’s stock market capitalization briefly exceeded the US market cap and (according to mainstream press and culture) Japan was supposed to dominate the 21st Century global economy.
"We" needed an industrial policy like Japan to compete!!! right?!!
A funny thing happened on the way to Japan's world dominance. Reagan offered a alternate model, whereby the private sector not government was the "answer." and then Japan’s stock and property bubble burst in 1989; the economy has been on a downward spiral ever since. The European Social Welfare model was also supposed to supersede American Cowboy capitalism, but we are seeing the fundamental flaws in that model. And finally we have China, finally bumping up against the limitations of Socialism with Chinese Characteristics which after the 2008 crisis and the relative success of the country in avoiding the global downturn looked like the new economic model for the rest of the world to adopt.
In fact, China’s economy is not a model to emulate. Nor for that matter is the current US model. The US model is often described in as cowboy capitalism or free market capitalism or l’aissez faire capitalism. This is a misleading characterization.
The US model is no where near a de-regulated, free market free for all. in fact, it has turned into the epitome of what is called Corporatism or Crony Capitalism as described by Charles G. Koch in the editorial he wrote on 9-10-12 WSJ titled Corporate Cronyism harms America. A fabulous book review on the book Twilight Of the Left by Fred Siegel published 9-11-12 in the WSJ echoes many of the same themes: don’t be seduced by government promises. Don't close your heart to the needy and to social problems. Act locally. volunteer your time and help a neighbor. But, don't expect the government to solve social or economic problems by raising taxes or issuing new regulations or implementing a new scheme aimed at controlling the economy via central planning institutions like the Federal Reserve.
The government can support industry and it must enforce a rule by law based system that punishes illegal behavior and activities. But the government should avoid excessive and narrow regulation regimes and any sort of subsidy scheme (however narrow or wide) because all of these are easily co-opted by big business for their own selfish uses. We American’s should avoid the seductive answer for society’s problems in more government.
Central government planning and execution and marshalling of national resources is NOT the answer to our personal or social moral problems nor is it the answer to our economic or environmental sustainability challenges. The solutions to the unknown and emerging problems in the future that we can only guess at now will come from private individuals and private enterprise looking to solve problems for a profit. profit is not evil per se. profit can be evil if it is pursued at all costs. but getting rid of profit does not solve any problem and it introduces many new ones. life is full of institutions that are both good and evil. We should not get rid of institutions that are part evil because we also get rid of the good.
The road to hell is paved with well intended government policies and programs that promise to actively shape the world into a “new” and more enlightened model of human society/economy.
Third way economic and social models have all “failed” as we saw with Japan since the 1990s and as we are seeing play out now with the Eurozone, and that will increasingly be evident as China struggles in the months and years to come – all the result of what appeared to be enlightened industrial and social planning that went (predictably) off the rails as it drained valuable resources from the private economy and were instead redirected by a well intended government aiming to improve upon what is assumed to be a free market that cannot be left alone.
The US model is another third way model that has been more successful than other third way experiments, but it is also headed toward failure.
Every experiment in third way economics and social engineering ends with what FA Hayek called the road to serfdom dialectic, that is a process whereby well intended government policy sows the seeds for negative unintended consequences that beg and require additional well intended government policies such that the government is stuck in a never ending cycle of fixing the negative unintended consequences of well intended policy that ends up creating more problems than it solves.
The paradigmatic example of well intended government central planning gone awry is the Federal Reserve Bank, established in 1913. We had a number of panics in the late 1800s and early 1900s that the government promised could be solved if we established a lender of last resort central bank. What followed in the 1920s was a period of booming growth and asset markets unprecedented in world history called the Roaring 20’s thanks to the Federal Reserves concentrated effort to reduce short term interest rates. for a while it not only looked like the Fed could eliminate panics, it looked like it could facilitate a sustainable boom.
Why did the Fed keep interest rates so low in the 1920s? England was suffering from post WWI recession and so the Bank of England begged the Fed to keep rates low so that gold would not flow out of England and into the US, thus causing England even greater economic hardship. The Fed complied by injecting liquidty into US markets which lowered rates in the US -- and in turn facilitated the roaring 20s, followed by the Great Depression.
What was the mainstream conclusion from this disastrous experiment in central planning monetary policy? the conclusion was only that the Fed didn’t intervene properly AFTER the 1929 crash. only Austrians bemoaned the Fed’s role in blowing up the credit and asset and growth bubble in the 1920s as a result of overly accommodative policy (which they could get away with because the US economy was in the middle of a historic productivity boom thanks to the introduction of electricity to the industrial economy). all things equal the US economy should have experienced natural and beneficial DEFLATION in the 20s as productivity boomed and the general price level declined .
Today modern technology markets operate within an environment of secular deflation – prices going down, down, down yet with profits going up up up such that Apple has the highest market cap of any US company. Technology companies deliver more for less. Conventional wisdom suggests that consumers will always wait for prices to go down further before buying, but we all know that is utter rubbish.
A pernicious deflationary spiral ONLY happens and "bad" deflation is set in motion AFTER the central bank knowingly or unknowingly blows up a credit bubble via easy money as happened in the 1920s and as happened again in America in 2000s thanks to a productivity bubble in China that echoed the one in the US in the 1920s. Naturally good deflationary forces in China allowed policy makers in the US and China to keep monetary policy lower for much longer than other wise would have been possible in "normal" times.
Bad deflation is self reinforcing when deleveraging creates a self reinforcing deleveraging cycle that leads to depression. There is no path to Depression nor to systemic failure in financial markets or in the larger economy without a central bank creating false signals to the “market.” Central banks also create private institutions that end up being "too big to fail" because the biggest banks tend to be bailed out during periods of stress and they thus get bigger and bigger and bigger – much bigger than they could without the central bank back stop.
The result we have now is that we have systemically large companies that have gotten that way thanks to well intended public policy aimed at fixing so called market failure. Fixing market failure with third-way policies (by third way I mean in between what everyone recognizes is impractical … either communism or unfettered “free markets.” My argument is that such third way “experiments” only appear to work "temporarily" – the problem is that these "temporary" periods can go on for decades such that it appears as if the third way policy is sustainable. When the third-way system "fails" it is the market that gets erroneously blamed. no one wants to blame the third way system. It is always that we need to do a better job designing the system. it is never that the third way is self destructive BY ITS VERY NATURE. ALL third way systems are doomed to failure because third way systems always sow the seeds of their own destruction.
Marx had it upsdie down: it isn't the market that sows the seeds of its own destruction: it is socialism which does. history has shown this over and over and over again. yet politicians want us to believe their next system will be "the one."
The beauty of markets is that they are imperfect. They follow a process of micro creative destruction where firms and businesses go bust, but the system itself remains robust precisely because of the micro level uncertainty and learning by failure that is allowed to unfold in a rule-based, market based system.
In our system, we don’t want to let anything fail. we don’t like business cycles or pollution or uneven opportunities or big companies appearing to dominate the market. and we like government subsidies for things we think the market doesn’t give us enough of, like education, housing, health insurance, financial stability, deposit insurance, infrastructure, regulations, clean air, higher gas mileage, space exploration, military might, etc, etc, etc. Subsidies are a recipe for disaster. And the US has become a toxic combination of Crony Capitalism and Subsidy Capitalism based on the proliferation of subsidies doled out by government agents to preferred special interests.
Obama’s plan for the US is to expand and improve our subsidy system such that we are promised a better economy and better society. Why do we believe in free lunch promises like this? Romney talks the talk of smaller government and letting the private sector lead the way, but does he have the political capital and the leadership vision and abiltiy to take on vested interests in the GOP itself??
The American Subsidy Economy is a bi partisan scourge. Neither side wants to give up the goodies. the GOP demonized OBama for talking about government led initiatives like Obamacare, but the GOP itself is part of the problem supporting tax breaks for business offering health insurance and for interest expense. The GOP MUST face down subsidy interests or all the rhetoric demonizing Obama for being a socialist is pure hypocrisy.
China's Solyndra Economy
Government subsidies to green energy and high-speed rail have led to mounting losses and costly bailouts. This is not a road the U.S. should travel.
By PATRICK CHOVANEC
On Aug. 3, the owner of Chengxing Solar Company leapt from the sixth floor of his office building in Jinhua, China. Li Fei killed himself after his company was unable to repay a $3 million bank loan it had guaranteed for another Chinese solar company that defaulted. One local financial newspaper called Li's suicide "a sign of the imminent collapse facing the Chinese photovoltaic industry" due to overcapacity and mounting debts.
President Barack Obama has held up China's investments in green energy and high-speed rail as examples of the kind of state-led industrial policy that America should be emulating. The real lesson is precisely the opposite. State subsidies have spawned dozens of Chinese Solyndras that are now on the verge of collapse.
Unveiled in 2010, Beijing's 12th Five-Year Plan identified solar and wind power and electric automobiles as "strategic emerging industries" that would receive substantial state support. Investors piled into the favored sectors, confident the government's backing would guarantee success. Barely two years later, all three industries are in dire straits.
This summer, the NYSE-listed LDK Solar, the world's second largest polysilicon solar wafer producer, defaulted on $95 million owed to over 20 suppliers. The company lost $589 million in the fourth quarter of 2011 and another $185 million in the first quarter of 2012, and has shed nearly 10,000 jobs. The government in LDK's home province of Jiangxi scrambled to pledge $315 million in public bailout funds, terrified that any further defaults could pull down hundreds of local companies.
Meanwhile another NYSE-listed Chinese solar company, Suntech, revealed on July 30 that the German government bonds an affiliate pledged as security for a $689 million bank loan it guaranteed never existed. Suntech, the world’s largest producer of solar panels, claims it was the victim of fraud. Considering Suntech already owed $3.6 billion (for a debt-asset ratio of 82%), and lost $149 million in the fourth quarter of 2011 and $133 million in the first quarter of 2012, many analysts believe the company could go bankrupt without a sizable government bailout.
Chinese solar companies blame many of their woes on the antidumping tariffs recently imposed by the U.S. and Europe. The real problem, however, is rampant overinvestment driven largely by subsidies. Since 2010, the price of polysilicon wafers used to make solar cells has dropped 73%, according to Maxim Group, while the price of solar cells has fallen 68% and the price of solar modules 57%. At these prices, even low-cost Chinese producers are finding it impossible to break even.
Wind power is seeing similar overcapacity. China's top wind turbine manufacturers, Goldwind and Sinovel, saw their earnings plummet by 83% and 96% respectively in the first half of 2012, year-on-year. Domestic wind farm operators Huaneng and Datang saw profits plunge 63% and 76%, respectively, due to low capacity utilization. China's national electricity regulator, SERC, reported that 53% of the wind power generated in Inner Mongolia province in the first half of this year was wasted. One analyst told China Securities Journal that "40-50% of wind power projects are left idle," with many not even connected to the grid.
A few years ago, Shenzhen-based BYD (short for "Build Your Dreams") was a media darling that brought in Warren Buffett as an investor. It was going to make China the dominant player in electric automobiles. Despite gorging on green energy subsidies, BYD sold barely 8,000 hybrids and 400 fully electric cars last year, while hemorrhaging cash on an ill-fated solar venture. Company profits for the first half of 2012 plunged 94% year-on-year.
China's high-speed rail ambitions put the Ministry of Railways so deeply in debt that by the end of last year it was forced to halt all construction and ask Beijing for a $126 billion bailout. Central authorities agreed to give it $31.5 billion to pay its state-owned suppliers and avoid an outright default, and had to issue a blanket guarantee on its bonds to help it raise more. While a handful of high-traffic lines, such as the Shanghai-Beijing route, have some prospect of breaking even, Prof. Zhao Jian of Beijing Jiaotong University compared the rest of the network to "a 160-story luxury hotel where only 11 stories are used and the occupancy rate of those floors is below 50%."
China's Railway Ministry racked up $1.4 billion in losses for the first six months of this year, and an internal audit has uncovered dangerous defects due to lax construction on 12 new lines, which will have to be repaired at the cost of billions more. Minister Liu Zhijun, the architect of China's high-speed rail system, was fired in February 2011 and will soon be prosecuted on corruption charges that reportedly include embezzling some $120 million. One of his lieutenants, the deputy chief engineer, is alleged to have funneled $2.8 billion into an offshore bank account.
Many in Washington have developed a serious case of China-envy, seeing it as an exemplar of how to run an economy. In fact, Beijing's mandarins are no better at picking winners, and just as prone to blow money on boondoggles, as their Beltway counterparts.
In his State of the Union address earlier this year, President Obama declared, "I will not cede the wind or solar or battery industry to China . . . because we refuse to make the same commitment here." Given what's really happening in China, he may want to think again.
