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Musings Report #9 2-28-15 Is China the Next Superpower or One of the Dominoes About to Fall?
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For those who are new to the Musings reports: they are basically a glimpse into my notebook,the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books. As always, I hope the Musings spark new appraisals and insights. Thank you for supporting the site and for inviting me into your circle of correspondents.
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Is China the Next Superpower or One of the Dominoes About to Fall?
There seems to be little middle ground in predictions about the Middle Kingdom (China): either it is poised to become the next global superpower, or it is another big domino that's about to topple.
Just this past week, I ran across two articles supporting each projection: Stratfor Claims EU, Russia Will Fall Apart and Is China Going to Be the World's Superpower Within a Few Short Decades?
I don't think either article sheds much light on the larger question: what factors strengthen or diminish a nation's resilience and ability to adapt successfully as the global status quo finds that "extend and pretend" no longer works?
Last week, I suggested that stability, social mobility and innovation will be scarce geopolitically. This line of thinking is based on the seminal article Labor, Capital, and Ideas in the Power Law Economy, which explains why profits will flow to the inputs that are scarce. In the authors' view, this is not conventional financial capital (which is abundant and cheap) or labor (also abundant and cheap) but ideas that create new markets and solutions.
This is why I was exploring the question, what are the characteristics of an economy/society that generates productive innovation? I concluded that the scale and interconnectedness of the innovation is critical, as is the system for distributing the useful innovations rapidly and widely throughout the economy/society.
Another way of approaching the same topic is to ask: what makes a society resilient in the face of crises and/or existential threats to its current arrangements? It's clear that what's scarce--structural stability, social mobility and innovation--are key factors in resilient systems, be they households, businesses or nations: what lends resilience to systems is scale-inavariant.
If we read this article between the lines-- China Starting to Realize America Isn't Necessarily in Decline (via Richard Metzger)--we can hazard that what the Chinese are recalibrating is not simply current measures of military or financial might but America's resilience, which is another way of saying "finding and distributing solutions before the problems collapse the system."
From my perspective (a view shared by many), the U.S. has accomplished little beyond half-measures: phony bank reforms, lowering interest rates to bail out borrowers, etc. But the fact that these tepid responses were enough to stabilize the U.S. and secure its currency is evidence that the U.S. was not as vulnerable as the Chinese might have believed. (This is the danger of believing your own propaganda.)
This also suggests that the Chinese leadership has a poor grasp of what generates resilience. Clearly, the leadership believes Party dominance is essential for Chinese stability. But they have little visible awareness of what Nassim Taleb has described in his books and articles: that real stability can only arise if volatility and the constant instability created by innovation, experimentation and challenges to the status quo are given free rein.
The test of a system's fragiliy/resilience is how it handles disorder. As Taleb puts it, "Fragility is aversion to disorder."
So resilience--what we might call survivability or anti-fragility, to use Taleb's phrase--is a dynamic full of irony: the tighter one controls everything to limit disorder and instability, the greater the system's fragility and vulnerability to collapse.
Any society/economy that invests much of its energy in propping up a superficial stability will be fragile. Any status quo that limits social mobility to benefit the few at the expense of the many is fragile. Any economy that generates innovations in isolated nodes that aren't interconnected, or that limits the distributions of innovations deemed dangerous, will be fragile.
To gain a truly meaningful context of resilience, we need to overlay a matrix of four fundamental factors:
1. the state (government)
2. energy sources and costs
3. the biosphere/ecosystem
4. finance
As Gail Tverberg has shown, energy is intimately linked to economic growth and thus to the state, which depends on growth for its revenues. There is a see-saw effect in energy: if the price plummets below the cost of production, supply will eventually drop as those pumping oil at a loss go broke. Low prices lead to high prices as shortages in supply eventually push prices much higher.
On the other end of the see-saw, high energy costs filter through into higher costs for everything in the material world and drain income from consumers. With less disposable cash to spend on consumption and new debt, the consumer economy crashes into recession/depression. This link between high energy costs and recession is quite obvious over the past 40 years.
If the ability to finance more consumption collapses, so too does the consumer economy. Once wages and profits tank, the state's revenues crater.
The Master System is of course the biosphere. Issuing regulations and new money doesn't resolve shortages due to environmental breakdown. Issuing new loans won't fix the consequences of an extended drought that devastates a critical breadbasket.
The third overlay is external costs: all the costs in the system that were dumped on the broader system without being accounted for in the cost of production, delivery, etc.
China and the developing world as a whole are examples of externalized costs coming home to roost. If it will cost $10 trillion to even begin to clean up the ravages of environmental damage in China, that $10 trillion will have to come out of capital or future income. (The $10 trillion is my back-of-the-envelope estimate of a good start.)
Externalities such as pollution are interesting examples of the Tragedy of the Commons that I discussed last week in the blog. When we dump waste in the air and rivers, at first it seems as if the dumping is "free"--it doesn't ruin anything and so the cost to us is free.
But then as everyone else also dumps waste in the air and water--and they must do so, if they want to compete with those who are "lowering production costs" by dumping their waste--the entire system is soon clogged with waste that is now affecting everyone who breathes, eats food grown on poisoned soils, etc.
Since the waste has reached truly epic levels, the cost of remediating the damage is now staggering: the sources of waste/pollution must clean up their production to emit no pollution (a horrendously costly project on a national scale) and the damage already done must be cleaned up--another project that will costs trillions of dollars.
If the nation extends-and-pretends to keep consumption steady, the waste will only get more costly to clean up later. In the meantime, everyone breathing the air and being exposed to toxins rediscovers TANSTAAFL: "there ain't no such thing as a free lunch." The illnesses caused by rampant environmental damaged deducts millions of years of productive life from the citizenry and rapidly increase healthcare costs. Both divert capital and bleed income fro consumption.
So putting off the $10 trillion in cleanup creates $10 trillion in reduced lifespans, productivity and healthcare costs--and eventually the $10 trillion clean-up will have to paid for anyway, lest the nation become unlivable.
There is no way to fund a consumer society and fund these external costs unless the economy generates steady surpluses that are invested in fixing these externalities. This is one major reason why the U.S. economy stagnated in the 1970s--the horrendous environmental damage inflicted by industrialization had to be cleaned up, and those costs suppressed consumption, as did higher energy costs.
Finance can play a role in paying for external costs. A nation with little debt can borrow 50% of its GDP to pay down these external costs. But unfortunately for the people living in the developing-world nations, most of these economies are already burdened with unsustainably high levels of debt. In China's case, the debt funded a massive building boom that long ago lost touch with the real-world value of what was being built.
The assumption that every new city, stadium, airport etc. will soon be filled with wealthy citizens is ultimately based on very shaky assumptions:
1. energy will stay cheap for years/decades to come
2. the monumental external costs of China's industrialization can be paid without affecting consumption
3. the astonishing expansion of debt in China can keep going for years/decades to come
4. the central state will manage all these unprecedented issues without mishap as global recession reduces social mobility and guts exports
As I have written before, dependence on others for markets, resources, capital, etc. creates another form of fragility, as any cutoff of access to markets for one's production, capital, food, energy, etc., will quickly cripple the consumer economy and pressure the state, which will typically be tempted to increase control and suppress instability--the precise path to greater fragility and eventual collapse.
As Charles Darwin observed, "It is not the strongest of the species that survives, nor the most intelligent, but the ones most adaptable to change."
In conclusion, I don't think a strong central state is enough to generate resilience. You need all four components--a state with stable rules and pathways of social mobility, a functioning biosphere, a source of energy within your control and a financial system that is not just a house of cards resting on phantom collateral.
To the degree that a nation lacks any of these, it is fragile and prone to collapse. All these factors are interconnected; you can't ignore external costs and hope you can get a free lunch. You can't devote all your capital to extend-and-pretend and think you've built real stability.
The last factor to monitor is the flow of capital. The truly big money is always owned or controlled by insiders. Stock investors know how this works: if insiders are selling (and they always have an excuse--"rebalancing my portfolio," etc.) then they're voting "sell now" with their own money.
Look at the flow of insider capital out of China, Europe, Russia and elsewhere. When insiders are voting with their feet and their money, it tells you all you need to know about the true situation. Insiders have a major motivation to put on a show of believing that all is well, because they need the unwary and credulous to remain passive while they sell/get their capital out of the country.
When U.S. CEOs, magnates, top politicos, etc. are all stealthily moving their capital and kids to China while proclaiming the U.S. is the place to be, it will be a sign that the status of superpower has shifted. But the reality is it is China's wealthy and powerful who are moving their capital and kids to the U.S. Who knows better than the insiders at the top? Who has better information than they do?
Resilience is scale-invariant, and we can all learn from an analysis of resilience, fragility and anti-fragility.
Summary of the Blog This Past Week
My 31-Year Old Apple Mac Started Up Fine After 15 Years in a Box 2/28/15
China and the Dragon Tail of Marx 2/27/15
U.S. Healthcare and the Tragedy of the Commons 2/26/15
Why It's So Difficult to Repair Stuff: It's Made That Way 2/25/15
Forget The $1 Trillion Platinum Coin--Here's the $10 Trillion Stone Coin 2/24/15
Grexit Drama Greenlighted for a 5th Season--New Characters, New Plot Twists 2/23/15
Best Thing That Happened To Me This Week
Heard Schumann's 1st Symphony played by the San Francisco Symphony, led by Michael Tilson Thomas. I heard any number of rousing film scores in the piece--it made me think many a film score composer had mined the 1st symphony over the decades.
Market Musings: TINA and FUGAZI
A number of non-institutional analysts and traders have hinted that they sense something big is just over the horizon. As noted above, insiders have tremendous incentives to exhibit calm confidence in public while they sell, sell, sell every at-risk asset they own behind closed doors.
Timing an intuition is not a science, it's an art. Two windows seem to be mentioned above all others: April-May 2015 and October 2015. Some sense the top of the six-year bull is close--at the end of April or so. Could "sell in May and go away" work this year?
Others see another six months of grinding higher on capital flows from overseas and the usual narrowing of stock leaders such as Apple. In this scenario, the top will be reached later in 2015.
Still others don't see a top until 2016.
All this makes me think of two acronyms: TINA and FUGAZI. TINA is "there is no alternative." This is the favored phrase of those benefiting from the current arrangement. TINA makes perfect sense to everyone who wants the status quo to remain stable, but it also suggests a rigidity that suppresses the very instability needed to maintain real stability and not just a phony extend-and-pretend pretense of stability.
FUGAZI has two current meanings, both apocryphal: phony/fake and the combat-context phrase "F**ked up, got ambushed, zipped in" (to a body bag, i.e. killed in action). While this certainly sounds Vietnam-era-like, I worked with many Vietnam vets in the 70s and 80s, and I never heard any use fugazi, so it may be a backronym, i.e. a phrase that did not start as an acronym but acquired an acronym later.
In any event, if the intuition of experienced traders has any value, perhaps we should think of them as hyper-vigilant leads on combat patrol in a steamy jungle filled with booby traps and threats. Those who have survived on an instinct for danger--listen to them. If you don't want to be ambushed by a market crash and zipped up in a body bag, cash in your chips now and let others play the last few spins of the roulette wheel.
From Left Field
My Life as a Communist Stooge: Working in China’s Ministry of Truth -- unvarnished account ....
Air Pollution Turned This Chinese City Into a Ghost Town -- should read "externalities and overcapacity turn city into ghost town"...
In China, Civic Groups’ Freedom, and Followers, Are Vanishing (via Maoxian) “The pressure on grass-roots organizations has never been this intense."
An Evergreen Island (44 min) (via Bart D.)
Synopsis: In 1989, the landowners of Central Bougainville closed one of the world's largest copper mines that was destroying their land. It remains closed to this day. In response, a blockade was imposed around the island. From scratch, the Bougainvilleans built their own schools, they revived their traditional bush medicines, they used solar and hydro power to generate electricity, but the most fascinating invention was the use of fermented coconut oil as a substitute for fuel. "An Evergreen Island" is a story of courage, survival and persistence - of inventiveness, imagination and creativity on a little-known Pacific island.
Bougainville Bamboo Band (16:24) (via Bart D.) watch a few minutes of this--remarkable musical instruments and a pleasing sound...
Alaska Farmer Turns Icy Patch Of Tundra Into A Breadbasket (via Joel M.)
DO NOT LOOK (Brazilian prank) (2:02) slapstick with the unwary....
Role of Wages of the Common Worker in Oil Prices, Collapse (Gail T.)
What Is Money And How Is It Created? Steve Keen explains in a few paragraphs...
Student Debt Grows Faster at Universities With Highest-Paid Leaders, Study Finds -- we need money to administrators as well as hedge fund managers...
An Embedded Photographer Empowers the Poor --interesting...
Even the Most Educated Workers Have Declining Wages -- man bites dog...
"The very essence of instinct is that it's followed independently of reason." (Charles Darwin)
Thanks for reading--
charles |
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