This is Us

Somehow we cling to the hope that debt on our side of the world works differently than debt on the other side of the world.  And then we wonder why GDP constantly falters and consumer spending is so reticent.

Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP…eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent…

China’s Economy Is Past the Point of No Return

by Gordon G. Chang

After a near-disastrous start to the year and a one-month recovery in March, the Chinese economy looks like it’s now headed in the wrong direction again. The first indications from April show the country was unable to sustain upward momentum.

Even before the first dreadful numbers for last month were released, Anne Stevenson-Yang of J Capital Research termed the uptick the “Dead Panda Bounce.”

The economy is essentially moribund as there is not much that can stop the ongoing slide. A contraction is certain, and a severe adjustment downward—in common parlance, a crash—looks likely.

At the moment, China appears healthy. The official National Bureau of Statistics reported that growth in the first calendar quarter of this year was 6.7 percent. That is just a smidgen off 6.9 percent, the figure for all of last year. Moreover, the quarterly result cleared the bottom of the range of Premier Li Keqiang’s growth target for this year, 6.5 percent.

The first-quarter 6.7 percent was too good to be true, however. And there are two reasons why we should be particularly alarmed.

First, China’s statisticians appear to be just making the numbers up. For the first time since 2010, when it began providing quarter-on-quarter data, NBS did not release a quarter-on-quarter figure alongside the year-on-year one. And when NBS got around to releasing the quarter-on-quarter number, it did not match the year-on-year figure it had previously reported.

NBS’s 1.1 percent quarter-on-quarter figure for Q1, when annualized, produces only 4.5 percent growth for the year. That’s a long distance from the 6.7 percent year-on-year growth that NBS reported for the quarter.

Even China’s own technocrats do not believe their own numbers. Fraser Howie, the coauthor of the acclaimed Red Capitalism, notes that the chief of a large European insurance company, who had just been in meetings with the People’s Bank of China, said that even the Chinese officials were joking and laughing in derision when they talked about official reports showing 6 percent growth.

Second, the central government simply turned on the money taps, flooding the economy with “gobs of new debt,” as the Wall Street Journal labeled the deluge.

The surge in lending was one for the record books. Credit growth in Q1 was more than twice that in the previous quarter. China created almost $1 trillion in new credit during the quarter, the largest quarterly increase in history. [The Fed has created $3.5+ trillion and counting during our non-recovery.]

Of course, Chinese banks tend to splurge in Q1 when they get new annual quotas, but this year’s lending exceeded all expectations.

The Ministry of Finance also did its part to refloat the economy. Its figures show that in March, the central government’s revenue increased 7.1 percent while spending soared 20.1 percent.

All that money produced good results—for one month. In April, the downturn continued. Exports, in dollar terms, fell 1.8 percent from the same month last year, and imports tumbled 10.9 percent. Both underperformed consensus estimates. A Reuters poll, for instance, predicted that exports would decline only 0.1 percent, while imports would fall 5 percent.

Exports have now dropped in nine of the last ten months, and imports, considered a vital sign of domestic demand, have fallen for eighteen straight months.

Both figures show a marked deterioration from March, when exports jumped 11.5 percent and imports fell 7.6 percent.

The trade figures followed extremely disappointing surveys of the manufacturing sector. The official Purchasing Managers’ Index came in at 50.1, down from March’s 50.2, barely above the 50.0 that divides expansion from contraction.

The widely followed Caixin survey registered at 49.4, down from March’s 49.7. April was the fourteenth straight month of contraction in this more representative—and far more reliable—survey.

Beijing will release additional numbers in the next two weeks, but its reported figures—especially those showing consumer prices, retail sales and industrial output—have obviously become less accurate in recent months. By now, with the first indications for April, it’s clear the economy did not turn the March spike into a recovery.

That has grave implications for Beijing, as Chinese technocrats have evidently lost control of the economy. For one thing, they are no longer helped by strong external demand, and there is little prospect of relief in coming months. As Zhou Hao of Commerzbank told the Wall Street Journal, “China is on its own.”

And alone, Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP.

Although debt does not work the same way in China’s state-directed economy as it does in freer ones, eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent, as Barron’s, referring to Victor Shih’s calculations, notes. Soros in January said the ratio could be as high as 350 percent, and Orient Capital Research in Hong Kong suggests 400 percent.

Whatever it is, China is just about at the limits of the debt it can bear, as growing defaults—and a stark warning from the Communist Party itself on Monday—indicate.

There are many problems, but state firms, backed by Beijing’s spend-like-there’s-no-tomorrow approach, are investing capital, and private ones are not. Leland Miller and Derek Scissors note that their China Beige Book survey of 2,200 Chinese businesses shows that in the first quarter, capital expenditure by lumbering state firms was “stable from a year ago” while private companies “cut back substantially.”

That is an issue because virtually no one thinks an even bigger state sector is a good idea. Yet Chinese leaders have opted for one because, as a practical matter, they have no choice. Structural economic reform, which everyone knows is necessary, would lower growth rates too far, well below zero. That’s politically unacceptable, so they continue with a strategy that must result in a crash, simply because it buys time.

It is no coincidence that Chinese leaders are now pressuring analysts and others to brighten their forecasts and not report dour news, to show zhengnengliang—“positive energy”—a sure indication Beijing has run out of real options.

China, therefore, has passed not only an inflection point but also the point of no return. There are no longer off ramps on the road leading over the cliff.

And that thud you just heard when the first April numbers were issued? That was the big black-and-white bear hitting the floor.

House of Cards: Truth Stranger Than Fiction

As a political economist and policy analyst I have to say I’ve found the NetFlix series, House of Cards very entertaining. Of course, it is over the top with political sleaze and corruption, something that probably syncs well with the public’s impression of Washington politics these days. (I find it interesting that the writers chose to designate the depraved, murderous POTUS Frank Underwood, played by Kevin Spacey, as a big “D” Democrat. With an annoyingly ambitious, self-righteous wife as co-president – sound familiar? Apparently, depravity with good intentions is somewhat acceptable these days in partisan circles, with Underwood often turning to the audience to explain the bare facts of Machiavellian realpolitik. How unfortunate for poor Niccolo, who was a true republican patriot, but recast by history as the apologist for a ruthless, depraved Prince.)

I have been most amused by Season 3, where Pres. Underwood proposes a massive jobs program paid for by slashing entitlements. This is just too juicy to let pass unnoticed. Let’s translate this “promise” of a full employment Nirvana: “I’m going to take your hard earned money we extorted through Social Security and Medicare taxes and give it away to companies that will employ workers for jobs that the productive private economy will not create because they lose money. Isn’t that grand? We’ll all feel better about humanity, even though we’ll be poorer for it (all except me, that is).”

The irony is that this absurd fiction is actually proposed too often as serious politics in the real Washington D.C. Quite a few other bloggers have explained the surrealness of a POTUS creating jobs from whole cloth just because he can command it from the White House. The numbers just don’t add up. But I was struck more by the widely accepted premise that asserts “jobs” as the end-all of what ails a society of free citizens. The Underwood character actually says, “People are dying from unemployment!” This cuts pretty close to home with Obama recently claiming that “chanting ‘Death to America’ does not create jobs.” Really? Is that what they’re beheading innocents over, a few good jobs?

People don’t die from unemployment, they die from poverty, deprivation, and disease. They die from oppression and violence. Unproductive jobs subsidized by governments do not alleviate poverty, they merely spread poverty around. The thing is, politicians focus on jobs because that is the only way they know how to spread the benefits of capitalism around the population. But we are moving into a new age that departs from the skilled labor-intensive manufacturing of the post-WWII years. Our financial policies have accelerated this trend away from labor by providing cheap capital to take advantage of cheaper labor overseas or machine/robot substitution. We are entering the information, artificial intelligence, and robotics age, and yet our politicians are still making false promises of a job and two chickens in every pot. Not going to happen. We need to think outside that box to discover how we are going to create and share wealth in the new economy. There are many alternative ways to participate in a market economy than solely as a labor input.

In the meantime, enjoy the entertainment. It’s hilarious. But don’t expect a job from America Works.

Somebody Loan Me a Dime…

Loan me a dime

…as Boz Scaggs sang (as Duane Allman burned on guitar).

Debt as a Share of GDP

This graph (compiled by McKinsey) shows the levels of debt by sector across several significant countries as a percentage of their GDP. This is the relevant measure because it tells us how much bang countries are getting for their borrowed ‘buck’  (in their home currency).

An analogy would be if you were borrowing money on your household account that did not increase your income over time, but instead increased the burden of interest you had to pay on the debt, which would reduce the share of your income for other purchases, like vacations or retirement savings. It makes sense to borrow to earn a degree that will increase your earning potential; it makes less sense to borrow money to take a vacation or buy a car you can’t afford.

A rising debt to GDP ratio means the excessive borrowing is not paying off with increased income (national GDP). We can compare countries on the chart below and see that the US has greatly increased government debt, which according to the effects of our monetary policies, has been used to retire private debt. In other words, we’ve shifted private debt, much of it from the financial sector, to taxpayers. Japan is not included, but would show that just government debt as a share of GDP is well over 200%. All this debt has not bought Japanese citizens much in terms of real wealth. One could argue it has just prevented the Japanese economy from imploding.

Another risk factor not displayed here is the effect of financial repression on the service of this debt. US debt is being financed at historically low interest rates that do not reflect the time value of money or the risk premium of lending. When interest rates rise, as they must eventually, all this debt will need to be rolled over at higher rates, meaning the service on the debt will explode, driving out other spending priorities while driving balance sheets toward insolvency. (If we can’t pay, we won’t pay.)

All in all, this is not a pretty picture. Be afraid.

World debt

Unforgettable Economics Lessons in Tombstone

The lessons of history are there for us to learn…

Economics One

Last night Yang Jisheng was awarded the 2012 Hayek Prize for his book Tombstone about the Chinese famine of 1958-1962.  It’s an amazing book. It starts with Yang Jisheng returning home as a teenager to find a ghost town, trees stripped of bark, roots pulled up, ponds drained, and his father dying of starvation. He thought at the time that his father’s death was an isolated incident, only later learning that tens of millions died of starvation and that government policy was the cause.

Then you read about the Xinyang Incident: people tortured for simply suggesting that the crop yields were lower than exaggerated projections. Those projections led government to take the grain from the farmers who grew it and let many starve; and there are the horrific stories of cannibalism.

You also find out what life was like as a member of a communal kitchen. With free meals people…

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Made in China, Made in the USA


Cronyism knows no borders…

Notable & Quotable

Martin King Whyte says the Chinese people protest because of official injustice, not inequality of income.

From Martin King Whyte’s “China Needs Justice, Not Equality” at, May 6:

Xi Jinping, the new leader of the Chinese Communist Party, and his colleagues have repeatedly expressed alarm at increasing social protests. According to confidential but widely circulated Chinese police estimates, there are now about 180,000 mass protest incidents each year, roughly 20 times more than there were in the mid-1990s. China’s leaders portray the surge of protests as fueled by popular outrage over the yawning gap between rich and poor—a chasm that the leaders have spent a decade trying to close. In reality, though, Chinese citizens are angry about a different gap: the one between the powerful and the powerless. . .

Chinese are growing ever more conscious of their rights as human beings. They know that there are regulations and laws on the books that appear to guarantee them fair treatment. However, the gaps between proclaimed principles and reality are huge. When they try to follow established procedures to challenge official unfairness, most likely they will fail or even get into serious trouble. And that is why they take to the streets.

Sound familiar?

China and the dangers of unbalanced growth


The article below reiterates one of the basic economic truths explained in Political Economy Simplified, which is that growth requires a cyclical balance between consumption and savings; borrowing and investment. China is producing more exports than the world can consume, especially by the de-leveraging developed economies. China’s growth path is essentially too steep to keep up and so will correct to a more sustainable path. This is what happened with the credit bubble in the US as well. China is attempting to turbo-charge both consumption and investment at the same time by excessive borrowing, just like the US did in the 2000s.

Fundamentally, the economy runs on four wheels: consumption, saving, investment and production. If either of these gets out of sync with the others, the vehicle will sputter and crash. Interest rates are normally what keeps it all together, but we’ve been distorting those worldwide for the past two decades. Such mismanagement will demand a reckoning, and more of the same merely delays the inevitable.

From the WSJ:

China Has Its Own Debt Bomb

Not unlike the U.S. in 2008, China is at the end of a credit binge that won’t end well.


Six years ago, Chinese Premier Wen Jiabao cautioned that China’s economy is “unstable, unbalanced, uncoordinated and unsustainable.” China has since doubled down on the economic model that prompted his concern.

Mr. Wen spoke out in an attempt to change the course of an economy dangerously dependent on one lever to generate growth: heavy investment in the roads, factories and other infrastructure that have helped make China a manufacturing superpower. Then along came the 2008 global financial crisis. To keep China’s economy growing, panicked officials launched a half-trillion-dollar stimulus and ordered banks to fund a new wave of investment. Investment has risen as a share of gross domestic product to 48%—a record for any large country—from 43%.

Even more staggering is the amount of credit that China unleashed to finance this investment boom. Since 2007, the amount of new credit generated annually has more than quadrupled to $2.75 trillion in the 12 months through January this year. Last year, roughly half of the new loans came from the “shadow banking system,” private lenders and credit suppliers outside formal lending channels. These outfits lend to borrowers—often local governments pushing increasingly low-quality infrastructure projects—who have run into trouble paying their bank loans.

Since 2008, China’s total public and private debt has exploded to more than 200% of GDP—an unprecedented level for any developing country. Yet the overwhelming consensus still sees little risk to the financial system or to economic growth in China.

That view ignores the strong evidence of studies launched since 2008 in a belated attempt by the major global financial institutions to understand the origin of financial crises. The key, more than the level of debt, is the rate of increase in debt—particularly private debt. (Private debt in China includes all kinds of quasi-state borrowers, such as local governments and state-owned corporations.)

On the most important measures of this rate, China is now in the flashing-red zone. The first measure comes from the Bank of International Settlements, which found that if private debt as a share of GDP accelerates to a level 6% higher than its trend over the previous decade, the acceleration is an early warning of serious financial distress. In China, private debt as a share of GDP is now 12% above its previous trend, and above the peak levels seen before credit crises hit Japan in 1989, Korea in 1997, the U.S. in 2007 and Spain in 2008.

The second measure comes from the International Monetary Fund, which found that if private credit grows faster than the economy for three to five years, the increasing ratio of private credit to GDP usually signals financial distress. In China, private credit has been growing much faster than the economy since 2008, and the ratio of private credit to GDP has risen by 50 percentage points to 180%, an increase similar to what the U.S. and Japan witnessed before their most recent financial woes.

The bullish consensus seems to think these laws of financial gravity don’t apply to China. The bulls say that bank crises typically begin when foreign creditors start to demand their money, and China owes very little to foreigners. Yet in an August 2012 National Bureau of Economic Research paper titled “The Great Leveraging,” University of Virginia economist Alan Taylor examined the 79 major financial crises in advanced economies over the past 140 years and found that they are just as likely in countries that rely on domestic savings and owe little to foreign creditors.

The bulls also argue that China can afford to write off bad debts because it sits on more than $3 trillion in foreign-exchange reserves as well as huge domestic savings. However, while some other Asian nations with high savings and few foreign liabilities did avoid bank crises following credit booms, they nonetheless saw economic growth slow sharply.

Following credit booms in the early 1970s and the late 1980s, Japan used its vast financial resources to put troubled lenders on life support. Debt clogged the system and productivity declined. Once the increase in credit peaked, growth fell sharply over the next five years: to 3% from 8% in the 1970s and to 1% from 4% in the 1980s. In Taiwan, following a similar cycle in the early 1990s, the average annual growth rate fell to 6%.

Even if China dodges a financial crisis, then, it is not likely to dodge a slowdown in its increasingly debt-clogged economy. Through 2007, creating a dollar of economic growth in China required just over a dollar of debt. Since then it has taken three dollars of debt to generate a dollar of growth. This is what you normally see in the late stages of a credit binge, as more debt goes to increasingly less productive investments. In China, exports and manufacturing are slowing as more money flows into real-estate speculation. About a third of the bank loans in China are now for real estate, or are backed by real estate, roughly similar to U.S. levels in 2007.

For China to find a more stable growth model, most experts agree that the country needs to balance its investments by promoting greater consumption. The catch is that consumption has been growing at 8% a year for the past decade—faster than in previous miracle economies like Japan’s and as fast as it can grow without triggering inflation. Yet consumption is still falling as a share of GDP because investment has been growing even faster.

So rebalancing requires China to cut back on investment and on the rate of increase in debt, which would mean accepting a rate of growth as low as 5% to 6%, well below the current official rate of 8%. In other investment-led, high-growth nations, from Brazil in the 1970s to Malaysia in the 1990s, economic growth typically fell by half in the decade after investment peaked. The alternative is that China tries to sustain an unrealistic growth target, by piling more debt on an already powerful debt bomb.

Cronyism: From China to Washington

Excerpted from Bret Stephens writing in the WSJ:

In a remarkable piece of investigative journalism last week in the New York Times, reporter David Barboza identified assets worth $2.7 billion belonging to various members of the family of Chinese Prime Minister Wen Jiabao, including his 90-year-old mother, a retired schoolteacher named Yang Zhiyun.

“The details of how Ms. Yang, a widow, accumulated such wealth are not known, or even if she was aware of the holdings in her name,” Mr. Barboza reports. “But it happened after her son was elevated to China’s ruling elite, first in 1998 as vice prime minister and then five years later as prime minister.”


All this is good to know as a reminder that China, so recently extolled as the very model of technocratic know-how, turns out to be a country heavily populated at the top by rent-seekers and kleptocrats. Should that be surprising? Not if you think that nothing else can come from the lucrative crossroads where politically directed capital and politically connected individuals meet.

This brings us to Al Gore.

Earlier this month the Washington Post’s Carol Leonnig reported that the former vice president’s wealth is today estimated at $100 million, up from less than $2 million when he left government service on a salary of $181,400. How did he make this kind of money? It wasn’t his share of the Nobel Peace Prize. Nor was it the book and movie proceeds from “An Inconvenient Truth.”

Instead, as Ms. Leonnig reports, “Fourteen green-tech firms in which Gore invested received or directly benefited from more than $2.5 billion in loans, grants and tax breaks, part of President Obama’s historic push to seed a U.S. renewable-energy industry with public money.”

That’s nice work if you can get it—at least if you’re on the investment-management end of the deal. But what if you’re on the worker-bee end?

Is America Becoming an Anti-Risk Welfare State?

In this Barron’s interview Ferguson makes some valuable observations of US policy, putting it into historical context. The most fundamental fallacy he cites is the idea that democratic government can eliminate risk for its populace. It cannot – it can only help individuals better manage their risk. But the risk is ever-present and the wrong government policies can make systemic risk considerably worse.


Niall Ferguson, economic and financial historian, sees parallels between the U.S. now and the mid-20th-century U.K.

In his latest book, Civilization, The West and the Rest, the economic and financial historian Niall Ferguson argues that Western civilization’s rise to global dominance over the past 500 years was due mainly to six killer apps, as he calls them: competition, science, rule of law, modern medicine, consumerism, and the work ethic.

While “the Rest” lacked these concepts, they might not for much longer, as emerging markets are quickly catching up. Someday, they could even surpass the West. (On May 22 and 29, PBS will air a program based on Civilization.)

The Scottish-born Ferguson says that North and South American economies and institutions are converging. And, he adds, while China remains a long way from a rule-of-law democracy, anyone who thinks it will retreat from the markets is in for a rude surprise.

Lately, Ferguson, who is a professor at Harvard—Barron’s interviewed him in his Cambridge, Mass., office—and holds similar posts at Oxford and Stanford, has been worried about the market-destabilizing potential of a Middle East conflict, and says that going long oil is a good bet. And he thinks the U.S. is on a slippery slope that could turn it into a European anti-risk-taking welfare state. For more, read on.

Barron’s: There are once again concerns about U.S. growth. What factors are keeping the economy from reaching what you call “escape velocity”?

Ferguson:I’m skeptical that the U.S. can get to a self-sustaining recovery if we only increase monetary or fiscal stimulus. Part of the reason why the U.S. economy is not growing faster is policy uncertainty, and part is structural weakness. In terms of institutional policy, the U.S. is a relatively less attractive destination for investment than it used to be. A large body of literature shows a strong relationship between the quality of institutions and the growth rate. When countries improve rule of law, property rights, and investor protections, and when regulation becomes more transparent and corruption reduced, there are major payoffs. The World Justice Project says the U.S. has been deteriorating for close to 10 years by all these measures, which contrasts with improvements in some emerging markets, like Hong Kong.

The rule of law has become more expensive in the U.S. without becoming more efficient. Any business, particularly small to medium-size, that has had encounters with litigation in the past 10 years will know what I’m talking about. The rule of law in the U.S. has become, at some level, dysfunctional. One reason for that is the way Congress works. It is a honey pot for lobbyists. The result is that complex legislation is riddled with ambiguities that—guess what?—only lawyers can resolve. Dodd-Frank is designed to improve regulation, but what it actually does is institute a massive job-creation scheme for lawyers. There isn’t a financial institution in this country that doesn’t now require its compliance department to retain a whole bunch of lawyers to explain to them what this 2,000-plus-page monster means for their business. That concerns me.

If you locate a new plant in the U.S., you encounter this increasingly unfriendly regulatory and tax environment. You don’t know what the taxes are going to be, because Congress is playing a game of chicken about the deficit. It ought to be solvable. However, there are vested interests in the political system that have no interest in solving this problem because they profit from it. It is a classic problem of rent-seeking behavior triumphing over profit-maximizing innovation and entrepreneurship. If you only look at monetary and fiscal policy, it is incredible that the economy isn’t growing faster [since] it has had more stimulus than at any time since World War II.

Can you liken this to anything in history?

A parallel is the way that things went wrong in Great Britain in the mid-20th century, when a combination of overseas commitments, excessive public debt, vested interests in the form of organized labor, and incompetent management and a pretty decadent ruling elite made Britain the sick man of Europe. There are some lessons there. Over time, good institutions tend to deteriorate because of the human condition. There needs to be a renewal of American faith in the founding principles. A lot of ordinary Americans, especially businessmen, yearn for this and resent the crony capitalism they see between Washington and Wall Street.

Are you optimistic or pessimistic?

It’s always a good idea to be optimistic about the U.S. Ultimately, political leadership will materialize, because the popular instinct on many of these questions is sound and there are political leaders—[Wisconsin Republican Rep.] Paul Ryan, for example—who have integrity and are prepared to push unpopular measures that will ultimately prove beneficial. It isn’t just the tax code. It’s an incredibly complex accumulation of regulation and legislation, the net effect of which is to make it harder to be an innovator and entrepreneur. Not only is the U.S. doing less well in these terms than Hong Kong or Germany, but it is doing less well than the U.S. used to do.

What are your thoughts about the Chinese economy? Japan was supposed to overtake the U.S. years ago and didn’t.

China is not where Japan was in 1989, but where South Korea was in about the mid-1970s, which means it has a lot further to go with its export-led industrialization strategy. It is a vast version of South Korea. A fifth of humanity is currently benefiting from a transition to market reforms. Anybody who bets that will suddenly stop is going to be disappointed, and make some epically bad investment decisions, too.

The people who are certain to emerge in charge of China, like Vice President Xi Jinping and Vice Premier Li Keqiang, are sympathetic to the argument that China needs to move in the direction of markets and away from state capitalism. The model that is gaining ground wants to see more privatization of state-run enterprises, increasingly flexible capital accounts, and an end to the manipulation of the exchange rate. If this happened, not only would hot money come into China, but actually a lot of Chinese money would leave. If you wanted to make a single thing happen to stabilize the U.S. property market, it would be liberalizing China’s capital account.

How compatible is capitalism with China’s form of government?

More than we might assume. A one-party state was essentially the norm in most East Asian economic miracles. South Korea only moved away from a military dictatorship in the 1980s. I don’t think we’ll see multiparty democracy in China in our lifetimes, because the Chinese are right when they say our system can’t work for a fifth of humanity at this stage of China’s development. They would be very foolish to rush into the kind of things we periodically say they should do, such as allow political opposition to form. The Chinese know how dangerous that is.

The lesson of Chinese history is that this enormous entity that we call China has a capacity for centrifugal forces to take over. China will move in the direction of rule of law with a one-party state, which will become more subordinate to a meaningful rule of law in the sense that the private property rights of individual Chinese will become more secure. Most absolutist monarchs in the 19th century made that kind of transition without ceding power to parliament.

One hundred years from now, if your grandchild writes a sequel to Civilization, what will it say?

It will say two things happened, beginning in the late 20th century and carrying through into the 21st. The rest of the world learned best practices in economic and, to some degree, political terms. The people living in Asia and South America and even parts of Africa no longer live in miserable poverty with no security.

The other trend that proved far more pernicious was that the West, particularly Europe but also the U.S., failed to update its political or economic institutions, and that’s why its economies stagnated. We already see that in Japan. It is already a feature of life in much of Europe, and we have to worry about it coming here.

What made the West unusual was that risk takers were not only rewarded but honored, whether in science, exploration, or in trade. Spreading across the Atlantic from Europe is an anti-risk culture that manifests itself in two ways. One is the welfare state, designed to remove risk from your life by guaranteeing you an income from the cradle to the grave. That’s great because it means that nobody is starving in the streets for want of work. But it isn’t great if you create poverty traps and disincentives, so that people in the bottom quintile never work, which is the case in much of Europe.

The other way in which the anti-risk culture manifests itself is with the manic regulatory mentality that tries to prescribe rules for every eventuality, including the tiny, tiny risk that an asteroid will hit this building. Regulations that protect from every eventuality end up being paralyzing because the more things are proscribed, the more the ordinary entrepreneur has to be afraid that if he doesn’t comply, he will get sued.

What about the euro?

The costs of dismantling the euro are so high that the Europeans will do whatever it takes to prevent that. What it will take is a transition to something like a fiscal federal system where there are no longer bailouts; there are automatic transfers and there are going to be eurobonds so that the full faith and credit of the German government lies behind at least part of the debt of the other countries. Berlin knows this but dares not spell it out explicitly, because the bill for the German taxpayer will be quite large. You are talking about 5% to 8% of gross domestic product every year for the foreseeable future.

But it isn’t in the Germans’ interest to blow up the euro. That isn’t something Chancellor Angela Merkel wants to have in her Wikipedia entry. The principal beneficiary of the euro is German business. As long as Corporate Germany appreciates having the euro, and German voters still have some residual guilt feelings about history, then they pay. How does this transition to something more like a Federal Republic of Europe happen? It will proceed along a very bumpy road over a 12-to-18-month period. The ultimate destination will be something like a European financial authority/treasury that gradually accumulates the funds it needs. There will be painful negotiations, but they’ll get there because they have to.

Can you make a case for South America catching up to North America? Or are Venezuela and Argentina the vanguard of another cycle of falling backwards. And what about Brazil?

It would be very surprising if Brazil was to fall back. The costs of being Venezuela or Argentina are too obvious to anybody in the region, and the benefits of being Brazil are even more obvious. Not only for Brazil, but quite a substantial number of the Spanish-speaking countries—Peru, Chile, Colombia, Mexico—the picture is sustained institutional improvement, with a long way still to go. Compared with where these countries were 20 years ago, they are closer to rule of law. If you had invested in those countries 10 years ago, you would be in a much better place than if you had invested in North America. I’m cautiously optimistic about the region.

Mexico, if you just looked at the numbers, is much closer to Brazil than people realize. A good test will be whether the new president turns the Mexican oil monopoly into something like Brazil’s Petrobras. This is a story of convergence. South America is getting more like North America, and North America is getting more like South America.

What big geopolitical risks do you see?

The Arab Spring has a long way to run, with many unforeseeable consequences. The biggest risk is conflict in the Middle East. Whether it is Israel/Iran I don’t know, but there is going to be trouble. Nothing about the Arab Spring is good news for Israel. Their insecurity can only increase over time, and there is a real struggle about who is going to run the region once the U.S. essentially ceases to run it or runs it much less than it used to. It’s hard to feel really cheerful about the prospects of peace. Being long oil has to be a simple bet under those circumstances, quite apart from supply-and-demand constraints.

The other big risk is the game of congressional chicken about the U.S. deficit. It’s the most dangerous game in the world today. Are we going to replay the debt-ceiling arguments of last summer right through November and into the new year? I worry that—at a time of already high uncertainty about policy with a train called sequestration heading towards the U.S.—political brinkmanship will ultimately have real economic consequences. The U.S. is on an unsustainable fiscal path. With every passing year, it gets harder to fix because the major problem, Medicare, gets larger, and the political obstacles seem to get larger with it. At what point does the U.S. start to jeopardize its credibility as a sovereign borrower? History suggests a great power can end up with a very large debt burden before the markets lose faith. The U.S. might play this game of brinkmanship for years before the deficit is brought under control. We can end up with a debt-to-GDP ratio of 250%. That’s happened to other countries. But you can’t guarantee that the markets will cut that much slack.

Western World Is ‘Finished Financially’

Really? I guess it might be true if you believe nothing will change. But given the historical record, especially for the West, that’s not a good bet. The economic model we’ve been working from for the past century is no longer working, but that just means it will change, by design or by necessity. (BTW, the developing world depends upon the same model, they are just at a different stage of development where they have relied on the developed nations for growth.) There is a sustainable free market model out there, our policymakers and politicians just haven’t discovered it yet.

This from

By Forrest Jones

Growth and investment opportunities will be found in emerging markets while the West is “finished financially,” says David Murrin, CIO at Emergent Asset Management.

“This is the moment when the Western world realizes it is finished financially and the implications are huge, whereas the emerging BRIC countries are at the beginning of their continuation cycle,” Murrin tells CNBC, referring to the BRIC group of big emerging markets Brazil, Russia, India and China.Leaders in the U.S. and Western European countries have been unable to craft policy that generates sustained growth, which will leave them in the economic doldrums from time to time.
When economies grow so slowly that they cannot outpace inflation rates, they experience negative real growth, which can be dangerous.
“Societies fracture when you have negative real growth and quite simply our society faces fractures for trying to stick Europe back together again,” Murrin says.

So in the long run, get ready for China to rule the world.
“This isn’t just a BRIC story, this is the end of the Christian Western Empire versus the rise of the whole emerging world led by China as the foremost and most powerful,” Murrin says.
China recently took an about-face with its economic policy, shifting away from fighting inflation to fueling more growth by cutting reserve requirements on banks.”This is a big move — this is easing,” says Stephen Green, China economist at Standard Chartered Bank in Hong Kong, according to Reuters.

“It’s a clear signal that China is on a loosening mode,” Green adds.