China's Monetary Tiger

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Mao Tse-tung
in 1956 called the United States an empire. He called it a paper

In appearance
it is very powerful but in reality it is nothing to be afraid
of; it is a paper tiger. Outwardly a tiger, it is made of paper,
unable to withstand the wind and the rain. I believe the United
States is nothing but a paper tiger.

It is now half
a century later. The United States is bogged down in a war that
has lasted longer than its participation in World War II. The government’s
on-budget debt is in the $9 trillion range. Its off-budget debt
is in the $70 trillion range. Here was Mao’s assessment in 1956.

The United
States owes debts everywhere. It owes debts not only to the countries
of Latin America, Asia and Africa, but also to the countries of
Europe and Oceania. The whole world, Britain included, dislikes
the United States. The masses of the people dislike it. Japan
dislikes the United States because it oppresses her. None of the
countries in the East is free from U.S. aggression. The United
States has invaded our Taiwan Province. Japan, Korea, the Philippines,
Vietnam and Pakistan all suffer from U.S. aggression, although
some of them are allies of the United States. The people are dissatisfied
and in some countries so are the authorities.

All oppressed
nations want independence.

is subject to change. The big decadent forces will give way to
the small new-born forces. The small forces will change into big
forces because the majority of the people demand this change.
The U.S. imperialist forces will change from big to small because
the American people, too, are dissatisfied with their government.

Mao has been
dead for three decades, yet his words seem strangely prophetic.
He understood what the United States was facing. Yet he had no clue
about what China was facing. He was completely wrong about China’s
role in the world economy in the decades that followed his death.

China remains
officially Marxist politically, yet in fact has become the fastest
growing large capitalist economy in history. This began in 1979
under Deng Xiao-ping, the man Mao failed to execute. (Deng was saved
by the personal intervention of Col. von Trapp’s son-in-law, but
that’s another story for another day.)


Economist F.
A. Hayek in 1969 offered his version of having a tiger by the tail:
monetary inflation.

Now we have
an inflation-borne prosperity which depends for its continuation
on continued inflation. If prices rise less than expected, then
a depressing effect is exerted on the economy. I expected that
ten years would suffice to produce increasing difficulty; however,
it has taken 25 years to reach the stage where to slow down inflation
produces a recession. We now have a tiger by the tail: how long
can this inflation continue? If the tiger (of inflation) is freed
he will eat us up; yet if he runs faster and faster while we desperately
hold on, we are still finished! I’m glad won’t be here to see
the final outcome. (Hayek, A
Tiger by the Tail
, Institute for Economic Affairs, 1972,
p. 112.)

As he spoke,
a recession in the United States was about to hit. There was another
in 1975. The United States went off the international gold standard
in 1971. Price inflation soared in the decade. Then the Federal
Reserve stabilized money in 1979. The result was a pair of recessions,
1981 and 1982. Price inflation slowed, but then an international
monetary crisis hit in August, 1982, when Mexico threatened to default.
To avoid a disaster, the FED pumped in money. Price inflation continued,
though at a slower pace.

Hayek died
in 1992. He lived long enough to see the Soviet Union fall. He did
not see the end of inflation.

So far, the
West has not gotten off the tiger’s back. But the tiger has not
yet eaten us.

Now it is China’s
turn to ride the monetary tiger.


At the beginning
of 2007, the Chinese central bank announced its monetary goals for
the year. As it does every year, it announced that the policy would
be prudent.

It said it
will continue to implement a prudent monetary policy and improve
its foresight on the country’s economy and financial sector.

Here is what
prudence is in today’s China. This was the target for M-2.

China aims
to keep the annual growth of its broad money supply this year
to within 16 percent, nearly 1 percentage point down from that
of 2006, the central bank announced on Sunday.

The target
was set on the basis of an expected 8 percent growth in gross
domestic product (GDP) and a less than 3 percent rise in consumer
prices year-on-year, the central bank said at its annual work
conference that concluded yesterday.

Consider 8%
growth. This means a doubling of the economy every nine years. As
for price inflation, the bankers expected 3%. This means that they
expected real economic growth of 5%, which is very high for a nation
of 1.3 billion people.

As for M-1,
the narrow money supply, the bank issued no target figure.

China’s bankers
underestimate money growth, year after year.

Last year,
the central bank set its macro-control targets at a 16
percent annual growth for M2
, a 14 percent rise for M1, and
2.5 trillion yuan (US$312.5 billion) of newly added loans in Renminbi.

Data from
the bank show the country’s M2 last year rose 16.94 percent year
on year to 34.56 trillion yuan, with M1 up 17.48 percent to 12.6
trillion yuan and new credit surging to 3.18 trillion yuan, or
27 percent beyond target.

This discrepancy
was easily explained: "The money supply and credit targets
are not missions it must meet but only a policy guide, the bank
has said." How will the bank achieve its goals in 2007? By
winging it. "The central bank pledged to adopt multiple tools
for monetary macro-control and to advocate flexibility in interest
rate adjustments to address excessive currency liquidity."

The money supply
in China has risen in the 15% to 18% range, year after year. By
April, the increase in M-2 was around 17%, year to year, slightly
higher than the announced rate.

But what of
official growth figures? The government claimed 10.7% growth in
2006, meaning a doubling every 6.7 years. It claimed price inflation
of 1.3%, meaning that China in 2006 had real growth of 9.2%. This
is astronomical. There is no historical precedent for anything like
this. I think we should employ skepticism regarding these figures.
Statisticians in Marxist countries must toe the line.


Jim Jubak has
offered an explanation of how these high economic growth rates are
possible. I have mine. They agree. It is due to a freeing up of
labor and capital. The labor market is outside the compulsory welfare
system of the Chinese government. He thinks this is bad. I think
it is good. He

It works
like this. A peasant looking for a better life can move to a city
or an industrial zone and get a job. But they can’t get a "hukou,"
the certificate of residence required to access public services
such as schools, health care and unemployment benefits. These
migrant workers live crammed in company dormitories, usually earning
far below the official minimum wage and sometimes as little as
$1 for a 12-hour day, doing the dirtiest and most dangerous work
that no worker with a certificate of residence wants. And quite
often, the company refuses to pay the migrant worker even those
wages. Official Chinese government figures say that more than
70% of the country’s migrant workers were owed pay by their employers
last December.

This is a free
labor market involving huge numbers of people. Jubak writes: "Estimates
of the number of migrant workers in China range from 110 million
to 120 million." He estimates that 3.7 million migrants live
in Guangzhou, which has 7.5 million people. "Migrants make
up 80% of all urban construction workers and 68% of workers in electronics
manufacturing, according to UNESCO (the United Nations Educational,
Scientific and Cultural Organization)."

Consider some
implications of these numbers. In China,
(2005), author Ted Fishman offers these tidbits of

month, China must build enough urban infrastructure to accommodate
a city the size of Houston in order to absorb the 300 million
rural Chinese who will move to cities in the next 15 years."

has 450 cities with a population of at least 250,000, compared
to 68 cities in the United States with at least a quarter of a
million people."

has over 100 cities with a population of at least 1 million people
— the United States has 9."

of China’s 1.3 billion people are under age 24. Over 300 million,
more than the population of the US, are under the age of 14."

We begin to
see the nature of the tiger that China is riding. China has the
highest rate of monetary inflation of any large industrial nation.
It is experiencing the largest migration of population in recorded
history. In less than one generation, well over a hundred million
people have moved from farms to cities. It may be closer to 200
million people.

Monetary inflation
is not the main source of China’s economic boom. This kind of increased
economic productivity does not arise out of increases in the money
supply. Fiat money does not create new wealth. Economic growth has
arisen out of a freeing up of capital and labor in what had been
a Communist economy.

Monetary inflation
does affect the allocation of capital and labor at the margin. Companies
that get access to the newly created money can buy goods and services
at yesterday’s prices. They can fund new plants and new projects
more inexpensively than companies that get access to the fiat money
later in the flow of funds.

Which are these
companies? Obviously, among the winners are companies that export
to the West, whose importers can buy the Chinese yuan at a low price
due to the increase in the supply of yuan. China is imitating the
five Asian "tiger" economies that were built on exports
to the West: Japan, Taiwan, Hong Kong, South Korea, and Singapore.

To subsidize
the export sectors of the economy, the Chinese central bank has
adopted monetary inflation. It has used its newly created currency
units to buy foreign currencies, which it then uses to buy the debt
certificates issued by Western governments, including the United
States. This has helped keep interest rates lower in the United
States than what would have prevailed, had the Chinese central bank
not inflated or else had bought assets other than T-bills.


Hayek pointed
out the nature of the tiger in 1969. He had learned this from Ludwig
von Mises, who had discovered the nature of the boom-bust cycle
in 1912. The
cycle comes from monetary inflation
, which stimulates economic
growth. Then, when the rate of price inflation slows, the underlying
forces of the economy reassert themselves. Interest rates rise as
prices rise. Projects that had been launched because of the low
interest rates that had been produced by the fiat-money-funded purchases
of government debt, now face bankruptcy because of rising interest

China has now
moved into the industrial world. It is part of the world economy.
It is experiencing huge population movements. People are moving
off low-output farms and moving into huge cities. In cities, there
is a much higher division of labor than in rural villages. There
is much greater specialization of production. So, there will be
much greater economic losses when a recession hits. On a farm, you
can switch production to self-sufficiency when market demand declines.
In a city, you get fired when market demand declines. Your income
ceases. You must find different employment.

How do you
do this if the urban economy takes the brunt of the economic losses?
You lower your price. You work for less. To persuade workers to
do this, companies must create incentives. They fire people. Until
workers recognize the new conditions and adjust to them by lowering
their wage demands, they remain unemployed.

This is a major
threat to the Communist government. The tight controls imposed on
the population by the political system were justified by guaranteed
employment in state-owned companies. These have been steadily shut
down by the government.

What happens
to the political order when the tiger of inflation is replaced by
the tiger of recession? This is the nature of the tiger that Hayek

The central
bank has placed the entire society on the back of this tiger. It
dares not stabilize the money supply. So, it continues to create
new money, hoping that prices will not rise domestically because
of the downward pressure on wages created by the flood of rural
workers streaming into the cities.

So far, this
policy has worked politically. Enormous economic growth has kept
down domestic prices. But the threat of recession grows ever greater
as people keep filling the cities. A fall in employment in a city
where millions of newcomers are living is far more dangerous politically
to a centralized political order than a dispersed, unorganized rural
society is.


No society
is riding a more dangerous tiger than China. China has combined
an aging, centralized political hierarchy with a youthful market-driven
population. To this risky brew the central bank has added monetary
inflation, which has now become endemic. Participants in the economy
have planned on this monetary inflation.

It is unexpected
changes in the rate of monetary expansion that create serious losses.
The central bank dares not reduce the rate of inflation.

So, the results
are predictable: rising commodity prices, supply bottlenecks, real
estate bubbles in fast-growing cities, a stock market bubble, and
euphoria regarding the future.

The move from
farms to cities by young men is the central factor in the deferral
of production crises. Labor is a large component of any economy.
China’s is no exception. The flood of immigrants from the farms
is holding down production costs.

The bubble
in China resembles the bubble 1995—2000 NASDAQ in the United
States. The Chinese stock market is trading at a price/earnings
ratio above 50. Some stocks are trading at 80. In a speech on June
12, Alan Greenspan commented, "Some of these price-earnings
ratios are discounting Nirvana." But let us not forget that
the NASDAQ reached a p/e ratio of more than 200 in December, 1999.

goods will continue to be cheap. In a recession, they will be even
cheaper. The problem will be in the debt markets. When the Chinese
central bank starts buying its own government’s debt in order to
bail out the Chinese government directly, interest rates in the
West will rise. China has exported price deflation: cheap goods.
It has done this by purchasing western governments’ debt. When that
strategy hits the iceberg of domestic recession and unemployment,
the West’s days of low interest rates and economic boom will cease

27, 2007

North [send him mail]
is the author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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