Wednesday, August 20, 2008

I blame the one child policy: explaining the brokers part II

This is going to look very tangential – but I know someone who is a demographer. And just as I think everything in the world comes down to banks (because that is what I understand) he think that everything in the world comes down to demographics.

He has a better chance of being right than me.

And the biggest thing going on demographically in the world is the one-child policy.

Asian style industrialisation and current account deficits

Pretty well every Asian tiger economy has gone into large current account deficit whilst it industrialises. Savings rates may have been 20-25 percent of GDP but the investment rates were higher. The high levels of current account deficits have left those countries vulnerable to current account crises – and they got their crisis in 1997.

China is different. The investment rate is higher in China then elsewhere. Chinese statistics are abnormally patchy – but Chinese investment may have got has high as 40 percent of GDP. (You can see this in the performance of various capital equipment exporters in the West.)

And yet China never managed to get a current account deficit. That is really strange.

We have investment of 40% of GDP and a large current account surplus. This means that the average Chinese person is saving maybe 46 percent of their income. Now once when I had a very high income I saved that much. But we have poor people saving half their income.

I ran this idea past a Chinese friend of mine (now resolutely middle class). He remembers his family saving money furiously whilst he was hungry for lack of food.

Question: what is it that makes them save so much?

Answer: fear.

In most poor jurisdictions there is a simple method of saving for old age. Have six kids. They will have a few each and if you survive there will be lots of grandkids trained to respect their elders who will look after you.

This does not work in China. Indeed if everyone has only one child there will potentially be four grandparents per grandchild. You can’t expect to get supported.

In most developed countries people trust the system to look after them. Mutual funds are well developed, there is often a social security savings net, and a lot of people (perhaps falsely) expect to sell their house and live in clover.

But in China you can’t trust that either. So you save. And save. And save…

Chinese families save because they have a gun at their head. They save an amount that is almost incomprehensible by Western standards.

I point this all out because there is a lot about excessive spending in the west (and the spending has been excessive). But for all this excessive spending there has to be an area with excessive savings. Japan has it. Petrodollars have it – but the big incremental excess savings of the last five years has been China.

And for that I blame the one child policy.

I am going to give Mr Bernanke a plug here. Before the crisis started Ben used to talk about excess savings in the world. He figured the bad lending in the US happened not because people were venal or stupid in the US – but that there was just an endless supply of investable funds because the world had excess savings.

I think he was right. Go look at a Japanese bank now and you still see excess savings. We discovered that we can’t lend them endlessly in America without substantial credit losses. But that doesn’t mean the excess savings aren’t there.

It is a strange reversal to blame bad lending on the people in China who wanted to take no risk with their savings – but it is the reversal that interfluidity made in one of the best blog posts of recent times. It’s a reversal I believe in too.

My thesis - which will be expanded in future posts is that the brokers have become the intermediaries between this endless demand for products to save in (China, Petrodollars etc) and the endless willingness of the profligate in the West to spend. What they do is - through their trading, their securitisation and through other things they turn the complex financial instruments of the West (mostly but not entirely debt) into vanilla instruments that the Chinese and petrodollars want to buy.

How they did that intermediation will be the subject of the next couple of posts – but it begins to explain why they got so big. This is the biggest demographic feature of the world and the brokers made themselves front-and-centre. (They may not have even understood what they were doing - but that is also subject of another post.)

Indeed how they did it altogether and its implications are for later in this series.

John Hempton


Scott said...

Very logical and sensible explanation of rationale for excess saving by Chinese/Japanese.

AldenPyle said...

I think this is right. Housing is a long-term investment, sensitive to long-term interest rates. Long-term real interest rates have remained low and even fallen in the face of massive US borrowing indicating a push of cheap long-term funds into the US. Demographics is the logical explanation.

But you might want to draw the further implication that the money is still out there looking to blow new bubbles somewhere else (perhaps even less able to manage it than Anglophone countries {+ Spain}). Where will it go now. US Treasuries forever?

jm said...

The problem is, saving in the modern world is not "saving" in the classical sense -- rather, it is lending, and the value that the "savings" will have when ultimately called upon will depend completely on the buying power of the currency received from the entity to whom the "saver" has chosen to lend.

In the case of China, the people save by lending their yuan to the government, which uses those savings to purchase US dollars whose buying power is only a fraction of that of the yuan exchanged. So from the very moment of that exchange, more than half the buying power of the people's savings has been thrown away to enrich the owners of the exporters subsidized by this variant of vendor financing fraud.

John said...

Wow! What an extraordinary post!

I personally always thought the "excess savings" notion was hogwash...but this is sort of like looking at the orbit of Pluto and inferring that there is another planet there. And, by God, there is another planet. (I realize I have my astronomical history wrong, but Shakespeare had history wrong too, and it didn't matter.)

k said...

"This means that the average Chinese person is saving maybe 46 percent of their income."

That is not correct. Total savings rate in China has been about 40% in recent years, but the bulk of the INCREASE in savings rate come from corporate saving. (Sorry, can't find the source of that information.) Personal savings rate has been quite steady in the range of 20%~30%, not inconsistent with other East Asian countries, though somewhat higher in China's case. Government deficit/surplus has been steady in the range of 1% of total GDP, so that doesn't count much. Yet in the case of corporate savings, one can observe SOEs have been profitable after painful reforms in the mid-late nineties. Due to lack of investment opportunities, most of the profits made have been stashed, hence the jump in the savings rate.

I do agree though lack of social support network has been a major contributing factor in high savings in China. A major medical operation can cost a family several years of income, and college tuition has tripled in the past ten years. One-child policy is a factor, but not the main cause as you suggest in the article.

k said...

A 2006 post on Chinese corporate savings, not too much change occurred in the past two years.

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