The China Vortex

Just in case you had any doubts that the world was going to hell in a handbasket, and that the inmates were running the asylum, you just might have had some of those doubts removed in the past week. And those doubts were removed in a very dramatic fashion, as in frontal lobotomy fashion.

“George Carlin, why did you have to die so soon, just before all the fireworks started? Did you actually think that the world was becoming so ludicrous that you couldn’t take it anymore, or think that you would run out of material?”

Let’s look at some of the fun things which happened this week:

• Sanlu’s dairy products were found to have killed three babies, and caused injury to several thousand others (at least)
• Baidu was accused of offering to help cover up the scandal by not showing the scope of the scandal in its search results. I wonder what genius came up with the idea that they could cover up a scandal of such immense proportions for a miserable 3M yuan? And who was the genius on the management side who approved such a deal? This would have taken at least two people who had frontal lobotomies. Most of the time, people who come up with dumb ideas like this are only employed in government (Most notably the US government, where they usually run smear campaigns for politicians during elections.) As for Baidu/Alibaba, now Baidu is threatening to sue Alibaba for spreading the Sanlu story. (Isn’t China becoming more like the US every day? At this rate China will be run by lawyers in five years. A sure sign of national dementia.) Are these initial signs that the Americans’ efforts to package and sell stupidity to the Chinese are showing signs of success?
• Lehman Bros., a US investment bank, declared bankruptcy, and Merrill Lynch sold itself to Bank of America for $50B. I have the utmost admiration for John Thain: Imagine taking a company which was rapidly going down the tubes, whose assets were unclear, and whose non-performing CDOs were increasing by the hour, and he SOLD it for $50B, finding a buyer in BA? Wow, that’s neat! How’d he do that? These bankers are amazing. None of that piddly million here, million there kindergarten dotcom stuff for these guys, we’re talking real money here (even though it’s US dollars).
• Is it just me, or am I thinking that Imagethief’s time has come in China? I keep on fantasizing what his first lessons for new official clients might be like. How about this:
  

  “First of all, let’s get it clear that lies, coverups and people getting poisoned are a necessary part of any nation’s path to greatness. There is no need to deny or cover it up; we must celebrate each event as achieving yet another milestone to greatness! Let’s celebrate it! Let’s roll in it! And let’s become more and more like America with each passing moment! Look at how the Americans don’t discriminate against the mentally handicapped anymore; instead they make them their leaders! If America can do that, then why can’t China! Our goal must be to pollute the global financial system on an even greater scale than the Americans have: this will show the world China’s power!”

Hmmm, on second thought…
UPDATE: Once upon a time, jokes were about comical situations which had a tenuous relationship with reality. Now, the jokes ARE reality.
DISCLAIMERThe above story is pure satire. Don’t take it as anything else.

Seeking Alpha has an interesting article The Power of the Market: 600 Million People Lifted Out of Poverty Since 1981. The article comes with two graphs, one of which is above.

This shows that there has been a gradual fall in numbers of poor since 1981, but there was a bump in the years from about 1988 to 1994, when the numbers of poor stubbornly resisted to fall. This was a time of high inflation in China.

Do I need to tell you what happened in China in 1989?

This graph gives a rough indication that as long as the Chinese government is able to show a descending line that poverty numbers are going down in absolute terms, then the government’s position is safe. If inflation should pick up and the number of poor goes up, then they have something to worry about.

So far, developments on the economic front have been going well in China, with the noted exception of high inflation in China, much of which is due to higher commodity costs (food and energy costs) and capital inflows. Much of the capital inflow into China is due to investors who want to get out of the US dollar, and see China as the most attractive growth market for their money.

Rising inflation is usually an early indicator of other economic and social problems to come.

A few years ago, investment money coming into China was welcomed with open arms, but now times have changed, and the government doesn’t see them nearly as favorably as they did just one year ago. Capital inflows which are liquid can come into China, and also leave it very quickly, leaving the country’s economy and society in a lurch, just as it did during the Asian financial crisis of 1997 for the countries of Southeast Asia.

With the US economy heading for the dumpster, and Europe showing signs of weakness due to rising energy prices, that is not something the Chinese government wants. It is more than likely that the Chinese government will do anything to keep those poverty numbers going down in China, regardless of what it means for the rest of the global economy.

The need for social stability in China trumps everything else. Including commitments to globalization and the WTO.

Fasten your seat belts.

Paul Midler is an experienced sourcing expert who has worked in China for many years, and publishes The China Game blog. I believe that he is the first person to coin the term “quality fade”. Quality fade is, according to this article published in Forbes:

This is the deliberate and secret habit of widening profit margins through a reduction in the quality of materials. Importers usually never notice what’s happening; downward changes are subtle but progressive. The initial production sample is fine, but with each successive production run, a bit more of the necessary inputs are missing.

It seems a long time ago, but last year, a great deal of ink was devoted to covering the issue of defective products from China. In some cases, lives were lost in the US.

If I have one criticism of Paul Midler’s criticism of this very real problem, it is the impression it gives that somehow unscrupulous Chinese exporters are deliberately seeking to cheat and harm Americans, when in fact, many more Chinese have been injured and even killed by defective products coming out of Chinese factories. It’s just that the US media does not pick up these stories because the victims are, well, Chinese.

But if we are going to be fair about this problem, then shouldn’t we talk about the Chinese and other non-American victims of this problem as well? I think so.

Now, when it comes to the credit bubble problem, the issue of quality fade becomes even more interesting. This time, the culprit is not Chinese, but American. For a problem of such immense proportions, which is getting bigger and bigger by the day, amazingly, no one has identified the human culprits responsible for the bad decisions. But then, accountability never been a strong point for this US administration.

In China, when there was a problem with deaths caused by tainted drugs, the head of the Chinese Food and Drug Administration was sentenced to death and executed. No one yet knows the size of the credit bubble, but I have heard numbers from $15 billion to $45 billion bandied about. Mind you, the US economy is a US$12 trillion a year economy, so we are basically talking about anywhere from 1 year to four years of economic output disappearing.

Americans are losing their jobs, many are losing their homes, and the Fed has been scared into a series of panic interest rate cuts and into subsidizing the purchase of Bear Stearns by JP Morgan Chase and offering a Fed-backed unlimited credit lending facility to US investment banks.

In this article from The Washington Note, Steve Clemons talks about how the US exported poisoned financial products.

So, while Chinese factories have on occasion exported defective products, the US has exported defective financial products. And the US government participated because Treasury sold T-bills which were backed by these defective financial instruments.

Hmmm….

Now, back to quality fade. Let’s see if we can modify his definition of quality fade to capture the credit bubble situation:

This is the deliberate and secret habit of creating the illusion of increased purchasing power through the creation of fiat credit derivatives of dubious value. Exporters usually never notice what’s happening; downward changes are subtle but progressive. The initial credit derivatives are fine, but with each passing year, lose their value as more credit derivatives are created until there is a gradual collapse and new currencies and trading rules have to be established.

(The italics are where I have made changes to Paul Midler’s original text.)

When it comes to quality fade, the Americans have been wholesalers, while the Chinese are just occasional retailers.