China: The Command Economy That Doesn’t Respond to Commands

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‘China’s biggest banks may fall short of loan targets for the first time in at least seven years as an economic slowdown crimps demand for credit…’

– Bloomberg

What? Who would’ve thunk it?! A command economy that doesn’t respond to commands. This isn’t how it’s supposed to turn out. China has tools…it’s meant to ‘fine tune’ the economy.

If you ever did believe that narrative, we have news for you – China’s economy is not an air conditioner. Just because it starts blowing hot air in the middle of summer, doesn’t mean you can just pull out the tool box and do some tweaking.

But that doesn’t stop the calls for more spending. Now, we’re told that China has room to cut interest rates…apparently to encourage more lending and spending. It won’t work. Lower interest rates will not lead to another lending resurgence…and it won’t encourage Chinese households to get into debt and to spend.

The increase in consumption that China so badly needs to rebalance its tottering economy requires higher, not lower interest rates. China doesn’t have a culture of personal debt like Western consumers do. China has a culture of saving. Those savings go into banks and the interest rate determines the return on those savings.

Lowering the interest rate lowers the return on savings. Rather than encourage Chinese households to spend, it could well have the opposite effect! That is, it could encourage households to save more to offset the lower return. At the very least it will push more savings into gold as the Chinese saver increasingly worries about preserving their wealth. China is not the West. Thinking of the relationship between interest rates, debt and spending in a western way and applying it to China is flawed analysis.

China’s post-2008 lending boom was made possible by the huge savings of its workers. Those savings formed the deposits and reserves of the banking system…which the government forced the banks to lend mainly to state owned enterprises to build infrastructure and housing.

And look where that’s got the Middle Kingdom now.

Of course it’s not all bad news. The US experienced its own credit bubble and bust in its fledgling years. They called the bubble the ‘Roaring Twenties’ and the bust ‘The Great Depression’. It took a decade or so to rebound, but it went on to become one of history’s most powerful empires. There’s no reason why China can’t go on to do the same.

The ‘gloomy China’ trade is becoming a little crowded. We warned Sound Money. Sound Investments subscribers about the coming China crash in October last year, telling them to get out of commodities. Now China bearishness seems pervasive (if still a little complacent). It’s time to move on…

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

The Physical Gold Market – From the Weak to the Strong
2012-05-18 – Greg Canavan

Why JP Morgan is Playing the Same Old Rigged Game
2012-05-17 – Eric Fry

Why Greece Can’t Afford to Stay in the Euro
2012-05-16 – Dan Denning

A Big Oops at JP Morgan!
2012-05-15 – Dan Amoss

Preparing For China’s Growth Slowdown With The ‘Energy Hub’ Portfolio
2012-04-14 – Dan Denning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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5 Comments on "China: The Command Economy That Doesn’t Respond to Commands"

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Lachlan
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Good one Greg, rounding off there with the other side of the story. One way or another, command economy or not, China has the greatest stash of paper and hard money (remembering their gold reserves are much higher than stated considering they are No.1 producer and all gold sold to the state), a great mass of people who produce real assets rather than financial garbage etc, access to commodities, people who save as you mentioned and a currency which may appreciate in the future. Also a government promoting the ownership of gold for citizens (somebody expecting a transfer of wealth… Read more »
watcher7
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“There’s no reason why China can’t go on to do the same.” History and an understanding of how the world really works are two big reasons why China will not do the same. Free-Trade-Area indicator: “The economic boom, felt everywhere but most intensively in Britain, sent government revenues soaring, and in the years 1823-25, the new Chancellor of the Exchequer earned himself the name “Prosperity” Robinson by across the-board reductions in taxes and duties… Many inland duties went altogether, so that Britain, and to a great extent Ireland, became the largest free-trade area in the world. All kinds of ancient… Read more »
Lachlan
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Well I don’t know about European hegemony Watcher but I can see which dregs will become the new new dregemony and that will be the US,UK and the PIIGS.
Germany and their non schwein mates should be able to trade and do well with China Russia Japs and Arabs. Australia would look good to me bar the unknown dangers posed by the globalist bankers of the new dregemony.

Ross
Guest
@Watcher, note the world power’s contemporary positions in the same agricultural revolutionary terms. For a century, the subsidised states brought high cost technology and inputs that increased productivity even while they sucked up subsidies and hid behind competition barriers. Productivity was cruelled in the COMECON bloc by the political systems, and by capital strikes and political meddling in Africa and South America. The latter day revolution in China can be held to be the land/agricultural reform capital of the world. The effect of this on growth potential is best demonstrated when you compare China’s progress with that of India in… Read more »
Lachlan
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I wonder about this united Europe whether its going to bend with the political imperative to remain or whether the German people actually have any real say in the matter. That they would reject the economic ties to PIIGS via Euro bonds or whatever comes next. They would have power, the citizens of Germany that is, however I doubt they can organise themselves effectively at this stage. Once again a welfare state amongst other things trumps opposition to monopolies in power. If the the financial power of Germany is diluted into the abyss of the PIIGS then their short term… Read more »
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