Paul Krugman on China

 LvMIC:

Keynesian champion Paul Krugman finally weighed in on China’s imploding property bubble in his New York Times article today.  Let me just say, it’s better late than never.  Reports on China ghost cities and looming bust have been floating around for years and are only now becoming more frequent.  As I posted on earlier, the bust is really getting underway.

While Krugman is finally acknowledging what should be a crash for the history books, his partisan ideology once again gets in the way of property diagnosing its true cause.  He writes:

Do we actually know that real estate was a bubble? It exhibited all the signs: not just rising prices, but also the kind of speculative fever all too familiar from our own experiences just a few years back — think coastal Florida.

And there was another parallel with U.S. experience: as credit boomed, much of it came not from banks but from an unsupervised, unprotected shadow banking system. There were huge differences in detail: shadow banking American style tended to involve prestigious Wall Street firms and complex financial instruments, while the Chinese version tends to run through underground banks and even pawnshops. Yet the consequences were similar: in China as in America a few years ago, the financial system may be much more vulnerable than data on conventional banking reveal.

Much like he goes about in describing the financial crisis in the U.S., Krugman attributes China’s property bubble to a lack of bank regulation.  To anyone who understands the nuances of the Austrian Business Cycle theory, this claim is absurd.  Not only is China’s property bubble a byproduct of the country’s inflationary currency peg to the dollar but it was openly encouraged by local governments!  From Seeking Alpha (my emphasis added):

China’s growth curve has gone parabolic in recent years. For the last couple of decades, China has typically averaged 10% GDP growth, and it has maintained that growth even as a multi-trillion dollar economy. Of course, 10% growth in an economy already worth trillions is an astounding achievement, but it can also lead to severe economic tribulations, such as soaring housing and food prices. China has incurred both of these troubles. As a growing middle class emerges, demand for beef has far outstripped supply growth, and beef is typically making record highs every month. Additionally, the usage of real estate as collateral for local government loans, amongst other factors, has led to soaring housing prices. 

Besides encouragement from local governments, money flowed into China’s real estate sector thanks to artificially low interest rates.  For years, China has pegged the yuan to the U.S. dollar in order to boost its own exports.  To maintain its peg amidst a continually devaluing dollar, the People’s Bank of China purchased dollars and sold yuan.  This monetary expansion lead to high inflation and misallocations of resources toward real estate.  In other words, the property bubble is textbook Austrian Business Cycle Theory.

While China has attempted to slowly deflate the bubble by raising interest rates and banking reserve requirements multiple times over the past year, these efforts have been in vain.  China is due for a hard landing; one which will have global implications.  As damaging as this bubble burst will be, it must be encouraged along with a ceasing of monetary manipulation that sets the basis for business cycle booms and busts.  Remember your Rothbard:

Once an inflationary boom is launched, a recession is not only inevitable but is also the only way of correcting the distortions of the boom and returning the economy to health.

Krugman’s attempt to paint a picture of China’s imploding property bubble being the result of a lack of banking regulation is both flat out wrong and disingenuous.  Local governments thrived on rising property prices and promoted them through unorthodox lending outlets (via Bloomberg):

Local governments, barred from borrowing debt directly, set up 6,576 financing vehicles by the end of 2010 to fund projects such as new roads and airports, according to a report from the National Audit Office on June 27. They had 10.7 trillion yuan ($1.7 trillion) in outstanding liabilities at the end of 2010, of which 8.5 trillion yuan was from bank loans, it said.

The type of policies Keynesian advocates (currency debasement to boost exports) are precisely what set the stage for this property bubble.  Krugman may be reluctant to admit this as it flies in the face of his ideology but sooner or later, more people are going to be looking at the Austrian Business Cycle Theory to make sense of what is happening in China.  Economist Tyler Cowen, who has been openly critical of the theory, is now embracing its relevance to the bust.  That’s one down and thousands of economists to go.

For a great explanation of China’s forthcoming bust, see Kel Kelly’s “The China Bust: Tic Toc.”