Debt Be Not Proud

By John Mauldin

Feb 24, 2015


Some things never change. Here is Eugen von Böhm-Bawerk, one of the founding intellectuals of the Austrian school of economics, writing in January 1914, lambasting politicians for their complicity in the corruption of monetary policy:

We have seen innumerable variations of the vexing game of trying to generate political contentment through material concessions. If formerly the Parliaments were the guardians of thrift, they are today far more like its sworn enemies. Nowadays the political and nationalist parties ... are in the habit of cultivating a greed of all kinds of benefits for their co-nationals or constituencies that they regard as a veritable duty, and should the political situation be correspondingly favorable, that is to say correspondingly unfavorable for the Government, then political pressure will produce what is wanted. Often enough, though, because of the carefully calculated rivalry and jealousy between parties, what has been granted to one has also to be conceded to others — from a single costly concession springs a whole bundle of costly concessions.

That last sentence is a key to understanding the crisis that is unfolding in Europe.

Normally, you would look at a country like Greece – with 175% debt-to-GDP, mired in a depression marked by -25% growth of GDP (you can’t call what they’re going through a mere recession), with 25% unemployment (50% among youth), bank deposits fleeing the country, and a political system in (to use a polite term) a state of confusion – and realize it must be given debt relief.

But the rest of Europe calculates that if they make concessions to Greece they will have to make them to everybody else, and that prospect is truly untenable. So they have told the poor Greeks to suck it up and continue to toil under a mountain of debt that is beyond Sisyphean, without any potential significant relief from a central bank.

This will mean that Greece remains in almost permanent depression, with continued massive unemployment. While I can see a path for Greece to recover, it would require a series of significant political and market reforms that would be socially and economically wrenching, almost none of which would be acceptable to any other country in Europe.

Sidebar: Japan would still be mired in a depressionary deflation if its central bank were not able to monetize the country’s debt. As Eurozone members the Greeks have no such option .

However, the rest of Europe is not without its own rationale. To grant Greece the debt relief it needs without imposing market reforms would mean that eventually the same relief would be required for every peripheral nation, ultimately including France.

Anyone who thinks that Europe can survive economically without significant market reforms has no understanding of how markets work. Relief without reforms would be as economically devastating to the entirety of Europe as it would be to Greece alone.

Ultimately, for the euro to survive as a currency, there must be a total mutualization of Eurozone debt, a concept that is not politically sellable to a majority of Europeans. (The European Union can survive quite handily as a free trade zone without the euro and would likely function much better than it does now.)

Kicking the debt relief can down the road is going to require a great deal of dexterity. The Greeks haven’t helped their cause with their abysmal record of avoiding taxes and their rampant, all-too-easily-observed government corruption, including significant public overemployment.

In this week’s letter we will take a close look at the problem that is at the core of Europe’s ongoing struggle: too much debt. But to simply say that such and such a percentage of debt to GDP is too much doesn’t begin to help you understand why debt is such a problem. Why can Japan have 250% debt-to-GDP and seemingly thrive, while other countries with only 70 or 80% debt-to-GDP run into a wall?

Debt is at the center of every major macroeconomic issue facing the world today, not just in Europe and Japan but also in the US, China, and the emerging markets. Debt (which must include future entitlement promises) is a conundrum not just for governments; it is also significantly impacting corporations and individuals. By closely examining the nature and uses of debt, I think we can come to understand what we will have to do in order to overcome our current macroeconomic problems.

Now let’s think about debt.

Debt Be Not Proud

Debt is future consumption brought forward, as von Böhm-Bawerk taught us. It is hard for me to overemphasize how important that proposition is. If you borrow money to purchase something today, that money will have to be paid back over time and will not be available for other purchases. Debt moves future consumption into the present. Sometimes this is a good thing, and sometimes it is merely stealing from the future.

This is a central concept in proper economic thinking but one that is all too often ignored. Let’s tease out a few ideas from this concept. Please note that this letter is trying to simply introduce the (large) topic of debt. It’s a letter, not a book. In this section we’ll deal with some of the basics, for new readers.

First off, debt is a necessary part of any society that has advanced beyond barter or cash and carry. Debt, along with various forms of insurance, has made global finance and trade possible. Debt fuels growth and allows for idle savings accrued by one person to be turned into useful productive activities by another. But too much debt, especially of the wrong kind, can also be a drag upon economic activity and, if it increases too much, can morph into a powerful force of destruction.

Debt can be used in many productive ways. The first and foremost is to use debt to purchase the means of its own repayment. You can borrow in order to buy tools that give you the ability to earn higher income than you can make without them. You can buy on credit a business (or start one) that will produce enough income over time to pay off the debt. You get the idea.

Governments can use debt to build roads, schools, and other infrastructure that are needed to help grow the society and enhance the economy, thereby increasing the ability of the government to pay down that debt.

Properly used, debt can be your friend, a powerful tool for growing the economy and improving the lives of everyone around you.

Debt can be created in several ways. You can loan money to your brother-in-law directly from your savings. A corporation can borrow money (sell bonds) to individuals and funds, backed by its assets. No new money needs to be created, as the debt is created from savings. Such lending almost always involves the risk of loss of some or all of the loan amount. Typically, the higher the risk, the more interest or return on the loan is required.

Banks, on the other hand, can create new money through the alchemy of fractional reserve banking. A bank assumes that not all of its customers will need the immediate use of all of the money they have deposited in their accounts. The bank can loan out the deposits in excess of the fraction they are required to hold for depositors who do want their cash. This lets them make a spread over what they pay depositors and what they charge for loans. The loans they make are redeposited in their bank or another one and can be used to create more loans. One dollar of base money from a central bank (sometimes called high-powered money) can over time transform itself into $8-10 of actual cash.

A government can create debt either directly or indirectly, by borrowing money from its citizens (through the sale of bonds) or by directing its central bank to “print” or create money. The money that a central bank creates is typically referred to as the monetary base.

Debt can be a substitute for time. If I want a new car today, I can borrow the money and pay for the car (which is a depreciating asset) over time. Or I can borrow money to purchase a home and use the money I was previously paying in rent to offset some or all of the cost of the mortgage, thereby slowly building up equity in that home (assuming the value of my home goes up).

Oh Debt, Where Is Thy Sting?

Let’s start with a simple analogy and then get more complex. When someone borrows money, they agree to make principal and interest payments over time. For instance, $25,000 borrowed at 5% interest over three years to pay for a car would require a monthly payment of $749.27. Not a problem for someone making $100,000 a year ($50 an hour) but a serious, almost impossible commitment for someone making $10 an hour. After taxes, the car payment would gobble up almost 50% of that person’s income.

All but the most disciplined of us have encountered the unpleasant reality of running up too much credit card debt, typically when we were young. For those outside the US, credit card interest rates can often run 18% or more, and the penalties for late payment can increase the net amount substantially and cause the interest rate to be jacked up even higher. The unpleasant reality of paying far more in interest each month than you are paying on the principal can be quite the eye-opener.

Sometimes debt can be overwhelming. In many countries, individuals can file for bankruptcy and get relief from their debt (as well as losing any remaining assets). In the middle of the last decade, the US bankruptcy laws were changed to make it more difficult to declare bankruptcy. As the chart below shows, bankruptcies fell precipitously but are now back to where they were just a few years before the law passed. Clearly the financial crisis contributed to the new steep rise in bankruptcies. (The 2005 spike in bankruptcy filings was from people rushing to file bankruptcy ahead of the new law’s taking effect.) The vast majority of bankruptcies are now filed by consumers, not by businesses. In 1980, businesses accounted for 13 percent of bankruptcies, but today, they are just 3 percent.
 


Personal bankruptcies can happen for all sorts of reasons, but in the US they are caused primarily by overwhelming medical expenses, accounting for around 60% of bankruptcies (depending on the year). Other causes are (in order of prevalence) job loss, out-of-control spending, divorce, and unexpected disasters.

Bankruptcy is designed to keep people from being literal slaves to debt. We have come a long way in our civilization from the days of debtor’s prisons. Texas actually wrote into its constitution that a debtor could not lose his horse, tools, or homestead, the principle being that a person needed to be able to move on from bankruptcy and make a living. That sort of basic protection has since evolved nationally into a rather complex but reasonable system for letting people move on from untenable financial situations.

I say that we’ve come a long way from debtor’s prisons. There is a qualifier to that statement. In the US, student loans cannot be discharged in bankruptcy. They are with you until you finally pay them off. In Spain, you cannot get out of a mortgage debt through bankruptcy. Even though the bank can take your home from you, you are still obligated to pay the debt forever. There are exceptions to bankruptcy protection everywhere.

Debt Is Future Consumption Denied

Why go on and on about personal bankruptcy when we are talking about government debt? Because the same principles apply, with a few caveats.

Governments have outright defaulted on their debt nearly 300 times in the past few hundred years. Spain is the all-time winner, with six defaults in the last 140 years and 12 if you go back to 1550. Italy and Argentina have made a sport of defaulting this last century, if you count monetization as a form of default, which it is. While I can find no statistics, inflation and loose monetary policies have almost surely destroyed far more buying power than outright defaults have.

There are times when a government simply cannot pay its bills and must either default outright or change the terms on its debt, just as individuals do.

If an individual or corporation or country has a significant amount of debt and their income drops by 25-30%, it may become impossible to pay that debt and also cover the necessities of life. Greece, as a current example, has not really added to the outstanding total of its debt over the past three years since its last debt default; but the growth of the country (and therefore of its tax revenues) has collapsed by about 25%. Even if tax collection can be improved, the interest rates Greece is forced to pay today may make the repayment of the country’s debt untenable.

Debt is future consumption brought forward into the present, but a corollary is that debt is also future consumption denied. If you will have to pay both principal and interest on debt in the future, then you are setting aside and spending money on debt service that is no longer available for current consumption. And, yes, that debt service goes to bondholders, but their return of capital does not necessarily express itself in consumption or further lending.

Further, when economies are debt-constrained, capital looking to be invested in fixed-income assets finds fewer creditworthy opportunities available and begins to take lower interest payments in a search for yield. The current low-interest environment is not just a product of the Federal Reserve and other central banks; it also stems from a lack of demand from creditworthy borrowers.

Dr. Lacy Hunt of Hoisington Asset Management has been documenting the drag on growth that overindebtedness creates. He recently wrote (emphasis mine):

Poor domestic business conditions in the U.S. are echoed in Europe and Japan. The issue for Europe is whether the economy triple dips into recession or manages to merely stagnate. For Japan, the question is the degree of the erosion in economic activity. This is for an economy where nominal GDP has been unchanged for almost 22 years. U.S. growth is outpacing that of Europe and Japan primarily because those economies carry much higher debt-to-GDP ratios. Based on the latest available data, aggregate debt in the U.S. stands at 334%, compared with 460% in the 17 economies in the euro-currency zone and 655% in Japan. Economic research has suggested that the more advanced the debt level, the worse the economic performance, and this theory is in fact validated by the real-world data.

There are a host of reasons for debt-related economic drag, but the primary cause is that the debt was of the nonproductive kind. The debt was incurred primarily to fund current consumption, whether to pay benefits or for defense spending or what have you.

Deflation Is the Enemy of Debt

Deflation is the general condition where prices go down. This can be caused by increased productivity or decreased demand. We all like it when the cost of our latest technological goodies and indeed everything else we buy goes down. We are generally not happy when the economy falters and prices fall because of slack demand. One of the primary debates among economists is whether economic slowdowns are caused by insufficient demand or insufficient income and productivity.

There have been periods in many countries when there has been economic growth in the midst of general price deflation, but we more typically think of deflation as occurring in periods of economic retreat. Recessions – and certainly depressions ­– are almost by definition deflationary.

In a growing, increasingly productive world, the trend for prices should be down, that is to say, deflationary. But that assertion assumes one necessary condition: a stable monetary base. Proponents of a gold-backed currency point out that gold offers a stable monetary base, while fiat currencies are subject to expansion or contraction by central banks and governments. It is often said that all fiat currencies will eventually explode or implode in value, but that is not necessarily true. A carefully constrained central bank and government will maintain the value of a country’s money. Think Switzerland (the primary example, but there are others). The value of the Swiss franc in relationship to currencies around the world has continued to rise even as the Swiss economy has grown, and their standard of living is among the highest in the world. (Of course, as the Swiss have learned, an overly strong currency can be problematic, too, in this era of intensifying curre ncy wars.)

But while a generally deflationary environment reduces the prices of things we buy, it does not reduce the cost of servicing debt – quite the opposite. Deflation is the enemy of debt. The obvious example, currently, is Greece, as noted above. The deflationary depression the Greeks are in has increased the value of their debt in relation to their income, even though the nominal value of the debt has hardly risen. And because they have not had the benefit of an increase in buying power (stuck, as they are  with the euro as a currency and having no control over Eurozone monetary policy), deflation has ravaged their economy.

To put it in personal terms, if your real income drops 25%, then whatever debt service you’re carrying will be a correspondingly larger portion of your income.

In a world where incurring government debt is allowed only when and if that debt is deemed productive, deflation would not be a problem, as incomes would rise with increased productivity. But debt that is nonproductive will grow in absolute cost to an economy in periods of deflation.

One can argue with John Maynard Keynes, and I do so rather aggressively at times, but he did have some valuable insights. If an economy is in recession, the government can lean against the drag on demand by increasing spending. That of course means increasing debt, and Keynes argued that government should borrow and spend in times of recession. Governments everywhere have taken that dictum to heart.

What they have ignored is his second point: a government should pay back that debt during the good times that follow. That discipline allows it to borrow and spend again in when recession recurs. The very concept of a balanced budget is now considered anathema in much of what passes for academic economic circles. It is perjoratively labeled as “austerity.” As if balanced budgets were the cause of economic pain and suffering…

Following the historic budget compromise between Clinton and Gingrich, the United States began to run actual surpluses in the late 1990s, and indeed we were talking about what would happen if we eliminated government debt altogether, so rapidly were we paying it down. The surpluses were accumulated during a rather remarkable economic time. Then the Republican Congress, aided and abetted by George W. and Karl Rove, came along and squandered that surplus. Dick Cheney famously said that deficits don’t matter, in defense of the Bush administration’s policies of cutting taxes and increasing spending in order to curry favor with voters. (Refer again to the quote from von Böhm-Bawerk at the beginning of this letter.)

Absent those large increases in debt and deficits, the Obama deficits, while violating the rule of only accumulating debt for productive purposes (to mention only one violation of principle), would have been manageable in the grand scheme of things. But we are now rapidly approaching a time when debt will once again become an important issue in the US, as it was in the ’90s. Too much debt will become an ever larger drag on the US economy, just as it already is in Japan and Europe.

This rising debt in the US and around the world is one of the primary reasons that central bankers fear deflation. A little inflation plus a little GDP growth helps reduce the overall burden of debt in an economy. While central bankers everywhere seem to think that 2% inflation should be a target, many of them would accept a somewhat higher number. I personally take issue with the 2% figure, because that’s an inflation target that will reduce the purchasing power of any saved dollar by 50% in 36 years. A 2% inflation target is essentially a tax on savings and investment, no matter how you look at it. In a low-interest-rate world, 2% inflation means conservatively invested savings are losing buying power every year. But a little inflation does make debt more manageable, and central bankers seem to be more concerned with making sure that debt can be serviced than that savings can earn an adequate return. Current central bank policy is tantamount to financial repre ssion of savers and retirees.

Neo-Keynesians would argue that debt and deficits are not a problem, in that the central bank can ultimately monetize the debt if necessary. And they point to Japan, whose central bank is doing just that. They look at our own national balance sheet and GDP numbers and ask, so what’s the problem?

But debt is future consumption denied. If you monetize your debt beyond the real growth rate of the economy, then you are reducing the value of your currency and thus reducing your potential future consumption. The fact that this reduction doesn’t happen all at once and may not happen in the immediate future does not remove the reality. In the fullness of time, quantitative easing will result in the reduced buying power of the US dollar.

Yet the US monetary base has expanded significantly, and there has been no real increase in inflation, and the dollar is actually getting stronger. “So what’s the problem?” Mr. Krugman asks. Inflation is brought about by not just an expansion of the monetary base but also by a stable, concurrent rise in the velocity of money. It’s complicated, I admit. I have devoted more than a few letters to the concept of the velocity of money. The current period of low inflation has been caused by a rather dramatic fall, over the last eight to ten years, in the velocity of money. As I predicted almost five years ago, the Federal Reserve was able to print far more money than anyone could imagine without the threat of inflation rearing its head.

The problem is that the velocity of money is a very slow-moving statistic. It is what we call mean-reverting, in that the velocity of money can’t rise to the heavens unless you have a Weimar Germany-type situation, and it can’t fall to zero. It oscillates over long periods (think decades) around an average or mean. Right now the velocity of money is falling, which allows the US Fed to have a very loose monetary policy without having to worry about inflation. When the velocity of money begins to rise, the Fed will have to lean against what could quickly turn into soaring inflation with a tighter monetary policy than it otherwise would have, because of its recent, extreme episodes of quantitative easing. Think Paul Volcker in the early ’80s, turning the screws on 18% inflation. That was not exactly a fun time.

Of course, economists think that we can avoid any big mistakes. But sadly, there is no such thing as a free monetary lunch. Today’s quantitative easing (in a period of reduced velocity of money) will mean tomorrow’s much tighter monetary policy – or much higher inflation. Or both.

The Black Hole of Debt

Debt, when used properly, can overcome obstacles to productivity and bring on a warm day of sunshine, fostering life and growth everywhere. But if debt increases too much, just like a massive dying star it can collapse upon itself, explode like a supernova, and become a black hole instead, sucking in all the life around it.

Without a massive increase in debt, present-day China would have been impossible. Clearly that debt has improved the life of its citizens. But in recent years China has used debt to maintain a strange new form of growth and is increasingly using debt to build and consume, heading toward an ever less productive outcome. As in many other places in the world, each new dollar of debt is producing less in terms of GDP growth.

There has been a massive explosion of global debt since the beginning of the Great Recession in 2007. Normally, after a banking and financial crisis, one would expect a period of deleveraging and a reduction of debt. This time is truly different. Next week we will look at the actual growth of debt around the world and what it has accomplished.

The 2015 Strategic Investment Conference

I want to urge you to register for my 2015 Strategic Investment Conference, which will be held in San Diego April 29 through May 2. You can save $200 by registering before the end of February. (Note: This year the conference is open to everyone, not just to accredited investors, which makes me very happy.) While I am still finalizing the last few speakers with my conference cohosts, Altegris Investments, we’ve already secured an outstanding lineup. The plan is for my old friend David Rosenberg to once again be our leadoff hitter. The last few years he has come up with surprises to share with the audience, and I suspect he will do the same this year. Then, I’m excited that we have been able to persuade Peter Briger to join us. Peter is the head of $66 billion+ Fortress Investment Group, one of the largest private-credit groups in the world. In 2014, Fortress Investment Group was named Hedge Fund Manager of the Year by Institutional Investor and Man agement Firm of the Year by HFMWeek. Peter knows as much about credit around the world as anyone I know.

Longtime readers and conference attendees know how powerful Dr. Lacy Hunt’s presentations are. I’ve also persuaded Grant Williams and his partner in RealVision TV, Raoul Pal, to join us. Raoul is not a household name to most investors, unless you are an elite hedge fund (and can afford his work), and then you know that he is an absolute treasure trove of ideas and insights. If you are looking for an edge, Raoul is at the very tip. Paul McCulley, formerly with PIMCO, will be returning for his 12th year. David Harding, who runs $25 billion Winton Capital Management, which trades on over 100 global futures markets, will tell us about the state of the commodity markets. My good friend Louis Gave will drop in from Hong Kong to help round out the first day. Louis never fails to come up with a few ideas that run against mainstream thinking. I can’t get enough of Louis. And then my Texas friend George Friedman of Stratfor will close out the day wi th his views on Europe and the world.

The next day my fishing buddy Jim Bianco, one of the world’s best bond and market analysts, will join us. I have long wanted to have him at my conference. I get the benefit of his thinking every summer, and I’m excited to be able to share it with you. Larry Meyer, former Fed governor currently running the prestigious firm Macroeconomic Advisers, will be there to give us his take on when the Fed might actually raise rates. He is a true central bank insider and will be flying in from a just-concluded Fed meeting. He is the go-to guy on Fed policy and thinking for some of the world’s greatest and largest investors. Then the intrepid and never-shy-with-his-opinion Jeff Gundlach, maybe the hottest bond manager in the country, will regale us with his insights. Is anybody more on top of his game than Jeff has been lately?

They will be followed by Stephanie Pomboy, whom I have wanted to have at the conference for years. She is one of the truly elite macroeconomic analysts, known primarily in the institutional and hedge fund world, and over the last few years her insights have been a regular feature in Barron’s. My friend Ian Bremmer, the brilliant geopolitical analyst and founder of Eurasia Group, who is consistently one of the conference favorites (and whose latest book we will try to have for you if it is off the press in time), will join, us followed by David Zervos of Jefferies, former Fed economist and fearless prognosticator, who has an enviable track record since he joined Jefferies five years ago. He is currently quite bullish on Europe.

On the final day we will have Michael Pettis flying in from China to give us his views on how Asia rebalances and China manages its transition. Michael has been one of the most consistently on-target analysts on China and is wired into the thought leaders in the country. And what fun would the conference be without Kyle Bass of Hayman Advisors offering us his latest ideas? I am excited to announce that William White, the brilliant former chief economist of the Bank for International Settlements has also agreed to attend. We are finalizing agreements with another three or four equally well-known speakers, which will include a few surprises, as well as rounding out the panels. I will share those names with you as we nail them down.

Since the first year of the Strategic Investment Conference, my one rule has been to create a conference that I want to attend. Unlike many conferences, we have no sponsors who pay to speak. Normal conferences have a few headliners to attract a crowd and then a lot of fill-ins. Everyone at my conference is an A-list speaker I want to hear, who would headline anywhere else. And because all the speakers know the quality of the lineup, they bring their A games.

Attendees routinely tell me that this is the best conference anywhere every year. And most of the speakers hang around to hear what is being said, which means you get to meet them at breaks and dinners. Plus, this year I am arranging for quite a number of writers and analysts to show up just to be there to talk with you. And I must say that the best part of the conference is mingling with fellow attendees. You will make new friends and be able to share ideas with other investors just like yourself. I really hope you can make it.

Registration is simple. Use this link: http://www.altegris.com/mauldinsic/index. While the conference is not cheap, the largest cost is your time – and I try to make it worth every minute. There are also two private breakfasts where hedge funds will be presenting. Altegris will contact you to let you know the details.

Orlando, Geneva, Zürich, Dallas, and San Diego

I will be in Orlando this weekend to do a keynote presentation for the American Banking Association and to share a dinner with my old friend Greg Weldon. A few weeks later I fly to Geneva and Zürich, where I have a very packed schedule. In addition to speaking, I’m particularly looking forward to being with Dylan Grice, plus lots of other friends, and meeting Bill White for the first time. I’m sure I will be staggered by the cost of everything in Switzerland, but the train ride from Geneva to Zürich is worth every penny. On a side note, Bill White was smart enough to negotiate his speaking fee in Swiss francs, while I’m getting dollars for mine. That probably tells you all you need to know about whose advice you should listen to.

I have some other speeches in Dallas and then a relatively quiet April (at least so far) until I head to San Diego at the end of the month for the above-mentioned Strategic Investment Conference.

I’m a little behind, finishing this letter on a Monday morning rather than on the weekend as usual. I took a little time off to watch an early Dallas Mavericks game with new player Amare Stoudemire, who will hopefully be the final piece needed to bring another NBA championship to Dallas. He certainly displayed his athleticism last night. Mark Cuban has gone all out to make the Mavericks champions again.

Dallas has turned rather cold, so it was good to come home to chili and my kids, who wanted to watch the Oscars in the media room. My personal favorite movie of the year so far has been The Imitation Game, the inspiring and ultimately tragic story of Alan Turing, played brilliantly by Benedict Cumberbatch. Cumberbatch also plays a thoroughly delightful Sherlock Holmes in the recent British series, which is available on Netflix. And while I was in and out during the actual Oscars, I will admit to being pleasantly surprised by the normally somewhat obnoxious Lady Gaga doing a splendid review of the music of Julie Andrews. Who knew? At 79, Julie still has a commanding and elegant stage presence. And, like most of the world, I will miss Robin Williams, who was among the stars we lost last year.

Have a great week, and if you are in the northern hemisphere, try to stay warm.

Your thinking about debt and productivity analyst,

John Mauldin

Opinion

The Search for a Monetary-Policy Wizard and Political Moral Hazard

Relying on central bankers to solve the world’s economic woes reduces public pressure on elected officials to act.

By Robert E. Rubin

Feb. 23, 2015 6:28 p.m. ET

    Photo: Getty Images/Ikon Images

The three major democratic advanced economies—the eurozone, Japan and the U.S.—continue to experience significant economic challenges. The eurozone is weak and vulnerable; Japan has been in recession again; and while recent data have been better, the American recovery is still slow by historical standards, with stagnant median real wages and a labor market that is weaker than the official unemployment rate indicates.

The particulars of these economic challenges differ, but in each region one thing is constant: endless focus by the media, analysts and investors on the yellow-brick road that leads to central banks. Will the European Central Bank’s quantitative-easing program have major impact?

How will the Bank of Japa n proceed? When will the Federal Reserve raise interest rates?

Monetary policy is important, but it is not omnipotent. The relentless focus on monetary policy creates serious moral hazard by taking attention away from elected officials’ failure to act on the fiscal, public-investment and structural issues that are the key to short- and long-term economic success. Commensurately, focusing on central banks reduces public pressure on elected officials to act. And monetary-policy decisions themselves require a rigorous balancing of benefits and risks.

ECB President Mario Draghi ’s famous promise to do “whatever it takes” to preserve the eurozone was a masterly move to buy time. But monetary policy cannot solve the currency union’s problems. In the eurozone, as in Japan, sovereign-bond yields have been very low for an extended time, especially when eurozone yields are viewed on a risk-adjusted basis. Even lower interest rates would probably have little impact on investment and consumer decision-making. ECB policy has generated a decline in the value of the euro that could go further, but the impact on the economy is likely to be limited and certainly not sufficient to revive the eurozone.

Given the limited transmission mechanism, QE in the eurozone is unlikely to raise inflation expectations significantly—though inaction could have reinforced deflation concerns and disrupted markets that already had reflected the prospect of policy action.

In the U.S., the risks from QE3—the most recent phase of quantitative easing—persist even though that round of bond buying is over. QE3 created comfort that the Fed could and would keep bond yields low. That, in turn, may have led political leaders to feel less pressure to act—political moral hazard—and exacerbated investors’ reaching for yield through riskier assets, contributing to excesses in the U.S. and globally.

The U.S. stock market has been roughly at an all-time high. Leveraged buyouts are being done with minimal or no covenants. Italian, Spanish and French yields on sovereign 10-year debt are lower than U.S. Treasurys. If these are excesses, the markets are at some point likely to destabilize, perhaps severely. Market fluctuations associated with the Swiss National Bank ’s ending of its cap on the franc against the euro could provide a glimpse of the destabilizing effects that central-bank currency actions can have, though in the Swiss case it was an appreciating currency after a long effort to maintain a capped exchange rate.

Moreover, the vast and unprecedented increase in the Federal Reserve’s balance sheet heightens the risk of a policy error—either too little or too much restraint—as the Fed manages the process of tightening. Some argue that risk can be minimized if the Fed tightens not through selling assets but by increasing interest rates on excess reserves or using instruments like reverse repos. But there is no magic solution here. The response of markets, banks and businesses to the use of such alternative tools is untested and unknowable. And the risk of economic slowdown or inflation may be about the same, though with different dynamics.

The greater these risks are, the more imperative it is that elected officials do what is needed for a successful economy. In the U.S., that agenda should include a sound and well-constructed fiscal regime, robust public investment, and structural change in areas like immigration, education, trade liberalization and much else. The fiscal regime should consist of upfront job-creating infrastructure spending, enacted simultaneously with somewhat deferred structural fiscal-discipline measures on the spending and revenue sides. And sequestration should be canceled.

In the eurozone, leaders of key troubled countries—including Italy, Spain, France and, most immediately, Greece—need to undertake structural reforms, further strengthen banking systems, and strike a fiscal balance between sufficient discipline to win market and business confidence and adequate fiscal room for growth. As to Japan, the fundamental requisite is structural reform.

In all three major advanced economies there should be a clear-eyed view of the moral hazard created by disproportionate focus on central banks. Monetary policy should be treated with a pragmatic analysis of all its attendant risks and rewards. Instead of looking for a wizard at the end of a yellow-brick road, we should demand that elected officials take the difficult fiscal, public-investment and structural actions that could do so much good now and that are imperative for the longer term.


Mr. Rubin, a former U.S. Treasury secretary, is co-chairman of the Council on Foreign Relations.

Central Banks Are Losing Control

by Phoenix Capital Research

02/24/2015 13:01 -0500

Global Central banks’ reputations are on borrowed time.

ALL of the so called, “economic recovery” that began in 2009 has been based on the Central Banks’ abilities to rein in the collapse.

The first round of interventions (2007-early 2009) was performed in the name of saving the system. The second round (2010-2012) was done because it was generally believed that the first round hadn’t completed the task of getting the world back to recovery.

However, from 2012 onward, everything changed. At that point the Central Banks went “all in” on the Keynesian lunacy that they’d been employing since 2008. We no longer had QE plans with definitive deadlines. Instead phrases like “open-ended” and doing “whatever it takes” began to emanate from Central Bankers’ mouths.

However, the insanity was in fact greater than this. It is one thing to bluff your way through the weakest recovery in 80+ years with empty promises; but it’s another thing entirely to roll the dice on your entire country’s solvency just to see what happens.

In 2013, the Bank of Japan launched a single QE program equal to 25% of Japan’s GDP. This was unheard of in the history of the world. Never before had a country spent so much money relative to its size so rapidly… and with so little results: a few quarters of increased economic growth while household spending collapsed and misery rose alongside inflation.

This was the beginning of the end. Japan nearly broke its bond market launching this program (the circuit breakers tripped multiple times in that first week). However it wasn’t until late 2014 that things truly became completely and utterly broken.

We are, of course, referring to the Bank of Japan’s decision to increase its already far too big QE program, not because doing so would benefit the country, but because it would bring economists’ forecast inline with governor Kuroda’s intended inflation numbers.

This was the “Rubicon” moment: the instant at which Central Banks gave up pretending that their actions or policies were aimed at anything resembling public good or stability. It was now about forcing reality to match Central Bankers’ theories and forecasts. If reality didn’t react as intended, it wasn’t because the theories were misguided… it was because Central Bankers simply hadn’t left the paperweight on the “print” button long enough.

At this point the current financial system was irrevocably broken. We simply had yet to feel it.

That is, until, in early January when the Swiss National Bank lost control, breaking a promise, and a currency peg, losing an amount of money equal to somewhere between 10% and 15% of Swiss GDP in a single day, and showing, once and for all, that there are problems so big that even the ability to print money can’t fix them.

Please let this sink in: a Central bank lost control last month. This will not be a one-off event. With the Fed and other Central banks now leveraged well above 50-to-1, even those entities that were backstopping an insolvent financial system are themselves insolvent.

The Big Crisis, the one in which entire countries go bust, has begun. It will not unfold in a matter of weeks; these sorts of things take months to complete. But it has begun.

viernes, febrero 27, 2015

IS GOLD RISK FREE ? / SAFE HAVEN

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Is Gold Risk Free?

By: Axel Merk

Tue, Feb 24, 2015

I’ve long argued that there may not be any safe asset anymore and that investors may want to take a diversified approach to something as mundane as cash. But what about gold? When I mentioned in a recent interview that not even gold is ‘risk free,’ it raised some eyebrows in the gold community. Let me elaborate.

Merk Gold Cartoon


To answer whether gold is "risk free", let’s look at it from a couple different vantage points:

When we look at gold’s "safety", let’s look at it from a storage and investment point of view.

Gold storage

Gold is just that – gold. One of the beauties of gold is that it has no counterparty risk. Except when someone touches it. This ‘touching’ can happen in different ways:
  • Physical storage. If one stores the gold at home, the ‘counterparty’ one needs to be concerned about is burglars. The same applies in a bank deposit box or specialized gold custodian. Insurance ought to alleviate that concern, but keep in mind that the insurance company is also a counterparty risk.

  • Allocated versus Unallocated. Financial institutions in the business of storing gold differentiate between holding gold on an allocated or unallocated basis. Allocated means it is segregated, held on behalf of the client; in the event of a default of the custodian, the gold still belongs to the beneficial owner. In contrast, unallocated gold, also referred to as paper gold, is merely a claim against the assets of the institution.
Central banks like gold because, in the words of former Federal Reserve Chairman Greenspan: "Gold has always been accepted without reference to any other guarantee" (for a summary of stunning quotes by Greenspan on gold in the current environment, please read "Greenspan: Price of Gold Will Rise").

Assuming one is comfortable with one’s choice of storage, is gold "safe" as an investment? If one asks U.S. regulators, the answer is no: only U.S. Treasuries are considered safe. If you ask gold bugs, the answer may well be that gold is the safer choice and U.S. Treasuries are the riskier choice. Which one is it?

As long as Congress authorizes it, U.S. Treasuries can always be paid back. The payment is in U.S. dollars that can be printed. If you take a dollar bill to your bank, the bank will give you a statement showing that you can get a dollar bill again. Similarly, the bank can go to the Federal Reserve to deposit cash; in return, the bank will get a receipt that it can always ask for its cash back. The guarantee is in the circular arrangement. As a result, to quote Greenspan once again, "We can guarantee cash, but we cannot guarantee purchasing power!"

In the U.S., as in many other countries, there’s a separation of fiscal and monetary policy. This means that while the government steers income and spending, the central bank controls the amount of credit (or the cost of credit) available to the economy. The idea is that the central bank will preserve the purchasing power of the currency. If history is any guide, however, central banks have a very difficult time to preserve the purchasing power of a currency when unsustainable fiscal policies are pursued.

And even during "normal" times, a central banker’s idea of preserving purchasing power is an inflation rate of around 2%. As such, since the introduction of the Federal Reserve, the U.S. dollar has lost over 95% of its purchasing power when measured by the Consumer Price Index (CPI).

In contrast, the reason why many investors like gold is because it cannot be as easily "printed" (although gold production can be increased, although not as easily). But that’s also the very reason why governments are not keen on backing their currency by gold: doing so limits the ability of the government to engage in excess spending. It’s for this reason that for the past 100+ years, we have moved further and further away from the gold standard. In doing so, cash is at risk of no longer serving its function as a store of value, a key criteria of money.

We argue that a government in debt does not have its priorities aligned with savers because the government has an interest in debasing the value of its debt. Debasing the value of one’s debt doesn’t solve the debt problem, but it helps to ‘kick the can down the road’, something politicians appear to be particularly good at. In the U.S., we also have many consumers with too much debt and non-voting foreigners owning much of the debt. One doesn’t have to be a gold bug to suggest that incentives are baked into the system for the further erosion of the purchasing power of the currency.

Back to gold: is gold risk free as an investment? These 100 ounces are "safe" in the sense that they will remain 100 ounces: 100 ounces of gold will be 100 ounces a year from now, ten years from now, 100 years from now. But when we talk about a "safe" investment, we need to look at the purchasing power of the investment. Roughly speaking, a suit cost an ounce of gold 100 years ago, as it does today; similarly, a gallon of milk costs about as much in gold 100 years ago as it does today.

However, the price of gold measured in any one currency, including the U.S. dollar, fluctuates, at times widely.

For U.S. based investors, most of our expenses are priced in U.S. dollars. If I know I have to spend $1,200 a year from now, I can put the cash aside or buy one ounce of gold. The cash will pay for my obligation. The one ounce of gold may or may not. As such, anything that fluctuates in value versus the U.S. dollar is inherently not ‘safe.’

This doesn’t mean that US dollar cash is preferable to gold. But what it means is that whatever one does with one’s savings is based on one’s risk assessment. Ultimately, investing is about preserving and enhancing purchasing power. The reason why we invest is because we can’t trust our government (this isn’t aimed at any one, but all governments) to preserve our purchasing power. In that process, we take risks. We invest along the risk spectrum from stocks to bonds, from real estate to commodities, to cash or alternative assets. Some reject gold because it’s an "unproductive" asset. So is your twenty-dollar bill. If one wants gold to be "productive", one can lease it out, although that process introduces the very counterparty risk many investors try to avoid. Allocated gold may be unproductive, but that beats an asset that, by definition, is destructive. In the current environment, real interest rates, i.e. interest rates after inflation, are negative. That may make a brick (of gold) that is unproductive, suddenly comparatively attractive.

Importantly, gold just is what it is. In contrast, when we reference the CPI above, it is subject to the collective wisdom of economists. Even as they try to do the right thing, many feel that annual inflation is higher than reported by the CPI. In fact, how is it possible for the price of a piece of brick to appreciate an annual rate exceeding 8% since 1970?


Gold Price 1970-2015

Some may argue that this suggests gold is in a bubble, however, gold has performed similarly over the 100 year period. In our assessment, the more likely interpretation is that the CPI under-reports inflation.

When it comes to choosing gold as an investment, the question is what the price of gold may do in the future. If history is any guide, the correlation to other investments, equities in particular, may stay low. It’s the positive return expectation that many have an issue with. And anyone who has followed gold for some time knows the price can be volatile. Investors can recently recall the 28% drop in 2013. That year, the S&P soared, so gold fulfilled its role as a diversifier.

In the short-term, investors are concerned about interest rate increases by the Fed: as the return on cash increases, it is competition to the brick that pays no interest. However, the FOMC statement’s last paragraph suggests to us that real interest rates may be negative to low for an extended period: "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run." Indeed, in our assessment, the U.S., Eurozone and Japan may not be able to afford positive real interest rates a decade from now.

Does this make gold a "safe" investment? No. No investor should have more money allocated to an investment than they can sleep with at night. And we don’t mean physically put under one’s pillow. If one cannot stomach a severe correction in an asset, one is likely over-allocated to that asset.

Talking about over-allocation: what about that equity allocation? For most investors, the equity allocation of their portfolio has done very well. In recent years, we believe volatility in the equity markets has been suppressed by central bank policy. Are you able to stomach a downturn should volatility surge? And if not, where do you hide? It’s that last part for which there’s no easy answer because central banks have created an environment where there may not be such a thing as a safe asset anymore. What investors can do is have a toolbox available to counter the toolbox of central banks. We think investors may want to consider having gold in that toolbox. How much?

viernes, febrero 27, 2015

INSIDE CHINA´S NEW NORMAL / TOMDISPATCH.COM

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Tomgram: Pepe Escobar, Inside China's "New Normal"

by Pepe Escobar

4:50pm, February 22, 2015.


Sometimes this planet changes right under your nose and you still don’t notice.  This sentence, buried in a New York Times piece on the Greek debt crisis, caught my attention the other day: “Greece, meanwhile, has suggested that it could turn to Russia or China for help if its talks on debt relief and a rollback of austerity measures break down.”  Russia is, of course, an unlikely bulwark, being on distinctly shaky economic grounds itself right now, but I’m not surprised by the thought -- at least from Syriza, the lefty party now in power in Greece.  But China?  Not since tiny Albania joined the Chinese camp in the Cold War have we seen a sentence that in any way resembled that one.  And yet it certainly catches something of the changing face of our planet. 

After all, as time goes by, the magnetic power of the Chinese economy is moving ever closer to Europe.  Just two years ago, the Chinese became the Middle East’s largest trading partner, leaving the European Union in second place and the United States in third.  By then, China was already Africa’s largest trading partner, having displaced the U.S. some years earlier.

This may not be making headlines here, but it’s no small thing.  The economic rise of China, especially in areas where the U.S. had committed so much in blood, sweat, and drones, should take anyone’s breath away.  Fortunately, TomDispatch’s peripatetic Eurasian correspondent Pepe Escobar (the man who invented the term “Pipelineistan” for the web of energy conduits that crisscross that vast continental area) arrives in the nick of time to offer us a view from Beijing of an economy still staggeringly on the rise and the plans of the Chinese leadership, from Asia to Europe, for knitting together what, if it happened, might indeed someday be seen as a new world economic order. Tom

Year of the Sheep, Century of the Dragon?  
New Silk Roads and the Chinese Vision of a Brave New (Trade) World  
By Pepe Escobar  
 
BEIJING -- Seen from the Chinese capital as the Year of the Sheep starts, the malaise affecting the West seems like a mirage in a galaxy far, far away. On the other hand, the China that surrounds you looks all too solid and nothing like the embattled nation you hear about in the Western media, with its falling industrial figures, its real estate bubble, and its looming environmental disasters. Prophecies of doom notwithstanding, as the dogs of austerity and war bark madly in the distance, the Chinese caravan passes by in what President Xi Jinping calls “new normal” mode. 
“Slower” economic activity still means a staggeringly impressive annual growth rate of 7% in what is now the globe’s leading economy. Internally, an immensely complex economic restructuring is underway as consumption overtakes investment as the main driver of economic development. At 46.7% of the gross domestic product (GDP), the service economy has pulled ahead of manufacturing, which stands at 44%. 
Geopolitically, Russia, India, and China have just sent a powerful message westward: they are busy fine-tuning a complex trilateral strategy for setting up a network of economic corridors the Chinese call “new silk roads” across Eurasia. Beijing is also organizing a maritime version of the same, modeled on the feats of Admiral Zheng He who, in the Ming dynasty, sailed the “western seas” seven times, commanding fleets of more than 200 vessels. 
Meanwhile, Moscow and Beijing are at work planning a new high-speed rail remix of the fabled Trans-Siberian Railroad. And Beijing is committed to translating its growing strategic partnership with Russia into crucial financial and economic help, if a sanctions-besieged Moscow, facing a disastrous oil price war, asks for it.

To China’s south, Afghanistan, despite the 13-year American war still being fought there, is fast moving into its economic orbit, while a planned China-Myanmar oil pipeline is seen as a game-changing reconfiguration of the flow of Eurasian energy across what I’ve long called Pipelineistan
And this is just part of the frenetic action shaping what the Beijing leadership defines as the New Silk Road Economic Belt and the Maritime Silk Road of the twenty-first century. We’re talking about a vision of creating a potentially mind-boggling infrastructure, much of it from scratch, that will connect China to Central Asia, the Middle East, and Western Europe. Such a development will include projects that range from upgrading the ancient silk road via Central Asia to developing a Bangladesh-China-India-Myanmar economic corridor; a China-Pakistan corridor through Kashmir; and a new maritime silk road that will extend from southern China all the way, in reverse Marco Polo fashion, to Venice. 
Don’t think of this as the twenty-first-century Chinese equivalent of America’s post-World War II Marshall Plan for Europe, but as something far more ambitious and potentially with a far vaster reach. 
China as a Mega-City 
If you are following this frenzy of economic planning from Beijing, you end up with a perspective not available in Europe or the U.S. Here, red-and-gold billboards promote President Xi Jinping’s much ballyhooed new tagline for the country and the century, “the Chinese Dream” (which brings to mind “the American Dream” of another era). No subway station is without them. They are a reminder of why 40,000 miles of brand new high-speed rail is considered so essential to the country’s future. After all, no less than 300 million Chinese have, in the last three decades, made a paradigm-breaking migration from the countryside to exploding urban areas in search of that dream. 
Another 350 million are expected to be on the way, according to a McKinsey Global Institute study. From 1980 to 2010, China’s urban population grew by 400 million, leaving the country with at least 700 million urban dwellers. This figure is expected to hit one billion by 2030, which means tremendous stress on cities, infrastructure, resources, and the economy as a whole, as well as near-apocalyptic air pollution levels in some major cities. 
Already 160 Chinese cities boast populations of more than one million. (Europe has only 35.) No less than 250 Chinese cities have tripled their GDP per capita since 1990, while disposable income per capita is up by 300%. 
These days, China should be thought of not in terms of individual cities but urban clusters -- groupings of cities with more than 60 million people. The Beijing-Tianjin area, for example, is actually a cluster of 28 cities. Shenzhen, the ultimate migrant megacity in the southern province of Guangdong, is now a key hub in a cluster as well. China, in fact, has more than 20 such clusters, each the size of a European country.  
Pretty soon, the main clusters will account for 80% of China’s GDP and 60% of its population. So the country’s high-speed rail frenzy and its head-spinning infrastructure projects -- part of a $1.1 trillion investment in 300 public works -- are all about managing those clusters. 
Not surprisingly, this process is intimately linked to what in the West is considered a notorious “housing bubble,” which in 1998 couldn’t have even existed. Until then all housing was still owned by the state. Once liberalized, that housing market sent a surging Chinese middle class into paroxysms of investment. Yet with rare exceptions, middle-class Chinese can still afford their mortgages because both rural and urban incomes have also surged. 
The Chinese Communist Party (CCP) is, in fact, paying careful attention to this process, allowing farmers to lease or mortgage their land, among other things, and so finance their urban migration and new housing. Since we’re talking about hundreds of millions of people, however, there are bound to be distortions in the housing market, even the creation of whole disastrous ghost towns with associated eerie, empty malls. 
The Chinese infrastructure frenzy is being financed by a pool of investments from central and local government sources, state-owned enterprises, and the private sector. The construction business, one of the country’s biggest employers, involves more than 100 million people, directly or indirectly. Real estate accounts for as much as 22% of total national investment in fixed assets and all of this is tied to the sale of consumer appliances, furnishings, and an annual turnover of 25% of China’s steel production, 70% of its cement, 70% of its plate glass, and 25% of its plastics. 
So no wonder, on my recent stay in Beijing, businessmen kept assuring me that the ever-impending “popping” of the “housing bubble” is, in fact, a myth in a country where, for the average citizen, the ultimate investment is property. In addition, the vast urbanization drive ensures, as Premier Li Keqiang stressed at the recent World Economic Forum in Davos, a “long-term demand for housing.” 
Markets, Markets, Markets 
China is also modifying its manufacturing base, which increased by a multiple of 18 in the last three decades. The country still produces 80% of the world’s air conditioners, 90% of its personal computers, 75% of its solar panels, 70% of its cell phones, and 63% of its shoes. Manufacturing accounts for 44% of Chinese GDP, directly employing more than 130 million people. In addition, the country already accounts for 12.8% of global research and development, well ahead of England and most of Western Europe. 
Yet the emphasis is now switching to a fast-growing domestic market, which will mean yet more major infrastructural investment, the need for an influx of further engineering talent, and a fast-developing supplier base. Globally, as China starts to face new challenges -- rising labor costs, an increasingly complicated global supply chain, and market volatility -- it is also making an aggressive push to move low-tech assembly to high-tech manufacturing. Already, the majority of Chinese exports are smartphones, engine systems, and cars (with planes on their way). In the process, a geographic shift in manufacturing is underway from the southern seaboard to Central and Western China. The city of Chengdu in the southwestern province of Sichuan, for instance, is now becoming a high-tech urban cluster as it expands around firms like Intel and HP. 
So China is boldly attempting to upgrade in manufacturing terms, both internally and globally at the same time. In the past, Chinese companies have excelled in delivering the basics of life at cheap prices and acceptable quality levels. Now, many companies are fast upgrading their technology and moving up into second- and first-tier cities, while foreign firms, trying to lessen costs, are moving down to second- and third-tier cities.  
Meanwhile, globally, Chinese CEOs want their companies to become true multinationals in the next decade. The country already has 73 companies in the Fortune Global 500, leaving it in the number two spot behind the U.S. 
In terms of Chinese advantages, keep in mind that the future of the global economy clearly lies in Asia with its record rise in middle-class incomes. In 2009, the Asia-Pacific region had just 18% of the world’s middle class; by 2030, according to the Development Center of the Organization for Economic Cooperation and Development, that figure will rise to an astounding 66%. North America and Europe had 54% of the global middle class in 2009; in 2030, it will only be 21%. 
Follow the money, and the value you get for that money, too. For instance, no less than 200,000 Chinese workers were involved in the production of the first iPhone, overseen by 8,700 Chinese industrial engineers. They were recruited in only two weeks. In the U.S., that process might have taken more than nine months. The Chinese manufacturing ecosystem is indeed fast, flexible, and smart -- and it’s backed by an ever more impressive education system. Since 1998, the percentage of GDP dedicated to education has almost tripled; the number of colleges has doubled; and in only a decade, China has built the largest higher education system in the world. 
Strengths and Weaknesses 
China holds more than $15 trillion in bank deposits, which are growing by a whopping $2 trillion a year. Foreign exchange reserves are nearing $4 trillion. A definitive study of how this torrent of funds circulates within China among projects, companies, financial institutions, and the state still does not exist. No one really knows, for instance, how many loans the Agricultural Bank of China actually makes. High finance, state capitalism, and one-party rule all mix and meld in the realm of Chinese financial services where realpolitik meets real big money. 
The big four state-owned banks -- the Bank of China, the Industrial and Commercial Bank of China, the China Construction Bank, and the Agricultural Bank of China -- have all evolved from government organizations into semi-corporate state-owned entities. They benefit handsomely both from legacy assets and government connections, or guanxi, and operate with a mix of commercial and government objectives in mind. They are the drivers to watch when it comes to the formidable process of reshaping the Chinese economic model. 
As for China’s debt-to-GDP ratio, it’s not yet a big deal. In a list of 17 countries, it lies well below those of Japan and the U.S., according to Standard Chartered Bank, and unlike in the West, consumer credit is only a small fraction of total debt. True, the West exhibits a particular fascination with China’s shadow banking industry: wealth management products, underground finance, off-the-balance-sheet lending. But such operations only add up to around 28% of GDP, whereas, according to the International Monetary Fund, it's a much higher percentage in the U.S. 
China’s problems may turn out to come from non-economic areas where the Beijing leadership has proven far more prone to false moves. It is, for instance, on the offensive on three fronts, each of which may prove to have its own form of blowback: tightening ideological control over the country under the rubric of sidelining “Western values”; tightening control over online information and social media networks, including reinforcing “the Great Firewall of China” to police the Internet; and tightening further its control over restive ethnic minorities, especially over the Uighurs in the key western province of Xinjiang. 
On two of these fronts -- the “Western values” controversy and Internet control -- the leadership in Beijing might reap far more benefits, especially among the vast numbers of younger, well educated, globally connected citizens, by promoting debate, but that’s not how the hyper-centralized Chinese Communist Party machinery works. 
When it comes to those minorities in Xinjiang, the essential problem may not be with the new guiding principles of President Xi’s ethnic policy. According to Beijing-based analyst Gabriele Battaglia, Xi wants to manage ethnic conflict there by applying the “three Js”: jiaowang, jiaoliu, jiaorong (“inter-ethnic contact,” “exchange,” and “mixage”). Yet what adds up to a push from Beijing for Han/Uighur assimilation may mean little in practice when day-to-day policy in Xinjiang is conducted by unprepared Han cadres who tend to view most Uighurs as “terrorists.” 
If Beijing botches the handling of its Far West, Xinjiang won’t, as expected, become the peaceful, stable, new hub of a crucial part of the silk-road strategy. Yet it is already considered an essential communication link in Xi’s vision of Eurasian integration, as well as a crucial conduit for the massive flow of energy supplies from Central Asia and Russia. The Central Asia-China pipeline, for instance, which brings natural gas from the Turkmen-Uzbek border through Uzbekistan and southern Kazakhstan, is already adding a fourth line to Xinjiang. And one of the two newly agreed upon Russia-China pipelines will also arrive in Xinjiang. 
The Book of Xi 
The extent and complexity of China’s myriad transformations barely filter into the American media. Stories in the U.S. tend to emphasize the country’s “shrinking” economy and nervousness about its future global role, the way it has “duped” the U.S. about its designs, and its nature as a military “threat” to Washington and the world. 
The U.S. media has a China fever, which results in typically feverish reports that don’t take the pulse of the country or its leader. In the process, so much is missed.  
One prescription might be for them to read The Governance of China, a compilation of President Xi’s major speeches, talks, interviews, and correspondence. It’s already a three-million-copy bestseller in its Mandarin edition and offers a remarkably digestible vision of what Xi’s highly proclaimed “China Dream” will mean in the new Chinese century. 
Xi Dada (“Xi Big Bang” as he’s nicknamed here) is no post-Mao deity. He’s more like a pop phenomenon and that’s hardly surprising. In this “to get rich is glorious” remix, you couldn’t launch the superhuman task of reshaping the Chinese model by being a cold-as-a-cucumber bureaucrat. Xi has instead struck a collective nerve by stressing that the country’s governance must be based on competence, not insider trading and Party corruption, and he’s cleverly packaged the transformation he has in mind as an American-style “dream.” 
Behind the pop star clearly lies a man of substance that the Western media should come to grips with. You don’t, after all, manage such an economic success story by accident. It may be particularly important to take his measure since he’s taken the measure of Washington and the West and decided that China’s fate and fortune lie elsewhere. 
As a result, last November he made official an earthshaking geopolitical shift. From now on, Beijing would stop treating the U.S. or the European Union as its main strategic priority and refocus instead on China’s Asian neighbors and fellow BRICS countries (Brazil, Russia, India, and South Africa, with a special focus on Russia), also known here as the “major developing powers” (kuoda fazhanzhong de guojia). And just for the record, China does not consider itself a “developing country” anymore. 
No wonder there’s been such a blitz of Chinese mega-deals and mega-dealings across Pipelineistan recently. Under Xi, Beijing is fast closing the gap on Washington in terms of intellectual and economic firepower and yet its global investment offensive has barely begun, new silk roads included. 
Singapore’s former foreign minister George Yeo sees the newly emerging world order as a solar system with two suns, the United States and China. The Obama administration’s new National Security Strategy affirms that “the United States has been and will remain a Pacific power” and states that “while there will be competition, we reject the inevitability of confrontation” with Beijing. The “major developing powers,” intrigued as they are by China’s extraordinary infrastructural push, both internally and across those New Silk Roads, wonder whether a solar system with two suns might not be a non-starter. The question then is: Which “sun” will shine on Planet Earth?  Might this, in fact, be the century of the dragon?
 
Pepe Escobar is the roving correspondent for Asia Times, an analyst for RT and Sputnik, and a TomDispatch regular. His latest book is Empire of Chaos.