Pettis on China, Part Four

Part Four dwelling on a Michael Pettis essay.  My comment are in between the ***  ***

Journey to the West

This issue of how much investment is enough is a very important topic that deserves much more discussion, but I think there is a very good example of why we need to be worried about how useful additional infrastructure investment in China might be. This shows up most clearly in China’s push to create development in the western part of the country.

***Forget about it.  China’s interest in Western China is existential, not economic.  Most of the territory of what we call China is lands Islamic for at least a millennia. There are strains in Islam inimicable to the Chinese state, and the Chinese are not about to allow any coalescing of opposition.  

Chinese settlement of the West is about China’s survival just as their domination of Tibet is an existential imperative to control the headwaters of the Yangtse and other major rivers.  It’s no accident that law is taught from the riverbank out.

It is another example of how the communists are fielding first stringers against USA’s third stringers inasmuch as where China has an existential threat both within and on their borders, yet largely peaceful relations, the USA has absolutely no interest in the Middle East yet is being broken in a conflict with the same.  And working hard to make maters even worse.

Capitalism so enriches the few that they have no real interest in the outcomes of any particular event, these few will simply move on to other domiciles if ideas have disagreeable consequences.

In China, Western development will be political, not economic.***

Often when I question the economic value of China’s push to the western, poorer parts of the country (by the way economic value is not the same as social or political value, the latter of which may nonetheless justify projects that are not economically viable) I am almost always treated with the story of the American West. In the 19th Century, as everyone knows, the US went west, and most economists agree that this made economic sense for the country and was an important part of the process that led it to becoming the wealthiest and most productive country in history.

***Well, it is more nuanced than that.  The legal system dominant in the Eastern states based on the English system of primogeniture eventually forced the “go west, young man” imperative of Horace Greeley.  The Spanish legal system of maternal inheritance offered those young men an alternative opportunity.  To this day the Eastern states’ courts upholding such contracts as NDAs and NCAs starved innovation and the Western state’s courts abjuring such contracts allowed innovation to flourish.

Will China allow Shariah law in its Western districts and see a result similar to that of the USA?***

...The US is not the only country in history that “went West”. ...

Most economists today agree that the Brazilian and Soviet experiences were economically unsuccessful and left those countries burdened with such enormous debts that they were at least partly to blame for Brazil’s debt crisis in the 1980s and the collapse of the Soviet economy in the 1970s. It turns out, in other words, that there are both successful and unsuccessful precedents for China’s going west.

***Those events are similar only in the coincidence, a 1 in 4 chance, of the word West.***

What are the differences and how do they apply to China? Again, I can’t say that I can fully understand or explain them, but one major difference leaps out. In the US it was private individuals, seeking profitable opportunities, that led the move into the American West, and government investment followed. 

***In US history there are two phases of the move West, pre and post civil war..  The first involved stealing land from Mexico to keep the inviable cotton/slave regime working.  Southern cotton farmers depleted their lands and needed more.  So the state obliged the farmers.  General Grant believed the US Civil war with near 700,000 dead and incalculable destruction was God’s punishment for the US war on Mexico.  

After the war those traumatized and bent by killing were sent West to ethnically cleanse the West to make it safe for democracy or whatever.  then laws began to change to benefit those who benefitted from government backing.

Government investment preceded the development of the West.  The investment was in the form of violence.  

The question is not whether “West” matters, but whether policies matter.  British imperialists shared power with their subjects.  The French never did.  Around the world, and even in the USA, among people of some African heritage, the impoverished largely come from former French colonies, and the wealthy largely come from the former British colonies. Ideas have consequences, not directions.***

In Brazil and the Soviet Union, however, there was little incentive for private individuals to lead the process. It was the government that led, and private businesses followed only because government spending created great opportunities for profit. Once government spending stopped, so did business.

***If the state were to end the agricultural subsidies for the Western United states, almost nothing going on now would continue.  Certainly other enterprises now crowded out would then be viable, but government interference does result in misallocation and malinvestment.**

My very preliminary conclusion is that large-scale government ambitions allied to strong political motivation and funded by cheap and easy access to credit can lead very easily to the wrong kinds of investment programs. The US experiences of government investment in the 19th Century, in other words, may be a very poor precedent for understanding China’s current policy of increasing investment spending, especially in the poor western part of the country.

***I concur!***

Brazil and the Soviet Union may be much better precedents. At the very least these gloomier experiences should not be ignored when we think of China’s policies. “Going West” isn’t always a great idea from an economic point of view and has led to at least as many, and probably more, bad outcomes as good outcomes. It is not clear why these lessons cannot possibly be applied to China.

*** Can China’s first string leaders keep up their winning streak?***

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What Fun!

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Pettis on China, Part Three

Continuing a review of Michael Pettis' essay on China.  My comments are in between the ***  ***

Internal improvements

The second element of the American System was internal improvement, which today we would probably call infrastructure spending. Proponents of the American System demanded that the national and state governments design, finance and construct canals, bridges, ports, railroads, toll roads, and a wide variety of communication and transportation facilities that would allow businesses to operate more efficiently and profitably. In some cases these projects were paid for directly (tolls, for example) and in other cases they were paid for tax revenues generated by higher levels of economic activity.

***If only it worked this way.  In fact the process of state involvement in “infrastructure” was so fraught with fraud and graft, embezzlement and so on, it often failed.  In his book “Confessions of an Economic Hit Man” John Perkins explains his role in financing “infrastructure overseas to advance imperial power.

This is the same thing we see domestically.  Student loans is the most common experience people have of this and an excellent example.  pat too much for poor quality and then stuck in debt for life, since student loans cannot be bankrupted.  What France did to Haiti, the state does to American Students.***

It is easy to make a case for state involvement in infrastructure investment. The costs of infrastructure can be very high, 

***If they are wildly out of scale, and pumped up with fraud. graft, embezzlement, union featherbedding, etc.

And here again, Pettis looks at the disastrous short term and finds it good.  If we stretch back to ancient Greece and Rome, with public works that stand to this day, it was private or community efforts that made those wonders of the ancient world.  We are in the habit of saying “Rome built” or Greece built” when it was in fact individual who built these “public works” for their own eternal glory, but built them they did. Without recapitulating what is well know to the classicists, there is simply no need for state involvement in “public works.”***

while even if the benefits are much higher they are likely to be diffused throughout the economy, making it hard for any individual company to justify absorbing the costs of investment. In this case the state should fund infrastructure investment and pay for it through the higher taxes generated by greater economic activity.

***Well, what happens is when the state creates bonds and uses usury to finance gigantism such as the interstate hiway system, in its wake comes the WalMarts and Tyson’s and Holiday Inns that destroy viable small businesses that cannot compete.  Next comes the lowering of quality and increase of production, so that for the first time in the history of mankind, we have a country where the poor people are fat.

Gigantism can be beat by small business, as I daily demonstrate, and there is a symbiotic relationship between large and small business if the large is not state preferred.  But the objection to gigantism is the death and destruction in its wake. But to be sure, gigantism is tradable, short or long.***

For me the interesting question, especially in the Chinese context, is not whether the state should build infrastructure but rather how much it should build. 

***How about zero? That would be really interesting. In a country where “face” still matters, let their richest create the railroads, mag lev systems, bridges etc.  China has a terrible problem with dodgy public works, and if no doubt experiencing tired trigger finger dealing with the malfeasants.

Someone organized enough to pull together billions in China should be creating the roads from here to there.  Immediately people will claim nationwide systems need central planning.  Sure, if you want bridges to no where and empty cities.  People need not central planning but close cooperation.  If there is anything the wealthy are good at, it is close cooperation.

The ancient world saw public works as individual efforts, or in medieval times short term corporate work.  If any place on earth could today revive the economical, efficient and rational delivery of public works, it could be China.  And again, just look to Hong Kong where its national airline and railway system and the famed Star Ferry were privately developed (the last by a Zoroastrian no less).

Never mind Mercantilism is inherently wrong.  What Mr. Pettis is advocating is a degree of mercantilism to which he can wrap his brain, and thus gauge what is tradable.  Not too much, not too little, just enough for him to get rich.

Better Mr. Pettis forget about the money, and open a business.*** 

In fact this is one of the greatest sources of confusion in the whole China debate. Most China bulls implicitly assume that infrastructure spending is always good and the optimal amount of infrastructure is more or less the same for every country, which is what allows them to compare China’s per capita capital stock with that of the US and Japan and conclude that China still has a huge amount of investing to do because its capital stock per capita is so much lower.

***Concur, faulty analogizing on the part of the bulls.***

But this is completely wrong, and even nonsensical. Infrastructure investment is like any other investment in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.

***Correct, such as we have in the United States where so much infrastructure is devoted to what is pointless, and beyond recovery when you consider the USA spends more on the military than all other nations combined.***

In China we have problems with both sides of the equation. First, we don’t know what the true economic cost of investment in China might be. In order to calculate the true cost we need to add not just the direct costs but also all the implicit and explicit subsidies, most of which are hidden or hard to calculate.

***”We?”  The point of the exercise is to assess risk and discover what is “tradable.”  But there is more to life than what is in it for me.  If China adapts the USA system, well, never mind “if” since it already has, then China will yield fairly similar results, as Pettis catalogs in this selective history.  

Better than to wish the inevitable destruction on the Chinese as they follow a well trod path, with quite predictable results, (and don’t investors love predictable results?) why not advocate China, which is in a position to do so, return to its Tang golden age by resurrecting the freedom that was the hallmark of that era?  Modern, with Chinese characteristics.

In USA we have disaster all around and exceptionally uninformed people at the commanding heights.  We will not get out of this with any of the policies on the table, nor the standby plans A, B, C ...

What USA needs is a competitor in freedom, not in Hamiltonian mercantilism.  We all love a system that works for us, and mercantilism does work for those who love what we have in USA: war, malnutrition, bailouts, brutal medicine, chaotic housing, subpar education, and so on.  But hey, we have more billionaires than any other country!***

The most important of these subsidies tends to be the interest rate subsidy, and this can be substantial. If interest rates in China are set artificially low by 5 percentage points, for example, which is a reasonable estimate, an investment of $100 million receives an additional subsidy of $5 million for every year that the loan funding the investment is outstanding – and loans are almost never repaid in China. Over ten to twenty years of outstanding debt this can add 30-40% to the initial cost of the investment. This means that the recognized cost of an infrastructure project is much lower than the true economic cost, with the difference being buried in explicit and implicit subsidies.

***Yes.  Now, do you see why all major religions and the Catholic Church to this day strictly forbids usury (interest?).  ***

But the bigger problem is in the value created by the investment. We can think of the value of infrastructure primarily as a function of the value of labor saved.

***There it is, the labor theory of value.  It’s where Karl Marx went wrong.***

 In countries with very low levels of productivity, each hour of labor saved is less valuable than each hour saved in countries with high levels of productivity. For this reason less productive countries should have much lower capital stock per capita than more productive countries.

***Too broad.  Every Chinese businessman complains about labor shortage.  China and an economic unit is roughly Africa wrapped around Europe.  Building infrastructure in Berlin is different than infrastructure in Benin.  Referring to China as a less developed country is misleading.  Europe would be “less developed” if it included Africa.***

This should be obvious, but it seems that often it isn’t. When analysts point to high quality infrastructure in China whose quality exceeds comparable infrastructure in rich countries, this is not necessarily a good thing.

***But of course we have the problem of calculation in socialist economies like the USA, wherein we simply cannot know how much airport to make or of what quality.  Nor do we need to bother with such triflings, since the game is the maxxing out of the airport district's credit card.***

 It might just be an example of the amount of waste you can achieve when spending is heavily subsidized, when there are strong political (or pecuniary) incentives for expanding investment, and when there is limited transparency and accountability.

***As we have in USA. Where did the bailout money go?***

Other things matter too. If a country has low levels of social capital – if it is hard to set up a business, if less efficient businesses with government connections can successfully compete with more efficient businesses without government connections, if the legal and political structure creates problems in corporate governance (the “agency” problem, especially), if the legal framework is weak, if property rights are not respected, if intellectual property can easily be lost – then much infrastructure spending is likely to be wasted.

***An excellent survey of the challenges facing USA businesses in USA, although the intellectual property riff is out of place.  We can do without IPR in USA.***

***

In fact it turns that it may be far more efficient to focus on improving, say, the legal framework than to build more airports, even though (and perhaps because) building airports generates more growth (and wealth for the politically connected) today. Weak social capital becomes a constraint on the ability to extract value from infrastructure, and this constraint is very high in poor countries with weak institutional frameworks,

***Once upon a time in the USA, if and when people went to court is was to get an answer, just about any answer, since regardless of the answer, once the answer was known, all could proceed in a rational basis and all would flourish.  This was back when we were common law based and before we became mercantilists and positivists.  Common law is private law in essence, like the Lex Mercatoria and the UCP of the ICC.  Now in USA, we have the state seizing private property to transfer to other private paprties and no end to chaotic rulings.  It is no longer possible to get an answer from the courts in which all parties can proceed and thrive.  Now it is just picking winners and losers on the most whimsical bases.  (It’s a fine, not a tax!)

In USA we are at each others throats because your victory necessarily means my defeat.  This is likely intended, under a divide and conquer strategy.

If Pettis is wishing private law such as lex mercatoria on China, I could not agree more.  If he is advocating damning the Chinese to the USA result, then I’d object.  China can do better.  We did better, but now we need help.  We need competition from the Chinese.

If you want a critique of Chinese law you could not do better than this by Laszlo LaDany:

***

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Pettis on China, Part Two

A continuing reply to Michael Pettis Post on the Chinese economic model:

There were three key elements of the American System. Historian Michael Lind, in one of his economic histories of the United States, described them as:

·      infant industry tariffs

·      internal improvements, and

·      a sound system of national finance

These three elements are at the heart, explicitly or implicitly, of every variation of the investment-led development model adopted by number of countries in the last century – including Germany in the 1930s, the USSR in the early Cold War period, Brazil during the Brazilian miracle, South Korea after the Korean War, Japan before 1990, and China today, to name just the most important and obvious cases. For this reason I think it makes sense to discuss each of them in a little more detail.

***I agree, but look at the list:  Germany 1930s... hmmmmm... Soviet Union, Japan, Brazil...  this list recommends the system?***

Infant industry tariffs

The “infant industry” argument is fairly well known. I believe Alexander Hamilton was the first person to use the phrase, and the reasoning behind his thinking was straightforward. American manufacturing could not compete with the far superior British, and according to the then- (and now) fashionable economic theories based on Adam Smith and David Ricardo, the implications for trade policy were obvious. Americans should specialize in areas where they were economically superior to the British – agriculture, for the most part – and economic policy should consist of converting US agriculture to the production of cash crops – tobacco, rice, sugar, wheat and, most importantly, cotton – maximizing that production and exchanging them for cheaper and superior British manufactured items.

In this way, as Ricardo brilliantly proved, and assuming a static distribution of comparative advantages, with each country specializing in its comparative advantage, global production would be maximized and through trade both the British and the Americans would be better off. 

***There are a couple of fatal flaws.

1. Mr Hamilton just KNOWS which industries to pick?  And by picking winners and losers, Mr Hamilton would NEVER starve a new technology, as yet unseen?  Mr Pettis might do well to consider J B Say.

And should they pick wrong, we’d never go to war to fix the mistake?

Recall what Reagan said: If it moves, tax it. If it keeps moving regulate it.  If it stops moving, subsidize it.  It’s funny becuase it is true.  In practice Hamiltonians are about misallocation and malinvestment.

And comparative advantage is a nice theory, but has never occurred in human action, for the very reason that at the moment hamiltonians begin managing the economy, it is tariffs, regulations and subsidies, not comparative advantage, that rules.***

Hamilton was convinced that it was important for the US to develop its own manufacturing base because, as he explained in his Congressional report in 1791, he believed that productivity growth was likely to be much higher in manufacturing than in agriculture or mineral extraction. Contrary to David Ricardo, in other words, Hamilton believed that comparative advantage was not static and could be forced to change in ways that benefitted less productive countries. What is more, he thought manufacturing could employ a greater variety of people and was not subject to seasonal fluctuations or fluctuations in access to minerals.

Given much higher British efficiency and productivity, which translated into much lower prices even with higher transportation costs, how could Americans compete? They could do it the same way the British did to compete with the superior Dutch a century earlier. The US had to impose tariffs and other measures to raise the cost of foreign manufacturers sufficiently to allow their American counterparts to undersell them in the US market. 

***  Undersell?  Or charge too much?  A great system for the industrialized North, which forced Southern growers to buy overpriced USA goods with revenues from sales of cotton to France, instead of cheaper French goods.  The result was the US Civil war, 700,000 americans dead, and the South destroyed.  And slavery permanently enshrined in the US Constitution. Mr. Pettis’ historical sketch here is tendentious.***

In addition Americans had to acquire as much British technological expertise and capacity as possible (which usually happened, I should add, in the form of intellectual property theft).

***How is “stealing British ideas” intellectual property theft when USA and the UK had no treaty on IPR?  UK IPR had absolutely no validity in USA.  How could any treaty even be written when the USA IPR premise of “inventor owns patent” was at variance from the UK “first to patent.”  Then there is the problem of what we understand as patents didn’t show up in the UK until about 1850.  This assertion is a complete mess.***

This the US did, and in fact I believe every country that has managed the transition from underdeveloped to developed country status (with, perhaps, the exception of one or two trading entrepôts like Singapore and Hong Kong, although even this is debatable), including Germany, Japan, and Korea, has done it behind high explicit or implicit trade tariffs and stolen intellectual property. The idea that countries get rich under conditions of free trade has very little historical support, and it is far more likely that rich countries discover the benefits of free trade only after they get rich, while poor countries that embrace free trade too eagerly (think of Colombia and Chile in the late 19th century, who were stellar students of economic orthodoxy) almost never get rich unless, like Haiti in the 18th Century or Kuwait today, they are massive exporters of a very valuable commodity (sugar, in the case of Haiti, which was the richest country in the world per capita during a good part of the late 18th Century).

***If we limit our view to only one century, as Pettis does here, and a century that saw human destruction never seen before in history, then ...  well, it still does not make sense.  If limited to his time frame, the cost is not worth the widespread use of cell phones, or whatever benefit all this brought us.***

 ... I suspect the difference between the countries that saw such rapid productivity growth behind infant industry protection that they were eventually able to compete on their own, and those that didn’t, may have had to do with the structure of domestic competition.

Specifically, it is not enough to protect industry from foreign competition. There must be a spur to domestic innovation, and this spur is probably competition that leads to advances in productivity and management organization. I would argue, for example, that countries that protected domestic industry but allowed their domestic markets to be captured and dominated by national champions were never likely to develop in the way the United States in the 19th Century.

***  OK, but this is not new.  Five families control all industry in Mexico, and to assure their steady stream. USSR centrally planned down to the number of toothbrushes.  Toothbrush shortage. In USA, design an electric toothbrush, do well, and the oligarchy takes a cut.  And then offers more credit to lend on a fractional reserve basis. In the modern societies, people are relatively free to do as they want, and if successful, the state takes a % for the oligarchy.  This mimics, or more likely mocks, freedom.  So far so good.***

I would also argue that companies that receive substantial subsidies from the state also fail to develop in the necessary way because rather than force management to improve economic efficiency as a way of overcoming their domestic rivals, these countries encourage managers to compete by trying to gain greater access to those subsidies. Why innovate when it is far more profitable to demand greater subsidies, especially when subsidized companies can easily put innovative companies out of business? Last April, for example, I wrote about plans by Wuhan Iron & Steel, China’s fourth-largest steel producer, to invest $4.7 billion in the pork production industry.

***Like Monsanto, a chemical company that sells seeds.  And odd, after the Wuhan move, we find...

The Ministry of Agriculture has launched an urgent investigation into the deaths of more than 3,000 pigs whose carcasses ended up in East China's Huangpu River.

Cha Siu Huang Po

Coincidence?  The problem is once started, there is no rational limit to the activity.

***

The company’s management argued that they could compete with traditional agro-businesses not because steel makers were somehow more efficient than farmers, but rather because their size and clout made it easier for them to get cheap capital and to get government approvals. They were able to invest in an industry they knew little about, in other words, because they knew they could extract economic rent. This clearly is not a good use of protection.

***No, but it is a rational use of state power and central banking, and the model of US capitalism. It is why “food” is cheap in USA. ***

The lessons for China, if I am right, are that China should forgo the idea of nurturing national champions and should instead encourage brutal domestic competition. Beijing should also eliminate subsidies to production, the most important being cheap and unlimited credit, because senior managers of Chinese companies rationally spend more time on increasing access to these subsidies than on innovation, a subject on which, in spite of the almost absurd hype of recent years, China fares very, very poorly.

*** And would Mr. Pettis recommend this for the UK and USA too?  I would go further.  The state should get out of industrial planning, and let “brutal competition” flower both domestic and foreign.***

There is nothing wrong with protecting domestic industry, 

***If you do not mind genocide, wars, disease, destruction, widows and orphans, starvation, boy bands, etc.  Otherwise, it works out ok for the grantors and grantees.***

but the point is to create an incentive structure that forces increasing efficiency behind barriers of protection. 

*** We have that, it is called the free market.  Why give an impossible task to a tiny group that cannot possibly effect any good?***

The difficulty, of course, is that trade barriers and other forms of subsidy and protection can become highly addictive, and the beneficiaries, especially if they are national champions, can become politically very powerful. In that case they are likely to work actively both to maintain protection and to limit efficiency-enhancing domestic competition. It was Friedrich Engels, not often seen as a champion of capitalist competition, writing to Edward Bernstein in 1881, who said that “the worst of protection is that when you once have got it you cannot easily get rid of it.”

***Well, there is a devastiig answer to mercantilism, such as Pettis recommends: unilateral free markets.  If you drop domestic subsidies and protections, and give foreign producers free range in your markets, they are soon brought to their knees.  Japan enjoys relatively unilateral free trade in autos with USA.  It is crushing Japan.  Hong Kong has unilateral free trade.  Hong Kong rocks.

What bothers me about Hamiltonianism is that is rules for crybaby billionaires.  Their "needs" crowd out the innovation that would make USA the envy of the world, instead of the desperate murder-for-oil and screw-pal militarism which is attendant to Hamiltonianism.  Let Americans trade freely, and we'll lead the world to peace and prosperity.***

Tomorrow:  Internal Improvements.

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misallocation and malinvestment

misallocation and malinvestment.

I was spellchecking the above essay when Google highlighted these two words.  Curious I clicked on them to find Google recognizes neither terms in the English language.

Sheeesh.  That explains a lot.

Keynesians cannot admit there is any possibility of either occurring.  If they ever show up in a dictionary, the picture next to misallocation should be of government-provided transit.  Malinvestments's picture would be Seattle's fourth major league stadium (or it is fifth now?)

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Pettis On China, Part One

Among China-watchers, Michael Pettis has had a sober and reliable view of China, and is consistently right in the estimation of the Chinese economy.  Mish Shedlock relies on Pettis.  Regardless of your views on China policy, good or bad, policies create winners and losers and to know the difference makes the actions “tradable” in the sense there is money to be made, one way or another.

It ain’t the hand you are dealt, it is how you play the cards.

Now we should not judge a man by how he plays his cards, but we can certainly listen to his motivations and critique those.  Pettis goes beyond studying what is tradable and actually attaches value judgments to ideas and actions.

He has writen a blogpost I would like to critique, since given his prominence and what as I see as wrongmindedness, it invites criticism.

To wit (my points between the ***   ***):

A brief history of the Chinese growth model

Posted by Michael on February 21, 2013

 in Uncategorized

As regular readers know I have often argued that the Chinese development model is an old one, and can trace its roots at least as far back as the “American System” of the 1820s and 1830s. 

***Yes, so have I and it is common for the Chinese to explain what excesses for which they are criticized by pointing out they are expressly using the means the USA used to get rich in China's quest to raise up the Chinese people.  For example, Chinese pollution mimics the pollution USA encountered on its rise to the top.  ***

This “system” was itself based primarily on the works of the brilliant first US Secretary of the Treasury Alexander Hamilton (see especially his report to the Congress on manufacturing and his two reports on public credit and banks).

*** to my mind Hamilton was a counter-revolutionary and hardly brilliant, his ideas go back to Joseph, he of Pharaoh’s Vizier fame.***

This development model was also implicitly part of the debate in France that led to one of the most important financial innovations of the 19th Century, the creation of the Crédit Mobilier in France in 1852. The debate concerned one of the great economic questions in France, especially after the defeat of Napoleon: why had England, a country that one hundred years earlier had been poorer than France, managed to surpass France and all other countries economically and technologically, even though in the pure sciences and engineering the French were at least the equal to the British and perhaps superior?

***  Now none of us has the whole picture, but Mr. Pettis really should pause and consider the French Revolution.  It did much to set France back, and the consequent Naploeonic wars rather stifled innovation by the yeoman, who was otherwise engaged, if not dead.

Further, Mr. Pettis ought to reflect on James Chanos' history of Credit Mobilier:

..if you go back to the 1870s, and the Crédit Mobilier, which was the Enron of its day, scores of lawmakers and the standing vice president were caught with their hand in public till – being paid off by Union Pacific Railroad through their fraudulent Crédit Mobilier construction company. But there were just reprimands. No indictments. The public was outraged; similarly to today, but law enforcement and Congress at the time did not police themselves.
***

One obvious reason had to do with the financing of the commercial application of new technology. The French banking system, dominated by rentiers and the landed aristocracy, seemed to specialize in protecting savers, in part by mobilizing capital and investing in gold or in government obligations. 

***One contribution to the French Revolution was the King took the savers' money.  Vast amounts of savings in the form of tontines was stolen to finance war and extravagances.  There were always private versions of the tontines, but as usual, when the state gets involved, disaster follows.***

The English banking system did this too, but it also seemed much more willing to finance infrastructure and manufacturing capacity.

In fact more generally I have argued that the main reason “industrial revolutions” have occurred largely in England and the United States is because industrial revolutions are not driven by scientific developments but rather by the commercial application of scientific developments. 

***Now this is the error of the narrow basis of comparison.  Looking back a mere 200 years is rather myopic.  The wheel and mill where industrial revolutions driven not by scientific development but by commercial application.  With a long history of scientific development, China knows from commercial application.***

For this to happen it seems that a robust financing system is key. England, and the US later, benefitted from a financial system that seemed to do better than others in financing new infrastructure and technological ventures.

***Never mind all the dead aboriginals who lands and resources were stolen to enrich empires. Never mind mankinds long history of industrial revolution sans modern finance.***

A well-functioning financial system, one that allocates capital to new ventures, in other words, may have been the key difference between England and France at the end of the 18th Century, 

***So the definition of a well-functioning financial system is one that allocates capital to new ventures. Pettis will get around to saying, like hamilton, this is the role of a state, ignoring that sans states we have allocation of capital to new ventures, but when states enter the arena, we have disasters following doon thereafter.***

and for this some historians blame the brilliant but erratic John Law and his Mississippi Bubble. 

***You mean the Scotsman who scammed the French? I suppose Bernie Madoff was brilliant, in a way. For the record, John Law was one odious man.***  

This concern about the inefficient French banking system led to the creation of Crédit Mobilier, whose role was to break the constraints of the existing Rothschild-dominated financial system, mobilize the savings of the middle classes, and allocate these savings towards financial projects, such as infrastructure development, that would, over the longer term lead to more rapid economic development.

***Or not.  It also collected everyone’s savings under the nose of the state so it could tax and speculate and create credit to lend out of thin air.  War and starvation ahead.***

Aside from Alexander Hamilton, its intellectual and political godfather, the main proponents of the American System were figures like Henry Clay, Henry and Matthew Cary, John Calhoun, and even Abraham Lincoln himself. 

***Scalawags all...***

Their vision of economic policymaking was looked down upon as naïve and even foolish by most American academic economists – schooled as they were in the laissez faire doctrines then fashionable in England – 

*** The dissenters were right about the victors policies, as we see today...***

but I think it is hard for any economic historian not to feel relieved that neither the academics nor the Jeffersonian and Jacksonian factions had the clout to force “good” economic policy onto US development. America got rich in part by doing the wrong things.

***Yes, like enshrining slavery in the US Constitution in the 13th amendment, racial cleansing of the US Indians, later embarking on empire to seize Spain’s holdings... etc...***

To get back to the main story, in another, also brilliant and provocative, book (America’s Protectionist Take-off, 1815-1914) Michael Hudson refers to a leading member of the second generation of proponents of the American System, a Columbia University graduate by the name of E. Pechine Smith. What is especially interesting about Smith in the context of China is that in 1872 he was invited to Japan to serve as advisor to the Mikado, becoming the first of a stream of economists and lawyers – most of them proponents of the American System – to advise and help shape Japanese development after the Meiji restoration.

Smith thus creates a direct link between the American System and the Chinese development model. It was of course the post-War Japanese development model, itself based on Japan’s experience of economic development during and after the Meiji restoration, that became the standard for policymakers throughout East Asia and China. I think of China’s growth model as merely a more muscular version of the Japanese or East Asian growth model, which is itself partly based on the American experience.

*** I don’t think we need to establish a link when all successors today expressly note they copy the USA imperial model.  There is no doubt our system can generate exceptional wealth for the few, but death and destruction are not far behind.***

More tomorrow.

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Can Cyprus Go Hong Kong?

The Cyprus heist is about stealing hot Russian money.  But it does follow a pattern among socialists where some seemingly unimportant side item becomes a watershed.

It was an apparatchik who when asked "when?" at the announcement of more liberal through-Berlin-wall traffic looked around and with a shrug said "12:01 am."  At 12:01 the gates open people streamed both ways, and then proceeded to take down the wall.  End of Soviet system.

So when the kleptocrats running Europe decided to pull a heist in Nicosia, ooops...  game is over.  Only a fool cannot see the game now.  Kleptocrats and targets.

Cyprus is largely Greek Orthodox and its Archbishop is a natural leader.  Here from Cranmer:

Because thou sayest, I am rich, and increased with goods, and have need of nothing; and knowest not that thou art wretched, and miserable, and poor, and blind, and naked: I counsel thee to buy of me gold tried in the fire, that thou mayest be rich; and white raiment, that thou mayest be clothed, and that the shame of thy nakedness do not appear; and anoint thine eyes with eyesalve, that thou mayest see. (Rev 3:17f)

Archbishop Chrysostomos hasn't quite told Cypriots to go and buy gold that is 'tried in the fire', but he might as well have done. The euro gave them the illusion of being 'increased with goods', and having 'need of nothing'. But the Beast has left them 'wretched, and miserable, and poor'.

Only three months ago the Archbishop was reminding his flock that they 'belong to the great family of European nations and must therefore fight for the rights that all Europeans enjoy'. In the trauma of financial crisis, he socialised the problem, pleading that 'we are all obliged to take our share our responsibility'.

Not any more. Enough is enough. Archbishop Chrysostomos has discovered the Gospel of Thatcher, now preaching fervently about the virtues of privatisation. "Business competition leads to economic progress," he declares, fully persuaded that a programme of privatisation of public organisations should be rolled out as soon as possible, beginning with Cyprus Τelecommunications Authority.

Well, hang on, the gold in the quote means a person who faces the struggle.  Privatization usually means corporatization, a capitalist event.  I think the Good Archbishop should consider Mondragon and call for co-operatization.  Convert the state monopolies into co-ops where the customers are the owners.   The process is you add up all of the assets and liabilities, and you transfer all to all who use the service, share and share alike.

I own REI with 12 million other people.  We each have a share worth about 5 cents when all assets and liabilities are accounted for.  That sounds irresponsibly tight, doesn't it?  Yet REI thrives even in an economic downturn.

The EU failure is capitalism run amok.  The answer is not localized capitalism, but free markets.  Look to Hong Kong for ideas.

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Regulating What Jews Eat

Anthony sends in a link to a blog post to wit:

Generating over $12 billion in annual sales, kosher food is big business. It is also an unheralded story of successful private-sector regulation in an era of growing public concern over the government’s ability to ensure food safety. Kosher uncovers how independent certification agencies rescued American kosher supervision from fraud and corruption and turned it into a model of nongovernmental administration.

Yes, I too have selected "kosher" on long flights to get a better meal.  Whereas the government is only reactive, kosher is proactive.  I recall going into a local grocery store in my youth and seeing the Rabbi overseeing the butcher.  Never in my life have I seen an inspector otherwise in a grocery store.

Currently, a network of over three hundred private certifiers ensures the kosher status of food for over twelve million Americans, of whom only eight percent are religious Jews. But the system was not always so reliable. At the turn of the twentieth century, kosher meat production in the United States was notorious for scandals involving price-fixing, racketeering, and even murder. Reform finally came with the rise of independent kosher certification agencies which established uniform industry standards, rigorous professional training, and institutional checks and balances to prevent mistakes and misconduct.

Exactly.  There is a transition where order emerges out of chaos if the free market is allowed to flower.  I haven't read the book but it is cited at the original blog, so buy it through there is you are interested.

And until someone does something about it, note that of the millions of meals served at Indian Reservation Casinos, there has never been a case of food poisoning.  Not yet.  It will happen.  But note that Indian Reservations are exempt from county health inspections.

We need markets, not states.

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Let Carlos Explain It

With Ry Cooder & Steve Miller, et al...



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Inflation Bad, Deflation Good

This is in the comments and I want to elevate it to a post, from Sweden...

Precisely agree about inflation and banks. Inflation is the driving force behind all speculative business ventures. But deflation on the other hand is just the other side of the same coin. It creates incentives to hold cash instead of creating ideas that solve real problems. (I've got to study the Austrian school of economics, which I've just read about in your book, to be able to see where you're coming from.)

Bank comes from Italian and means table I've heard, as in the table they were counting coins in those times. Trading in the old times was simply goods traded for other goods. People sometimes forget that our systems today are not as universal as they seem. Studying a crisis that happened a decade or two ago won't solve the fundamental problem with the system. 

Inflation certainly invites speculation, which results in misallocation and malinvestment of credit (for we are beyond money now.)

Deflation can be the other side of the coin, in which the state begins withdraw currency, and fewer dollar chase the same goods, therefore, that which does sell sells for fewer units.  But there is another form of deflation, in which more better cheaper faster is produced so prices naturally fall.  For example in the cell phone or computer industry.  We all know in a few months the computers will be exponentially superior, but we all buy computers today.  Well aware of deflation in computers, no one waits or holds on to their money.

Deflation is an indication the market is free.  In a free market, which is inimicable to the state, all prices are constantly drifting down and we are constantly being offered more better cheaper faster.  So yes, state manipulation of the currency causing deflation is a bad thing, but no state wants deflation.  So what deflation we see is the natural kind, that should make us all happy, producers included, since they produce something narrow but buy from the entire market to meet their needs.

Another irony is deflationary free market eras are the most profitable for businesses because the perceived value of goods falls slower than deflation moves, thus widening profit margins.  So no one holds cash (money) in a deflationary era because there are the best profits to be had in business.

Now if you mean deflation causes people to hold credit, then yes, and in the Austrian school Dr. North and Mish Shedlock  have wrestled over this, with Mish noting few economists, even Austrians quite get this point.  (Mish says no inflation, North says hyperinflation.)  In essence, most Austrians say creating too much currency (credit in our system) causes hyperinflation.  Mish asks then how come not so far?  Mish says the currency is created, but it is parked on balance sheets, not being used.

Which makes our entire national balance sheet suspect.

So Mish has contributed to the discussion with his insights on money vs credit.

I've heard bank means shelf as to where gold was stored for people, although you may be right.  But as to trading in the old times was simply barter, we have barer today.  We had barter in the first records of man.  And certainly the Austrian canon says subsistence, barter, coins.

Graeber most recently and others going back have long noted that what is missing in the discussion is vendor financing, something very common today.  Any merchant, especially in B2B, will give his customers time to pay. See this point here...(especially the latter half where I get into vendor financing).

This is nothing new, it goes back to the Phoenicians trading with the Celts 500 BC.  For most of history, money was not in the deal.  It was all credit, as it is to this day.  So yes we do have examples of properly working economies going back to prehistoric times.  What has always been the case is the networks were so small that any failure was local and immediate and ended there and then.

What we have never seen before is every single transaction goes through a bank that is tied to every other bank, and the fractional reserve leveraging of credit to the point no one has any idea what the underlying assets are worth, nor who really owns what.  As recently as 150 years ago this was impossible for the simple reason contracts were not assignable.  No secondary markets to speak of.

The crises of a decade or two ago were simply warm-ups, test runs for what we have now.  Since no one went to prison for the PennCentral bailout, since no one went to prison for the Chrysler bailout, every economic crisis since then followed the same pattern and every time it got worse.  When the EU decides it needs to clip bank accounts in Cypress 10%, then we are very close to the end.

Yes, the system we have today is not universal, but it is different in scale, not kind.  So we can know what will happen.  And we do have responsible actors today, as we have had all through history.   We can go back to any point in history and see examples of how to do economies right, and how state intervention is always disastrous.

This system is failing, and is certainly past the point of no return.  This will not work itself out, and it will most likely result in the state changing the subject from its policy failure to war.  That too has always worked.

When we've been punished enough for our sins, among the survivors will be those who know how to do economies right.  Then the process starts over.

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Calling All Anarchists!

In a bookstore yesterday settling up there was at the counter a flier calling for solidarity with some people who are rotting in jail for failure to cooperate with a grand jury.  It seems some people who call themselves anarchists may have information about some broken windows at a Federal Courthouse and refuse to say what they know.  So off to federal lockup they go.

Each invites you to write, and provides an address, reasonably enough, in the federal lockup.

Now, my first impression was each of the three statements were written by the same person.  My suspicions are grounded in the well-established pattern that anyone who advocates violence is an agente-provocateur, working for the state.  In this case, people writing these three (who are now no doubt freely provoking violence as agentes-provocateur elsewhere) "prisoners" will have their letters of support read by the authorities.

And if all three were written by the same person, then the authorities really should kick in for more creative writing courses.  This just won't do.

The brochure unfolds into a nice poster that incoherently states "Solidarity Defiance Grand Jury" ...  OK, which is it?  Solidarity or Defiance?  And then...

"When confronted with repression the proper form of politeness is attack."  Uggghh... that is not even bad execution, the inspiration is too muddled to develop.  What makes me doubt the bona fides of this effort is it lacks intelligence.  Real resistance movements have a profound intelligence at the hear to it.  This whole brochure just feels like stupid cops running a scam.

But what do I know, except having met brilliant resistors and stupid cops running scams.

One line in the document inspired me to write:  "When we talk about property, State, masters, government, laws, courts and police we say only we do not want any of them."

I think the pro-violence "anarchists" would all agree with that statement.  And I've pointed out before, true anarchists love government, laws, courts, property, police, and masters is in the sense of experts, but not in the sense of superiors.  What true anarchists disdain is the State.  If all above is voluntary, then a true anarchist could care less what anyone else does in terms of government, laws, courts, property, police, and masters.  It is the coercive aspect of the state that is non-negotiable.  This anarchist loves the game of chess, and obeys the laws governing chess.  I love skiing, and obey the laws of the hill.  Intertwined with the violence-addled "anarchists" is an ignorance of what anarchy is.

And in no area are they more misled than in the area of property.  In being carte-blanche anti-property, they fail to distinguish legitimate property from capitalist property notions.  But I will not rehash that point here, I mean to make an offer:

What if legitimate anarchists such as myself were to give up the demand for property rights?  Would the violent anarchists be willing to give up something as important to them in the name of solidarity?    Would they give up violence?

If the pro-violence anarchists would give up violence, and the pro-property anarchists were to give up property rights, then the project may be advanced.

Can you really have anarchy without property?  No, but you can get pretty close, as in the case of Hong Kong and the Vatican, where no one owns real estate.  So there is an offer.

Those who advocate violence, no matter what they call themselves, do not want change, they only want to be in charge.  This is invariable.  The funny thing is, if you look at violent revolutions, the people from the old order end up in charge of the new order.  Look at all of the soviet apparatchiks running liberal democracies.  Angela Merckel was a communist youth leader.  Putin was a KGB operative.  If "anarchists" take over, expect the maximum leader to be named "Bush."

Violence is non-negotiable.  It would seem property rights is non-negotiable.  The offer is on the table.

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Cypriot Confiscation

The EU "bailout" of Cypress is where the EU gives German and French banking speculators $10 billion and then removes the same from the bank accounts of Cypriots.

Since the scale is so small, it is so very clear to see what has been going on all the time.  And contrast this experience of Cypress with another island, Iceland.

But wait wait, there is more...

The tax on deposits, as well as hurting wealthy Russians with money in Cypriot banks, will also sting ordinary citizens. Some ATMs in the country ran out of cash, Erotokritos Chlorakiotis, general manager of the Cooperative Central Bank, told state-run CYBC.

This is a warning shot to all those who have money in safe-keeping in overseas banks.  The ten percent today is only the down payment.  Russia is not in the eurozone, and the EU just gave Russian savers a haircut.  This is only a test.

If you depend on a paycheck, pension or property, you are sunk.  Now add savings (pork?) to that list.

Savings has been targeted all along, by means of central bank inflation targeting, 2% or so, so really nothing new here except the powers that be seem to be in a hurry.

No doubt this will cause a spike in the gold price as people take out currency and use it to buy gold.  That would be a mistake.  Gold will eventually be taken or made worthless for the cost of getting caught with it.

The money should be taken from the banks to start a business.  There is your only harbor in the coming storm.

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