Episode 145 – The Fall of Evergrande with Robert Hockett

Macro N Cheese – Episode 145
The Fall of Evergrande with Robert Hockett
November 6, 2021

 

[00:00:03.730] – Robert Hockett [intro/music]

Even if there were no fraud or corruption, it would still be a structural problem that the Chinese state has to deal with in the same way that it’s one that the US state has to deal with. The US state, however, has not dealt with it. And the Chinese state, I think, probably will deal with it, at least in a more intelligent way than we’ve done. And I think it’s partly because they don’t seem to be subject to the same sorts of bullshit politics that we are.

[00:00:27.230] – Robert Hockett [intro/music]

You want an economy’s absorptive capacity to keep pace with its productive capacity, because otherwise you get production gluts or under consumption problems, just the flip side of the same problem. And so what you really need to do is tie people’s purchasing power to that growth itself.

[00:01:35.370] – Geoff Ginter [intro/music]

Now, let’s see if we can avoid the apocalypse altogether. Here’s another episode of Macro N Cheese with your host, Steve Grumbine.

[00:01:43.350] – Steve Grumbine

All right. This is Steve with Macro N Cheese. Got my good friend Bob Hockett joining me today, and Bob requires no introduction. Bob is family here. We are going to be talking about the Evergrande calamity that’s heading like a tsunami at the global economy.

In just the most recent days, they’ve got $305,000,000,000 of debt and they haven’t been able to make their interest payments on US denominated bonds. And this is going to have huge consequences, not just in China but around the world. And so I don’t know enough about this. I know about elite control fraud and the US real estate market and how it has been played with and how the oligarchs and the investor class have really done a number on us.

This is something different. This is the juggernaut of China and all of its financial and real estate holdings coming to roost. And so I figured what better guy to ask than Bob Hockett, who has deep insights to this stuff to explain it. And so with that, let me bring on my guest, Bob Hockett. Welcome to the show, sir.

[00:02:57.150] – Hockett

Hey, Steven, great to be with you again, brother. Always a joy to talk with you. These are always the most enjoyable and informative discussions I ever have. I usually feel like I should be interviewing you other than the other way around. And I reckon this is going to be kind of a similar story here.

[00:03:12.030] – Grumbine

Oh, I don’t think so, man. I am like a babe in the forest on this one. As I read through this stuff, I just think about $305,000,000,000 is half of our annual military budget. This is a huge amount of money for one Corporation to be carrying and just the idea of it defaulting. One person’s spending is another person’s income. There’s a lot of people not getting paid and not just the big companies. I imagine this trickles down all the way through the economy. What’s going on with Evergrande?

[00:03:48.490] – Hockett

Yeah, so there are a couple of ways to look at it, I suppose, Steven. I think maybe the best way to do it is to divide it in two perspectives. We might talk kind of ultra macro on the one hand and then mini macro on the other. And by that, I mean, I guess let’s talk about Chinese economic policy or development strategy writ large on the one hand, and then the Chinese real estate markets, on the other hand, right?

So, both are pretty big. Both are pretty macro, but the first is a little bit more macro, of course, than the second. So, to start with the first, which I think will help put everything in perspective a little bit more. As you know, China has been a so called developing country for some time now, and orthodox economists for quite some time prescribed various development strategies that they would tend to say would be the best way for a country to leap-frog ahead or to move itself rapidly from a so called underdeveloped or non-developed state to a developed state.

And one time-honored method that was employed by the US during its developmental period, by Germany and then Japan during their developmental periods, then by the so-called Asian Tiger economies during their periods, and then ultimately by China during its first phase of its development period is the so called export lead growth strategy.

So what you try to do is you try to develop industries that can get you a good deal of market share in global markets for various products, typically not services at that earliest stage of development, but products, in particular, various manufactured goods, starting from so called low end and then proceeding up to higher and higher end products.

Thereby accrue large current account surpluses and then use those surpluses as sources of domestic investment. So you keep investing in domestic capacity with the proceeds of your sales. And the ideal would be that you would get underway a virtuous circle, as they might say, a virtuous cycle whereby you start at the low end, you’re producing textiles on the cheap. You get a lot of current account surpluses through the sales of those textiles.

Then maybe you move on to plastics or metallic goods of various kinds or consumer electronics, things of that sort. You reinvest the proceeds of those export sales. You develop yet higher end industries and so forth, right? Now, that’s a pretty effective strategy, let’s say, if other countries are willing to go along with it for a while and often what the history seems to have been over the last 2, 300 years is that first movers or first advantaged countries or first to develop countries have sometimes been willing to, in effect, finance those current account surpluses of developing countries when they’ve had political reasons of one kind or another, to basically look kindly upon that growth.

So, when they viewed the countries that are developing more as client states than as future rivals, they’re willing to put up with the current account deficits that they suffer as the flip side of those current account surpluses that the export led growth growing country accrues. And they can put up with it for quite some time until things become problematic when it comes to industrial hollowing out at home.

But then they start to complain, right? So European countries, notably the Netherlands, even Great Britain, were willing to endure, let’s say, current account deficits with the early developing United States on the theory that they thought, well, the United States will ultimately be a great trading partner to have and might actually even be a force for good in the world system that was dominated by the Netherlands and then by Great Britain.

Similarly, the US was willing to play that role, basically to endure current account deficits visa vie Germany and Japan in the early Cold War era, the immediate post war era for fear that, well, if we don’t actually help those countries grow rapidly and get themselves back onto their feet quickly, they might be attracted to the Soviet model, or they might be seducible by the Soviet Union, which was engaged with the US in this existential cold war for influence across the world.

Somewhat similar story with the Asian Tiger economies. The US was willing to, in effect, finance their export led growth strategies through the current account deficits that we endured with them for the same reason, right? A cold war struggle, we were trying to make sure that they were going to stay on our side, so we wanted to see them get relatively prosperous as quickly as possible. Things got a little odder, I think, in the 1990s, during the Clinton years, right?

In effect, the same playbook was followed. China was welcomed into the neoliberal global trading order, and the US was perfectly happy to have the Chinese accession to the WTO in 2000. And even before that, the US was willing to endure or experience sustained current account deficits visa vie China on the theory that China developing more rapidly in consequence of that strategy would ultimately give it a stake in the global neoliberal order that it would become a team player, so to speak, a kind of a fellow responsible steward of this beautiful, wonderful world economy.

And the thought that China might actually become an existentially threatening economic competitor, not just military competitor but economic competitor, doesn’t seem to have occurred to these people, maybe partly owing to kind of racist attitudes. Maybe they just thought, well, you know, the Chinese, they just imitate us. They can’t actually do anything on their own. So they’ll never really be a serious competitor to us.

And so there’s only something to gain, nothing to lose by helping China develop more rapidly in the same way that we helped Germany and Japan after the war grow rapidly, again, by tolerating long term trade deficits with the Chinese. And so the Chinese actually managed to succeed quite well in pursuing this particular model. But as tends to happen over time, after a while, the countries that are footing the bill as it were, or in this case, the US, which was footing the bill in the form of rapidly hollowing out industrial base and even more rapidly eroding labor standards and workplace standards all in the name of global competition or competitiveness.

Eventually the US began to object, right? Even 15 years ago, you might recall, Steve, that there was a constant discussion during the Bush years, at least before the Iraq War became unmanageable, as the so called shall we call it, the pacification efforts were increasingly failing and the insurgencies were increasingly waxing rather than waning.

Before all of that began to happen in a big way around 2006, 7, 8 in Iraq, there was a lot of talk about Chinese currency manipulation, and calls on Bush and his treasury secretary to designate China a currency manipulator and so forth. The merits of those cases doesn’t really have to concern us at the moment. But the main point is that this became an increasingly controversial aspect of the Chinese growth model because other countries had to suffer the adverse consequences, you might say, of those current account deficits with China.

So what that led the Chinese government to do or the Central Committee of the Communist Party to do was to think in terms of relying less on exports as a source of demand for domestic production and more on domestic investment of various kinds and domestic real estate development as internally generated alternative sources of demand. And in this particular instance, the Chinese were again following a playbook that had been pioneered by the US.

The export led growth model was itself pioneered by the US. That was our growth model in the 19th century. Americans tend to forget that when they get on a high horse complaining about other countries pursuing that model, conveniently forgetting as Americans tend to do. But that’s what we did. That’s not where we are.

And in fact, you can actually find all kinds of interesting rhetoric from Great Britain in the mid to late 19th century complaining about cheap American imports. In fact, even if you’re reading novels by Dostoevsky, you’ll find references to cheap American furniture finding its way into St. Petersburg and tsarist Russia.

[00:12:28.570] – Grumbine

Leave it to Bob Hockett to drop a Dostoevsky,

[00:12:33.490] – Hockett

Isn’t that funny, yeah. In Crime and Punishment, you’ll see references to this, right? So, the US had this reputation in the 19th century as the exporter of chintzy, cheap goods. And of course, later that came to be in the US, the complaints were about China. So, China was following a well-trod American pioneered path in this form of what J.M. Keynes might have called globally antisocial behavior, better known as export led growth strategy.

But when the pressure began to mount on the Chinese for relying on this form of growth, they heard it, and they thought, well, let’s think in terms of, again, more domestically generated demand. And again, the US served as something of a model. They, among other things, looked at the commercial real estate bonanza that had driven a lot of American growth during the Reagan years, and then at the residential real estate bonanza that drove American growth during the Clinton years.

All of that was, of course, substantially debt fueled. And to use our friend Mr. Minsky’s typology here, it was largely ponzi-financed, right? And another way to put this was it was a credit-fueled private debt bubble that led American growth during the Reagan years. It was this so called Morning in America, although again, it was focused largely on commercial real estate at that point.

And you might recall, Steven, we’re probably both just old enough to have been kind of conscious of the fact that there was a commercial real estate bubble in this country in the late 80s and early 90s, just like there was in Japan and Scandinavia and elsewhere. And then, of course, there was the residential real estate bubble of the Clinton years on into early Bush years. And the Chinese followed that, too, right?

And that’s what takes us to Evergrande. And what takes us to the next perspective from which we can look at things right now in China, which is slightly less macro than what I was just talking about, but still pretty macro. And that is this reliance on real estate speculation as a source of generating, domestically, continued domestic demand for Chinese produced goods and services.

Since, politically, it came to look to the Chinese government as though reliance on exports might not be quite as robust as it could be assumed to be during the Clinton and Bush years, and even during the early half of the Obama years. And so what we’ve seen going on for quite some time now is this reliance first on commercial real estate than on residential real estate.

Now you might recall our mutual friend, Steve Keen, was predicting a mega crash, essentially a real estate crash in China about five years ago that he was thinking would dwarf that in the US, and I was more or less with him on that. I was often prognosticating to similar effect, although perhaps slightly less apocalyptically, because it was pretty clear that we did have a massive debt-fueled real estate bubble underway in China and that the Chinese were relying on that as a source of demand generation, just like the US had done ten years earlier.

The reason I was a little less pessimistic than Steve, however, and I’m still a little bit less pessimistic than probably Steve, and certainly than many other people, is that China also has capacities that the US, itself, didn’t have to deal with a crisis like that back around 2005, 2006, 2007. For one thing, there’s a very significant state presence in nominally private sector firms in China.

For another thing, there’s a government with a great deal of political capacity as well as just technical capacity and technical knowhow to engineer soft landings and even just to bail out companies temporarily, if need be, in a manner again, to engineer a softer landing than the US was able to muster. There’s also much greater willingness to attach strings to bailouts.

So I’ll pause for a second to let you jump in after one final point here maybe worth noting. And that is you’ll recall that when we were bailing out large financial institutions that got themselves into trouble through real estate speculation here in the US back in late 2008 and early 2009, a good many people recommended that, well, if we’re going to do that, we ought to attach strings.

We ought to take ownership stakes, for example, in these banks. We ought to socialize them or partly socialize them by giving the public sector large equity stakes in these firms as a condition for the bailing out. But of course, a lot of US politicians were horrified at the prospect of socialism, although they certainly were troubled by the socialism that the bailouts themselves amounted to, in other words, socializing the harm.

They were simply horrified by the idea of socializing the benefit that might be demanded as a price for taking over that harm. China doesn’t seem to have that problem. In other words, to decry something of socialism in China probably really won’t be much of a decrying.

It might actually be viewed as virtue, especially in Xi’s China, where the Communist Party is actually trying to revitalize the ideological origins of the state of the People’s Republic of China itself. So given all that, I actually think China is going to do a much better job and weather this storm much better than the US was able to do 14 years ago.

[00:17:56.890] – Grumbine

Yeah, it seems like they’re willing to do whatever they have to do to win. And we don’t have that. We want some people to win, but we’re cool with everybody else losing. And from my vantage point, I look at our friend Bill Black, and we know that there was a lot of shenanigans going on in the United States.

There was an incredible amount of revolving door of corruption that was never addressed. Or if it was, it was waved off and paid lip service. We saw no real white collar criminals go down. Is this a case of corruption and fraud in China, or is this just a case of something got too big and they can’t manage it?

[00:18:40.630] – Hockett

Yeah, so my take on this is complementary to your’s and Bill’s in discussing the US case and the view that I have of it in the Chinese case, then is quite similar. So on the one hand, I’m entirely on board with you and Bill that control fraud, various forms of corruption and fraud, and near fraud were rampant in the lead up to 2008. And indeed they always are.

In a way, the spearhead of the ultimately wounding spear or lance, typically, is fraudulent activity, fraudulent behavior on the part of various actors. At the same time, however, I’m always keen to emphasize the sense in which there’s an inherent structural problem in decentralized financial markets that renders it the case that we would be vulnerable even if there were no fraud of any kind.

In other words, when I think in terms of what I sometimes call, echoing the title of the piece I wrote a long time ago called, Bubbles, Busts, and Blame, there is an inherent structural flaw in decentralized finance with endogenous money that makes it the case that even if people are all of them moral and perfectly individually rational, you can still end up having the same kinds of difficulties.

So that in that sense, you want to attend to the fraud but you also want to attend to the structure. And here, in a way, I’m speaking in a manner that’s, I think, very consonant with the way in which, again, our friend Dr. Minsky thought, and the way our friend, I guess I should call him Lord Keynes, even though I don’t like those hierarchical terms.

He was called Lord Keynes in his day. But the basic idea is that the way a bubble dynamic works is it really amounts to what I call, more generically, a recursive collective action problem, right? And I know that you and I have talked about this before, but the basic idea is a hallmark of a collective action problem is the circumstance in which multiple acts of individual rationality aggregate into collective irrationality, right?

So, if you take a consumer price inflation, which is just a bubble in consumer goods instead of in financial assets, as an example, If you and I, Steve, know that the price of bread tomorrow or later this week is going to be much higher than it is today, we can quite individually, rationally, decide to go out and buy more bread today rather than waiting until tomorrow, right?

And other people are thinking the same way we are. Let’s buy it now rather than buying it later because it’s going to be more expensive later, right? So we’re, in effect, reacting to an inflationary environment, let’s say, and we’re acting quite rationally in regard to it. But, then, when we act in this particular way, which again, is individually rational for us to do, we add, of course, to the problem that we’re reacting to.

Collectively, we generate more inflation because we generate more demand or more rapidly felt demand for particular products that whose supply might not be as quickly responsive to our upping demand as we might hope it would be. And so we generate yet more inflation. And then, of course, we reaction very rationally to that by buying it more, even sooner and so on and so forth. This is the proverbial vicious circle.

Now, financial bubbles are the same way, right? Real estate bubbles are the same way. In the Clinton years, if you knew, if you were thinking about buying a house some years down the road but you saw that the prices were going way, way up really rapidly, you might decide to buy it now rather than later.

And if you could borrow really cheaply in order to do it, which you could do when finance was being deregulated in the way that it was in the nineties, then you’re probably going to go ahead and buy it now rather than later. And if you have to borrow more in order to do it, well, so be it. At least you can borrow cheaply.

And since the prices are rising so rapidly, there’s going to be a significant spread between the capital gains rises on the one hand, and those borrowing costs on the other. So, it’s actually individually rational for you to do it. So, lots of people acted rationally in this way and, collectively, they, of course, just drove the prices of housing higher and higher and higher, which was the housing bubble, right?

Now it seems to me that something much like that dynamic has been underway in China as well, right? You’ve had real estate speculation underway for quite some time now. The public sector or the Chinese government has made it the case that the credit to do this would be really cheap. They’ve engineered it that way precisely because they wanted something of a bubble to occur because of the so-called wealth effect that that would generate.

This is exactly what the Clinton people were doing as well, and what Summers and Greenspan wrote about in the 90s, that, basically, if you and I see our house price going up or the blue book value, so to speak, of our home rising, even though we’ve already bought it, we’re living in it, we feel wealthier and so we’re willing to spend more.

And Furthermore, we might even borrow on the strength of the growing equity value of our homes in the form of so-called home equity lines of credit or ELOCs which were rampant in the 90s and do a lot more purchasing of consumer goods, even, on credit than we otherwise would have done. Because after all, all we’re doing is monetizing wealth that’s growing in our portfolios as our housing values rise.

But we might lose sight of the fact that this is sort of artificial. It’s being artificially generated and even engineered by financial technocrats in the government, and just proceed on our merry way, thinking everything is great. And I think that something like that, that same dynamic, this particular recursive collective action problem that every bubble of any kind is and every hyperinflation of any kind is, has been underway in China.

And what that means in turn, then, is even if there were no fraud or corruption, it would still be a structural problem that the Chinese state has to deal with in the same way that it’s one that the US State has to deal with. The US state, however, has not dealt with it, and at least not in any serious way yet. And the Chinese state, I think, probably will deal with it, at least in a more intelligent way than we’ve done. And I think it’s partly because they don’t seem to be subject to the same sorts of bullshit politics that we are.

[00:24:48.430] – Grumbine

It’s interesting, because no matter what anyone does, our government can do what it needs to do to take the right corrective action to make something, not be a thing. There’s always an option to, like we always talk about, spend and then we’ll worry about the taxing later. It doesn’t mean the taxing is not required.

It just means that we’re not going to put health care at risk because we’re going to fight a “pay for” game. And in this case, these crimes, the frauds that we saw without anybody standing in the way they, can create these problems. And if the government sits on its thumbs and doesn’t take corrective action, it can make everyone suffer.

And so, structurally, irrespective of the actual crimes, the government could have chosen to make everyone whole. So, 100% agree with you there decision wise. It doesn’t prevent me from wanting to see them all brought down.

[00:25:48.430] – Hockett

Oh, yeah, yeah, yeah. I agree. The thing is, you still have to, I think, police the fraud, bring people to justice because, first of all, these people worsen things, right? They exacerbate problems. They can initiate or get the ball rolling when it comes to the problems that occur as well. And there’s also just the fact that we have, indeed, criminalized fraud for a reason, right?

And so if you don’t want fraud to be rampant, you ought to be pretty serious about your criminalization of it and your enforcement of the laws. And this is yet another respect in which I think that Chinese do a better job of this than we do. Some, I’m sure, would argue that they go “too far” in the other direction. And I’m not an expert on the Chinese criminal process or judicial process to weigh in or definitively declare whether I think they go too far in this realm or not.

I can only note that people often claim this, but setting that to one side, I think it can be said without blushing or without balking, that the Chinese state is perfectly ready and willing to enforce laws. And, in fact, you don’t tend to see business tycoons or financial tycoons dominating happenings in China for any length of time in the way that you see happening here in the US.

Jack Ma, who just reappeared for the first time in many months in Spain, is a virtual poster child for this, right? Now, again, maybe the Chinese state went too far, in effect, making him disappear for a time after he dared publicly criticized the way Chinese regulatory authorities were clamping down on his firm, but there’s something to be said for saying, look, the state is speaking in the name of the entirety of the public, not in the name of one group of shareholders or one group of oligarchs, and so don’t fuck with it.

Sure, dissent if you think that it’s doing something wrong and speak out. But don’t dare try to buy or bribe politicians and don’t dare lie in your criticisms. Right? I think that there’s something to be said for a regime that at least imposes that much integrity on people, including business tycoons, rather than treating them as a separate class of the citizenry that somehow is subject to a different set of laws and enjoys much more comfortable prisons when they are like Martha Stewart in prison, quote, unquote.

[00:28:56.930] – Intermission

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[00:29:23.170] – Grumbine

I was looking at some pictures and all this stuff is very anecdotal, of course, pictures of subways in China. And in New York, subways were built a long time ago, but it looks like a third World nation, and they look like they are the Jetsons. And beautiful works of art, like when we were building our monuments and our halls of justice out of marble, they’re going next level with that in China right now. Some of the things I’m seeing, human beings built that? Wow.

[00:29:55.330] – Hockett

Yeah.

[00:29:56.650] – Grumbine

And I’m wondering, as we look at the dilapidated infrastructure in the United States and the lack of development, we’re building these cheap, common cookie cutter houses. They’re creating amazing things that I’ve never seen in the US. Is this part of the debt they’re struggling with?

Where does this come from? I know the owner of the company came from a steel tycoon that took Evergrande further and further into real estate. But where is the debt holdings? What is causing this?

[00:30:30.670] – Hockett

So, another great question, Steve. So, another part of the Chinese strategy to steadily increase the domestic share of demand for Chinese production in the economy at large that we haven’t talked about yet, you can situate halfway between the export led growth strategy on the one hand and the real estate bubble type stuff on the other.

And that is the investment, more broadly. The investment is a broader category than just real estate alone. So here’s what I mean by that. As you know, again, one of our intellectual forefathers, Mister or Lord Keynes, canonically divided or decomposed, you might say the demand side drivers of productive activity into three categories, right?

One was consumer spending, another was investment, and then the third was government spending. Now, another thing that the Chinese government has done in order to try to stoke adequate domestic demand for Chinese production or productive activities or produced goods and services, has been just massive investment in all manner of things, right, not just real estate, but other things, right?

So China, notoriously at this point, has all sorts of bridges to nowhere, as they say, highways to nowhere, buildings that are completely uninhabited. You’ve probably heard the phrase ghost city. There are, like, entire cities that are just waiting to be inhabited, but just don’t have inhabitants yet. Just full of structures, buildings, roads, bridges overpasses, railroad track, subway track and empty structures, right?

And that can be laughed at on the one hand because if there’s not real demand for those things yet, then China is artificially generating that demand in order, artificially, to keep economic activity underway. And in order to keep that 8% to 10% annual growth rate, which some people have cited or at least speculated is a source of or maybe one of the only sources, even of the Communist Party’s legitimacy, right?

That they have to deliver to the Chinese people, as the pundits say, like 10% growth rates are thereabouts, in order for people to tolerate the oppression or the repression or whatever? Well, there’s some truth in that, of course, but it’s also very much exaggerated. But there’s something interesting about it from my point of view, at least, and it’s part of what may be described as being halfway between export led growth strategy on the one hand, and the real estate bubble inflation strategy on the other.

And that is that at least it really does entail the actual building of stuff, right? There’s actually physical stuff that’s there. And it’s not like those cities are going to be ghost cities forever, right? We tend to forget that many more people than the entirety of the US population are still basically rural peasantry in China, and China is a rapidly urbanizing society.

And as more and more people come in from the countryside and want to move into the cities, those ghost cities are going to be animated, not be ghost cities anymore. Some of them, at least, are probably going to become live cities, right? Actual places where people can live.

And this is real stuff. And so, one way to look at this form of investment in China is as paying it forward, so to speak, saying, look, a lot of these people who are in the countryside are eventually going to come into the cities, and we need cities for them rather than having to build tent cities or Hoovervilles in the alleyways of Beijing or something, which is the way urban sprawl has often happened in other developing countries.

And so why not get this stuff ready before the mass influx is completed? And, in so doing, that gives us a way of spending yet more money into the economy to keep it growing at a good rate for a bit longer here without relying as much on exports as we had previously done. That, of course, then invites the question, all right, well, what do you do, then, to keep that growth going once you can no longer build more ghost cities, right, before you can do more of that kind of investing?

Well, my guess is that that question is precisely is what’s actually motivating the most recent shift in policy that’s been announced by President Xi. And if I’m right about this, then he’s looking pretty wise to me. And he’s talking now quite directly, again, about what he’s calling shared prosperity. Now, you can interpret that in an uncharitable way or you can interpret it in a charitable way.

I have a charitable interpretation on offer if anybody is interested. I might be wrong. If I’m wrong about it, when it comes to China, maybe I can be right about it when it comes to the next wave of policy here in the US someday.

But what I mean is, ultimately, when you get right down to it, the problem that’s looming behind all of this lurking in the background when we look at export led growth strategy which is unsustainable, ghost city strategy which is only medium term sustainable, and debt bubble strategy which is also, at best, only medium term sustainable, is the problem of production supply outstripping demand, right, overproduction relative to the capacity of the populace of an economy to absorb what that economy itself produces?

That was something identified by Keynes. He did it on the rubric of the differential marginal propensity to consume as between the wealthy and the poor, and the fact that if you have a massive maldistribution of wealth in a society, basically, the proletarians, as Marx would call them, wouldn’t actually be able to purchase that which they produced, which would lead to a chronic under demand or oversupply problem.

That was the fundamental problem of political economy. Now, my own view is that the only long term solution to that problem, and that’s what this forthcoming book that I’ve got coming out, this Republic of Owners book is all about, is you really have to directly couple individual consumption capacity or effective demand capacity on the part of people who work in an economy to the growth of that economy itself.

Another way to put this is, you want an economy’s absorptive capacity to keep pace with its productive capacity, because, otherwise, you get production gluts or under consumption problems just the flip side of the same problem. And so what you really need to do is tie people’s purchasing power to that growth itself. And there are various ways to do that.

But I tend to think that what Xi is actually on about in a fairly high level of abstraction because he’s not really talking about the mechanics yet of how to do it, and that’s what this book that I have coming out is all about.

It’s about the mechanics of how to do that, but leaving the mechanics to one side for the moment, what Xi is really talking about here, in so many words, it seems to me, is basically now addressing the inequality problem that has emerged in China in a manner that ensures that those who are not the top of the distribution can afford to buy as much as the economy is producing, so that the economy’s productive capacity and its absorptive capacity to keep pace with one another.

And that’s what actually gives you long term, indeed, indefinitely sustainable growth, right? So, you don’t have to rely, then, on quick fixes like suddenly selling a whole bunch of stuff to other people elsewhere, or investing in ghost cities or artificially fueling real estate price bubbles by making debt really, really cheap to people and then telling the corrupt speculators to have at it.

Best case scenario for China and I’m being quite candid when I say I don’t know that they will pull this off. But I’m also being candid when I say I think they have a better chance of pulling it off than any country in the world right now is that they’ve basically proceeded through, like, three phases, and they’re now ready for phase number four, which is since the final phase, which is the one where you actually couple individual purchasing power or household purchasing power directly to economic growth so that you don’t have to worry about supply and demand imbalances and also known as, again, gluts or overproduction or under consumption problems of the kind that, again, Keynes’ general theory was all about and Marx’s Capital, in a certain sense, is all about.

I think the Chinese government is pretty savvy about this stuff. It helps that Marxism is actually a state ideology because they actually understand Marx in a way that American critics and Marx don’t, and that enables them to understand Keynes in a way that most self-styled American Keynesians don’t understand Keynes.

And they seem to be a lot closer to the truth, this underlying fundamental truth of consumption and production’s essential couple-ability and also decouple-ability if you have the wrong institutional arrangements that we are here in the US, and I think they’re moving in, then, to that fourth phase, probably, which is going to enable them both to weather the current storm and to do even better than they’ve already done, which has, of course, been quite phenomenal as it is.

So, if they can simply avoid a nuclear war with an increasingly resentful United States, they might actually be showing us a pretty good path forward. Now, again, none of this is to endorse any of the apparent hostility to certain basic civil rights that the party sometimes shows. I don’t want to endorse that, but I also don’t want to endorse the exaggerated portrayals of that by some Americans who seem to be weirdly convinced that China lacks democracy that the US has.

I’m sorry, but I see Joe Manchin preventing what 70% of Americans want from actually happening, and I find it pretty difficult to think of that as democracy. I don’t know about you, Steven, but it doesn’t seem especially Democratic to me.

[00:40:39.190] – Grumbine

Not at all. Well, as we’re winding through this, I guess the next part of this that I really want to touch on. You made the statement that you feel like China has the capacity to do it much better than the US. But Evergrande was unable to make their payment in September. They were given a 30-day grace period. We’re here in October. They still haven’t made their payment.

They’re wondering if they’re going to make the next payment and there’s evidence to suggest that they’re not going to be able to even though they’ve been offloading whatever they can get rid of. What is the potential here for downfall? They’re talking about a global meltdown worse than ’08, ’09. And that could be completely hyperbolic or it could be a statement of some probability. What are your thoughts on that?

[00:41:31.870] – Hockett

Yeah, so, I actually don’t think anything even remotely like that is going to happen and there are various ways to phrase the explanation that I would give for why. But the simplest way would just be to say three things. The Chinese state or the government of China understands that that would happen if they don’t do the right kind of bailout.

Two, they know how to do the right kind of bailout, and then, three is they have the capacity. There are none of the usual constraints, at least, that we tend to think of here in the US, stand the way to their doing the right kind of bailout, right? China is not dependent on foreign capital. It doesn’t perceive itself to be dependent on foreign capital.

The Chinese government is not dependent on the good graces of financiers or real estate moguls. In fact, it can imprison them at will. Probably most of the culprits of our own crash in 2008, had this been China, would still be languishing in jail at this point, I would bet. So, it’s not politically constrained by financiers or real estate moguls or any folk of that kind.

It’s not constrained in any way financially for reasons that you and I know about. It’s a sovereign currency issue and isn’t dependent on the good graces or the credit of other nations. So, it’s got all the wherewithal to do what needs doing domestically, and it knows what it needs to do. The people who run the People’s Bank of China are at least as savvy now about the way finance works as anybody at the US Federal Reserve.

Ten years ago, I used to say that they’re right up there with the Fed, but now I’m tending to think they might be actually wiser than a lot of our Fed folk. So, I actually just have a great deal of confidence that they know what they’re doing, they know what needs doing, and they’re going to show us how it’s done. Now, people like you and I were telling people how we thought it should be done ten years ago or more, you know, back in ’08, ’09.

You and I were telling folk how we thought it should be done. We were right. And I guess another way of rephrasing what I’m saying to you now is I think the Chinese see it the way you and I saw it then, but they’re not constrained. People actually listen to Xi. They’d better. But they didn’t have to listen to you or me back in 2008, and they didn’t. That’s the difference in a nutshell, I think, right?

[00:43:59.470] – Grumbine

Well, okay. So, I hear what you’re saying. I guess my question comes down to we know that they seem to have a better understanding. They’ve always manipulated their currency to some degree. And so they understand how to work. The question is, depending upon what they do, how will the rest of the world be impacted by what they do?

The way that they’re saying it now is that if anything happens with Evergrande, they’re going to prioritize domestic Chinese debts, and then foreign debt will be taken care of after all, the domestic debt. What does that do to the rest of us? Because we don’t have a great government.

Our government doesn’t seem to take these things seriously. We don’t seem to actually have a straight path to fixing them like they do. They just make things happen. What happens if, for example, they take care of the domestic debt? What kind of an impact would that have if other governments don’t respond appropriately?

[00:45:03.730] – Hockett

Yeah. Great question, Steve. So, it really depends on some details that I don’t have access to. They might be available. I suspect that insofar as they’re available, the information is probably quite patchy, but it really depends on the composition of what you might call the total debt burden of Evergrande, right? So, how much of what it owes is owed to foreigners and how much of what it owes is owed to domestic actors, for one thing?

Secondly, who precisely are those foreign creditors to whom it owes and how integrated are those foreign creditors to credit conditions in their own domestic economies? In other words, if Chase Bank were somehow very much on the hook, basically stood to lose trillions of dollars because of the Evergrande debacle, which, of course, isn’t the case.

But if Chase stood to lose immensely and that, in turn, meant that Chase’s depositors were imperiled in some way, that would be, of course, significantly scarier than it would be if it’s just some private equity funds or some hedge funds who no ordinary American consumer or saver has any particular relation to, right?

Now, that’s sort of what I don’t know precisely how much specific US financial institutions that might be integrated into the demand side of the US macroeconomy are, how vulnerable they are. But my impression over the last number of months, ever since Evergrande became kind of a thing, has been that the exposure of ordinary Jane’s and Joe’s financial institutions here in the US to Evergrande difficulties is pretty minimal.

It’s not anything massively significant. But let’s assume, for the sake of argument that it’s more significant than I’ve thought or that I’ve come to appreciate thus far. Well, then, of course, how things pan out depends, in part, on how other governments respond to those crises that are faced by their own financial institutions as well.

Like, would the US bailout Chase, so to speak, or would the US make sure that Chase’s depositors were kept whole or made sure that adequate credit was being extended into the American economy if there was suddenly a crunch, at least where Chase is being willing to credit various productive activities here in the US is concerned. So then, of course, other countries domestic responses would be relevant, but that all, in turn, depends on your scenario, right?

Does China insofar as it bails out Evergrande do it only on behalf of Chinese creditors, or does it do it on behalf of all creditors? Now, my guess is that given that China seems to be increasingly interested in becoming a global leader in the monetary space, at least in the long run and in the global financial space in addition to the productive or manufacturing space, my guess is that China would, basically, do all that it could to make all of Evergrandes’ creditors whole, whether they be domestic or foreign.

The bailout would, effectively, take the form of a restructuring of Evergrande as well, right? They might follow the so-called bad bank path, where they, basically, create an entity that becomes a kind of a holding company of all of the bad assets of Evergrandes’, on the one hand, and thus takes those off the books of Evergrande and then reconstitutes Evergrande is a new, fresh, clean company that has only good assets but is under significantly more detailed or micro-managerial state control.

And then it, basically, deals with the bad assets in the so-called bad bank that’s spun off from Evergrande in any number of possible ways that it would have the capacity to deal with. But my guess is that the Chinese principles involved in all of this, that’s to say, the government officials who would oversee the process, know what they’re doing just as well as, if not better than, their American counterparts in ’08 and ’09. And that they’ll organize, again, a relatively smooth restructuring and soft landing that doesn’t actually impose calamity on any foreign investment entities, at least none that would be tightly integrated into the national economy.

Now, I might be wrong about that. Let’s say that President Xi was really pissed off at Biden or pissed off at the Biden administration, and then somebody said, you know what? You could bring down the entire American banking sector if you don’t bail out Evergrande when it comes to their obligations to American banks and only bail them out with respect to their obligations to Chinese investors. Maybe he’d be pissed off enough that he would be willing to do that.

My guess is he probably wouldn’t. But who knows. If they, yesterday, had invaded Taiwan and so the whole world is, like, on the brink of war or something, then he might just say, oh, what the hell. Okay, let’s throw another bomb in the middle of their lives over there and take down Chase and Wells Fargo while we’re at it. But again, I think, first of all, it’s doubtful that Xi would want to do that at this particular juncture.

And second, I think it’s quite doubtful that any American investing institutions that are on the hook to or vulnerable to Evergrande are that integrated into the American economy. That losses that they suffered would be somehow transmitted to the broader macroeconomy here in the US. I just don’t think that’s going to happen. I mean, remember the thing that really made the crash here in ’08 and ’09 so dreadful was that it really suddenly made the value of housing plummet.

And that’s the primary asset, of course, held by most of the American middle class. So, all of us saw our wealth suddenly diminished, not merely diminished, but plummeting. And that, of course, sucked a bunch of our consumer demand out of the economy. We were more cautious about buying and so companies were more cautious about hiring.

And all of this was basically based on the fact that the thing that crashed, it was less about the bank crashes and more about the real estate crash that made it such a systemically scary thing here in the US, right? I don’t see any counterpart to that here in the US this time around. I don’t see an exposure of the typical American consumer or the typical American member of the middle class or even working class of the sort that was so manifest and so salient in 2008 when it comes to Evergrande.

I just see some vulnerability on the part of some financial institutions that we’re not really dependent on. And an actual crash of Evergrande that brought some of them down would be kind of instructive and interesting, I think, if I’m right, insofar as it showed that we don’t actually need these speculative institutions here in the US anyway. Just to rip people off some money. Well, tough luck, man. That’s what you get for investing in communism, which I say Ironically.

[00:52:01.210] – Grumbine

Alright. Well, look, Bob, there’s so much more to talk about, but we’re out of time. I want to thank you so much for being just a phenomenal guest and I asked you yesterday and you jump right into it so I can’t thank you enough for that.

[00:52:13.930] – Hockett

Really my pleasure, Steve.

[00:52:15.190] – Grumbine

Well, it’s good to talk to you again, sir. Let me just say this is Steve Grumbine, Bob Hockett, Macro N Cheese. We’re out of here.

[00:53:08.490] – End credits

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