The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Monday, January 24, 2011

Where to for China? And Sorosian Reflexivity

I am writing this at the beach, so apologies for any ill-formed thoughts.

For the last few months I have been trying to slowly skill-up on China. To have any hope of divining Australia's destiny you have to understand China. And, of course, that is no easy task. Yet in the simplest possible terms I think I am getting a sense of the contours that lie ahead.

At this juncture, my best guess is that the China story will roll-forward without serious interruption for longer that the markets and most observers deem possible. One of China's greatest strengths is its very low levels of leverage and, ironically, immature banking system. This means that for the foreseeable future, the State will be able to recapitalise its way through financial system shocks. But not forever.

Think of China as a glimmering skyscraper, rising up every day via its seemingly boundless economic resources. There is, nonetheless, an essential problem with this structure. It has fundamental design flaws. Of this, one can be sure. The cracks are subtle and not necessarily obvious to the eye. But they grow as the building's mass rises higher. The vulnerabilities I am thinking of here include, amongst presumably many other things:

*an intrinsically unstable social system that is beginning to resemble a plutocracy;

*in turn, a plutocracy that governs by way of fear, graft and the diminution of three of the critical elements of sustainable societies: the rule of law and an independent judicial system (the Party is the law in China), acceptable levels of free expression and media scrutiny, and the right to political and religious self-determination; and

*massively widening inequality, which as I have argued before need not be a bad thing when you have a durable and bona fide meritocracy. However, much wealth creation in China is internalised by the bureaucracy and the non-democratically elected despots that control the country (thus the recent story of the President's wife walking into a jeweler in Hong Kong wearing $400,000 worth of gems, which was promptly erased from the media).

My point is that this not a tenable system of governance in the very long-run. In my mind, it is inevitable that at some stage a catalyst emerges to trigger cataclysmic change, or even collapse. This ultimately occurs in all fascist and centrally controlled societies. It happened in the Soviet Union. And it will certainly come to pass in China.

My guess is that when the impressive visage of today starts to crumble, the people will end up demanding an alternative model. It is not necessarily true that democracy arises through this process. We thought that we would find democracy in Russia, but we have been left with a kleptocracy. And I think that there is merit in having a centrally-managed, authoritarian government if you are deliberately seeking to build a nation state from scratch, and/or quickly industrialize and urbanize. It is similar to the different governance models applied to start-ups and mature, listed companies. Democracies never work well in new businesses. They do, however, seem to be a better management framework once a company has fully formed.

Here the contrast between the glacial pace of change in democratic India and the extraordinary decision making speed witnessed in its much more rapidly evolving neighbor is often highlighted. There nevertheless comes a time when the costs of suppressing individual liberties and the ruling elite's misappropriation of resources outweigh the benefits of being able to efficiently effect economic progress. Put another way, the Beijing model has an inherently limited life.

As Australians, these are very important issues to wrap our heads around. And indeed many are. I have noticed that Australian experts are now being regularly consulted by the Western media as sources of China knowledge. Accepting that China will one day be subject to sudden and possibly catastrophic change means that we should prepare for these circumstances. We must embed as much adaptability and elasticity in our economy as realistically possible to insure against some of these risks.

Already we sell more to, and import more from, China than any other partner. Our dependency on the Middle Kingdom has grown immensely during the last decade. This is a mixed blessing. For the current time these developments have been highly propitious, and helped us weather recent economic storms. In the future, however, they will become much more of a liability, and, as I have argued many times here before, expose Australia to greater volatility and uncertainty. It will also likely result in a telescoping of the nation's productive capacities in ways that do not necessarily suit our long-term interests. This is the so-called Dutch Disease. So we must be mindful that today's gift-horse will eventually become tomorrow's bucking Brumby.

China is an economic narcotic. Contextualised against the sweep of history, she will doubtless stimulate our short-term performance. Looking over the horizon, however, the Chinese dependency brings with it tremendous hazards.

I'd like to acknowledge that this analysis borrows from Sorosian reflexivity. George Soros is, to be sure, one of the most remarkable financial minds of our times, and sagely anticipated the deep flaws in the prevailing economic orthodoxy decades before almost anyone I know of. His principles of imperfect knowledge, and reflexivity between thinking participants and economic realities, have proven to possess superior explanatory power of real world events than the rational expectations, efficient markets, or behavioral financial models. Soros is being judged more and more favourably by the effluxion of time.