On January 31, 1958, Mao Zedong issued his Draft of the 60 Articles on Work Methods. The fourth of those 60 concerned the Communist ideology trying to manage its own principles in a modern world. It was to be, as he called it, a “unity of opposites” where professional skill would be integrated into his view of the correct political ideology, and vice versa. Mao demanded that experts in various fields of study and business would be grounded in that doctrine, while simultaneously those working in the government were expected to likewise obtain a high degree of professional competence and not just in their area of their responsibility. It became known simply as “red and expert.”
China was transformed, long after Mao it apparently needs to be pointed out, though to the shading of various hues of red. Even if the nation wasn’t to be the shining Communist example of perfect Marxist technocracy, it could still be a technocracy nonetheless; the politics of it all, they thought, could be made more flexible so long as expertise was the baseline guide.
This was the basis for China’s stunning transformation starting in the 1980’s. The country moved on from red and expert to just expert. The rising stars of the new era were less pure Maoists and more so bland technocrats, though exemplary professional conduct wasn’t sufficient on its own. There still had to be some red in there somewhere. Among those who had embodied this evolution of perhaps “pink and expert” was Lou Jiwei.
Lou had been a computer programmer of some quite noticeable skill who in the late 1980’s had attracted the attention of Shanghai’s powerful mayor, Zhu Rongji. Zhu was going places, first to head the People’s Bank of China and then later to become the country’s premier. Throughout Zhu’s tenure in his various posts, he was an active reformer who had battled political inertia (red) such that China might realize this new Chinese dream of a stream-lined (expert) but still state-run economy. Lou Jiwei was instrumental in that process and his career reflected as much.
In addition to computers, Lou had undertaken formal, orthodox economics training. His graduate thesis was written on the topic of general equilibrium theory, the “perfect” marriage between math and what economics is “supposed to be” according to all mainline economists around the world. Holding all the “right” pieces within his resume, Lou was lauded both inside and outside China, as this quote from a glowing Washington Post article from July 1998 makes clear:
“Lou represents the best hope for China’s troubled Communist Party, the prototype for a generation of technocrats rising through the upper ranks of the government. A computer programmer turned economist, this 48-year-old protege of Premier Zhu Rongji has played a pivotal role in the overhaul of China’s tax system and in drawing up plans for a domestic bond market.”
In reality, the process was less transformation from red to expert than red to Economist (capital “E”). To the Washington Post and the outside world, they had at that time yet to see the difference.
When in March 2007, Chinese financial authorities announced their intentions to create a sovereign wealth fund, there was only mild surprise that they chose Lou to be its inaugural Chairman. The idea was simple; as part of China’s “miracle” economic expansion of especially the decade of the 2000’s to that point, the country had accumulated, as it was “supposed to”, enormous forex “reserves” for which it had done up to that point little with them. Invested primarily in US Treasury securities, China Investment Corporation (CIC) was China diversifying.
Formally structured in September 2007, CIC completed its first bond sale that December just in time to make its first big investment – in Morgan Stanley. When Lou was introduced as the leader for CIC, there were reported whispers from among those in China’s financial industry that he was in over his head. As the Financial Times put it in a March 2012 profile, there were worries “he would be out of his depth in global financial markets.” In addition to buying into MS, Lou directed CIC to also make a major investment (a 10% stake) in Blackstone Group, also at the worst possible time.
Despite what was an inauspicious start at CIC, Lou was never seriously in danger of paying for it. He was severely criticized, of course, from within as well as without the government, and speculation of his removal was near constant in some media circles, but as near as I can tell (and you obviously have to take this with a grain of salt because we don’t nor will ever know what really went on behind the closed party doors) there was no high level disillusionment, and nothing that would have gone so far as to trigger formal parliamentary procedures to make a change.
CIC managed to do much better as far as returns in the years after the Great “Recession” and crisis that general equilibrium theory was (and is) incapable of predicting (or understanding), but that really isn’t much of a benchmark. Instead, there were further rumors of improprieties at the fund that in June 2014 compelled the National Audit Office to issue a scathing report alleging, among other things, mismanagement and dereliction of fiduciary duty. The audit was meant to cover only the year 2012, and was therefore appropriate to Lou’s stewardship of the fund. But by then he had already been elevated to Finance Minister, one of the most important posts for economic affairs in all China.
After surviving all of that on mostly reputation, just this week China observers were stunned with the news that Lou had been sacked from his post by parliamentary vote. When he was first appointed as Minister in March 2013, the South China Morning Post wrote of him that he “is viewed as a no-nonsense official with profound knowledge of China’s economy and the inner workings of its financial system.”
Not eighteen months ago, in March 2015, amidst growing turmoil and economic doubts, the government was working feverishly to maintain him. Bloomberg reported at the time, “China’s leadership is considering ways to keep Finance Minister Lou Jiwei in office beyond retirement age so he can retain his top role in restructuring local government debt, said a person familiar with the talks.” They were thinking as they had done with PBOC Governor Zhou, another indispensable finance official, to give Lou a legislative position so that he could continue as Finance Minister past his mandated retirement age of 65.
It is easy to assume in general what happened between now and then; China has been the unwilling epicenter of almost every form of economic and financial negativity these past few years. It would be understandable to simply believe Lou’s mistakes had caught up with him at long last. But that would, as usual, leave out too many important and intriguing developments, especially those of the past few months. The People’s Bank of China has been waging a conspicuously uneven struggle with financial conditions there. The intriguing part is not the struggle, that has been constant during this period, rather it is the sudden ad hoc nature of it.
China’s central bank has been given far too much deference in Western perceptions, appearing to be almost omniscient in whatever that might go right being attributed directly to it. Part of that stems from its very rigid nature in terms of how it conducts its actual operational policies. As you might expect as an embodiment of modern Chinese “red and expert”, it has taken on great technocratic actions that are inviting to many here in the West. When it does something, it does it all the way and to the penny, or renminbi as it were. In September 2008, the FOMC (internally) ridiculed the PBOC for cutting its main policy rate by 27 bps in the wake of Lehman, an exact number that to the blunt (ineffective) workings of the Federal Reserve seemed unnecessarily cute. But it fit the Chinese technocratic standard perfectly.
They continue to operate in much the same way. Confronted by enormous “dollar” funding pressure and the duality of Chinese money at the heart of its technocratic origins, they eventually responded with similar precision and decisiveness. In the realm of onshore RMB liquidity, they drew a line in the sand at 2.05% overnight SHIBOR and maintained it below that level for almost a year come hell or high water. And both did come, as holding SHIBOR steady actually had no alleviative effect. Though it was not successful in its intentions, the central bank at least stayed true to its operation.
At the end of August 2016, however, this monetary stoicism abruptly ended; no reason was given, nor should one have been expected. In the almost preternatural tug-of-war between “dollar” and RMB, suddenly RMB was on the losing end. Holding CNY steady, suddenly RMB liquidity tightened dramatically onshore as well as offshore. Money market rates exploded, including those like the repo rate beyond SHIBOR. Then, just as suddenly, in late October it all changed again, as if the PBOC, of all agencies in the world, would have betrayed its usual rigidity and gone soft. After some weeks of what seemed to me like indecision and even confusion, RMB is now again the priority and CNY is left to its own damaging devices.
Reiterating the same caveat that what we talk about in this regard is all inferred from an incomplete working knowledge, what is still very striking about all of it is the trajectory, including that of Lou Jiwei. Reform had been a priority since before the 2013 Party Congress that enshrined it as an official doctrine, but we need to be clear about what that meant. In very basic terms, it was a tectonic shift from previously prioritizing growth above all else to instead being far more concerned about monetary, financial and economic imbalances that had appeared as a result of that prior emphasis.
In 2009 and again in 2012, China had done what it was “supposed” to do; what all the dynamic equilibrium models told its authorities it must. They embarked on truly massive “stimulus” as a way to wait out the global storm raging everywhere else. China was affected in 2008 and mostly 2009, but nowhere near so many other places. The intent of “stimulus” was to fill the void while the rest of the global economy healed, at which point China’s miracle would continue on as before.
By 2013, it was clear to China’s political authorities, though not Western economists, that the events of 2012 were conclusive on the matter – there would be no full recovery. What that actually meant for China wasn’t so clear, but they foresaw big problems after having taken on so much debt in anticipation of prior growth rates at some point. In other words, there was the very real danger of China in 2015 or 2016 or at some juncture perhaps too close in the near future becoming Japan 1990. The combination of massive debt and no growth is fatal, especially in China where existential stability is a very real issue for the government.
Lou Jiwei was a big part of this shift in priorities, where it was believed China must sacrifice growth (because the global recovery was never going to happen) in order to deal with its debt and money imbalances before it became too late. Among Lou’s larger initiatives was a debt swap for local governments. Banks had been lending furiously to municipalities as part of those prior “stimulus” regimes in order for localities to meet economic growth targets. Sitting on a mountain of bad debt meant to have been paid back during far better times, Chinese authorities really don’t know how to avoid repeating Japan’s monetary mistakes. Lou has been instrumental in this swap plan, including the latest that would see dodgy bank loans converted to some form of equity.
Given all what has transpired of late, including the dizziness in PBOC conduct, we have to consider a power struggle that came to a head toward the end of September, and then was amplified toward a resolution in October that seems to have resulted in perhaps repudiating the 2013 reform agenda. Monetary policy in November is consistent with a huge liquidity operation (look at copper prices since October 26, the day SHIBOR stopped rising) that when combined with Lou’s ouster looks very much like China’s authorities have been pushed to the brink on sacrificing growth. It appears to my eye as a panic response.
And with good reason. The economic stats of late have been just as bad as they had been all throughout this two year period of the “rising dollar.” It is as much true of the external global economy as internally under these China-specific adjustments. Exports dropped another 7% in October after falling more than 10% in September, some of the worst figures at any time. Had the global economy just stabilized as all the technocratic economists here and everywhere had expected and predicted, perhaps Chinese reforms could continue as they were if maybe adjusted. But the global economy is not stabilized, and so China is in a great bind because of it.
For its Finance Minister to turn from indispensable to disposable in just a year and a half is a sign of great trouble, an unsettling economic nature where those truly in charge understand all-too-well that China’s economy cannot withstand still more monetary instability. Reform or not, this is down to raw survival. It does seem as if the world that was supposed to be by the enlightened hand of these technocrats is running out of time.
Here in the United States, of course, we have just had close experience with just that, though far softer in its immediacy. Donald Trump’s victory was as much a repudiation of technocracy as the changing operations of the PBOC and the sacking of that country’s finance minister. It cannot be understated that the electoral votes which gave Trump his margin of victory were those of the rust belt. Rural Pennsylvania and Michigan voters who delivered to Mr. Trump those states have in the very few days since the election been slandered repeatedly as xenophobic, sexist, and racist despite twice voting for Barack Obama.
“Something” is very wrong in the world and a great many people know it. Some have chosen to ignore it as the product of contemptable (their view) populism and nationalism, but it is quite telling that those people doing so are the same who get all their economic questions answered by the likes of Paul Krugman and Janet Yellen. Pennsylvania is today a “red” state because it had before given the “experts” all the chances in the world and then some.
I wrote in early November 2012 just after the last Presidential election that:
“The one issue that needed prime treatment and hard fought campaigning is the one issue that never saw the light of day. Having disappointed so many voters by not even addressing it, can anyone really be surprised that turnout was so low, and on both sides? Though Romney clearly lost and Obama remains in the White House essentially by forfeit, nobody but the apparently uninterruptable processes of volatility and flow can actually claim a victory.”
Volatility we have seen again, and flow referred then as now to the negative; this constant deceleration in the whole global economy that the technocrats just can’t explain let alone solve. The Trump campaign, as the Sanders campaign in the Democratic primaries, came close to that issue if by proxy. The contentious arguments about immigration, TPP, and all the rest of the economic angst are all tied to it. For the third election in a row, economic concern remains by far the biggest one – and for both parties. We aren’t supposed to speak of it because it is “settled science”, but Trump will be in the White House in January because of it.
The question is what will now be done. A President Trump isn’t constrained in the way a President Romney would have been, and I mean that as more than just ideology. Romney would have had QE3 at his back and all the visions of success that went with it; Trump will have empirical knowledge that QE3 was, as all the others, a massive scandal. Not even its proponents back it or its promises anymore, as very quietly from one central bank to another they have all just moved on.
I write constantly about the Fed, PBOC, BoE, BoJ, etc., etc., and am criticized for it, because that is where the global economic problem is. And I mean that in more than one respect. Yes, the “dollar” is the primary immediate problem, but economists are no less so because by their very place they actively impede the public’s ability to see it. They are powerless as far as the “dollar” is concerned, but they guard all the doors and intellectual access points to do something about it. If you had asked Janet Yellen what’s been wrong, as countless politicians and media did, she during the first two years of her post would have denied that anything really was. Now, all of a sudden, she admits there might be something wrong, but hasn’t any clue about what it is even though she openly speculates “it” will seriously obstruct the Federal Reserve’s policy window.
As for rural Pennsylvania and Michigan? A shrug of the shoulders and some rambling, mumbling statement about demographics and hysteresis. Those states turned red because she and all her cohort are no experts, a fact that any accountability apart from this vote would easily establish. At least the Chinese fire their misfits at some point.
We live in an increasing technocracy that is a contradiction because each of these technocrats and their institutions are incompetent. Because of that, without the vast monetary support of a growing global eurodollar system their schemes are exposed as such where once they were hidden by massive, worldwide “dollar” growth. But in that failure when inevitably the people search for answers and responsibility, they are given none. Worse, technocrats actively suppress anything that could fix the problem if it doesn’t directly involve them in it.
The world will not recover until it stops asking Janet Yellen for the answers. It really is that simple. That means more than just looking to the FOMC to vote on some new scheme, or to raise rates because they view the economy as if great things are just around the corner. The recovery was just over the horizon at the last election in 2012, too, and despite QE3 (and 4) it “somehow” remains so? No, everyone needs to realize that Janet Yellen doesn’t have any answers because she doesn’t even know the questions – and barring a true miracle she never will. But by her position and the deference to it in the mainstream, media as well as politics, nobody is even given the opportunity to ask the right ones.
The only question the Trump administration should be contemplating is whether it will follow the Chinese in just shuffling the deck, trading one incompetent technocrat for another and maintaining the system as it is, or will it, given this chance and the manner in which it was derived, strive for something truly substantial to finally open the door to what could be actually hopeful and optimistic. I have written all along that I viewed Trump’s ascendance as a great and positive sign that at least the American people wouldn’t just consent to this forever (nine years is enough), to become like the Japanese accustomed to the appearance of ability while quietly acknowledging and accepting that it isn’t or won’t ever be. Is Trump the answer, or merely the first step via further unrest? The hard part comes next.
Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor.