China's Boom or Bust: the Paradox of Easy Money

The Chinese perpetual growth machine chugs along, leaving many commentators shaking their heads (The Coming Chinese Meltdown at PrudentBear), and some nodding in approval (such as The Secret of China's Economic Miracle by Ellen Brown.

According to my analysis, typical economists do not understand the benefits of the state controlled banking system (that China has and Ellen Brown recommends), but free money advocates like Ellen Brown do not understand the dangers of government control.

The benefit of state banking are clear and persuasive: control over credit, done for the public benefit, allows a remarkable immunity to the laws of finance that govern private banking systems. Bad loans piling up seems to be a huge problem, right? Not so much to the Chinese. When the bank is the government, just write them off, and start lending again.

The Chinese system is remarkably like the core action of my Jubilee People's Bailout, and is living proof that it works. Instead of letting bad debts and tight money constrict the real economy, just write the debts off and supply more money. Viola, economic growth continues! It really is that easy. The Chinese are proving it right now in the sheer incredible volume of loans that the government is forcing, literally requiring by law, banks to issue into the productive economy. Hence, Chinese growth continues even as the rest of the world contracts, despite supposed Chinese reliance on exports.

The problem with this permanently state-run system is the issue of malinvestments and waste. The free market is necessary because it gives real signals about available resources. If the government continually pumps the system full of money, those profit and loss signals are lost. In a free economy, the business cycle is a natural response to too much malinvestment, as prices collapse, companies fold, and everyone tightens their belt and retools into profitable areas. If government floods the economy with cash at every sight of problems, malinvestments are never cleared out, meaning true and sustainable profitability is never reached.

With its tight controls on capital flow and currency trading, along with state planning and bailouts, the Chinese economy today is much like the old Soviet economy. The big difference is that the Soviet block was firewalled off from the economy of the free world. China today is like a parasite on the free world's economy, sucking in the world's resources in the effort to delay the day of reckoning that eventually befell the Soviet system. The problem for us is, this time, we are not firewalled off, so our markets and way of life have become hostage to Chinese malinvestment and economic reality-denial.

The Paradox of International Trade Deficits

Many people still have the idea that a trade deficit is an unqualified negative, but since we went off the gold standard, that unqualified judgment no longer really applies.

Back in the days of the gold standard, an imbalance of trade would be settled in gold. So, a country operating a trade deficit would be chronically bleeding gold. In fact, that exact thing was happening to America in the early 1970s, leading Nixon to take the dollar off of its international gold standard .

The situation today is much different. The deficit country gives slips of paper to the surpluss country, in return for real goods. Who is really getting rich in that scenario? Obviously, its better to get stuff and give paper. The surplus trade partner is just plain dumb in the first place for accepting a non-objective currency as a settlement of account.

They are even dumber for then reinvesting those dollars in dollar-denominated debt. Seriously, would you give a loan to someone expecting repayment in a paper currency they can print out at will? It is asking to be taken advantage of, quite frankly.

The only rational thing to do with a paper currency from a foreign issuer is to immediately plow it back into real goods and services.

This analysis merely highlights how irrational Chinese economic policy has been. Actually, to be clear, it is only irrational from the perspective of maximizing value. It is not irrational, it makes perfect sense actually, in light of their true policy objective: full employment. The Chinese are willing to sacrifice a great deal to maintain full employment.

The problem for us is that by hitching our economies together, our economy is distorted by their irrational economic objectives. We get tons of cheap Chinese junk and a bloated financial sector, but lose real productive jobs.

Worst of all, we are subsidizing the unsustainable, inefficient, and destructive production goals of the Chinese government. In classical economic terms, this is called malinvestment.

It makes no economic sense to keep people employed by making half of them construct houses and the other half tear them down. But under a command economy, such economically destructive processes go on all the time. In fact, the Chinese already have a large overcapacity of housing supply, but that doesn't stop them from building more under the direction of central planners.

In the Soviet days, their planned economy was isolated, firewalled off from the free world. Today, ours is linked to theirs. On the one hand, we benefit from all the cheap goods they give to us for paper dollars, on the other hand, we suffer from inflated commodity prices and the loss of jobs, and we encourage an unsustainable and destructive economic system.