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Right. Bezzle is my new favourite word.
It explains so much.
We'll start in China where an enormous spending spree over the past three decades has generated a staggering amount of GDP, but at what cost?
Here's a chart of China's GDP growth since 1989 👇
As the Chinese economy developed, GDP was growing at 8-14% per year.
Even as global growth took a nosedive after 2008, China still managed to grow at a respectable 6-8% per year.
The problem with debt-driven expansions? As they mature, you get less bang for your buck. Or less GDP for your debt...
Enter the ever-increasing Bezzle 👇
"The bezzle... is the temporary gap between the perceived value of a portfolio of assets and its long-term economic value."
"Economies at times systematically create bezzle, unleashing substantial economic consequences that economists have rarely understood or discussed."
The above is taken from this superb read by Michael Pettis 👇
💡 I'll keep referencing/quoting this from here on, and I highly recommend reading it in full as it explains so much about the current era.
How does the bezzle apply in China?
There are various ways, but we'll focus on the two that I think are the largest culprits 👇
#1 Substantial over-investment in infrastructure or manufacturing facilities that isn’t subsequently justified by the economic value created.
The most famous example of this is Japan’s notorious “bridges to nowhere,” although China has increasingly become the most representative example of this type of bezzle, in which as much as half the growth in GDP in recent years may be a function of bezzle creation.
#2 Housing Bubbles: Self-explanatory, and we've written about China's property market extensively:
MP: Perhaps the classic case in real estate was Japan in the 1980s, when the total recorded value of all the country’s commercial and residential property was equal to roughly four times the total equivalent value in the United States.
For a while (until the 1990s, when Japanese land prices fell by 85 percent during the decade), the total recorded wealth for Japanese households collectively was boosted enormously by the overvaluation of its real estate
If that sounds familiar... 👇
These wealth effects and spending tend to go hand in hand. It's simple human nature. If people feel wealthier, they spend more. Everyone behaves as if the wealth is real.
Which is why the CCP's move to crack down on property prices at the same time as they're trying to promote a stronger domestic economy made NO sense to me.
I've seen first hand how people behave when property prices are falling. You'll be shocked and amazed to hear that they essentially stop spending. The reverse wealth effect... 👇
Barely three months have passed since Evergrande and Lehman Moment started trending together, and Chinese policymakers are already panicking about growth...
MP: Authorities need to boost domestic demand, the authors say, including consumption and investment, to counter the property slump and any slowdown in exports, or else GDP growth will remain low.
If China’s problem were that Chinese businesses are eager to expand production facilities to meet surging demand, but are unable to do so because borrowing costs are too high, this would make sense, and the resulting growth would be sustainable.
But that really isn't the case. Businesses aren't banging down the doors of the banks to get loans and make new investments. China is far from alone in this respect as the rise of zombie companies worldwide shows.
So, if China wants growth, what are the options?
MP: We are still stuck with the three options Beijing faces that I have been writing about for several years: because China cannot rely on an ever-expanding trade surplus, Beijing must ultimately choose between rebalancing income, more debt, or lower growth.
China has been unable yet to rebalance income, so if it does not want much lower growth, it must choose more debt. This means that if it reins in debt in the property sector, it must expand debt somewhere else.
That's probably what will happen.
Fast forward a few hours, and we're already hearing about new infrastructure projects.
2 trillion yuan = ~$314 billion
The Bezzle goes on!
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Now, China is far from alone in benefiting from the Bezzle...
It's a worldwide phenomenon:
Real asset valuations have increased over the past two decades as interest rates have fallen and operating returns have stagnated or declined
"Nearly all net worth growth from 2000 to 2020 occurred in the household sector as a result of growing equity and real estate valuations"
Charlie Munger explains how it works:
As Keynes showed, in a naive economy relying on earned income, when the seamstress sells a coat to the shoemaker for $20, the shoemaker has $20 more to spend and the seamstress has $20 less to spend.
But when the government prints another $20 bill and uses it to buy pair of shoes, the shoemaker has another $20 and no-one feels poorer.
And when the shoemaker next buys a coat, - the process goes on and on, not to an infinite increase, but with what is now called the Keynesian multiplier effect, a sort of lalapaloosa effect on spending.
Similarly, an undisclosed embezzlement has stronger stimulative effects per dollar on spending than a same-sized honest exchange of goods.
Now, Munger said that 21 years ago. Way before QE and rock-bottom interest rates. Don't confuse 'government printing' with the Fed's balance sheet.
QE is largely an accounting trick that kind of indirectly enables the Bezzle.
GDP growth is artificially boosted by a rising bezzle, which in turn is justified by rising GDP.
The two elements reinforce each other in a seemingly virtuous cycle.
At some point, there will almost certainly be a Minsky moment when all faith is eroded from the current system, and assets quickly lose value.
MP: The bezzle can also be eliminated much more slowly, as the gap between reality and the growth expectation implicit in the price of an asset is slowly amortized.
When this happens, the loss associated with the bezzle is effectively eliminated through (often hidden) transfers that force the loss onto one economic sector or another
Higher interest rates are the biggest threat to the current system, which is why investors are concerned about the Fed's renewed focus on inflation.
If they take rates too far (& especially too fast), the bezzle will look unsustainable, and it will take a lot more than a Build Back Better plan to recover.
Until that Minsky moment, investors will still need somewhere to park their increasing pile of savings... 👇
And if it is the beginning of the end, at least we can go out laughing about Elon Musk being named TIME Person Of The Year...
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