The Mystery of Mr. Wu

Recently, Greg Grillot took a trip to the Far East…and between exploring terracotta warrior tombs in Xi’an, and drinking the healing "Sea Horse with Reptiles Liquor," he pondered the enigma that is the Chinese banking system…

Yesterday afternoon, a wizened Manchurian fellow with an enormous, yet calming, black mole on the tip of his nose beckoned me over to his rickety rickshaw. I have no idea what language he spoke to me: maybe Mandarin, perhaps Manchurian – definitely not French -but he felt certain I understood him.

We hurtled through the chaotic traffic in Beijing’s ancient Hutong district. Hey – if the cars and buses don’t acknowledge right of way, why should my hardy pedal pusher? Maybe he felt invigorated pulling along a young, 143-pound sapling in place of the usual quarter-ton cargo of elderly, flabby American couples.

In any case, he certainly cut off a fine share of buses and Honda sedans on our way to the tortuous labyrinth of alleyways and enmeshed houses of the 800-year-old neighborhood where Mr. Wu patiently awaited me.

Mr. Wu is a kind man. He’s a long-retired archaeologist — meaning he most likely excavated dynastic treasure and terra cotta warriors for the glory of Mao. Mr. Wu is of the eternally young variety of Asian elders. He smiles with his eyes and mouth as he answers questions through his interpreter — he understands English, but doesn’t speak it.

My companion, The Supper Club’s Karim Rahemtulla, asked Mr. Wu some interesting questions. Here’s a portion of their conversation:

Karim: "How has your standard of living changed in the last two decades?"

Mr. Wu’s interpreter: "Thirteen years ago, his pension was 250 yuan a month. Now it is 2,500 yuan. [250 yuan = $30.21 and 2,500 yuan = $302.06 at the time of this writing. Because the yuan is exactly pegged to the dollar, those conversions will no doubt be precisely the same when you read this…but not forever.] He recently had a cash offer to buy his home for US$300,000, which he’s lived in for 50 years, and his two sons live here, too. He won’t sell, though. He wants to leave this house on to his sons and his wife after he passes…"

The other folks that joined Karim and myself on the tour asked some questions about Mr. Wu’s single outdoor bathroom, his marble-tiled living room, etc., while I noted a subtle cloud of suspicion pass over Karim’s face.

Chinese banking System: 900% Pension Increase in 13 Years?

After Mr. Wu graciously answered the final questions, I followed Karim outside into the courtyard amid the beautifully painted porcelain dining set and vacant birdcages.

"Greg, something doesn’t add up here. His pension shot up 900% in 13 years while inflation snoozed at 2-5% per annum. How could the government pay him that much more in such a short period of time? I’ll tell you some more about the banking system when we get back to the hotel."

Karim was right – my happiness for the kind old man’s recent prosperity nearly overawed my critical faculties. A gaping enigma lay somewhere between 900% and 2-5%…something didn’t add up. Why does it matter, though?

He’s a nice old man, and it doesn’t seem to occur (or matter) to him that anything is wrong with this situation.

In fact, the more you look around, the more you notice that no one seems to know, or care, how so many people can produce so much so cheaply…and sell it below production cost. How does the Chinese miracle work? Are the Chinese playing with economic fire?

All over Beijing, you find people selling things for less than they must have cost to make, like watches – I fended off the 24-cent "Woe-lex" slingers and landed in the comfy cab of my furiously beckoning and smiling Manchu friend…absorbed in confused economic thought, I gazed at the passing Shicha Lake.

Weary from my reeling thoughts, I returned to the hotel.

Chinese Banking System: Three Questions

Plopped in a fine fake-leather chair in the lobby of Beijing’s Grand Hyatt, I tried to answer three interwoven questions:

1. How did Mr. Wu’s pension jump 900% in 13 years, when the average rate of inflation loomed under 5% annually over the same time period?

2. How can you buy a disposable cigarette lighter in Beijing for 12 cents?

3. Why does the love of my life have to pay back the money she borrows on her credit cards?

Okay, the first two questions look enigmatic to me – the third has a simple, reflexive answer. But the answer to the final question just might unlock the first two.

I recalled the rich Cuban cigars I’ve been smoking with my travel mate, newfound friend and vintage Harley restorer, T.M. Offering me ignition, he laughed about the 12-cent lighter he bought from a street monger.

I thought: "12 cents…hmm…I know labor’s cheap. Cost of living’s damned cheap, too…but how can it possibly be so rock bottom that they can sell lighters and working counterfeit watches for 12-24 cents?" The more you look around, the more you wonder.

I recalled one of Karim’s recent quandaries: "I took a 20-minute cab ride today for $1.50. The gas prices here are the same as in America – crude’s cut in dollars – so let’s say we used a half gallon. The gas alone cost $1.10. Now include the driver’s time, the vehicle’s cost with wear and tear — that cab’s gotta operate at a loss. How’s that possible…?"

At this point, I wondered how much virtue would cost me in the narrow alleys here – I’m not wealthy, and my aforesaid love would appreciate it if I picked some up…virtue never comes cheap, and that’s why it’s so rare…a moral luxury item…although some would say the demand for it is (or at least should be) inelastic, but back on topic for now!

Back at the Hyatt, in the realm of numbers that either do or do not add up, Karim and I looked over the books of a Chinese steel company. Its year-over-year gross sales increased at a fine, steady clip…but despite these increasing sales, its debt ascended a bit faster than its sales.

So its net profits slowly dwindled over time. Convenient – despite increasing sales, its taxable revenue went down. But it also looked like the company never pays down its debt…which is a good deal, if you can get it. But in a free market system, a free lunch is mythical (like my virtue).

Chinese Banking System: The Banks and The Government Are Identical

If the Chinese aren’t paying their debts…is there any limit to the amount of money the banks can lend? Just who are these banks, anyway?

Could this be the key? Alexander’s sword to my Sino-Gordian knot?

In the land of the world’s greatest capitalists, there’s one business that isn’t even remotely governed by free markets: the banks. In the simplest terms, the banks and the government are one and the same.

Like modern American banks, the Chinese banks (read: the Chinese government) freely loan money to fledgling and huge established businesses alike. But unlike modern American banks (most of them, anyway), the Chinese banks don’t expect businesses to pay back the money lent to them. That’s what the perpetually rolled-over debt on the steel company’s books told us.

So peering hyperopically from a panoramic view, here’s how China looks to me: domestic steelmakers, lighter producers, and cabbies produce their goods and services for free. So they can peddle their wares for far less than production costs.

Free money, via loans not needing repayment, essentially lets the steel company produce steel for next to nothing and then sell it at market price.

Which, in the West, is far below what you’d pay for a company that had to worry about profits and paying back loans or selling at ABOVE the cost of production.

That may be how T.M. bought a 12-cent Chinese lighter to inflame our $20 Cubans.

That may be how Karim’s cabbie barely pays for gas with his fares. (I wish I could collect a free paycheck – please don’t read this, Mr. Bonner!)

But even more than that, I wish my love, like the Chinese steel barons, didn’t have to pay her credit card bills.

It would be nice to get a free lunch every single day of the week, and dessert too!

No, wait – my greatest wish is this: to purchase that virtue for 12 cents.

Enough of the virtue stuff – Karim mentioned something about the savings and loan crisis that swept over America. Even if it’s a deliberate policy, an economy can’t be deliberately inefficient in allocating capital. Things cost money. They cannot, typically, cost less than the value of the raw materials to make them. The whole cannot be worth less than the sum of the parts…anymore than you can buy virtue in a dark alleyway in Beijing.

Some laws of economics, like the laws of ethical behavior, can be bent, but not broken…at least not without consequences.


Greg Grillot
for The Daily Reckoning

May 10, 2005

P.S. After a harrowing day of travel from Beijin to Xi’an to Shanghai, my jetlagged insomnia finally broke. I slept for a good 6 hours last night – and this morning I awoke refreshed. Then at dusk, as the smog and twilight mingle in a creepy skyscraper slashed sunset, millions of artificial stars break through the murk and assail my bloodshot eyes.

A billion light bulbs baptize Shanghai’s half-mile highbrow. More shine than Vegas – more luminescence than St. Petersburg on a winter night. This reckless use of electricity is a brownout waiting to happen – a permanent blackout lurking on the horizon.

You can almost see the dirty coal transform into pure photon energy – no doubt you saw the hazy effect of that burnt coal before the sun retreated tonight…

Greg Grillot is an erstwhile 26-year-old student of philosophy, whose only similarity to Socrates is an utter lack of knowledge. Under the inimitable guidance of Dan Denning, Byron King, Chris Mayer, Tom Dyson, and Addison Wiggin, he hopes to learn enough about the markets and macroeconomics to actually say something meaningful someday. He enjoys jiu-jitsu, Russian literature and pitbulls. He rues the day he left his tree-trimming job for publishing, as he has no time to think anymore

"Globalization works fine," said colleague Dan
Denning, "as long as people are trading for different goods. But when
they begin competing for the same market with the same goods, someone’s
going to be out of a job. It’s all very well for the Chinese to grow
rice and Americans to grow wheat. They can trade with each other. But
when they both produce cars…somebody’s going to lose."

losers in the globalized car business are not hard to identify: Ford
and GM. Every car GM makes has to bring in $1,500 just to cover
employee health care. The new Chinese automakers have no such burden.
Their labor costs are only about 5% of those in the United States.

say the displaced autoworkers will find new jobs," Dan continued. "But
what new jobs? What are they going to do, polish Chinese shoes?"

things work well in theory…but not so well in practice. And vice versa.
In national stereotypes, the French are famous for abandoning things
that work in practice…because they couldn’t make them work in theory.
Anglo-Saxons, typically, don’t understand the theory well enough to
know if it works or not; they care only about the results.

traditional economic theory, people save. Their savings are borrowed by
entrepreneurs and businesspeople to build new enterprises, new
factories, and new consumer items. This new output is then sold at a
profit, which creates new jobs – and higher incomes – that give people
more purchasing power, more savings, and so forth.

in modern America’s fabulous economy of 2005, things happen so much
differently that we wonder: Is the theory mistaken…or are Americans?
Hardly a dime is saved today. We have not seen a new factory put up in
the last 20 years, though we don’t deny there must have been a few. Per
hour, jobs pay little more – in real terms – than they did 30 years
ago. And yet, Americans seem to have more purchasing power than ever.

is wrong. The picture is grotesque, unnatural…like a pretty wife who
rotates her own tires – almost too good to be true. We suspect we’re
going to find out later that she sets fire to her cat.

problem with not saving money is that you have no savings. If you want
to do anything beyond what you’re already doing, you have nothing saved
up to do it with. Even current levels of consumption cannot be
maintained. Factories wear out and need to be rebuilt. And competitors
race ahead. There is no standing still. You are either going forward…or
falling behind. "Day by day, all the earth ages, drooping unto death,"
saith the old Anglo-Saxon poets. You need a reserve of "energy" –
savings – to give it life again.

the mainstream media has begun to notice how odd things have become.
"If current trends continue, the United States will borrow an
unprecedented $1 trillion this year alone, mostly from abroad, a sum
that is reflected in huge U.S. budget and trade deficits. Any sane
analyst has to wonder how long it can last…" The quotation comes from
yesterday’s International Herald Tribune’s editorial page. We were
surprised to find it there; we’ve gotten so used to reading Thomas
Friedman’s puerile claptrap on the editorial page. (Later in the
editorial, the IHT partially recovers its habitual senselessness,
noting that the savings – like practically everything else in its view
– is a collective responsibility and a partisan issue. "The most
powerful way to increase national savings it to cut the budget deficit.
To do that, Bush and his allies in Congress must defer the
gratification they would derive from showering more tax cuts on the

How then can Americans live so well – without savings? The IHT explains:

argue that the amount of personal savings is understated because it
does not take into account the increase in housing values, which has
many homeowners feeling flush. But elevated home values do not add to
national savings. [Or to national wealth, we add.]

wealth is not converted into cold hard cash until a house is sold, and
at that point the money flowing into the seller’s pocket is simply
money that is flowing out of the buyer’s pocket. No new wealth is
created, unless the seller saves the windfall – which is generally not
the case in today’s consumer economy. Instead, sellers increase their
purchasing power, while the saving rate declines and the United States
as a whole becomes poorer."

theory has worked all along. People do save. They do invest. They do
get richer – just as they’re supposed to. They just don’t happen to
live in the United States of America. The world economy has been
globalized. In the new, international division of labor some people
save and get rich. Others consume and get poorer. In the United States
it is just a matter of time until theory catches up to practice – when
the spell is broken and the delusions of house-price wealth – and the
lack of savings – finally catches up to us.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Manhattan…

GM’s investment-grade rating sheds its mortal coil, the entire
corporate bond market may suffer a near-death experience, especially
the junk-bond sector…"


Bill Bonner, back in London:

*** Jonathan Kolber, with advice on how to invest better than a venture capitalist…

"I look for the little undervalued public companies I call ‘transformational technologies stocks.’

technologies stocks are those capable of changing the world in some
area. They don’t offer a marginal improvement to the status quo.
Rather, they have the potential to overturn a whole industry…"

"How can I say, ‘I told you so,’ without it sounding like I’m saying ‘I
told you so?’" asked our Daily Reckoning London editor, Adrian Ash,
this morning.

"The English economy is
a mess. Just as we said it would be. Bankruptcies have risen to record
levels. House prices are flat or falling. And did you see the latest
factory output figures? The lowest in 10 years."

The English are ahead of us.

The newspaper business stinks. Fewer people are reading newspapers.
They’re getting all the news they want from the Internet or TV. As a
consequence, ad revenues at major newspapers all across the country are
falling – while those of Google and other Internet media soar.

Murdoch addressed a group of newspapermen. If we’re going to survive
and prosper, he said, we need to provide: "Deep, deep local news.
Relevant national and international news. Commentary and debate. Gossip
and humor."

the same time, we may want to experiment with the concept of using
bloggers to supplement our daily coverage of news on the net."

Our own blogger, Dan Denning comments:

have one real advantage over bloggers…newsgathering organizations.
Bloggers are essentially parasites to the stories churned out by big
newsgathering organizations.

the newspapers have lost, though, is their monopoly on choosing the
stories that matter or what the stories mean. They’ve also lost a lot
of credibility, or trust, which is why people want contrary advice or
opinion in the first place, whether it is from a blogger or a

there be some people who always think the New York Times is the
official paper of record for the world? Probably. Its brand hasn’t been
fully tattered yet. But I remember a couple of years ago the
centrifugal effect [concept was used] to describe how technology
devolves from the center the periphery.

think it’s accurate for describing what’s going on in the media
business. More competition is taking down unwieldy institutions with
their institutional biases. They’ll either adapt… or die.

rather find out what’s going on in Iraq from a U.S. solider or an Iraqi
blogger than a New York Times reporter. Even among our own subscriber
base we have tons more experience and expertise than your average
journalism hack. We just need to build that into an alternative
network…which is exactly what [we’ve] been doing the last five years.

junkies will still read papers because they are information addicts.
But the days where big papers had a monopoly on choosing the stories
that matter, and dictating how they’d be covered are over. Thank

The Daily Reckoning