The Introduction for the 1962 Translation of F.A. Hayek's The Road to Serfdom is Now on Amazon.

I just published my first translation on Amazon.  It is the Introduction to the 1962 Chinese translation of F.A. Hayek's The Road to Serfdom.

F.A. Hayek's The Road to Serfdom was translated into Chinese in 1962. The Great Leap Forward had failed, and China was making slow moves back towards market reforms after the Great Chinese Famine. A split in Sino-Soviet relations was forming. 

This translation was never meant to circulate publicly. It was considered an "internal document" and was not allowed to leave book collections of high-level institutions. The translator, Weizao Teng, who referred to Hayek as "[A] loyal lackey defending the capitalist system," and believed his books were "[F]ull of poison," wanted to translate the book so that academics could "[C]riticiz[e] modern bourgeois reactionary economic theories." 

According to rumor, Premier Zhu had a copy of this book on his desk while leading economic reforms in the 1990s.

Preview: Rational Considerations of China's Reforms.

I have finished Chapter VI of the Logic of the Market.  (Note:  I am not going in order.)

Here is my favorite part:

I once used a mathematical equation to analyze and show that the increase in actual corruption has a few origins. One is that with the increase in the degree the Chinese economy has monetized; the economic value of power has increased. The second is that the complexity of economic relations has caused supervision to become more and more difficult. The third is the growth in market opportunity caused government officials to “preserve utility” (the utility they would receive if they were forced out of the government as punishment for corruption). The fourth is the level of punishment has been reduced (such as the amount embezzled to receive the death penalty was increased significantly). The fifth is the formal salaries of government officials are relatively low. 

The five factors described above are all related to power. Power is the root of corruption; other aspects are its symptoms. Anti-corruption measures must address both the symptoms and its root, but direct action would cure the root. That direct action is to reduce the power of government officials. Some have proposed “high salaries to encourage honesty,” which makes a bit of sense. In a situation where the power of government officials is excessive, honesty cannot be encouraged with high salaries. If officials’ salaries are too high, the masses will not accept it. The key issue here is that government departments in our country have monopolized many rights that belong to private citizens and businesses in other countries with a market economy. Examples include starting a business and engaging in investment activities, which require government approval. Individuals and businesses have no option but to “buy out” by means of corruption rights to engage in normal economic activity that should belong to them in the first place. In connection with anti-corruption measures at present that only cure the symptoms without curing the cause, I said in 1994 that if we do not change the fundamentals of our government controlled economic system, and reduce the government’s administrative approval authorities, corruption of private goods (according to the definition in economics, without exclusiveness) is instead a “sub-optimal” choice. My meaning is that to stop corruption we must cure its root, not its symptoms. On the one hand stressing anti-corruption measures without wanting to reduce government power on the other hand is self deception. Not only can it not succeed, or even if it succeeds in the short term, it comes at the price of a huge impairment to society. A prerequisite for high economic growth without corruption is the abolition of the government’s monopoly over the power to allocate resources. Some say that I am defending corruption, but actually this is a misunderstanding of my views. Penetrating discussion of issues is the responsibility of scholars. In 1999, at the High Level Forum on Chinese Development, I said, “Government control needs to be given up just as drugs need to be given up,” and added, “If government examination and approvals were abolished, corruption could be reduced by at least 50%.” This message had a large impact on the proceeding system of examination and approvals reform. Ten thousand good wishes cannot match one effective action!

The Chinese National Basketball Team.

When I choose to read a book about economic or financial history, I have a general rule: Avoid anything that was written less than 20 years ago. Over the last few centuries of boom and bust, the names have changed, but the story remains the same. One exception I made to that rule was Tom Woods’ Meltdown, published in 2009.

He uses an excellent analogy to describe how credit expansion leads to lower-rated credit portfolios.

When banks lend out the new money created by the Fed, they necessarily lend it to people whom the banks had previously deemed unworthy. It’s like the situation a basketball team would face if it added two new roster spots—those spots would go to players who would otherwise have been cut. [14] In an atmosphere of rising prices and general prosperity, it also becomes difficult to distinguish between sound projects and bubble projects—that is, between projects that would make good economic sense during normal times, and projects that can survive only if credit remains artificially cheap. (Page 27) 

Back in the 1980s and 1990s, even a few years after the new millennium, observers were very worried about a Chinese banking crisis. The following quote is from an article in the New York Times written in 1993, but it could have just as easily passed for a quote by an official today: “For Mr. Zhu, who has day-to-day management control over the economy, engineering a "soft landing" for China's economy is a test of his political skill and China's credibility.”

Instead of allowing the economy to adjust, credit was expanded. Although statistics are lacking, we can tell that standards were lowered, because a few years later the officials were denying how bad the loans had performed.

''You can argue about whether this 5-6 percent is accurate or not,'' Mr. [Xianglong] Dai said. ''But I don't want to hear anyone repeating those rumors that it is 25-30 or even 40 percent. That would be irresponsible.'' [Source]

Mr. Xianglong Dai, the Governor of the People’s Bank of China, said that in January of 1998. In August of 1998, the Bank of China and the China Construction Bank received a bailout totaling $32.5 billion from the government. Apparently that was not enough to cover the “5-6 percent,” so in 2000 and 2001 the government provided another $169 billion in bailouts to buy non-performing loans for dollars on the dollars. In January of 2004, another $45 billion was handed out. [Source]

These may sound like relatively small numbers, especially in comparison with the Toxic Asset Relief Program, which was originally $700 billion, but later reduced to $475 billion. However, we need to put it in context to understand the scale of the bailout.

If those bailout amounts are compared with the money supply at the time, it would total 12.86% of the money supply added together. At today’s level, 12.86% of the money supply would be ¥12.5 trillion. Converted into U.S. dollars, it would equal $1,986 billion. That number is almost three times the original TARP bailout. This all happened before 2004, but no one seems to be bothered by the extent of this bailout.

To borrow an analogy, China's National Basketball Team is now actively recruiting non-athletes.  Instead of improving the quality of loans, the Chinese banking system has drowned non-performing loans with new loans that over-stimulated the economy and spurred asset price inflation.  Loans to non-financial institutions by Chinese banks now stands at ¥70 trillion.  If we assume 40% of them are non-performing loans, that means the Chinese banking system has ¥27 trillion worth of malinvestments.  A bailout that size would be about 28% of the entire money supply (M2), or 90% of M1 (as of December, 2012).  That is more than half of China's GDP.

The most important thing to realize is that bailouts are counter-productive. They reward the risk-takers at the expense of everyone else. They give investors a false sense of security, but actually make the banking system unstable.  The systemic risks that led to the bailouts in 1998, 2000, 2001, and 2004 will return, but now with bigger consequences.  One banker interviewed in the articles above put it so well: "Why do you want to buy Chinese banks — what makes you think these guys will do anything any differently in the next four years?"

Japanese Capital in China.

In “A History of Interest Rates”, Sidney Homer remarked on the trend of low interest rates concentrated in certain financial centers over time.  He said, “Holland had first experienced such low rates in the seventeenth century, England in the early eighteenth century, and Europe generally in the mid-nineteenth century. Now “Dutch finance” crossed the Atlantic [in the late nineteenth century].”  If he had written the book a few decades later, he certainly would have reserved more of the book to discuss Japan’s "Dutch finance".

Japan’s low interest rate policies can be directly linked to the Asian Financial Crisis, the Treasury Bubble, and the Australian Dollar Bubble.  There is reason to believe that a correction in China will be caused by financial pressure in Japan.

In April of 1987, the Bank of Japan set the discount rate at 2.5%, and would leave it at that historically low level for 26 months.  It was a contributing factor to one of the largest equity bubbles in history.  At the end of 1988, Japan made up 40.69% of world equity market capitalization.  That was only a few percentage points lower than the market capitalization of the English-speaking world.

Interestingly, China dropped its discount rate to 2.7% in February of 2002, and left it there for 31 months.  It has kept the level at about 3.00% since then.  Maybe China is just a bigger version of Japan.  The major difference, and one very hard to explain, is why Japan had a stock market and real estate bubble at the same time, whereas China has an incredible real estate bubble and a reasonably priced stock market.  (Reasonably priced, if we ignore the fact that the earnings are a fantasy.)

Perhaps the spread between the two discount rates are more important.  In the beginning of the 1990s, the spread between discount rates in Japan and China was under 4.00%.  It then dropped below 2.00%.  At that time, the yuan was rapidly depreciating against the yen.  It lost about sixty percent of its value in less than six years.  During this time, the People’s Bank of China increased the discount rate while the Bank of Japan decreased it.  By 1996, the spread had reached 9.94%.  The yuan began to appreciate against the yen, but the spread decreased and interest rates have stabilized.  Since the spread hit 2.74% in June of 1996, the CNYJPY rate has traded in a range between 16.1468 and 12.0191, with an average of 13.8221 (until December of 2012).

Anyone who was in China during the 2012 anti-Japanese riots would have seen just how extensive Japanese investment in China has been.  Any Chinese seriously looking to boycott Japanese products would have soon realized that they could not use almost any household appliance, drive their car, use their building’s elevator, use telecommunications, or watch pornography.

For at least the last fourteen years, China’s discount rate has been Japan’s discount rate plus about 300 basis points.  At some point Japan will have to increase interest rates to rebuild its domestic capital structure.  With the current political environment, that may be a long time from now.  When it does happen, Japanese capital will leave China and repatriate for higher yield in more productive investments.  China will be left to raise its own cost of capital, exposing the malinvestments that had been hidden by the high tide of overinvested capital.

¥100,000,000,000,000

On April 11th, the People's Bank of China announced that Chinese M2 had surpassed ¥103 trillion in the first quarter of 2013.  The announcement was a press release (Chinese language), but the official statistics page has not been updated.  The English language version of the statistics page has not been updated since 2010, so no one outside of China seems to be paying attention.

Let's put that ¥103 trillion into perspective.  Converted at current exchange rates, that is about $16.5 trillion.  That could buy the entire New York Stock Exchange, with money left over.

In January 2000, M2 stood at ¥12 trillion, so it has grown at a rate of about 19%, compounded.  That is much higher than Chinese GDP growth over the same period.

The People's Bank of China holds ¥2.5 trillion worth of foreign exchange reserves.  That means if every Chinese yuan was converted into U.S. dollars, there would only be one U.S. dollar for every forty yuan.  That is much higher than the current exchange rate.

Since 2000, the exchange rate (red line) has been moving down with the ratio of M2 to foreign exchange reserves (blue line).  In 2008, this trend began to change, as the ratio moved upwards, but the renminbi continued to appreciate against the U.S. dollar.  I think this is where a lot of money will be made in the future.

Translated Introduction to "The History of the Development of Chinese Banking."

Translator's Introduction:  I came across this book in the library.  It was published in 1957 by the Shanghai People's Press.  The author is Yulan Zhang (张郁兰).  I have not been able to find much information on him, but I did find that he was purged during the Anti-Rightist Movement and possibly died during the Cultural Revolution.

Buried under references to Marxism and anti-foreign sentiments, the reader will find interesting content about the history of Chinese banks.  It is obvious that the author was very passionate about the topic of banking, but his works had to go through a filter before being published.  The sudden changes in tone in the last sentence of certain key paragraphs shows an unrefined attempt at meeting certain political requirements, most likely by a revolutionary intern.  This book could actually be two books.  One about the history of Chinese banking, and the other about how the average Chinese is educated on the history of China's recent past, and why Chinese are so untrusting of the outside world.

- - - 

(I) After the Opium War, capitalism invaded China. Its exports of merchandise and capital caused huge changes in Chinese society. In order for international financial capital to dominate the economies of colonies and semi-colonies, it first needed to form a controlling financial interest in colonies and semi-colonies. The foreign banks that implemented the invasion policies of imperialism had already ruled financial markets for forty years before the emergence of the Chinese banking industry. Therefore, to research the Chinese banking industry, one must first understand the influence of foreign banks in China. 

(II) The clue to understanding the history of the Chinese banking industry is to further investigate China’s pre-capitalist financial institutions. This is not only because of the close relationship between China’s old-style financial institutions (qianzhuang and piaohao) and new-style banks, but also because the decline and growth between the two will expose more issues, and deepen understanding of this topic. 

(III) China’s political change has had a big influence on the banking industry. The relationship between Chinese banks and public finance was extremely close, more so than in any capitalist country. Public finance was reliant on the banks, and the banks were subordinate to public finance. At the same time, finance is the general hub of society’s economic activity, so its receptiveness is very keen. Political and economic changes will invariably first be reflected in financial markets. Because the Chinese banking industry itself did not have a stable foundation for development, banks collapsed one after another during political crises. Therefore, we also cannot ignore the political background during the history of the banking industry’s development. 

(IV) When researching the history of the Chinese banking industry, if we solely acquaint ourselves with its business services, the significance of this is clearly limited. The financial market is a microcosm of the entire social economy. The banking industry forms an important part of the modern social economy. From the qualitative changes in finance, it is easy to catch a glimpse of China’s economic issues. The characteristics of modern social economy are also reflected by the banking system. The main goal of this book is to understand the nature of the modern Chinese social economy from the point of view of the banking industry. 

In accordance with the principles and requirements described above, this books starts from the creation of China’s first new-style bank in 1896 and ends with the outbreak of the War of Resistance Against Japan in 1937. Those more than forty years of history in the development of the Chinese banking industry are set forth in three periods, with the focal point of each period analyzed. 

The first period (1896-1911) is the end of the Qing dynasty. Analysis is mainly focused on the conditions under which China’s new-style banks emerged, as well as asks what effect did foreign banks in China and old-style financial institutions have on the emergence of China’s banking industry? It also explains the reasons it was feudalistic and compradoristic from the start. 

The second period (1912-1927) is the era of the Northern Warlords. Analysis is mainly focused on how the Chinese banking industry developed from speculations on public debt. What effect did bank capital in public debt speculation have on the modern Chinese social economy? At the same time, the more obvious manifestations of the banking industry’s feudalism and compradorism are explained. 

The third period (1928-1937) is ten years of civil war. Analysis is on two main aspects. The first aspect explains why Chinese bank capital could not transform into industry capital. Why could not the development of China’s bank credit system wipe out high-interest debt in the countryside, but instead itself resort to high-interest debt? The other aspect explains why the national network formed with the central bank, the Bank of China, the Bank of Communications, the Farmer’s Bank of China, the Central Office of Trusts, and the Office of Postal Savings and Remittance at its center could bring about thicker feudalism and bigger compradorism? 

It must be pointed out that when discussing the laws of Chinese banking industry development, it incidentally explains the inevitability of the old-style banking industry’s decline and the trend of the invasion of foreign banks in China. Generally speaking, this book attempts to resolve two issues:  

(1) The characteristics of China’s modern social economy, and how it was reflected in the banking industry. 

(2) What effect the Chinese banking industry actually had on the development of Chinese capitalism.

Since 2000, the Money Supply of the World’s Major Economies has Tripled.

Over the last twelve years, the nine largest currency blocs in the world have increased their total money supply by 205%, if calculated using current exchange rate values. The wealth transfers over that short time period may surprise us, as well as the behavior of certain central banks. The most surprising phenomenon of all is the disappearance of real wealth in the world.

Back in 2000, Japan had the largest domestic money supply in the world. The United States was second, followed by the Eurozone. China’s domestic money supply was about the size of Great Britain’s.

By 2012, the euro had outpaced the dollar, and the dollar had outpaced the yen. The yuan had outpaced everyone to become the largest currency bloc in the world. The case could be made that China is a huge, developing country, so it requires a larger money supply. If China’s economy is only 3.4 times the size of Brazil’s, why is China’s money supply 18.4 times larger than Brazil’s?

The Bank of Japan had the most conservative monetary policy, as the yen money supply only increased 30.73% in nominal terms. It was the only central bank to keep its money supply growth over twelve years in the double digits.  First and second, the European Central Bank and the Federal Reserve, saw their money supplies grow 118.79% and 124.37%, respectfully. Perhaps these three currencies should not be considered complete garbage, yet.

The worst behaved central bank was the Central Bank of Russia. The ruble money supply increased 3,762% over those twelve years. The People’s Bank of China was the second worst behaved central bank. The yuan money supply increased 703.62%. The ruble’s foreign exchange value managed to remain stable, so the dollar value of the ruble money supply increased 3,521% over that period. The yuan’s foreign exchange value managed to appreciate against the dollar, so the dollar value of the yuan money supply increased 967.47% over that period. Added together, the dollar value of the world’s money supply increased 205.82%.

Those of us that view the world in terms of gold would notice that the dollar price of gold over that same period has increased 487.36%, so the real value of the world’s money supply has decreased.

That decrease has not happened evenly. The gold value of Russia’s domestic money supply has increased 516.60%, while China’s has increased 81.74%. Japan has lost 71.37% of the gold value of its money supply, and the United States has lost 61.80%. The two countries with the worst monetary policy have gained the most, in real terms, and the two countries with the least bad monetary policy have lost the most, in real terms. Something is not right.