In Theory, Wealth Trickles Down

In Blame It On The Fed (Again), we asked, “If it’s not the Fed, where is the inflation really coming from?
After seeing a segment on Bloomberg earlier this week about a “booming” Philippines, I asked myself, “Is there ANY Asian country that ISN’T booming? In fact, the boom is so big, Asian casinos are filling up like there’s no tomorrow.
What is the proximate cause of all this apparent prosperity? Here’s the conventional wisdom:

Developing Economies’ Lead Over Rivals Poses Risks
In the past, the developing world depended on advanced economies – particularly the United States – to generate global growth, which trickled down to them when the rich countries bought their exports. And when rich countries faltered, poorer ones suffered too.
“The conventional wisdom was when we went into recession, they went into recession,” says Robert Lawrence, professor of trade policy at Harvard University’s Kennedy School of Government.
The Great Recession overturned the old relationship. Emerging economies dodged the housing crisis that froze credit markets in the United States and Europe and threw the rich world into the worst downturn since the 1930s. Developing countries just kept growing, though more slowly.
They never had to bail out their banks or endure the high unemployment and stagnant growth that historically follow financial crises. India’s heavily regulated banks never made disastrous bets on the U.S. subprime mortgage market.
Neither did China’s, which are almost all owned by the government. As fear paralyzed financial markets in the rich world, Beijing simply ordered state-run banks to keep lending to support the Chinese economy. And they did, unleashing more than $1.4 trillion in new loans in 2009 alone – a year when bank lending fell in the United States.

Hmm, come to think of it, ANY country that does business with China is booming: Rest of Asia, Canada, Australia, BRIC countries. The list goes on, and it’s because Chinese Property is The Most Important Sector in the World.
I don’t need to rehash how many TRILLIONS of real money has been dropped on the streets since 2009. What’s more interesting is how much shadow money has been created — and how it continues to be created off-balance sheet, feedback-loop style via loans collateralized by gold, and now, by hoarded copper stocks.
Knowing what we know, I am pretty confident that the main source of inflation is rooted in the China real estate boom. This reminds me of what happened in the United States after the 1987 Crash. Greenie’s answer was lower rates and more lending, but at some point, the amount of money needed to move all the players up one rung on the Ponzi scheme was too much and the bubble burst. When this will happen in China, we don’t know, but I think the potential for a hard landing is immense, so let’s not get all worked up about the Fed’s QE which pales by comparison.

In Practice, Money Rises Like Hot Air

Let’s explore why the bubble might burst sooner than everyone thinks. While this is not a political forum, let’s make the observation that poor people are getting poorer all over the world — fast. This matters to us as investors because we need to un-brainwash ourselves after watching the evening news where those who would be king pander for votes. We do not make investment decisions based on folk finance.
Two stories oft repeated:

Private jet makers eye China’s billionaires
Driving that surge is China’s red-hot economy which has produced about 875,000 millionaires and almost 200 billionaires, according to the Hurun Rich List.

So after all this, there are only 875K millionaires in China. The people buying luxury goods are regular kids living at home spending several months’ salary on a purse. This has ALWAYS been the case in the culture.
Back at Foxconn, the worker who meets “expectations over the following three-month period . . . is entitled to a base salary of 2,000 yuan a month, which means that after other income is taken into account, the worker’s total salary would rise to between 2,700 and 3,600 yuan a month.” That’s US$550 for the top tier, working six days a week.
America made subprime loans to undocumented workers to move people up the real estate Ponzi scheme. How will China do it with workers that make so little? If anything, China’s Gini coefficient is getting worse over time, not better.
Ditto India:

In India, Doubts Gather Over Rising Giant’s Course
Ravi Venkatesan, until this week chairman of Microsoft Corp.’s India arm, says his nation is at a crossroads. “We could end up with a rather unstable society, as aspirations are increasing and those left behind are no longer content to live out their lives. You already see anger and expressions of it,” he says. “I strongly have a sense we’re at a tipping point: There is incredible opportunity but also dark forces. What we do as an elite and as a country in the next couple of years will be very decisive.”
. . .
These days, India often is held up as an example of how a democracy in Asia can mirror the spectacular growth of authoritarian China. In the year ending March 31, India’s economy is expected to expand by about 8.5%.
Other important gauges of national well-being paint a more troubling picture. “What has globalization and industrialization done for India?” asks Mr. Venkatesan, Microsoft’s former India chairman. “About 400 million people have seen benefits, and 800 million haven’t.”
Calorie consumption by the bottom 50% of the population has been declining since 1987, according to the 2009-10 economic survey conducted by India’s Ministry of Finance, even as those at the top of society struggle with rising obesity. Mainly because of malnutrition, around 46% of children younger than 3 years old are too small for their age, according to UNICEF.
Infrastructure in cities and the countryside remains woefully inadequate: In recent years, China has added, on average, more than 10 times as much power as India to its electricity grid each year.
Data from McKinsey & Co. show that the number of households in the highest-earning income bracket, making more than $34,000 a year, has risen to 2.5 million, from 1 million in 2005. But the ranks of those at the bottom, making less than $3,000 a year, also have grown, to 111 million, from 101 million in 2005.
Mr. Singh, in a speech to parliament in 1991 upon unveiling major reforms, said he wanted to avoid what he considered to be the ills of unabashed spending. “My purpose is not to give a fillip to mindless and heartless consumerism we have borrowed from the affluent societies of the West,” he said.
But among the most visible signs of India’s modernization is an entrenched consumerist creed. Sales of luxury goods are booming. Mansions are replacing one-story homes in middle-class neighborhoods. Upscale malls are sprouting up around the country.
Many of the urban poor, in contrast, are slipping backward because of rising prices—a persistent and destructive accompaniment to India’s high growth rate. Much of that inflation is in basic foods. Some economists say one cause is the government’s reluctance to allow the development of agribusiness or to break down barriers to interstate trade, which would increase productivity in the countryside.
Food inflation today is running at about 10%, and general inflation in excess of 8%.

So it is true that the rich get richer and the poor get poorer, but growth requires new people to enter on the ground floor so that the rest can move upward. Trickle down is nice in theory, but let’s face it, it takes money to make money, and an economic ecosystem that fosters a race to the bottom is unlikely to produce new entrants with enough money to leap over the divide. (America’s own version)
Or, in the immortal words of William Eckhardt,

If a betting game among a certain number of participants is played long enough, eventually one player will have all the money. If there is any skill involved, it will accelerate the process of concentrating all the stakes in a few hands. Something like this happens in the market. There is a persistent overall tendency for equity to flow from the many to the few. In the long run, the majority loses. The implication for the trader is that to win you have to act like the minority. If you bring normal human habits and tendencies to trading, you’ll gravitate toward the majority and inevitably lose. — The New Market Wizards: Conversations with America’s Top Traders

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