Forget the Fake Statistics: China Is a Tinderbox

When China’s tinderbox economy implodes, who will be left to bid up the world’s surplus commodities and real estate?

After 30 years of torrid expansion, perhaps the single most consequential factor in China’s economy is how much of it is a “black box”: a system with visible inputs and outputs whose internal workings are opaque.

There are number of reasons for this lack of transparency:

1. Official statistics reflect what officials want to project, not the unfiltered data.

2. Policy decisions are made behind closed doors by a handful of leaders.

3. There is little institutional history of transparency.

4. Many important statistics are self-reported and prone to distortion.

5. Large sectors of the economy are informal and difficult if not impossible to measure accurately.

6. Endemic corruption distorts critical economic yardsticks.

7. There is little historical precedent to guide policy makers and individual investors.

None of these is unique to China, of course, with the possible exception of #7: few nations in history (if any) have experienced an equivalent boom in infrastructure, credit, housing and wealth in such a short span of time.

Saving Face By Editing Data

As anyone who has lived and worked in Asia can attest, public perception (i.e. “face”) is of paramount concern.  There is tremendous pressure to put a positive spin on everything in the public sphere.  Negative publicity causes not just the individual to lose face, but his boss, agency, company and family may also be tarnished.

For this reason, reporting potentially negative numbers accurately may put careers and hopes for advancement at risk.

This accretion of fear of reprisal/disapproval builds as it moves up the pyramid of command.  This process can lead to tragic absurdities being taken as truth.  In one famous example in Mao-era China, officials ordered rice planted in thick abundance along a particular stretch of road, so that when Chairman Mao was driven along this roadway, he would see evidence of a spectacular rice harvest.

In reality, China was in the grip of a horrific famine resulting from disastrous state policies (The Great Leap Forward). But since everyone feared the consequences of telling Mao his policies were starving millions of Chinese people, the fields along the highway was planted to mask the unwelcome reality.

Even the most honest reports reflect the biases of those summarizing feedback for their superiors. As a result, when the feedback finally reaches the top leadership, it may be inaccurate or misleading in ways that are difficult to detect.

The Dangers Of Opaque Leadership Decisions

All leaders have their own biases and experiential limits, and left unchecked by accurate feedback and honest dissent, these have the potential to generate disastrous decisions.

Perhaps the top leadership in China is soliciting honest dissent, but without a vigorously free media and multiple unedited feedback loops, this is unlikely for systemic reasons.

Most people—leaders and followers alike—seek to confirm their own views (i.e. confirmation bias). A system in which key decisions are not aired publicly and the trustworthiness of the data being considered behind closed doors is also unknown is a system designed to reinforce confirmation bias and yes-men.

In this environment, destructive policies may be supported by the chain of command despite the consequences.

Lack Of Institutional History of Transparency

Institutions with a long history of independence and a policy of priding transparency have the potential to counter the tendency of hierarchies to encourage confirmation bias and fudged feedback.

But China’s tumultuous history in the 20th century—invasion, foreign occupation, civil war, revolution, mass famines, the Cultural Revolution’s mass disruptions and purges, the end of Mao’s Gang of Four and Deng Xiaoping’s “to get rich is glorious” reforms—has not been conducive to the establishment of independent institutions.

Developing the independence of institutions in the midst of such unprecedented political, social and economic turmoil is a long-term work in progress. Though no comparison is entirely analogous, we can look at the first equally tumultuous 30 years of the American Republic (1790 – 1820) and the French Republic (1789-1819) for historical examples of the difficulties in establishing enduringly independent institutions.

Self-Reported Statistics

Self-reported data plays a significant role in any economic snapshot that measures sentiment and expectations. But when it comes to income, outstanding loans and other data, there’s no substitute for accurate numbers.

As a general rule, the larger the informal cash economy and the greater the leeway and the incentives to under-report, the lower the quality of self-reported statistics.

Take income as an example. In the U.S., the vast majority of non-cash income is reported directly to the tax authorities: wages, 1099s, sales of securities, etc.  The leeway to fudge income is low, which pushes the incentives to fudge onto the expense/deduction side of the ledger.  For this reason, IRS income data is more trustworthy than self-reported measures of income and employment.

Consider this chart of household income in China.  A survey of households found incomes were much higher than the officially collated numbers. In the case of the top earners, the difference was significant enough to skew a variety of key numbers such as household income as a percentage of GDP.


The differences between official data and data collected by surveys is troubling for a number of reasons. Given the incentives to under-report (to avoid paying higher taxes), why should we trust the accuracy of self-reported income? Who’s to say that wealthy households don’t habitually under-report their true income even to surveys?

Given the ubiquity of the informal economy and shadow banking system in China, official data cannot accurately reflect peer-to-peer lending, private loans outstanding and many other data points that are critical to understanding income, risk and credit flows.

The Informal Economy & Shadow Banking

These discrepancies between actual debt and what’s reported could have monumental consequences should expansion turn to contraction and debts become uncollectible.

It’s been estimated that a third of all Chinese households engage in informal lending to friends and family, as well as to enterprises that pay high rates of interest due to the risky nature of their investments.

Interest can run as high as 34% — loan-shark rates.

Even the slices of the credit/investment sector that are reported—for example, Wealth Management Products (WMPs)—are more Wild West than staid banking. WMPs are managed off-balance sheet and don’t require any reserves:

“Legally WMPs are not deposits. They are investment products that are managed ‘off-balance-sheet’ by banks, and there is little transparency about where the funds are going,” said Stephen Green, head of Greater China research at Standard Chartered in Hong Kong, in a note.

According to Green, the funds from different WMP products are often mixed and deployed to finance a broad pool of assets that more often than not fall into the sectors of the economy that regulators have attempted to fence off from normal bank lending (real estate, local government infrastructure, etc.), partly because these sectors are deemed to be particularly risky. In addition, the banks hold neither reserves of WMP deposits nor capital against the assets.


In other words, transparency is low while risk is unknown but possibly high.  This volatile mix of opacity and risk is the perfect recipe for cascading defaults and catastrophic losses.

Endemic Corruption Distorts Data

In China, as in many developing economies, problems such as permit applications, tax bills or development rights are solved by greasing the skids of officialdom.  Just received a big tax bill? Maybe a friendly tax official can help reduce the tax in return for promises of favors and an envelope of cash.

While the central government is cracking down on highly visible corruption, the system of buying privileges with influence, favors and cash is too deeply entrenched to be eliminated in a few months or years by high-level policies.

As with all the factors listed here, the impact of corruption is difficult to assess — and that’s what makes China’s economy such a black box: if what’s known is untrustworthy, and what’s not known is potentially destabilizing, then how reliable is any projection?

Few Historical Precedents to Guide Policy Makers and Individuals

In the U.S., analysts and policy makers can draw upon a long history of economic policies and debate their applicability to the present.  Rising income disparity, for example, is often compared to the Gilded Age of the late 19th century. The financial crisis of 2008 is often viewed as an analog of the 1929 crash that triggered the Great Depression.

China’s recorded history stretches back thousands of years, but in terms of applicable financial and economic parallels to the current economy, there is no precedent.  China’s leadership is truly in uncharted waters.  This in itself heightens the risk of miscalculation and basing policies on faulty premises.

As the housing bubble bursts, alongside the trillions of losses already experienced in the Chinese stock market, the flood of capital from China into world assets is going to be substantially compromised. Asset prices are set at the margin: what the highest buyer is willing to pay. For many years now, the world has become accustomed to China’s dependable willingness to pay well in excess of everyone else. When China is no longer the highest buyer, how far will prices need to fall in order to match the next highest buyer’s ability to pay?

In Part 2: Why China Is Extremely Vulnerable Now, we zero in on China’s real estate bubble, and the outsized risks it poses to China’s economy — and the world.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

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  • China is just following the path America has taken for decades. Why would Communist care for one second? The New World Order of the Bankster’s soon will be here all of the pieces are in order except one huge thing! Disarm ‘ALL’ Americans. Now, you know why they will not be stopping anytime soon!

    October 8, 2014 It’s Official: China Dethrones America As Largest Economy

    Under One Test We reported in April 2012 that leading Chinese economic analyst (and American ex-pat) professor Michael Pettis argued in 2011 that China’s GDP might already higher than America’s in terms of purchasing power parity. And we noted that Arvind Subramanian – former assistant director in the Research Department of the International Monetary Fund, and now senior fellow jointly at the Peterson Institute for International Economics – says that China passed up the USA in 2010.

    China – the largest army in the world full-hell march HD

  • Isn’t Obama’s campaign slogan Forward? P.S.- I know

    Mao’s Great Famine great leap foward, history of china ‘HDTV’

  • Yes it is and it is about to fire up! Aug 11, 2015 China Devalues: Currency Wars Explode

    China’s surprise currency devaluation yesterday has fueled the ongoing currency wars. Escalation is on the way. Who wins? Who loses?

    • jadan

      Sorry Ron. Gold and silver are also “fiat” currencies. Money is created by law, not God. God did not render the gold standard unto Moses. Gold has no intrinsic value. The management of paper dollars is the issue. The greenback, created by Lincoln to finance the war, was pure fiat monery. It was well-managed and traded on a par with gold.

      • animalogic

        Calling gold and silver “fiat” currencies is liable to cause confusion. Regardless of whether or not god created gold/ money, and regardless of whether or not gold has any intrinsic value, the fact is that gold is not a fiat currency because, unlike paper or blips on a screen gold can not be commanded into existence. Its finite nature renders it to some degree a scarce object. Gold’s inherent resistence to bank/government fiat is what makes it so beloved by “goldbugs” every where. Although highly problematic as a currency standard, gold makes pretty jewellry and excellent electricity conduction too

        • jadan

          It’s not the quantity of gold or silver, it’s the price. Who sets the price? The “market”? For years the price was $35/oz. If it had been traded as a commodity that $35 price would have fluctuated, as it does today. Who set that price? Who said gold or silver could be legal tender in the first place? At any time government can command that gold is legal tender, or it can deny that it is. It is done by fiat, by law. Ron Paul thinks it is a divine fiat. He thinks we need a new gold standard. It didn’t work then and it sure wouldn’t work now.

          • animalogic

            I’m afraid i still find your views on Fiat confusing and confused.
            Essentially you seem to arguing that because goverment “commands” that gold be a legal tender
            gold, therefore, becomes a fiat currency. This, i believe, is confused.
            ANY legal tender is necessarily created by government /legal “command”. However, such a fact does not affect the nature of the physical medium of exchange.
            A fiat currency is “fiat”because it lacks any significant intrinsic value. In essence it is finite: for all intent and purposes, it is capable of infinite physical and numerical multiplication
            (government may create a trillion trillion dollar “notes” /key-stroke credits. ) Such notes etc would then be “valued”by the market.
            Gold however can NOT be infinitely created by ANYONE . Nor can anyone,goverment included simply command its value. Of course governments can TRY to do so. When governments, such as Rosevelt’s, as you mention, command an (official rate of convertibility between dollars and gold they are NOT by definition creating a fiat currency, and nor can they do more than influence the UNofficial market value of gold (i believe its called a “representative” currency.)

          • jadan

            OK, you’re right, gold is not a fiat currency. However, it’s value is determined by fiat and that’s what makes it no better than paper, or tally sticks, or shells, when it is used as a currency. The government declares a legal tender and, ex nihilo, it is valuable. Government could declare gold not acceptable to pay taxes. Still gold has a commodity value and would be considered valuable without being monetized by government. Other commodities have “intrinsic” value also, tobacco, bear grease, platinum. I am just trying to emphasize that the school of thought represented by Ron Paul’s superstitious awe of gold ( the “Austrian School”) is completely wrong-headed. They use “fiat money” as a term of abuse. A new “gold standard” is being introduced at the international level, called the “SDR”, “sovereign drawing rights”. It is intended to become the benchmark of value that gold once was. But only solid management will stabilize the monetary system and, despite what these gold bugs say, the private central banking system is simply not capable of good management. Genuinely democratic government would do a better job of managing fiat money, and fiat money is the only democratic and practical money we have.

  • A.T.

    Its called the ‘boom-bust’ cycle, and that’s all it is.

    Lots of fiat American dollars simply amplified the effects of natural economic cycle. Russia was caught off-guard by the oil boom-bust, the boom fed by fiat dollars stoking fracked oil. China’s mercantile economy was caught off guard by boom-bust consumerism that followed the oil/commodity boom-bust. All after the Fed taper on QE.

    The BRICS and especially the cornerstones, made the mistake of assuming constant upward trending and shared mutual interest in stability across the board. Despite America’s record for fostering chaos, most obviously by war, less obviously by market manipulation. Its so simple yet so ingenious; just play the boom-bust cycle and let the more naive players hang themselves.

    If America’s competitors learn not to fall for that trick, well that would be interesting since it plays off the psychology of greed and need. China’s stock market players single-handedly torpedoed their own economy with a little Goldman-Sachs goosing of the invisible hand.

    Its not a convincing argument to say China’s black box system is any more dishonestly inscrutable by its opacity than the West’s incomprehensible crony capitalist open box system. Especially given

    For example, Doug Litowtz put out a hilarious column speculating that Donald Trump is actually broke, based on Trump’s financial disclosure documentation mandated by his GOP entry. Trump’s finances supposedly are an open book. Good luck deciphering what it actually says.

  • jadan

    In order to interface with the global economy, China has to construct a financial Potemkin Village. This creates an impression of familiar territory for foreign investors. They persuade themselves that familiar economic “laws” work in China, as they do everywhere, even on Pluto. There is the god-almighty market, supply & demand, foreign exchange and so forth. They are naive, however, and I have read nothing that indicates to me that your typical swash buckling western capitalist understands what really moves China.

    Here’s what really moves China: the number of “mass incidents” that occur each year. When the Party gathers up all its membership for the Big Party in Bejing, particular attention is paid to these mass incidents. They could be minor altercations, such as 200 outraged villagers attacking a corrupt party official and sacking his premises. They could be larger incidents involving thousands protesting one social problem or another. The Party evolves policies based on the number and character of these mass incidents. The overriding goal for the Party is social stability. China IS a tinderbox, the world’s largest.

    Therefore the Party aims to achieve enough employment and enough of everything else the mass of people require so that they won’t spontaneously erupt in an uncontrollable mass incident that sweeps the nation into chaos. Too much debt? No problem. The state banks eliminate it. It’s just a keystroke or two or three after all. The Fed has to devise something that looks and sounds like real finance, say, “quantitative easing”. This bails out the favored few and saves the stupid and senseless private monetary system. The Party doesn’t need such pretense. By dark of night, the debt evaporates. And so what? Where’s the harm if the blue nose westerners don’t see the sleight of hand and are just ga ga over growth stats? There’s no harm. Debt is not sacred. Bankers do what they’re told. Forget generally accepted accounting principles. Legal is what the Party says it is.

    The Party can and will do whatever it takes to hold 1.5 billions people together.

    • Just like here in America, “Who controls the issuance of money controls the government!” Nathan Meyer Rothschild

      • jadan

        True enough! The monetary system here is manipulated in the interest of the 1%. China is “Keynesian economics” ( as Ron Paul would call it ) and the massive population demands that monetary policy takes the 99% in greater consideration….

  • A.T.

    This article and discussion are certainly interesting. Brings to mind an RT article by Pepe Escobar:

    “Mass incidents” eh? Love that democracy in action. So far few corrupt Western banksters or officials ever face serious justice. Although Mr. Hugh Smith has written about Western, and particularly American, political economic corruption, what are his credentials to evaluate China?

    Suddenly he’s an expert on China, repeating an almost propagandistic evaluation of an opaque, floundering and corrupt Chinese economy? Its also interesting to note – Democrats have tended to be more hawkish on China than Republicans in recent decades. Its sort of a good cop bad cop routine.

    A more polished and experienced international commentator, Pepe Escobar, is quite taken with China’s drive to realize MacKinder’s Heartland theory. A Eurasian century with the indigenous Slavs and Asians in control of their geographies and destinies, not Anglos, as envisioned by Mackinder.

    No government follows GAAP. Generally Accepted Accounting Principles are separate and distinct from GAS, Governmental Auditing Standards.

    Each country has its own version of the ‘yellow book’. Potemkin the historical man, was actually an able administrator. The Potemkin Village something of a contentious myth amongst historians. How mythological yellow book narratives are, rarely come to light although Cyprus and Greece are notable exceptions.

    Watching Potemkin American versus Potemkin China is better than Game of Thrones.