Fragile or fine, China continues to puzzle

Given its history of excesses and imbalances, it's difficult to categorise or identify China as a political-economic risk. But fragility could be its black swan event in 2015.

Lowy Interpreter

The Black Swan, by Nassim Nicholas Taleb, is a parable for unanticipated risk: the possibility of 'unknown unknown' events that no-one sees coming.

In a new essay, The Calm Before the Storm, Taleb further posits that perceptions of risk are distorted by 'fragile stability'. Some countries (eg. Saudi Arabia) are inherently more vulnerable to exploding one day in spite of (or likely because of) their continuity, concentration and monolithism. The flipside of this concept, less intuitively, is that 'anti-fragility' can be borne out of the very experience of crisis. The likes of Italy may be resilient precisely because they continually face chaos and flux.

Taleb's idea isn't a new one -- the economist Hyman Minsky noted 'the instability of stability' decades ago -- but his anecdotal depth and topical understanding of current affairs makes the essay a riveting read.

Even to the formidable Taleb, though, one country is sui generis and escapes easy identification. At the very end of the essay, he acknowledges 'the China puzzle.'

Another superbrain, historian Niall Ferguson, also concedes that 'China is the country hardest to categorise' as a political-economic risk. China is difficult for Westerners to understand because its singular pursuit of economic development tempts excesses and imbalances. Yet the farther, faster and longer it gallops, when a bust would typically loom more probable, China looks ever more invincible and assured. As Ferguson admits, "there is unlikely to be a Lehman moment".

China may end up with something different, however: a prolonged correction.

Japan in the 1980s was also a robust, healthily growing country with a dominating political system and abundant domestic savings. Few would have characterised Japan then as endangered, but its unwillingness to confront its economic excesses haunted it for 20 years and left Japan today 'moderately fragile' (in Taleb's definition) because of soaring leverage.

Some of Japan's blights have become worryingly apparent in China: zombie companies supported by zombie local governments often hiding local debt and propping up their own land markets.

It is often joked that there are no communists in China, and that Japan and North Korea are the only communist regimes remaining in Asia. But one commonality between China and Japan is their distaste for social disruption from the capitalistic purges of bankruptcy.

This is where Chinese see things differently from Americans. Chinese officially viewed the 2008 financial crisis, America's 'Lehman moment', as an unmitigated failure of the US system and a mistake to be avoided at all costs. They proclaimed their 'superior system advantage' as they poured on the stimulus. "The Chinese lost a lot of respect for the West," a car company executive famously commented. "When you've seen a multinational exec on his knees begging for help, you are not so intimidated by him after that."

But a funny thing happened on the way to America's decline. Its stock market has tripled from its 2009 bottom; employment and growth have recovered. Americans of a certain persuasion would argue that it is the boom and bust cycle that undergirds their system, that the elixir of progress is the creative destruction of crisis that moves capitalism forward.

So the 70 per cent jump in Shanghai's A-share market, now the world's second largest, in just two months is remarkable. When $US2 trillion of market value appears so suddenly, the world pays attention.

True, stock markets are notoriously poor short-run predictors of economic health. This recent action could be more noise than signal, as Taleb would understand. Supportive factors such as lower oil price may be at work. But the bull case doing the rounds is the 'removal of risk', meaning government stimulus and 'doubling down on mega-infastructure'.

Taleb would revel in the irony of this explanation: Chinese domestic investors think that policy continuity, and therefore more leverage, is positive. Yet since 2009 Chinese shares have badly lagged America's, belying the narrative of relentlessly monotonic Chinese growth. There is a giddy, speculative retail feel to the latest bounce. Japan's market also saw huge episodic rallies during its grinding recession. Shanghai's bull market today could be implying that Chinese growth is solidly sustainable, or alas it might be telling us nothing at all.

Because of its vast savings pool, China won't experience a precipitous financial collapse as America did in 2008. Its model of rigid resilience will continue. Just as Chinese media exaggerate problems elsewhere, outsiders can easily take a dark view of China. Adult Chinese have living memory of crisis and struggle; that is an antidote against fragility. Despite occasional external glimpses of frailty and utterances of humility, most Chinese remain convinced of their unstoppable rise. Fragility, either economic or political, would surely be a 'black swan' event in 2015.

This article first appeared on the Lowy Interpreter blog. Reproduced with permission. 

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