Chinese Salami Slices

In 2008, a 22-year old recent college graduate, Michael Largent, was arrested for bank robbery to the tune of $50,000 in Plumas Lake, California. Yet instead of finding the prosaic weapon and ski mask typically associated with a run-of-the-mill bank theft, prosecutors raided his computer to find that Mr. Largent had funneled several cents from tens of thousands of brokerage accounts on E-trade and into several accounts to amass a small fortune.

However, this imaginative stunt, also known as “salami slicing”, may not be limited to computer nerds with a working Internet access. On the contrary, entire extractive institutions have been constructed to facilitate the theft of wide swaths of the population. And perhaps the most blatant form of this kleptocratic system can be found in the world’s largest emerging market: China.

In last night’s debate, there was a significant amount of debate surrounding China’s currency manipulation and their financial practices. Mr. Romney in particular was perhaps the most blunt when he stated, “It holds down the prices of their goods. It means our goods aren’t as competitive and we lose jobs. That’s got to end.”

Putting aside the fact that his protectionist policy to impose tariffs would result in a devastating trade war and the fact that there are even worse manipulators out there than China, the fact of the matter is that the United States “only” exports approximately $103 billion worth of goods to China every year – a paltry .06% of the United State GDP. While our trade partnership with China is an important one, the more important economic concern with China is its stability in the future.

Paul Krugman in a recent post pointed to an interesting theory on the Chinese version of kleptocracy and financial repression. The theory posits that the Chinese elite artificially lowers interest rates through currency sterilization (printing up massive amounts of Chinese RMB for the sole purpose of buying up US dollars) and regulated returns on savings. Lower domestic interest rates mean lower savings returns for every low and middle-income worker in China. For example, instead of earning 8% interest on their savings to keep up with 8% inflation, they are earning near 1%, essentially losing 7% of their earnings every year in real terms. For the average family who deposits $1,000, they may see their savings account earn $10 when in reality they should be earning close to $80 to keep up with inflation.

You may be asking, “where does that extra 7% go?” Here’s where it gets interesting: Usually when you take out a loan to pay for a home or a business, you pay interest and that interest is used to partially pay the bank and partially pay the depositor. However, because everything in China is state-run from their banks to their corporations, banks are able to lend state-run corporations extremely cheap loans to finance anything from apartments and airports to factories and office buildings, which bureaucrats can then use to pay off loans and make an immense profit at the expense of the working class. Essentially, the 7% off of every bank account in the country goes straight into the pocket of the Chinese elite.

These “investments” continue the cycle as they continue to artificially drive up GDP and inflation and make the gap even larger. And because the elite make a profit regardless, by financing these projects with no risk (no interest), they could invest in any number of unprofitable ventures (unused roads, empty malls, etc) and still drive the cycle, while still keeping the people happy by giving them a paycheck at the end of the day. In fact, the incentives are so distorted that its more profitable to invest in an apartment with -3% returns (or say a US Treasury bond with 2% returns – which may explain the Chinese penchant to buy up US debt) than a bank account with -7% returns, leading many to speculate on China’s massive housing bubble. With the savings rate as high as 38% and limited options for banking, the average working Chinese middle class family gets robbed of their wealth little-by-little every year by their government – a real salami-slicing scheme of massive proportions.

If this theory is correct, China is in for a rude awakening, as a rapidly aging population (due in large part to the one child policy) with no welfare state begins to pull out their savings – drying up the capital for the elite to embezzle. And with no more capital to invest, GDP deflates, as state run corporations are no longer able to run a profit and the cycle begins to accelerate as the gap continues to shrink and all the costs of all those unprofitable ventures finally begin to collapse.

While the United States may not be the example of a moral arbiter given recent events in Guantanamo and Abu Ghraib, the issue of a stable and prosperous China is one that is not only important to United States and its own stability, but the hundreds of millions of Chinese low and middle income people that continue to see their wealth deteriorate at the expense of their government. Americans would do well to stop demonizing all Chinese people in public discourse and begin to look at real world solutions for the well-being of all.

As always, I am always open to emails at, tweets at @timthwang, and Facebook messages at timthwang.


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