Painting, above: Ancient Chinese Rockets  Around 1500, a Ming Dynasty official named Wan Hu decided to use his nation's advanced rocket technology to become the first man in space. He attached 47 small rockets to a chair. Dressed in his finest clothing, Wan sat down holding the strings of two kites that would help guide his flying vehicle. Servants lit the fuses, and then . . .

Boom! A massive explosion! And when the smoke cleared, Wan was gone, never to be seen again. Or he had been burned beyond recognition. It depends upon which version of the story you believe.

Whatever the truth, the tale could have originated only in China. The Chinese were far ahead of everyone at that time in developing rockets, which they used as weapons in combat and as fireworks in celebrations. Ancient Chinese rockets date back to at least the third century. In 228, the Wei State used torches attached to arrows to defend Chenkang against the invading forces of the Shu State.  By the late Tenth Century, the Sung Dynasty (960-1279) had mastered the art of using gunpowder in its rockets. Paper tubes filled with gunpowder and fitted with blasting fuses were attached to arrows. Later on, the gunpowder was carried directly inside the arrow. These high-speed weapons wreaked terror on the enemy.

The Ming Dynasty (1368-1644) saw major developments in rocketry. In the 1550s and 1560s, the famed General Ch'i Chi-guang invented three types of new rockets while fighting against Japanese pirates. One type had a body made of hard wood topped with an armor-piercing sword, spear or knife. Ch'i equipped his ten warships with more than 2,000 rockets; infantry and cavalry units received 4,760 rockets. The missiles were placed on wooden racks, with soldiers holding the rear and lighting the fuses.  Another innovation in ancient Chinese rockets was the multishot rocket, which involved. . .  [more]

JOHN BATCHELOR SHOW

Co-hosts: Gordon Chang, Forbes.com. Dr. David M. Livingston, The Space Show.

Hour One

Wednesday  30 April  2014 / Hour 1, Block A: Scott Harold, associate political scientist at RAND Corporation, on Obama's Asia trip in re: Pres Obama's visit to Japan went well fr both sides: praise fo Abe, and US-Japan Security Treaty reaffirmed (incl Senkakus); progress on TransPacific Partnership deal.  Manila: enhanced defense cooperation agreement. AS China rises and dvps more offensive strike capability, need not to consolidate all defense in one or two places – rather, diversification, and rotational access.  Pyongyang.  Two or three-ear delay, or a conditions-based delay?  Need the latter.  this was  an important and timely trip to ur stops in Asia – need to show the flag, have president, personally involved; with a strong team  All four of these allies have suffered from one or another disaster; US has brought in massive response. 

China tends to see all such visits are entirely related to it; huge PLA dvpt raises the question of how intimately thye US ought to be involved in China.  China: Blast Reported At Railway Station In Urumqi  An explosion occurred April 30 at a railway station in Urumqi, the capital of the Xinjiang region, Xinhua reported. No information is currently available on potential casualties or damage

U.S., Philippines Sign Defense Pact Amid China Tensions  The Philippines and the U.S. signed an agreement that will boost the American troop presence in the Southeast Asian nation, as President Barack Obama said America’s strategic rebalancing to Asia isn’t aimed at combating a rising China.  “Our goal is not to counter China, our goal is not to contain China,” Obama said at a briefing today in Manila, hours after the 10-year defense agreement was signed. “Our goal is to make sure that international rules and norms are respected and that includes in the area of maritime disputes.”  Philippine President Benigno Aquino is strengthening military ties with . . .  [more]

Wednesday  30 April  2014 / Hour 1, Block B: Sarah Cook, senior research analyst at Freedom House, in re: Big Bang Theory TV:  was available to Chinese viewers abt the same time as to US viewers for  seven years.. Suddenly, Chinese State Administration removed it in China – rev=moved a lot of CBS shows.  What does the Chinese Communist party fear now?  Latest theory is that it's pulling viewers away from CCTV, the Party channel. In other words, if you're in China you need to watch what the bureaucrats decree.  Character: Leonard Hofstadter, physicist with 170 IQ. Sheldon Cooper has 180 IQ.  Now people are on social media decrying censorship. These video streaming sites have licensed the shows they stream; ergo, was all legit, no IP violations, till several days ago. 

For months, there have been signs that China’s leaders were poised for a crackdown on the internet. Last year, the government began a campaign against “online rumors,” and new laws against rumor spreading on social media resulted in their first conviction earlier this spring. Last fall, Xi Jinping told propaganda workers that the Party must have “a strong army” to “seize the ground of new media” — particularly the Internet. In February, at the first meeting of China’s new central cybersecurity group, Xi repeated his call for an Internet that will nurture “socialism’s core values.”  “Making cyberspace clean and bright,” as Xi put it in February, is generally seen as a thinly-veiled promise to eliminate any content the Communist Party of China find objectionable — from pornography and graphic violence to accusations of corruption with the CPC. As Tyler Roney wrote earlier this month, China’s anti-pornography campaigns leave major porn hubs untouched while cracking down instead on sites that feature user-generate content, some of which may be offensive to the Party for reasons having nothing to do with pornography.  Last week, China’s anti-pornography campaign struck harder than anyone had expected it to by stripping internet giant Sina  Corp. of its online publication and distribution licenses for both print and audio/video content. Sina’s alleged crime? Releasing 20 articles and four videos that China’s watchdog deemed pornographic. Sina quickly apologized, but that hasn’t helped stem the tide of . . .

People’s Daily: Massive use of exotic words harms purity of Chinese Language  People’s Daily, the state-run newspaper criticized massive use of exotic words in its comment article of April 25 Why ‘Zero-Translation’ Prevails.      Appearance of words like [[http://english.sina.com/culture/p/2014/0425/694986.html – have a look!]] in newspaper reports and serious academic journals not only harms the purity and health of the Chinese Language, but also erodes the essence of Chinese cultural spirit, as the article pointed out. “Why can ‘Nokia’ and ‘Motorola’ be translated into Chinese but not ‘iPhone’ or ‘iPad’? When English absorbs Chinese words, the words are written in roman letters, why the Chinese language has to be mingled with a lot of English words?” The article questioned.

Some doubted that the Chinese language would be ‘impure’ just for a few English words. One named“动衣” said on Weibo: “Chinese Language has incorporated so many words during the thousands of years such as Buddhist terms and Arabian numbers. If the Chinese is becoming impure for several English words, you can’t read anything but ancient Chinese, because all the punctuation marks come from foreign languages.” Famous blogger “五岳散人” said: “I don’t know what has to be pure in Chinese. Do you think simplified Chinese characters pure**? Can you even speak without the modern words taken from Japanese? Health is to move forward (with time). There’s no sense of calling an old virgin healthy.” There are also netizens who supported the article. “海中岩ha” commented on Weibo that  . . .

Wednesday  30 April  2014 / Hour 1, Block C: Michael Listner, SpaceLawSolutions, in re:  "Outer space shall be used for peaceful purposes" – e.g., US GPS program, which began as mil and now is primarily civilian. An anti-sat weapon, or positioning one in space, wd be prohibited if it had an aggressive nature to it.  Were China to withdraw from the treaty it'd damage it’s regional soft power.   Treaty requirements have been followed for so long by Russia, China, and the US that it's now de facto in practice more than simply treaty regs.  US has annoyed Russia, which in response remarked, "If the US wants to keep getting to the ISS, it'll have to use a very large trampoline." The IGA: all signatories to this on ISS (?).

China's President Xi Wants More Military Use of Space: Report   Chinese President Xi Jinping reportedly asked his nation's air force to hasten its integration of air and space capabilities. During a visit to the air force headquarters of the People's Liberation Army in Beijing on Monday (April 14), Xi urged the development of a "new-type combat force" and told military leaders they need to be able to deal with air and space emergencies "swiftly and effectively," the English-language newspaper China Daily reported. The news report gave few details on how . . . [more]

The SpaceX lawsuit filed against the govt to break the AF launch monopoly: SpaceX is being opportunistic about RD-180 engines, esp Atlas 5 rockets; political posturing.  Not natl security but legal considerations will resolve this.   Air Force hurrying up deliveries because of Ukraine pressure? Bill in House to prohibit AF from using the RD-180 in any launch vehicle. 

Remark by Xi Jinping that he wants China space to hurry to more militarization . . .   looks to be a challenge to Outer Space Treaty 1967 . . .  China's President Xi Wants More Military Use of Space: Chinese President Xi Jinping reportedly asked his nation's air force to ... But China's space program has raised some concerns among U.S. ...   China's president Xi Jinping warns against growing threats ... Chinese President Xi Jinping said on Saturday that China faces increasing threats to national security and warned of the dangers of terrorism in a speech indicating that Beijing could impose tougher controls on its ethnic minorities. Mr Xi told a study session of the party's decision-making Politburo "to resolutely stamp out the brazenness of the terrorists," the state-run Xinhua news agency said. Mr Xi's comments come at a sensitive time for China, as authorities battle unrest in the Tibetan regions and in Xinjiang, home to Muslim Uighurs.  Unrest in Xinjiang has led to the deaths of . . .

U.S. Submarine in Asia Trip as Obama Seeks to Assure Allies   A U.S. nuclear submarine is making a port call in Singapore as the Navy showcases its ability to operate in shallow coastal waters after questions about the fitness of its Littoral Combat Ship for use in Asia.

Wednesday  30 April  2014 / Hour 1, Block D: Alim Seytoff, Uyghur American Association president, in re: An attack in Urumchi, in Hsin Jiang ("New Territories") or East Turkestan: Urumchi South Railroad Station, three dead, many injured.   Beijing claims it's done by "splittists"; others say that, after a four-day visit to Xinjiang by Xi, the Uyghurs are weary of  being physically and culturally oppressed under the Party's colonial rule and heavy  boot. Total failure of the Party's colonial rule.  After Xi Jinping became president over a  yea go, he took a very harsh approach; more violence in the region and police authorized to shoot and kill Uyghurs – many many extrajudicially.  Note also attack at Kunming station in the southwest – apparently not Uyghurs but outsiders who’ve taken up the Uyghur cause.  Govt shot people dead; there was an unfamiliar flag there, and a knife used was distinctly not a Uyghur knife. Govt washed the crime scene in hours, no one has any way to figure out what happened. Cover-up.  Failure of the security forces.  Xi may have non-Uyghur enemies who had something to do with this. 

Hour Two

Wednesday  30 April  2014 / Hour 2, Block A: Anne Stevenson-Yang, co-founder of J Capital Research in Beijing and author of China Alone: The Emergence from, and Potential Return to, Isolation, on her "The End of an Era."; in re:  Cities all around Hangchou: residence prices are 30-40% down. Food consumption either is flat or has been falling for years.  Govt numbers are horrendously unreliable; financial svcs my be slightly up. When you have to keep driving the GDP, it’s frozen-heated. PMI at 51.4 – purchasing mfr index.  The HSBC Market PMI is better: above 50 = expansion, below 50 = contraction.  New York: $18.5 mil for a three-bedroom in Manhattan;  Chinese  are buying apt in New York, ostensibly for their children to attend college – and the children are toddlers.  Falling real estate prices in China and falling ren min bi (7RMB to $1) mean that Chinese people want to pull their money out.  "It's only when the tide goes out that you see who's swimming naked."—Warren Buffett.  China held RMB at 8.5/1 for twenty years; then let it fall to bring cash in to the economy, now has to let it plunge. There aren’t a lot of buyers in China any more – just syndicates, group buyers and organizations; but outside of the huge cities, no real market.  One secondary city has 15 years' worth of inventory. 

Wednesday  30 April  2014 / Hour 2, Block B: Mike Davis, professor of law at the Hong Kong University, on this: Chinese call for boycott of Hong Kong after urine incident  A Mainland couple with a small baby allowed it to pee in situ; HK was offended, issued a desk appearance ticket; Mainland now proposes to send thousands of adults to pee in the streets.  Mainlanders also want to sit on the train, or eat on it, both f which are forbidden and incur a polite remonstrance.  On the Street in Mainland, children run around with no diaper, which is forbidden in Hong Kong.  SoHu, an online news outlet, asked, got 260,000 Mainlanders responses saying that they think Hong Kongnese are prejudiced against them.  [In New York City, often easy to identify some Mainlanders in the subway: clothing unsuitable by local standards, personal carriage a bit off.] 

Wednesday  30 April  2014 / Hour 2, Block C: Gordon Chang, Forbes.com, in re: in 2012 the US did not honor treaty obligation with Philippines in protecting Scarborough Shoal from China . If Pres Obama becomes resolute, problems can be obviated; if not, we may be heading toward the next enormous conflict. "Don’t you do a NATO on us" cried the Chinese defense minister (ref: encircling China with US allies). But of course, the US is trying to contain China, which engages in acts of naked aggression, and heading to the same thing in the second Thomas Shoal.   The knife attack in Urumchi immed following Xi's visit was seen as a specific offense to Xi. 

Wednesday  30 April  2014 / Hour 2, Block D: Paul R. Gregory, Hoover &  Real Clear World, in re: Is Putin's New Type of War in Ukraine Failing?

Hour Three

Wednesday  30 April  2014 / Hour 3, Block A: Monica Crowley, Fox, in re: "Kyiv has lost control of Eastern Ukraine," incl Donbass raion, also Odessa oblast.  Senate Republicans are pressing the Obama administration to do more to help Ukraine and hurt Russia and are introducing a new bill that would provide for weapons, sanctions, and more aid. Nineteen Republican Senators joined together Wednesday to unveil new legislation on Ukraine and Russia in an effort to pressure the Obama administration to increase its support for the embattled Ukrainian government and provider harsher sanctions on the Russian government and economy.

The legislation is born out of increasing GOP frustration with the Obama administration’s policy. It would authorize arms for the Ukrainian armed forces and mandate, with a waiver for the president, more sanctions against Russian officials, banks, and leading companies including Gazprom and Rosneft. The bill is sponsored by Bob Corker, the ranking Republican on the Senate Foreign Relations Committee, and co-sponsored by eighteen other Republicans including Minority Leader Mitch McConnell and John McCain.

Wednesday  30 April  2014 / Hour 3, Block B:  Ben Protess, NYT, in re:  U.S. Close to Bringing Criminal Charges Against Big Banks

Wednesday  30 April  2014 / Hour 3, Block C:  Jamie Dettmer, Daily Beast, in re: Kiev has lost control of eastern heartland, says Ukraine's acting leader  Police and security service units defect to pro-Russian rebels as more government buildings are taken over in Luhansk and Donetsk.  (1 of 2)

Wednesday  30 April  2014 / Hour 3, Block D: Jamie Dettmer, Daily Beast, in re: Reality Check in Ukraine
 Both sides are stretching the truth about what’s happening in Ukraine, but one side stretches it more than the other.  Observers Snatched in Ukraine
 EDT Putin supporters have detained the people supposed to help implement the peace agreement signed by Russia in Geneva last week. (2 of 2)

Hour Four

Wednesday  30 April  2014 / Hour 4, Block A: Terry M. Moe, Defining Ideas (Hoover Institution), in  re:  Has Ed Reform Failed? 

Wednesday  30 April  2014 / Hour 4, Block B:  Ken Croswell, Scientific American, in re:  Lives of stars.

Wednesday  30 April  2014 / Hour 4, Block C: Jay Wertz, author,  D-Day: The Campaign Across France (War Stories: World War II Firsthand)  (1 of 2)

Wednesday  30 April  2014 / Hour 4, Block D: Jay Wertz, author,  D-Day: The Campaign Across France (War Stories: World War II Firsthand) (2 of 2)

..  ..  .. 

The end of an era   By Anne Stevenson-Yang April 28, 2014

Last week, in reviewing my coverage list, I read through filings by Yurun Food Group, the pork producer based in Jiangsu. The 2013 Annual Report had this preamble:

“In 2013, domestic food and beverage consumption slightly declined while household demand for meat consumption remained flat, and the growth of the overall pork consumption slowed down.”

This shocking statement is as good a place as any to mark the end of an era in China. Future generations will draw a line at 2014, when the expansion kicked off by the 1994 reforms of then-Premier Zhu Rongji came to an end. From now on, Chinese policy must fight the bottom, not defend the top. The coming year is likely to bring:

• Continued depreciation of the Renminbi toward 7:1 and perhaps even lower.
• Falling commodity prices. We have been predicting for some time that iron ore will go to USD 85 this year. There is no return to USD 115 and above. Copper, as well, we believe will head lower, and other industrial metals and agricultural commodities should follow.
• Defaults on external debt. As we have written elsewhere, Chinese property developers have sucked up the lion’s share of USD debt raised in the last year. They are also the most highly geared of Chinese companies and will have the hardest time paying in a depreciating-RMB environment.
• Continuing defaults on domestic debt. The Chinese market has relied heavily over the last year on liquidity from overseas to support loan rollovers. That liquidity is drying up and, as that happens, there will simply not be enough cash to staunch the flow of debt.
• A free-fall in consumption. Lower returns to capital added to trapped liquidity in the property markets mean that people will have less and less money to spend.

The spark: less capital coming in

Our work on fraud on China’s trade and capital accounts, although prone to a wide margin of error, indicates that more and more of China’s net inflows of hard currency actually represent borrowings from offshore investors who want to benefit from high interest rates in China and are encouraged by a belief in a reliably growing economy and ever-appreciating currency.

Although China has run a net capital inflow every year but one since 2008, the capital exiting both through trade and investment has risen steadily each year. That means that the country has a higher and higher bar to meet in order to keep the domestic economy irrigated with the capital flows required to drive growth.

Table 1. Capital flows by year

Bln USD	Incoming	Outgoing	Net
2008	984.53	944.40	40.13
2009	863.41	664.94	198.47
2010	1,166.65	879.79	286.86
2011	1,449.47	1,184.00	265.47
2012	1,378.32	1,395.14	(16.82)
2013	1,727.10	1,400.90	326.20

Source: State Administration of Foreign Exchange (SAFE)
Here is the quarterly chart showing outflows.

Some of those flows come from corporate borrowings. An even higher amount is speculative investment: based on our analysis of China’s reported trade with Hong Kong versus the trade that counterparties report, we believe that a minimum of USD 210 bln in hot money entered the country in the five quarters from September 2012 through 2013. China may well be entirely dependent now on hot money to supply its banking system with needed capital. That money is essentially hidden debt and ultimately will be reclaimed by overseas investors.

Although China continues to run a current-account surplus, that surplus has come down as a proportion of trade.

Table 2. Annual trade surplus

Bln USD	Trade surplus	Trade value	Current account surplus	Surplus YoY
2007	262	2174.42	0.12
2008	297	2561.06	0.12	13%
2009	198	2205.82	0.09	-33%
2010	185	2972.35	0.06	-7%
2011	158	3640.71	0.04	-14%
2012	233	3867.45	0.06	47%
2013	261	4159.96	0.06	12%

Source: China Customs

This is critically important, because China needs incoming capital to expand credit domestically, and expanding credit is critical not only to economic growth but to keeping debt afloat. With likely more than half of all new credit going to roll over the old, the Chinese financial system is dependent on inflows of capital just as if the nation were hooked up to an IV.

Property: the lynchpin

Hot money, as we have argued before, is a significant source of liquidity for the banking system and therefore financing for property.

My colleague Kevin estimated that, in 2013, hot money was equal to 11.1% of new lending (up from 1.4% in 2009) and 5.7% of 2013 Total Social Financing (up from 1% in 2009).

Table 3. Hot money growth faster than lending

Source: Wind, J Capital Research

This matters, because demand for money to keep property afloat is rising, while the supply is shrinking proportionately. This can only mean defaults.

And this is precisely what has been happening this year. Now, cash-starved, property developers everywhere are dropping their prices to drive cash flow, while also slowing delivery of new property to the market. We recently visited new housing complexes in cities around Hangzhou, where prices have been reported down 30%. In Xuzhou, Changzhou, and Ningbo, as well as Hangzhou, we generally found asking prices down by 20-30% and transactions very slow. Some developers that had sufficient cash resources were simply holding their property off the market and not transacting. We have found the same trends in the Northeast, and China Securities Net reported this week that, in April, prices for housing in Changsha, Hunan fell 30%, while transaction volumes were down 60%.

Cascading failures

As property transactions slow, more and more liquidity is trapped in the sector, and this inevitably leads to financial failures. The most recent report on such a financial failure

	2008	2009	2010	2011	2012	2013
New loans (USD bln)	800	1563	1293	1221	1339	1451
TSF (USD bln)	1139	2271	2288	2094	2573	2822
Hot Money % new loans	3.7%	1.4%	3.3%	6.0%	8.4%	11.1%
HM % TSF	2.6%	1.0%	1.9%	3.5%	4.4%	5.7%

concerns an online lending and investment company called Ruilong Trust, which collapsed in April, leaving over RMB 700 mln in debt outstanding to more than 10,000 investors in 20 provinces. The company had been registered in Shenzhen only one year earlier. The incident prompted Zhejiang police to warn the public that 10 similar online platforms in the province had been operating illegally and had gone bust. The website “Online Loan Home” (Wangdai Zhijia) reported that, in 2013, these online platforms raised RMB 105.8 bln.

Distress among private finance companies tends to multiply. China Business News reported today on a series of failures among textiles firms in Jiangsu Province, a good example of such a chain effect. The textiles industry has hardly been a magnet for financing. But companies without significant hard assets to collateralize typically rely on mutual guarantees to support their borrowing, and the guarantees are often organized through trade associations. As the collapse of the steel trading industry in 2012 proved, this creates a pro-cyclical gearing in a whole industry and region. In textiles, the collapse of one firm affected five others and put at risk nearly half a billion U.S. dollars in mutually guaranteed loans.

In 2012, steel-trading firms, heavily inter-dependent for guarantees, began going bankrupt. Bankers in Shanghai, the hardest-hit region, estimate that local banks are holding RMB 50 bln in bad debt from the steel traders.

Falling consumer spending

All of this inter-related distress leads back to consumer spending. The Yurun report surprised me enough that I looked up statistics on food consumption per capita. Most numbers are available only through 2012, but, even so, only one category, fresh fruit, rose sharply (8%), while four categories, including grain consumption, fell, and the other six rose by less than 5%, surprising in an economy that was reportedly growing at nearly 8%.

Consumption numbers from the NBS almost universally show vigorous growth in the 12% region. But those numbers are the most problematic of all China’s error-riddled statistics system. For one thing, statistics are collected from companies “of a certain size.”

Statisticians seeking to achieve a bureaucratic goal often change the companies included in the survey, so that, last year, only companies selling more than RMB 20 mln per year might have been included and now, companies over RMB 10 mln are included, boosting the sales volume reported. Also, sales are reported by value on a nominal basis and so do not discount for inflation, which is particularly acute in food categories.

It does appear that consumption is falling in many categories and softening in all. Liquor sales rose 4% in 2013, but inventories rose by 46.5% and the proportion of liquor sold to manufactured fell from 99% to 95%. Likewise, beer sales rose 3% in 2013 over 2012, but inventories rose by 23%. Cigarette sales through February 2014 fell very slightly YoY after growing 1% in 2013. The proportion of lower-priced cigarettes rose.

Listed-company reports indicate a gloomy picture. Same-store sales growth was negative in 2013 Q4 for Carrefour, Walmart China, and Jingkelong and in the low single digits for other domestic food retailers. Department stores Golden Eagle, Parkson, Springland, and New World in 2013 Q4 also saw negative SSSG. The exception was Intime, which reported 2% SSSG. Footwear stores all reported zero to negative SSSG in Q4 and in 2014 Q1: Belle, Daphne, Stella, and C. Banner. Esprit and Giordano China also experienced negative growth in 2013 Q4. The bright spot is Coca-Cola, with 12% sales growth in 2014 Q1.

I have written a good deal on the luxury categories in the past, and at the premium end, sales have been plummeting for some time now. The anti-corruption drive supplied a price catalyst, leaving vendors holding years’ worth of inventories. Households at all levels are feeling their economic situation is deteriorating, which is not the consumer confidence scenario that drives luxury goods consumption.

The economist Lynette Ong recently wrote in China Quarterly about her survey of villagers who had been moved into high-density apartment buildings as part of the government’s urbanization program. Among Ong’s conclusions:

“Almost all of my peasant-interviewees complained that their financial situations had deteriorated after being relocated. Closer examination of their pre- and post-relocation

income and expenditures verifies this. . . . While the incomes of displaced villagers declined or remained largely unchanged, their living expenses rose.”

Indeed, this is the situation across China, where “urbanization,” far from creating wealth, has destroyed it.

The new China

These dynamics indicate that there is no return for China to stimulus-led growth. Falling property prices, financial defaults, the promise of higher rates overseas, and falling rates within China have all conspired to make China’s market much less attractive to incoming capital. As long as China chooses to defend its exchange rate, this means low demand for Renminbi and consequently less investment capital within China. And less investment capital in turn means more defaults and more fire sales by developers.

In the meantime, falling consumer spending robs the economy of a critical motor, and, lacking that spending, China can only increase its dependence on credit. All this puts China into a deflationary spiral, with more RMB being sold to defend the exchange rate, tightening credit, more defaults, and so on.

China’s great expansion began when then-Premier Zhu unified the currency, in 1994, at a newly low rate of 8.6:1, bringing together the Foreign Exchange Certificates that could be exchanged for hard currency and traded at 3:1 with the soft Renminbi, which was trading informally in “swap markets.” The January 1 unification began an era of trade expansion that was mirrored by repressed consumption in China, a vast accumulation of foreign reserves, and a concomitant credit expansion within the Chinese economy, as the PBOC busily bought the incoming dollars. Credit expansion well in excess of GDP growth rate has driven one of the world’s most prolonged and extreme investment bubbles, bringing us to where we are today: empty buildings stretching across every landscape in China.

Future generations will mark 2014 as the end of an era in China. From now on, policy choices become critical. Given excellent infrastructure, high savings, and a reasonably stable political system, we can hope that China will weather the coming downturn and emerge stronger.

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