When Chinese President Xi arrives in America, he might best take a detour to Detroit and learn from our mistakes. China, in its attempt to straddle capitalism and socialism, is experiencing cracks in their economic system. A lesson to be learned from capitalism is that failure and bankruptcy are possibilities. Rebirth is an important aspect of capitalism.
“It doesn't matter if a cat is black or white, so long as it catches mice.” “Cross the river by feeling for stones.” These have been repeated phrases uttered by China's Deng Xiaoping, who set the country on its current path toward rapid economic growth after Mao Zedong's disastrous era. China's economic opening-up worked well enough and were most welcome by the Chinese people, especially after thirty years of the disastrous policies. However, some might say, China's economy has hit another road-bump.
Laws and Gravity
If there's an iron rule in economics, it may well be Stein's Law (named after Herb Stein, former chairman of the Council of Economic Advisers): “If something cannot go on forever, it will stop.” This economic law is a way of forcing leaders to address reality.
China has been misallocating its resources. If it does not change course, the country will continue to stumble, turning the Chinese Dream into a nightmare. While President Xi Jinping is in town this month for his State dinner with President Obama, he should dispatch a team to study Detroit's bankruptcy.
Denial has consequences
Once more than $18 billion in debt, Detroit became the largest U.S. municipality to ever file for Chapter 9 bankruptcy protection. The city stumbled into disrepair over multiple decades, taking unnecessary risks. Its leaders made both bad and corrupt decisions.
U.S. Bankruptcy Judge, Steven Rhodes, who skillfully guided Detroit's bankruptcy proceedings, pointed out that the city's bankruptcy plan allowed the city to shed more than $7 billion of its $18 billion of debt and obligations. The bankruptcy plan also brought its credit rating up from junk status to “investment or nearly investment grade” and treated the city's creditors as fairly as it could, setting Detroit on course to restore adequate city services.
The city's troubles not only impacted the image of the city and the people living in it, but it also impacted tens of thousands of people's pensions and benefits, other creditors, and the economy of the entire region and state. As Detroit's problems affected outside it's city bounds, so too has China's economic troubles affected world currency markets.
While the Detroit bankruptcy was painful, it created a once-in-a-lifetime opportunity to shed useless assets and reinvent the city. This phoenix-like rise of Detroit began the moment leaders came together and made tough, painful decisions so that valued assets could be re-deployed to produce productive outcomes. Only a return to corruption and poor decision-making will drag the city back to the nightmare it exited.
Lessons Learned
These basic lessons learned from Detroit's situation could be applied to China:
1) If you have a hole in your roof, fix it! Pretending to patch a hole does not keep the rain out.
2) Real leadership matters. Michigan's Governor Rick Snyder took a calculated political risk in deciding to stop kicking the can down the road and instead make timely, tough, and painful choices to fix a mess that festered for decades by predecessors. Yes, many other players had a role, but a single leader got the ball rolling.
3) Act like President FDR during the Great Depression when he said, “Do something. If that does not work, do something else. But for God sake do SOMETHING.” By acting, Detroit cut loose the anchors of the past and set sail for a new and better tomorrow.
4) Prevention is key. With truthful leadership, thoughtful decisions, mid-course corrections and not denying reality, most financial calamities can be avoided. Making promises that are knowingly impossible is a prescription for disaster.
5) Budget. Make decisions that are rational and for the long haul. To balance a budget you must increase revenue, decrease expenditures, or have some combination of the two.
Tim Worstall, Forbes Magazine contributor and Senior Fellow at the Adam Smith Institute in London puts it this way:
“The underlying point being that making a loss is not just a problem for the organization that is making a loss. At the level of the whole economy it means that everyone is getting poorer. We have some assets here that are worth, say, $100. We use them to produce something that is worth $90: that's what making a loss means, that the costs of production are higher than the value of what is produced. Society as a whole is now $10 poorer. This obviously isn't a situation we want to see continuing. We would much rather, at whatever cost in debt and or shareholder losses, see those assets moved off to do something else, where perhaps $100 worth of assets might make something worth $110, making the society $10 richer.”
China's leaders must address the fundamental and underlying problems facing their economy. China has companies and municipalities with debt that is not repayable and assets that are being wasted.
Perhaps a look to Detroit might work. See what decades of denial followed by facing reality and making tough choices with solid leadership at the helm can accomplish.
“If something cannot go on forever, it will stop.”
No Country can outrun Stein's Law.
