A very particular theory of political leadership

I don’t mean this to apply to any specific country, but the recent reaction of Chinese policymakers to their stock market crash got me thinking.

Imagine two equilibria.  In the first, repression is harsh.  Policymakers don’t have to do such a good job with the economy, because they keep their jobs no matter what.

In the second equilibrium, people recently have come out of the first equilibrium, and so they do not trust policymakers very much.  They judge policymakers by outcomes, and so policymakers feel compelled to perform and to deliver high rates of economic growth.

When the tailwinds are positive, political stability is fairly high and policy is good and growth is robust too, the best of all possible worlds.   Policymakers take a long-term perspective because the favorable tailwinds still enable them to meet the expectations of the citizenry, and the long-term perspective keeps them in power for a while to come.  Of course you can think of catch-up growth, and the seizing of low-hanging fruit, as one form of positive tailwinds.

But recall that the “citizen trust contract” with policymakers is ultimately a fragile one and based on a series of quite short-term evaluations.  When the tailwinds are less positive, the policymakers must take on a much shorter time horizon.  They will prop up stock prices now, or try to, even if that is foolish.  They are quite afraid to show their impotency as policymakers in some realms, for fear of looking weak more generally.  Their favorable performance in the previous periods was in fact based on relatively modest levels of talent advantage, relative to other potential leaders, and so they are reluctant to see the citizens asking so many questions.  They want to keep all of the economic reports positive, rather than look like people who would allow 80 million citizens to lose most of their savings.

But avoiding the unpleasant outcome is not possible, and so these bad policies in turn make the tailwinds yet more negative.  An unwinding begins, as both policies and outcomes become less positive, and the contract with the citizens is based on actual trust less and less.

The same leadership structure can perform either very well or very poorly, with both the same leaders and the same citizens.  And the switch can come fairly quickly, and be occasioned by events which are significant but not transformative on a world-historic or even a country-historic scale.

But fortunately this is a model only, and as well all know, models are false.

Addendum: Here is Christopher Balding on recent developments in China.  But he seems to be more worried since he wrote that post.  At the moment, trading in 89% of the stocks on the Chinese market is halted.  My own tweet was: “One subtext is how much the 2008 crash caused Chinese loss of faith in the USA.”


Can someone explain Tyler's tweet?


They don't want people to lose trust in them like they lost it in the US?


The US stock market crash convinced Chinese the US economy was doomed. So what will Chinese conclude from a Chinese stock market crash?

That's precisely the problem. Only 6 years ago everybody was saying that a bank and market crash was the "end of capitalism" and the " debacle of the US". They put too much effort in saying it was a fail of the government. That discourse made very popular the leaders in China in 2009 but it's a little toxic legacy for leaders in 2015.

I was worried in 2009. From my initial investments in equities for long term I

........I was 70% below in March 2009. Couple years later I was 90% above the initial investment, it was a rough ride . As long as the Chinese avoid selling and stay for long term, they will be fine.

The Shanghai Composite Index lost >70% of it's value from November 2007 to October 2008. What is different this time?

It seems nothing have changed, you read the story from April 2008 and it seems like it was written today.


However, in 2007 it took 10 months for the 70% plunge, this time may be two months for the same outcome.

Of course you can point some blame to government for 2008:

1) Fed blew interest rate policy
2) Regulators may have convinced Lehman they would be bailed out due to previous bail outs
3) Fannie and Freddie did go under, even though years before questions were asked, but some politicians wanted to "roll the dice"

And when he writes "Chinese", which ones is he talking about? All of em? A few? The taxi drivers? Restauranteurs?

The Fed allowed US NGDP to crash in 2008, which had dramatic global implications. So China cannot just except the US to act optimally.

I think China over-revved their economy for the last 15 years or so precisely so the leaders would keep the support of the masses. They overestimated the rate of progress they needed to deliver and thereby set up their economy for a huge correction that could bring about their worst fears.

A slower rate of progress would have caused much fewer misallocations of capital and prevented the Chinese economy from achieving such a severe level of imbalance.

This has been my belief for some time in regards to the Yuan rate and the sterilization of trade surpluses.

China could have been more open to imports via exchange rate and regulation (not demanding JV domestic production for everything, not forcing Chinese to always buy national champions, not forcing Chinese firms to always buy domestic parts, etc.)

Yes, growth would have been a tad slower, but imports do add to growth, and it would keep your trading partners happier, and avoid the eventual problem if a huge mountain of US bonds and what to do with them.

"and avoid the eventual problem if a huge mountain of US bonds and what to do with them. "

I'd consider that a small problem at best. They've got decades to move their investments around.

"A slower rate of progress would have caused much fewer misallocations of capital"

This seems a much more immediate problem. How many apartment buildings that don't have any prospective paying tenants and wind turbines that aren't hooked up to the electric grid can you build?

How long can the Treasury get away with burying old bottles filled with banknotes?

Time to murder a few more political opponents.

It has been an exceptional run. It seems that year on year the standard of living has improved for most people since the Reagan years or longer. As mentioned, lots of low hanging fruit, and a very clearly and violently enforced arrangement where politics is out of bounds, just go make money.

The lack of political feedback and flexibility backed by societal consensus will be a real problem. The self correcting mechanism is to hang someone.

Are 80 million people really so important in a country with 1277 million more people?

As long as food and fuel keep moving...

How do you incinerate that many people?

Depends - do you prefer the more precise version of MIRV delivered nuclear warhead favored by the U.S. or the more brute Russian approach?

And do keep in mind that both countries spend a notable fraction of their GDP to ensure that outcome - though at least according to the U.S., the tens of millions of civilian dead expected in a massive nuclear damage would be unintentional, as the U.S. would only be striking militarily significant targets. In other words, such an exchange is likely to muss the hair of a few more wedding guests, but it would be the fault of the guests for being in the wrong place at the wrong time, and not the U.S. for delivering the ordnance needed to destroy a legitimate target according to American criteria.

"Depends – do you prefer the more precise version of MIRV delivered nuclear warhead favored by the U.S. or the more brute Russian approach? "

Why would you not mention the favorite methods of your most favored country, Herr P_A?

They are far too primitive - the Germans never developed nuclear weapons, and let's be honest, Zyklon B was used for gassing, not incineration. Bullets are probably too mundane to mention in this context, it should be further noted. And though the V2 was an inspiration, especially for the U.S. after testing at White Sands, its death toll was definitely second rate (7000 dead following 1500 launches, with a death toll of less than 5 for each launch, according to this link - http://www.dailymail.co.uk/news/article-2750353/Interactive-map-reveals-hundreds-sites-Hitler-s-V2-rockets-killed-thousands-British-civilians-final-months-WW2.html ) when compared to either Fat Man or Little Boy.

'your most favored country'

Actually, my most favored country remains the U.S. - but I've given up hope that it will ever return to its peak when I was growing up, as seen during the age of civil rights, the Nixon resignation in the face of impeachment for gross misuse of power, and when a brutal war involving the death of millions based on lies was ended due to public opposition. A nation possessing a manufacturing economy that was the envy of the rest of the world, one able to reach the Moon, based on publically funded institutions providing the basis of continuing expansion of America's abilities, such as NASA, the NIH or (D)ARPA.

But unlike with Germany, where essentially no one denies their nation's horrible past (and those that do are generally considered Nazi scum), that American phase of actually acknowledging its own history and actually trying to do better lasted somewhere around a decade and a half.


INOW, everything you mentioned happened, the result was a decline in the US, therefore we should do it all again.

"Are 80 million people really so important in a country with 1277 million more people?
As long as food and fuel keep moving…"

It's not the number. It's the fact that those people represent the Chinese upper class. If the upper class believe they are going to loose substantial assets, they'll take actions to prevent the 'realization' of the loss.

"As long as food and fuel keep moving…"

The food and fuel haven't stopped moving in the US for over 150 year. That doesn't mean the Great Recession wasn't pretty bad.

Yea, there are no shortage of countries of late that underwent revolution despite plenty of food and fuel. Id say all the middle eastern counties in turmoil right now fit that description.

Rephrasing a bit perhaps .. When times are good and the money is rolling in then speculative projects and employee hirings get funded. Trust and optimism are high. Over time the original advantages lessen (substitution goods, competition, declining marginal productivity and so on). Belt-tightening ensues (and the Madoff's and Milken's no longer sustainable get uncovered, but types of resource diversions are clever and numerous). Deadwood employees and projects not in the reach of the core competencies (comparative advantages) becoming increasingly cut-off to maintain the core businesses. Much screaming and wailing ensues. Trust evaporates. People become pessimists. Marketing perspectives dominate during the optimism phase, accounting and finance during the pessimist phase. Kind of a standard cycle for many industries and businesses? A simple model I more or less encountered in a business history case-studies course decades ago. Grow and trim gardening. Only generalizing to the nation-state level?

Sure, it was too be expected; the longer the boom time goes on the more bad decisions pile up making the inevitable correction more dramatic.

But this isn't about economics, it is about the legitimacy of the government. In a democratic system the discontent is channelled through the electoral system, vote the bums out or whatever. In an authoritarian system you have the central bankers flee the country. Bernanke didn't have to.

An even simpler theory - when the consequences for incompetence are low, incompetence flourishes. That applies to nearly every human endeavor - for example, the TSA's recently reported 98% failure rate of detecting concealed weapons, when there are no actual terrorists it doesn't matter if you can't detect them.

Apparently ordinary Chinese are not very invested in the stock market and financial assets more generally. Also China is dominated by an authoritarian state and the finance sector is much less powerful and influential. Financial asset price inflation is less of a priority there and there's less demand for it.


"The stock market wealth effect in China is smaller than many assume, as stocks represent less than 15% of household financial assets and equity issuance accounts for less than 5% of total social financing," writes Qu Hongbin, HSBC's chief economist for Greater China, in a Tuesday note to clients.

For the average household, consumption growth is driven primarily by income growth, not changes in wealth, according to Qu. Also, most households put their wealth in cash and deposits — not in stocks.

As for corporations, most of them don't rely on the stocks as a source of financing, and a huge part of China's banking sector isn't "imminently linked" to the stock market, according to Qu.

Excluding the recent IPO surge, the total equity financial year-to-date makes up less than 5% of the total social financing.

And "third, although margin financing on the equity market has risen rapidly, the trend has started to reverse over the past few weeks," Qu said.

Interestingly, not only do most Chinese people and corporations stay out of the stock market, but many also have a different view of the system than the average American or European.

"Local investors see the stock market as a short-term place for profit-taking, not an indication of China's well being, and are far more confident in the Chinese authoritarian, state-capitalist system (and are certainly untroubled by its sustainability as a new, hybrid model)," Eurasia Group president Ian Bremmer wrote in a note on Monday.

Does this really add up with the government's actions over the last week?

They want to keep all of the economic reports positive, rather than look like people who would allow 80 million citizens to lose most of their savings.

To put that in perspective, the Chinese Communist Party has more than 86 million members:


I wonder what a venn diagram of those two groups would look like.

You would need to include relatives/family members, and then work out the guanxi factor - https://en.wikipedia.org/wiki/Guanxi

Apparently,, "In terms of occupation, farmers, herders and fishers totaling 25.35 million is the largest group," in the Chinese Communist Party.


Instead of assuming that the Chinese leadership and citizenry are neo-liberals and theorizing from there, you should read what they, you know, actually say and stuff.

From China’s recent “Document 9″, a Communiqué on the Current State of the Ideological Sphere A Notice from the Central Committee of the Communist Party of China’s General Office:


Noteworthy Problems Related to the Current State of the Ideological Sphere

4. Promoting Neoliberalism, attempting to change China’s Basic Economic System.

Neoliberalism advocates unrestrained economic liberalization, complete privatization, and total marketization and it opposes any kind of interference or regulation by the state. Western countries, led by the United States, carry out their Neoliberal agendas under the guise of “globalization,” visiting catastrophic consequences upon Latin America, the Soviet Union, and Eastern Europe, and have also dragged themselves into the international financial crisis from they have yet to recover.

This is mainly expressed in the following ways:

[Neoliberalism’s advocates] actively promote the “market omnipotence theory.” They claim our country’s macroeconomic control is strangling the market’s efficiency and vitality and they oppose public ownership, arguing that China’s state-owned enterprises are “national monopolies,” inefficient, and disruptive of the market economy, and should undergo “comprehensive privatization.” These arguments aim to change our country’s basic economic infrastructure and weaken the government’s control of the national economy.

It wasn't so much a change of tailwinds as doing something so obviously unsustainable that any eight-year-old could have told them it would end like this.

Cut 'em some slack. They're still pretty new to this whole market economy thing.

Eh, not really. Other than the recent, brief on a historical scale interruption, they've had a market economy continuously for thousands of years, and for much of that it was the most successful in the world. The Chinese people are short of some things, but literacy in market economics is not one of them.

Even if China had endured a thousand years of total socialism, that would still be no excuse for manipulating a stock market up by 150% in a year and then panicking when it drops 30%.

A false model is one that makes only incorrect predictions. Its existence is logically contingent on that of a true model.

You can't even trust models to be wrong.

So perhaps the crackdown on liberal reforms since the new premier was installed was a prelude to the what the Chinese saw as an inevitable crash of the market.

I wouldn't be surprised if corruption was such a big part of the Chinese economy, and involved so many people, that Xi's recent crack down was the trigger for this.

Corruption is a big part of every economy. In fact, corruption is THE major factor in every aspect of human existence, including politics, government, religion, business, education and even sports.

Please yourself.

The leadership should have played the crash as a "healthy correction." Milk it as a sign of financial maturity. Foreign investors would lap that up and it would absolve the leadership of any responsibility. Yes people would lose money, but not enough to threaten the regime.

Instead, they told state-owned banks to prop up the market. Then the market continued to drop, and now it looks like the leadership is powerless to stop the carnage they clearly want to stop.

Really they picked the worst option. Now they are simultaneously creating moral hazard by supporting dumb investors, and also looking quite impotent. Hope the generals chose to invest in real estate or there could be fireworks

Another demonstration of the importance of having a plan B ?

This very interesting article provides a plausible account of how the Greek government reached its current bind:

It's original plan - attempting to achieve solidarity between the southern debtor states - was rational. The reaction to the plan's failure less so.

Does this model include the effect on the ruling cadre of what happened to dear Mr and Mrs Ceaușescu?

This made me look up Ceaușescu. Interestingly, in "Ceaușescu's final speech" in wikipedia:"Thousands of workers were bused into the square under threat of being fired. They were given red flags, banners and large pictures of Ceaușescu and his wife."

Except for the " under threat of being fired", how this approach is still being used by US version of the Communist Party.

Ceasescu had been kicking around for 24 years. Chinese leaders now circulate in and out at five and ten year intervals. There was also a bizarre cult of personality surrounding Ceausescu and his wife. In addition, the general public had seen a severe decline in personal consumption as Ceausescu was determined to pay off the foreign debt early. To add to that, Ceausescu got the ideal in his head that peasants should live in dormitories, so most of the country's antique villages were razed and replaced with multi-story flats.

Yes, yes, but more importantly what does this mean for house prices in Vancouver?

The elites sold shares to illiterate farmers and put the money in their pockets. Now the market is collapsing and the peasants are angry. The elites still have the sale proceeds and a new motivation to "get out of Dodge".

Conclusion: this is positive for Vancouver house prices over the next few months.

Policy makers' response in China is different from the policy makers' response in the U.S. and Europe: in China, it's a combination of aggressive monetary stimulus (highlighted by Cowen) and aggressive fiscal stimulus, whereas in the U.S. and Europe, it's been primarily monetary stimulus with little fiscal stimulus. Will it make a difference? We'll see. What we know in the U.S. is that reliance solely on monetary stimulus has its own risks, including fueling another bubble. What's more, monetary stimulus favors owners of assets (because it inflates the value of assets), which helps preserve, and exacerbate, excesses, including excessive inequality; to the extent excessive inequality is an economic problem, reliance on monetary stimulus reinforces the problem. How is China's response different: by including aggressive fiscal stimulus, the effect should be a more balanced recovery, not one dependent on inflating the value of assets. As a contrast, economists of the Austrian school would eschew both monetary stimulus and fiscal stimulus, and let markets correct excesses - including excessive inequality (albeit that isn't something they emphasize). Whatever result China experiences from its two-pronged response, the singular response in the U.S. (and the unbalanced recovery that has resulted) is likely to add support to the Austrian approach in the next financial crisis; my observation is that resistance to fiscal stimulus (and the absence of a more balanced recovery that would have resulted with fiscal stimulus) has been part of a strategy to create resistance to any stimulus, including monetary stimulus, in the future. Cowen is the optimist (or pessimist, depending on one's point of view), and seems to believe policy makers will always respond to the loudest voices, which typically comes from those with the most to lose (and gain). Who would that be? The owners of assets. Which suggests that policy makers (i.e., the Fed) will always respond to a financial crisis with aggressive monetary stimulus to inflate the value of assets. I'm not as optimistic (or pessimistic), and fear (hope for) the Austrian day of reckoning.

"What’s more, monetary stimulus favors owners of assets (because it inflates the value of assets), which helps preserve, and exacerbate, excesses, including excessive inequality; to the extent excessive inequality is an economic problem, reliance on monetary stimulus reinforces the problem."

Prof. R. A. Werner believes that there is a 'right' type of credit and a 'wrong' type of credit. There is 'productive' and 'unproductive' credit.

“Importantly for our disaggregated quantity equation, credit creation can be disaggregated, as we can obtain and analyse information about who obtains loans and what use they are put to. Sectoral loan data provide us with information about the direction of purchasing power - something deposit aggregates cannot tell us. By institutional analysis and the use of such disaggregated credit data it can be determined, at least approximately, what share of purchasing power is primarily spent on ‘real’ transactions that are part of GDP and which part is primarily used for financial transactions. Further, transactions contributing to GDP can be divided into ‘productive’ ones that have a lower risk, as they generate income streams to service them (they can thus be referred to as sustainable or productive), and those that do not increase productivity or the stock of goods and services. Data availability is dependent on central bank publication of such data. The identification of transactions that are part of GDP and those that are not is more straight-forward, simply following the NIA rules.”

This is indeed interesting. The DJIA 45% average descent in mid-late 2008 took 10 months to find a bottom. Shanghai Composite index went down 30% in one month. The positive side is the bottom should be very near at this rate.

For journalists, where's the boundary between sell-off and crash? A 45-50% average equity price loss is called market crash. So far, a 30% price loss is a "sell-off", "a fall in the markets", "turmoil".

"The positive side is the bottom should be very near at this rate."

Is your assumption that the bottom is bounded by 50% of the high?

It doesn't seem it will take 10 months to make 70% plunge as last time in 2007-2008.

I'm curious if the people that borrowed money in the last months to buy equities are the same that got caught in last crash.

stock market panics may be bad, but political leadership panics are worse.

You're right to point out how Chinese political leaders and their apologists trumpeted the failure capitalism in 2008. However, the Chinese leadership won't eat crow, unless they're from Guangdong.

One big concern would be a military move designed to distract the Chinese people.

"as well all know, models are false."

... but some are useful.

Tommy Friedman and all the others who fantasize about turning the US into a communist dictatorship "for a day" are going to be so sad.

China stock market crash, NYSE suspended, United flights grounded due to computer "glitches".

Cyberwar could be a possible alternative theory.

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