The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (19 page)

So exporting China’s infrastructure boom around the world is China’s preferred route for the much-vaunted ‘global rebalancing’ agenda. Other post-crisis efforts at rebalancing the global economy have made minimal progress. One leading central banker refers to the discussions at the G20 as a ‘depressing waste of time’. The mere absence of a savage trade war in the aftermath of the crisis is the only notable but limited sign of success.

During 2012, Chinese purchases of US Treasury bonds peaked, and then fell substantially. But Japan simply increased its US loans by even more. China slowly began to readjust the value of its currency against the dollar and other currencies. The fundamental imbalance, however, between Western debts and over-consumption, and Eastern surpluses and overproduction, got even worse.

In the USA, the defence secretary and others have played down any potential leverage that China might possess with its still massive stock of US government debt. The situation is broadly described as ‘mutually assured destruction’. China would sustain massive collateral damage if, for example, it attempted to dump its bond holdings.

In this situation, the USA does appear to have obliged China to become a forced lender, a type of bonded banker for its ever-growing debts. It is a form of international financial repression. China’s currency policy, in effect, holds down the living standards of its people, obliging them, and the nation generally, to lend its hard-earned dollars back to the USA. This arises because the dollar is the world reserve currency, and US Treasury bonds are a trusted form of liquid international mega-cash to be swapped with other nations, banks and pensions funds. For the past decade China has had nowhere else to go to park its massive reserves. The USA enjoys what France has referred to for half a century as the ‘exorbitant privilege’ of being the world reserve.

The fundamental question is whether the status of the dollar will change. If you look carefully at what China has been doing, you’ll see that it has been quietly amassing bilateral deals with key neighbours and oil exporters to swap its currency with other central banks. International trade deals are beginning to be priced in renminbi. The Chinese government have called openly for the replacement of the dollar with an alternative based on a basket of currencies. Slowly, surely, in accordance with Deng Xiaoping’s mantra of ‘Crossing the river by feeling the stones’, the renminbi is being internationalised. In February 2013, the UK became the first Western G7 nation to sign up to a central bank agreement to swap currencies. France followed suit weeks later. Twenty of these swap arrangements are now in place. China will have to fully float its currency, and free up financial flows, before the ‘Redback’ threatens the ‘Greenback’. But the keyboards manufactured (probably in China) for the world might soon require a ‘¥’ key alongside the ‘$’.

That is for the future. The recent past and present is still a battleground. Was the global financial crisis China’s fault or America’s? China clearly has some responsibilities, but the overwhelming weight of evidence points towards the USA. Justin Lin goes further, arguing that China does not in fact even manipulate its currency. The evidence for this, he says, is that inflation has not exploded in China despite this suggested manipulation. Indeed, from 1979 to 2002 China’s growth averaged 9.6 per cent, and nearly 11 per cent from 2003 to 2010. As Professor Lin points out, ‘Prior to 2002, double-digit growth was always accompanied by double-digit inflation. Whereas from 2002 to 2010 the inflation rate was not more than 5 per cent.’ That means the inflation-adjusted exchange rate with the dollar, the ‘real exchange rate’ as it is known, is not actually significantly undervalued. Even if it was undervalued, China’s currency has appreciated markedly since 2007, in real terms. Its surplus with the rest of the world is smaller than Germany’s. The growing strength of the renminbi has led some global production to relocate to countries such as Bangladesh and Vietnam that have even lower costs than China.

In practice, that means the flows of those Chinese migrant workers from Sichuan and other places to the coastal factories have sustainably increased the capacity of China’s economy. It was these migrant workers who were the principal reason for China’s giant surpluses. China’s increasing wealth really rests on their shoulders, more than on its currency management. But it cannot last: China’s single-child policy means that by 2015 the size of its working-age population will peak.

More important than the blame game, perhaps, is what China’s growth can teach the rest of the world. As Justin Lin argues, ‘If you look at the experiences of all the successful countries in economic development – postwar Japan, Korea and Taiwan, the transition nations of China and Vietnam, or even the early development of the UK, German, US and French economies – all have relied on the market mechanism combined with active interventions of government.’

The future of China, and the pattern of the world economy, depends squarely on China’s workers becoming even more productive. Three decades ago, only 1 in 1,000 were graduates. Now the figure is 1 in 40. Almost all are products of the single-child policy. Their challenge is to produce more, raise the value of China’s exports, consume more domestically, and also to consume more imports from the West.

Already the transformative geo-economic currents of 2001–2010 seem to be changing direction. China’s piggy bank may have to be deployed closer to home, in support of the murky depths of its banking system. The world’s central bankers are deeply sceptical about China’s conventional and shadow financial system. A glut of cheap credit was deployed in 2009 to keep China growing. Then again, with trillions of dollars saved, the Chinese state has enough cash to keep its banks afloat, without needing to borrow. Chinese factory production is moving inland from the coasts. The great migration appears to be happening closer to the migrant workers’ villages. China’s army of migrant workers wants a fairer share of the profits made, or at the very least to ensure their wages keep up with rising prices. Wages have gone up in some factories, and some lower-value manufacturing is being outsourced to Vietnam and Bangladesh. Younger generations are becoming more consumerist. In inimitable Chinese style, just an hour’s journey from the city centre, the Beijing authorities plan to create a £1 billion ‘Music Valley’ to house music studios and instrument makers. Whereas much of China’s recent growth has depended on
shanzhai
– imitations or pirated copies of Western brands and goods – now the government wants to encourage a more indigenously creative economy. Gangnanomics is half-serious.

When I met Deng Zhi in Dong Guan, he had escaped the production lines, deciding that factory life was not for him. Over the next decade and a half, the wage aspirations, hopes, dreams, eating habits and travel plans of Deng Zhi – and 300 million Chinese like him – will be one of the largest determinants of global prosperity. Just as they have been in the last decade and a half.

As for Deng Zhi himself, he was not left rambling from factory to factory, offering his labour for a pittance. He’d found his calling as a punk hairdresser, catering to his fellow migrant workers. As we spoke, he was dyeing a young man’s spiky mullet a shade of neon pink. Perhaps we are now at the point, where he, and others like him, no longer need our thank-yous.

Dramatis personae

Anonymous UK bank chief executive

Esther Spick, thirty-something holder of Northern Rock Together mortgage

Bertie Ahern, Irish Taoiseach (1997
–2008)

Jay Belleti (name changed), Caribbean hotel owner, former subprime banker

John Muellbauer, Oxford University professor, expert in housing economics

Adam Applegarth, chief executive of Northern Rock

John Apicella, Mr Vigneswaran, Mr Thorogood, mortgage brokers

Antony Elliott, former group risk director of Abbey National

Louise Gowens, struggling with boom-time debts in 2006

Sir John Bond, former chairman of HSBC

Shane O’Riordain, director of HBoS

Brad Rosser, Inside Track property investment club

Andrew Pellegrino, Newcastle buy-to-let property investor

Naomi Jacobs, young first-time buyer in Newcastle, priced out

The Faircloughs, a couple helped by the UK government’s Help to Buy scheme

Peter Redfern, CEO of housebuilder Taylor Wimpey

‘What is the most dangerous toxic financial asset in the world?’ This was the question put to me by the chief executive of a leading European bank. Anxious to display my superior knowledge of the darkest corners of the shadow banking system, I replied: ‘Credit-default swaps on super-senior tranches of asset-backed, security-collateralised debt obligations.’ I thought I had come up with a pretty pithy answer.

‘No,’ he gently chided me. ‘The most dangerous financial product in the world,’ he paused a moment for effect, ‘is the mortgage.’

The mortgage: from the Old French words
mort
and
gage
. Disputed translation: ‘death contract’.

In the middle of the credit-crunch crisis of 2008 I met Esther Spick, then a single 34-year-old mum with two kids living in a maisonette in Surrey. It was the first home she’d owned, bought with an entirely inappropriate mortgage in 2005. She had been living on a council estate in Kingston, Surrey, working day and night to get a deposit to get a mortgage for her £235,000 maisonette. It had been sold – or mis-sold – to her during the boom by Northern Rock, and now the mortgage payments had rocketed by £500 per month. Faced with this, but determined to keep the keys to her home, she had been forced to hand her children over to their grandparents. She’d had to give up her local job and find higher-paid employment further afield. The result? Four hours’ commuting per day.

‘I don’t want to have my home repossessed or for Northern Rock to say I haven’t been making my payments,’ she told me. ‘I will do whatever I have to do, even if it means I have to get out and get a second job. I will definitely make these payments.’ At that point, however, she was in negative equity – not surprising, given that she had been lent over 100 per cent of the value of her home. And her new mortgage was eating up two-thirds of her new take-home pay. ‘They lent me too much. It was a time when everything was wonderful. There was a great big property boom, the prices went through the roof. You were encouraged to go out and buy.’

Now she had boxed up her children’s teddy bears after a charging order arrived in the post. She had fallen behind on just three payments on the unsecured part of the loan. Northern Rock had taken her to court in Newcastle, 500 kilometres from her home. A ‘death contract’ indeed.

The presumption of ever-rising house prices in the USA was, of course, one of the core reasons behind the failure of banks during the crisis. But it was in the eyes of a young single mother from Surrey that I saw the truth: Britain’s housing obsession had become a form of mass psychosis. Housing and property had become hardwired into the sense of national economic well-being. Rising house prices were being reported like football scores. A property portfolio acquired the quality of a household market capitalisation. As house prices surged in Britain, Ireland and Spain, those that pointed out the pitfalls were derided as pessimists, Cassandras and nay-sayers. For example, in Ireland, the then Taoiseach Bertie Ahern said that he could not work out why people ‘cribbing and moaning’ about the property-fuelled Irish economy ‘didn’t go and commit suicide’.

The tiny metal skulls were threaded into Jay Belleti’s dreadlocked beard by the local Garifuna Afro-Amerindian fishermen. He had every reason to exaggerate his eccentricity to the locals. They were naturally suspicious of this gringo and his partner opening a new bar on the poorer shores of the Caribbean. A taxi driver had recently stumbled into the bar, bleeding from gunshot wounds to his ear. He had been left for dead by a pair of Colombians after his cab radio. It turned out he had only been hit in the fleshy part of his ear.

Eccentricity wasn’t always enough. There were plenty of violent chancers in the neighbourhood who saw the forty-something mid-Western couple as easy prey. Belleti needed to make a point. So there, in his yard, the latest pair of would-be thieves dangled upside down. The bandana-sporting Yanqui told them the next time his dog would eat their faces.

This was not the career trajectory Belleti might have envisaged for himself. Before the subprime crisis, he had been a banker in Florida, running a team of loan officers. Some might argue it was a natural progression. This tale is one small vignette of the changes sweeping people’s lives in the aftermath of the great crisis of 2008.

‘I hired a bunch of really smart girls to work with me,’ Belleti told me. ‘They had MBAs, masters degrees, they could speak languages. They were really smart. You wanna know why I chose to work with women? Because if a guy makes $12,000 commission, he doesn’t come in for the rest of the week ’cause he thinks “Oh yeah, I’ve earned it.” If a woman does that, she comes in real early the next day and works twice as hard. Anyways, these chicks were used to pulling in $200,000 a year and they all bought nice houses and cars. And then all of a sudden things went south, they weren’t making shit and they started coming in with black eyes saying they’d walked into a door or something. I knew their husbands, we were all friends, but it was obvious what was happening. It was terrible to watch – broke my heart and sent my blood pressure through the roof. Do you know what they’re doing now? Waiting tables in Mexican restaurants because they speak languages. These are real smart, educated people and that’s the best they can get. We saw it coming in ’07 and knew we had to get out. And do you know what people called me? Chicken Little. Thinking the sky would fall in.’