Tidbits On China: Hidden Trillions Trickling Down

There are many of us who live here in China for well over a decade. In my case, its been 11 years. Amongst the many fascinating observations on business and culture in China, one thing we all noticed from the very first day we arrive is that there is a massive untold, uncountable grey market “cash” economy.

Frankly, they like it that way. Wouldn’t you?

Your first eye-opener can start in Chengdu, Sichuan province, circa 1999, when you learn that a certain well known local Chinese government office needs to hire several foreigners to some much needed editing for the program of an upcoming international conference hosting heads of state from all over the world. On the day to collect payment for said editing work, the local gov’t official opens the one square meter sized office safe at which moment you can’t resist peeking to notice stacks and stacks of cash inside. That’s not to say the cash is not fully accounted for and reported within the system. This story is simply to point out the mere tip of the cash economy iceberg in China. It is amongst the wealthiest in the country where most of the cash economy changes hands. We often go to the bank where it is in fact normal policy and procedure to take your “bag of cash” to make the payment on the home you just purchased. While that bank transaction is definitely recorded at the bank and government real estate office, where that cash came “from” runs deeper into the mystery of China’s not-so-hidden economy.

Finally, this not-so-little gem of trillion dollar knowledge has made it to international headline status courtesy of a research study commissioned by Credit Suisse.

Highlights from the report include:

“…The study found that the “hidden” household disposable income could be as high as 9.3 trillion yuan in 2008, equivalent to about 30% of China’s gross domestic product.”

Ok, now we’re cookin’…

“…the flow of funds data don’t accurately track the income of top households because much of it are the results of “illegal or quasi-legal” activities.”

How do you define quasi-legal please and in what culture?

“…the shortfall in the figures revealed in the economic census and what households really received — at 5.4 trillion yuan in 2008.”

Enlightenment approaching…

“…Credit Suisse said investors may be setting their sights too low when it comes to gauging the impact of this vast pool of wealth.”

That’s a big bingo.

So then, above and beyond the known $2.4 trillion of government reserves, plus my estimated $15 trillion of mortgage-free home equity amongst the middle class, plus the known highest savings rate in the world at 36%, now we factor in an ongoing cash economy that has finally been estimated at between USD $1 to $2 trillion.

When you are perusing analysis China’s economy that somehow blindly dismisses a trillion or two in its underlying assumptions, you can safely conclude that whatever gloomy conclusion the author comes to is full of holes and laid on a rickety table with 3 legs.

Let me ask you a couple of questions:

If you owned a home without a mortgage and it declined in value by 30%, would you freak out? No you wouldn’t. You wouldn’t fall behind on payments and you certainly wouldn’t foreclose.

If you are a typical middle class American, but had no debt and, for example, $50,000 or more in your mattress and you lost your job, would you freak out? No you wouldn’t. You have time to regroup and redirect your life.

You’re starting to understand the much more comfortable and secure situation which exists for somewhere between 100 to 300 million Chinese citizens.

Home Sweet Mortgage Free Empty Home

Empty homes in China are a bank account, a long-term store of value. Note the anecdote of “Henry” below on the subject of overseas Chinese coming back to China to buy property for their future retirement:

At a recent Naked Capitalism article on China, commenter Henry says:
August 4, 2010 at 8:23 pm

My parents…went back to China 10 years ago and bought 4 apartments for their retirement…I think they paid $300k for all of them with cash. Today they are probably worth $2m (million). Along with my parents, I know most of my parents’ Shanghainese friends also did the same thing. My point is that a lot of these vacant apartments are owned by overseas Chinese planning their retirement, and not for speculation.”

Where do you think people in a hidden $1-$2 trillion cash economy can put all that cash? In India, they buy a lot of gold to store value and Chinese are just starting to do that too. But real estate is by far their first choice. Hence, relative to vacancy levels you might otherwise consider healthy in other real estate markets, you will find higher vacancy rates in China from long-term mortgage-free property purchases which serve a meaningful and understandable purpose when understood in the context of the entire economy including the grey market cash economy. Suddenly it doesn’t seem so strange that there would be so many empty apartments, does it? They were bought for the long-term to build the family estate and and they will be passed on to the next generation.

Richest 10% Average USD $16,000 Per Year: Kickbacks Not Included

This tidbit from the Credit Suisse report is worth further discussion:

“…Average per-capital income for the richest 10 percent, at 97,000 yuan, was 65 times of that of the poorest 10 percent, Wang’s survey showed…”

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I am shocked as I note that even this estimate of income is far too low. If you believe that the richest 10 percent in China average only USD $16k per year in income, you’re just buying into another inaccurate assumption underlying analysis on China.

One of the glaring inaccuracies of this report is how it attributes the grey market income in China to “stock market manipulation, property deals, vast bonuses from state-owned firms with a monopoly on the market, and even large wedding and other gifts to powerful officials and their relatives.” I don’t see the word “kickbacks” on the list, yet they are probably the largest category of cash exchange in business. For example, Ms. Wang is the store manager and Mr. Li is the product supplier. Mr. Li will of course give Ms. Wang a thank you kickback of 10% or so if she can get his products into their store with an order. You may ask, does the boss know or care? Of course the boss knows and doesn’t care, he used to be the store manager! In the end, if the bottom line cost of goods sold numbers come in line each month on the accounting reports, the system doesn’t need any further scrutiny. It is how business here.

A friend in the luxury retail products industry wanted to be paid for his product order. The purchasing manager, that’s the guy or gal sitting in the accounting office who actually pays the bills and who had absolutely no intention of ever paying the invoice without getting his expected share. It wasn’t a discussion. It was expected behavior. Middle level managers at small and large companies all across China do business in a perfectly normal and understood manner which includes cash kickbacks to supplement their low salaries. We could safely suggest this is a much larger percentage of the grey market economy than the Credit Suisse report suggests.

Driving Through Crosswalks

I often speak about how a culture truly brainwashes many of our behaviors beyond the cultural ideals of right and wrong which exist only in that culture. For example, as a American, I used to think that driving through a crosswalk intersection with people in it was irresponsible and insane. Now I understand that in America, that is true, but not true in China where stopping to let people cross will be more likely to cause the accident rather than avoid one. Let’s understand why. I have a Chinese driver’s license and I think and drive exactly the way Chinese do; that is to say I also drive through cross walks while throngs of people are crossing on either side of my car. You know why? Because if I stopped and didn’t drive through the intersection, everyone within 5 meters including the driver’s behind me AND the women with their infants crossing the street would think “What’s wrong with this guy? Damn foreigner, he doesn’t know how to drive!!” And I would be the one causing an accident! The Chinese driver’s test clearly mandates that cars yield to pedestrians; that means “slow down and avoid”, not stop, and in fact, often the cross-walk lights are green while the traffic flow lights are also green. Everyone knows it, both drivers and pedestrians, and has the rules and expectations crystal clear in their respective minds.

So on the subject of Chinese being cash rich, foreigners hear it said but only through the filtering psyche of their cultural bias. This enormously significant piece of the China and global economic puzzle goes in one ear and out the other preventing even otherwise intelligent economic and market analysts from properly integrating its meaning and influence into their views, thereby misleading many. It is an uphill battle to remind every foreigner on planet earth who makes their deeply flawed and filtered analysis of China to comprehend the bare truth of trillions and its significance. There are trillions and trillions and trillions of cash and other asset value here in China; it is woven deeply into the fabric of society from ultra-rich to local workers; from cash to empty apartments passed down the family heirs. This liquidity is a shadowed powerhouse driving China’s economic development and societal trends. As the west faces its unprecedented economic woes, it is a welcome trillion dollar tidbit.

Mario Cavolo
Shanghai

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