“If the Communist Party can't take sufficient political reform in five or ten years, it could miss the chance entirely. As scholars, we always say it's better to have reform than revolution, but in Chinese history this cycle repeats itself. Mao said we have to get rid of the cycle, but right now we’re still in it. This is very worrying.” - Lifan Zhang, 2015
The recent events in China seem to have finally made investors and analysts around the world realize that the Chinese ‘Great rebalancing’ toward healthier growth is easier said than done. More importantly, it seems that the confidence in the (only) ruling party to manage the transition is rapidly faltering.
Xi Jinping’s ascension to the People’s Republic of China Presidency of in late 2013 coincided with the start of a long overdue economic slow down. Faced with a huge and growing domestic debt with decreasing, if not already negative return on investments, President Xi chose to concentrate political power in order to ‘push through’ much needed reforms, including economic opening.
However, the crackdown on corruption has severely impacted GDP growth through the inhibition of wasteful public spending and the rapid decrease in official expenses, highlighting how much ‘crony capitalism with Chinese characteristics’ was entrenched.
As part of the reforms and in the midst of a real estate slump, the government actively promoted investments in the stock market, and when the latter tanked it stepped in to support unsustainable high prices. The incredible mismanagement of this sorry bout of speculative frenzy has at the very least raised a few eyebrows among Chinese watchers.
To put back the current crisis in context, we need to understand the following:
- The Chinese Communist Party (CCP, the ruling party) is the only political entity authorized in China, which means that there is no viable political alternative;
- The CCP primary objective is political stability, until now supported by rising economic growth, to preserve territorial integrity and avoid the historical chaos that usually came out of the increasing regional economic disparities;
- China is a big country (the size of the USA) and it is impossible for the government to effectively control all of its 80 million CCP members,
We can thus quickly understand that some of the objectives are contradictory (i.e.: decreasing inequalities, rising economic growth, and ‘healthier’ growth). In addition, the management of a transition needs to be carried out with the support of local governments. Yet because the latter are the main beneficiaries of the 30 years economic boom, it seems difficult to expect a radical reform where it is most needed.
As Michael Pettis has continuously argued, an economic rebalancing process always is a political question: who pays for growth, how to redistribute wealth, and who pays to clean up later? In the case of China, we still need to see whether the government and industries will share the pie with ‘ordinary’ Chinese citizens. If not, the concentration of wealth may reach extreme levels while the economy will not be able to continue to function effectively.
Growing at 10% per annum for 30 years was actually the easy part of an imbalanced economic model copied from Japan (who in turn copied it from the nascent USA who in turn studied the German model) and built on financial repression designed to accelerate growth by the creation of imbalances. But economies become rapidly addicted to growing imbalances, and eventually start building up unsustainable and massive amounts of debt.
As a result, while many nations were awarded the title of ‘growth miracle’ throughout the last 150 years, only a handful managed to leap on to the status of ‘developed countries’. Among them are Europe, the USA, Japan, South Korea, Taiwan, and some financial havens (i.e.: Singapore and Hong Kong).
The Japanese experience shows us how fast a miracle becomes a government debt nightmare, while South Korean levels of debt for all economic actors are at very high levels (and thus prone to potential breakdowns). The rest of the ‘economic miracles’ underwent powerful debt deflation dynamics which took decades to clean.
In other words, China is now at a cross road which branches out either in the middle income trap or developed country status. Clearly, the track record of other countries shows that China is not starting out with the best endowments. We thus remain cautious in regard to the eventual situation China will reach through the coming decade. Our main fear is that given the sheer size of the problems, a political backlash from within the CCP takes the power out of the reformers before meaningful reforms improve the economic situation.
While the comparison is somehow extreme, we could say that China has late 1980’s Soviet Russia’s political apparatus with late 1980’s Japanese economic problems. Violence is not out of the question even though until now it remains a low risk. But 2020’s China is certainly not going to be the country everyone dreamed of or feared during the last decades.
Science, General Knowledge & Environment
Poisonous connections – Tianjin’s explosions “So a company with an opaque ownership structure, connected by family ties to a port official under investigation, was helped by an order signed by another man under investigation to expedite its handling of dangerous chemicals.“
Devenir riche ne s’apprend pas à l’école – (Hat tip Lao Ho) – “Le système d’éducation est conçu pour produire de bons employés et non des employeurs. Seul un sens des affaires aiguisé, et non un savoir académique, procure une sécurité financière.“
History & Geopolitics
No need to idolise China’s accident-prone technocrats – (Hat tip Lao Ho) – “It is worth recalling that in the 1970s and 1980s, when Japan was the rising Asian economic power, US experts characterised the Tokyo bureaucrat as a superman. Now Japan’s change-resistant bureaucracy is seen as one of the economy’s biggest problems.“
The Chinese model is nearing its end – George Magnus “The centralisation of power is proving to be a double-edged sword for reform, the anti-corruption campaign is choking off initiative and growth and the economy cannot be kept on an unrealistic expansionary path by unending stimulus.“
Conversation: Connections in the Rabbi Kahane Killing – [Video] – “Stratfor Editor Margaret Fox and Vice President of Intelligence Fred Burton discuss the assassination of Rabbi Meir Kahane and how it still reverberates today.”
Finance & Economics
Something Is Still Ridiculously Wrong – “It’s the reality that all the money printing in the world isn’t translating into reflation. That is dangerous on many levels, and if the stock market begins to care about the fact that all of these tools central banks are using aren’t actually filtering to the economy, then the future is likely to be extraordinarily more volatile than the past.“
Chanos: China worse than you think – [Video] – “It’s worse than you think. Whatever you think, it’s worse than you think.“
Picture of the day: Explosions shock China’s Tianjin port
About Carlito Riego
"Great perfection may appear imperfect, but its usefulness is inexhaustible. Great abundance may appear empty, but its usefulness cannot be exhausted. Great correctness may appear twisted, great skills appear crude, great eloquence appear awkward. Activity conquers cold; inactivity conquers heat. Clear serenity governs the world." - Lao Zi