Let China sleep. For when China wakes, it will shake the world.” - Napoleon Bonaparte (unsourced)

Nobody knows what is going in China: this is probably the only conclusion that we can draw when we seek to understand the world second largest economy. We can read about pretty much anything about China in the foreign media, some of it good, most of it rather mediocre. But no one has access to the economic and political elite. Most of the gossips are at the very best second hand stories from the people hovering around the decision makers, but China’s direction is decided behind closed doors, leaving the rest of the world to decipher hints from the flamboyant prose of the CCP’s edicts.

To palliate the lack of information, we could use Stratfor’s framework, a mix of geographic and historical insights used in light of current constraints and goals. We can thus derive the core of China’s objectives: party survival and territorial integrity, from which derive domestic social ‘stability’, the pressure to secure essential raw materials through direct investment or along the seaborne ‘Silk Road’, and increased military investment.

But due to the poor communication organization of the PRC, its actions are usually misunderstood. Those who have read about the origins of the First World War can probably draw parallels between pre-1914 Prussia and modern China. In both cases, an unsecured growing country scared its immediate neighbors when its badly understood various factions inside government and the military issued contradictory statements on policy. As inconsistencies increased, confusion becomes mistrust, feeding a vicious circle that heightens potential conflicts.

As we mention regularly, those who argue that economic integration and nuclear weapons prevent conflicts apparently didn’t draw the right conclusions from the Great War and ignore how close we came from total humanity wipe-outs during the Cold War (1962, 1983, 1995 for publicly known incidents).

With China’s economic slowing, impacting more or less severely other countries, the calculus of all actors start to change. Economic partners realize how dependent they are on the continuous growth of unsustainable imbalances in China and ask themselves how the government is going to address its growing problems.

Measuring the actual impact of China’s slowdown is difficult due to the complex financial links throughout the world: household consumption in commodity exporting countries may be driven by the Chinese demand for those products and foreign companies may be heavily relying on sales in China to record a profit amid price wars in their sluggish home market.

China Qarterly Imports

The above graph shows that China’s Q1 2015 total imports value fell to levels comparable to the worst of the Great Financial Crisis. Of course, the first quarter has always been heavily impacted by the Chinese New Year, but this 10 years historical graph is another sign that the current crisis is serious.

Meanwhile, the Chinese government is rapidly losing credibility as they are unable to stem the debt tsunami created over decades of imbalances. We can only expect more (downward) surprises handled by a startled government on the defensive. While the arcane of Beijing politics make it difficult to understand China’s political direction, the worst is probably that only a handful of people truly understand China’s economic dynamic (our long time favorite Michael Pettis is one of them).

Analysts throughout the business, financial and governmental institutions have been systematically misunderstanding the roots of China’s rapid growth, and will likely systematically misunderstand its slow down. This has powerful implications for their prospects in China, their future operational results, and the way the world sees China. The opacity of large parts of the economy and politics were convenient in time of boom, but now become serious brakes on decision making and evaluation of the actual situation.

China always was and will remain a place stirring strong feelings among those who interact with the country. It was a mistake to believe that one of the oldest civilization on Earth would bend to Western culture and institutions. Now that hard times are falling upon the world, we shall see how the country will evolve, but given the lack of understanding of China’s direction, we can only assume that anything could happen.

Science, General Knowledge & Environment

Conversation: Terrorism Theater and Social Media – [Video] – “Stratfor Vice President of Intelligence Fred Burton and Vice President of Tactical Intelligence Scott Stewart discuss how technology is enabling grassroots terrorists to use social media to bypass traditional media.

History & Geopolitics

Pondering Hitler’s Legacy – “Hitler drew the Americans into the heart of Europe and left the Europeans completely vulnerable to the emerging, and quite strange, modes of thought that a nation that holds shopkeepers in great regard can produce. Hitler destroyed the dams that Europe had built around itself. He crippled all of Europe, including the Soviet Union.

Europe Rethinks the Schengen Agreement – “The main threat to the European Union is that the weakening of the free movement of people could precede the weakening of the free movement of goods, which would end the European Union in its current form.

Conversation: Venezuela’s Precarious Position – [Video] – “Stratfor Deputy Editor Lynn Wise and Latin America Analyst Reggie Thompson discuss the precarious political, economic and security climate in Venezuela.

Our Radical Islamic BFF, Saudi Arabia – (Hat tip Lao Ho) – “Nothing has been more corrosive to the stability and modernization of the Arab world, and the Muslim world at large, than the billions and billions of dollars the Saudis have invested since the 1970s into wiping out the pluralism of Islam — the Sufi, moderate Sunni and Shiite versions — and imposing in its place the puritanical, anti-modern, anti-women, anti-Western, anti-pluralistic Wahhabi Salafist brand of Islam promoted by the Saudi religious establishment.

Conflict Over Water In Central Asia – “On the banks of a chilly river some 4,600 km away, a gigantic dam sits unfinished, the victim of a process of speeches and votes between rivals far more bitter than Prussia ever faced – Uzbekistan and Tajikistan.

U.S. Adversaries Are Becoming Better Trained – “Both Russia and China appear to be determined to continue investing in their forces’ development, despite growing financial constraints; even if military spending is ultimately cut, training and instruction will likely continue to take precedence over other areas. Superior training alone cannot win a war, but it can make the difference between success and failure.

Militarism is a risky temptation for Beijing – (Hat tip Lao Ho) – “The real risk is not that China will choose war, but that its leadership might miscalculate the reactions of its neighbours or the US — and that a territorial dispute or an unplanned military clash at sea then escalates into a major international incident.

3 Takeaways From China’s Military Parade – “All told, the parade was an impressive display of the strength of Xi Jinping’s government, and his control over China. But with the big party over, and serious challenges still ahead, what comes next?

Finance & Economics

A Hedge-Fund Manager’s Challenge to the Fed – (Hat tip Lao Ho) – “These long-term debt cycle forces are clearly having big effects on China, oil producers, and emerging countries which are overly indebted in dollars and holding a huge amount of dollar assets—at the same time as the world is holding large leveraged long positions.

Drop in the Bucket – (Hat tip Lao Ho) – “But for most firms the prospect of selling billions of products to Chinese consumers remains more of a promise than a reality. Goldman Sachs, for instance, estimates that just two per cent of the S. & P. 500’s revenues come from sales to China.

If we don’t understand both sides of China’s balance sheet, we understand neither – Michael Pettis “The economy is a dynamic system made up, as Minsky said, of interlocking balance sheets, and the way economic growth, exogenous shocks, debt dynamics, income distribution, and ever other dynamic process is intermediated from balance sheet to balance sheet depends both on the structures of the balance sheets and on other institutional constraints that characterize each economy.

China risks an economic discontinuity – (Hat tip Lao Ho) – Martin Wolf “A big question is whether a market-driven economy is compatible with the growing concentration of political power. The next stage for China’s economy is a conundrum. Its resolution will shape the world.

China: Credibility on the line – (Hat tip Lao Ho) – “Many of the market’s substantive worries (economic collapse, financial collapse, competitive devaluation) are overblown. But markets trade as much on policy signals as on economic reality, and there has clearly been a breakdown of communication between Beijing and the rest of the world.

Picture of the day: Migrant crisis in Europe


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