China is in trouble….

12 06 2018
Between yesterday’s revelation of Saudi Arabia’s appointment with 2030 and now this, the global economy is looking ever more shaky….
Republished from MISES WIRE..
06/09/2018

Before we discuss the economic situation of China, a few words about China’s strongman, Xi Jinping. The “new Chinese emperor” has engineered a meteoric rise. He started off as simple rural laborer but is now the most powerful Chinese president since Deng Xiaoping. Such a career path requires strength, tact, and probably a dash of unscrupulousness. 

While the rulers of China have been able all along to hedge their plans over longer periods than their Western counterparts have, the new legal situation has extended this planning horizon even further.1 In comparison with those of Western economies, China’s countermeasures against the crisis in 2008 were significantly more drastic. While in the US the balance sheet total of the banking system increased by USD 4,000bn in the years after the global financial crisis, the balance sheet of the Chinese banking system expanded by USD 20,000bn in the same period. For reference: This is four times the Japanese GDP.

increm-China-1.png

The following chart shows the expansion of the bank balance sheet total as compared to economic output. Did the Chinese authorities assume excessive risks in fighting the crisis?

increm-China-2.png

Neither the fact that China’s bank balance sheets amount to more than 600% of GDP nor the fact that they have doubled in terms of percentage of GDP in the past several years suggests a healthy development. Our friends from Condor Capital expect NPL ratios51F to rise in China, which could translate into credit losses of USD 2,700 to 3,500bn for China’s banks, and this is under the assumption of no contagion (!). By comparison, the losses of the global banking system since the financial crisis have been almost moderate at USD 1,500bn

The most recent crisis does teach us, however, that the Chinese are prepared to take drastic measures if necessary. China fought the financial crisis by flooding the credit markets: 35% credit growth in one year on the basis of a classic Keynesian spending program is no small matter.

increm-China-3.png

Chinese money not only inflates a property bubble domestically but also around the globe (e.g. in Sydney and Vancouver). Further support for the global property markets is in question, given the measures China has recently launched. Due to financial problems, Chinese groups such as Anbang and HNA will have to swap the role of buyer for that of seller.

The IMF has forecast a further doubling of total Chinese debt outstanding from USD 27,000bn in 2016 to USD 54,000bn in 2022. By comparison, in 2016 China’s GDP amounted to USD 11,200bn. This spells debt-induced growth at declining rates of marginal utility. From our point of view, this development – which we can also see in the West – is unsustainable.

increm-China-4.png

In its most recent report, “Credit Booms – Is China different?”, the IMF states that in 43 cases worldwide of strong credit growth (i.e. the ratio of credit to GDP grows more than 30% over five years), only five cases ended up without a significant slowdown or a financial crisis. The IMF also points out that no expansion of credit that started at a debt to GDP ratio above 100% of GDP ended well. It is worth noting that China has a high percentage of domestic as opposed to foreign debt, which definitely makes matters easier for the country. But the question is: Will it be different for China this time?

The 19th-century Opium Wars that China fought with England, which are deeply rooted within the collective memory of the Chinese people, are historical events that are of great importance in connection with the punitive tariffs imposed by the US, as they remain a fixed and integral part of the Chinese history curriculum in schools.2 If necessary, China could stir up anti-Western sentiment in order to implement measures that are hard on its own population, even if they are unpopular. The buck would of course stop with the Americans. Thus, the US could shoot itself in the foot with any escalation of the trade war, as we regard the ability to bear hardships and the cohesion of Chinese society as much stronger than those of the American society.

The demographic development of China is also worth a quick sidebar. The World Bank forecasts a population peak of 1.4bn for China in 2028. The decline in population that is predicted to set in around that time should proceed at a similar pace as the increase towards the peak.

increm-China-5.png

The fit-for-work population (aged 16 to 59) has been decreasing since 2012 and is expected to decline by almost 25% to 700mn by 2050. Thus China, much like the West, has the problem of an aging population.

increm-China-6.png

Conclusion

Unlike his Western competitors, China’s new strongman, Xi, can implement his long-term strategy in a targeted and gradual fashion. Xi explicitly underlined his goal of asserting China’s interests in the world by referring to military, economic, political, and diplomatic means in his speech at the National Congress in October 2017.3 He left no doubt that China was not willing to compromise in any shape or form with regard to its territorial integrity (N.B. Taiwan, Hong Kong, Tibet), and he issued point-blank threats against separatist tendencies.

However, the transformation of the economy could (intentionally or otherwise) cause economic distortions not only in China but globally. Recent years have been dominated by a massive expansion of credit. In fact, it is often said that China has blown the biggest credit bubble in history.

It seems, there are greater similarities between China and the US than may be visible at first glance. China builds real estate for a shrinking population, invests for an overindebted client (the US, which even insists on a drastic reduction of the bilateral trade deficit) and finances all this with money it does not have.4

  • 1.An analogy from the field of sports: The national sport of the USA is baseball; in China, it is Go. The approach to foreign politics is similar: The Americans are known for their short-term “hit and run” foreign policy, whereas the Chinese play the long game in their foreign policy and are very difficult to read in doing so.
  • 2.Recommended reading: The Opium Wars, by Julia Lovell
  • 3.http://www.bbc.com/news/world-asia-china-43466685
  • 4.A paraphrase of the famous quote from “Fight Club”: “We buy things we don’t need with money we don’t have to impress people we don’t like.”

Ronald-Peter Stöferle is managing partner and fund manager at Incrementum AG, Liechtenstein. He invests using the principles of the Austrian school of economics.

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7 responses

12 06 2018
Jonathan Maddox

This discussion (as you’d expect from the source) completely fails to distinguish between the debts of currency users and of currency issuers. China is not financing anything with “money it does not have”, it is issuing renminbi, of which it has a limitless supply. Individual currency-using banks and other financial institutions in China might go bust, but regulation is tightening in order to reduce that risk, and the government stands guarantor for the economy as a whole.

It is qualitatively true for monetarily sovereign capitalist countries as well that the government stands guarantor, but the Chinese government is quite immune from western capitalist managers’ aversion to intervention.

12 06 2018
rabiddoomsayer

Social cohesion in China is not what it was, the “little princes” are not as adult/authority worshiping as their forebears. (But they still have way more social cohesion than the US)

12 06 2018
John Doyle

I agree with Jonathan’s comments. China can jubilee any and all debts it wants to. It is all in its own currency at home. It could even do it under the counter so it won’t distort the normal budget figures. The USA does that now, so China won’t have a problem. The overarching rule for the Party is that the populace must be kept satisfied. A debt burden will threaten that so it won’t be allowed to happen. Remember money is an IOU, it has no reality of its own. If the debts it represents are deleted, so will the money disappear. The whole economy will reset at a lesser level.

16 06 2018
psile

It can’t jubilee its oil consumption though, which is now the highest in the world. Their economy won’t reset, it will collapse, along with all the others, once decline goes too far.

16 06 2018
Jonathan Maddox

China’s oil consumption is around 12 million barrels per day, significantly less than US consumption of 19 million barrels per day.

China’s chemical industry has extensive experience with synthesis of products which other countries make from petroleum, using coal. This includes synthetic liquid fuels. Switching to electrical energy instead of fossil fuel feedstock is the next step.

17 06 2018
psile

All these things are simply derivatives of a cheap oil-based economic infrastructure and cannot exist without it.

12 06 2018
Brandon Young

“This spells debt-induced growth at declining rates of marginal utility. From our point of view, this development – which we can also see in the West – is unsustainable.”

Of course it is unsustainable, unless you are deluded by a fantasy of infinite growth. You can only feed finite real wealth into a planet destroying machine in the production of purely virtual wealth for so long.

Although it might be possible for China to potentially dictate its way out of a financial crisis, because its political system is still at the top of the food chain, and still has some power to control the banks.

In the US and the West the political systems have been bleeding power to the banking system for nearly 50 years, so the power relationships are well and truly reversed, and governments now have the obligation to serve and rescue the banks.

The primary function of government in the West is now to do everything possible to keep the Ponzi scheme going, and this means shaping public policy to maximise the demand for private debt. That is the whole reason the great ‘neoliberalism’ swindle was engineered.

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