China v Dollars III - The Future of China
For us in Russia, communism is a dead dog, while, for many people in the West, it is still a living lion – Aleksandr Solzhenitsyn
In the first installment of this series, I discussed my belief that China lacks the level of US dollar reserves that are reported in their Currency Reserve Account. Here’s a link: https://www.zerohedge.com/news/2024-06-04/has-china-run-out-dollars In the second piece, I discussed the impact of China’s troubles on the Eurodollar market. Here’s a link: https://www.zerohedge.com/news/2024-06-06/china-v-dollar-ii-impact-eurodollar-market In this piece, I would like to discuss the future of the Chinese economy.
The Chinese people take to capitalism like a duck takes to water. Having watched their rise from Tiananmen Square until today, the only thing holding them down is the CCP and Marxism in general. Deng set them free to compete in a market economy with extraordinary results until the GFC or Great Financial Crisis.
Under Jiang Zemin and then Hu Jintao, the CCP got progressively greedier and its officials extracted ever-increasing levels of rent from the economy, culminating with the real estate bubble that is now pulling the economy into depression. Xi Jinping’s efforts to force the people back into full-blown Marxism is the death knell of Deng’s efforts. The people no longer have a reason to work hard which is why young people have adopted the economic philosophy of “lying flat” or doing just enough to survive.
The government’s response has been a series of bad McKinsey presentations based on Xi’s scattered thoughts on the subject. First, they were going to centralize industries to create “super competitors” that enjoy channel leverage in international markets, then they were going to throw billions of yuan at semiconductors/solar panels/lithium batteries, etc. to lead the global green revolution. The only thing Xi hasn’t tried is getting out of the way and trusting the Chinese people.
China was still ascendant going into the Great Financial Crisis of 2008 but they were unprepared for the tidal wave of money that hit the Middle Kingdom from 2010 through 2013 from investors across the globe that feared hyperinflation in the West. As I wrote in previous pieces, they squandered that money with CCP-directed investment programs to build excess infrastructure, vanity projects and industrial capacity.
The pity of it all is that the CCP leadership thought that they were the ones who created the commercial success when it had nothing to do with them. It was always about unlocking the potential of the Chinese people at the heart of the advance. China’s state-owned enterprises (SOE’s) were beneficiaries of private companies growing the economy, not the other way around. It was the southern and central megacities that dominated contract manufacturing with cheap labor, rampant intellectual property theft, and complete disregard of the environment that produced the “Chinese Miracle.”
The game is over for China and now it looks like Max Yasgur’s farm after the Woodstock concert was over. The CCP has destroyed the private sector and salted the earth with its environmental abuses such that I don’t believe China will be able to rebound from this disaster. The CCP has destroyed everything it touched.
The Curse of Jack Welch
Show me the incentive and I will show you the outcome – Charlie Munger
At the heart of China’s current problems was an incentive system that started with Jiang Zemin in the 1990’s and ended with Xi Jingping during his first term – grow at any price. The incentive system for regional governors looked like it was borrowed from the way Jack Welch managed GE’s diversified portfolio. The only difference was that Jack Welch incentivized his lieutenants to free up cash for stock buybacks where China looked to employ the flood of cash coming in from exports.
The Chinese incentive system was dumb with a capital “D.” At the time, the Chinese economy was kicking in high gear thanks to its cheap labor and disregard for the environment. Private companies and foreign subsidiaries combined to create the greatest mercantilist juggernaut the world had ever seen. Dollars, euros, and yen flooded in to the People’s Bank of China increasing money supply and threatening inflation.
Instead of allowing the yuan to rise, they kept it pegged to the US dollar which meant that the PBOC’s monetary policies were inherently being run by the Federal Reserve. The act of pegging one currency to another is a tacit transfer of power to adjust money supply from one country to another. For the Excel enthusiasts, a country’s money supply policies go from being an independent variable to a dependent variable. In this case, they were dependent on the Fed.
During this period, the Fed maintained unusually liquid monetary policies to prevent deflationary pressures from sinking the US banking system but those policies were wholly unsuitable for a country in growth mode. The correct approach for the PBOC would have been to allow the yuan to rise gradually by limiting domestic money supply. Instead, they threw jet fuel on a fire by allowing CCP toadies seemingly unlimited liquidity to invest on infrastructure and vanity projects.
The feedback loop resulted in the need for new capacity in steel and concrete and a surge in the prospects of state-owned enterprises which now invested to create jobs, not returns. To paraphrase Munger, if you put tons of liquidity in the hands of idiots to invest, you’re going to get a catastrophic outcome.
Crossroads for Communism
The goal of socialism is communism – Vladimir Lenin
Information technology has given wannabe central planners the green light to try to run top-down policies around the world, particularly in China but also by varying degrees throughout North America and Europe. As it relates to China, Xi has knocked off all his domestic competitors and has made himself something akin to a God-Emperor. He calls it “Socialism with Chinese Characteristics” but it is pure totalitarianism and a complete failure.
The CCP has been in charge since the late 1940’s and over that span, they’ve managed to kill millions of their own people with their policies while concurrently destroying much of the water resources and arable lands they started with. People with nothing to lose are dangerous and increasingly, the Chinese people have nothing to lose. A hundred years ago, the CCP harnessed the same anger to overthrow the Kuomintang, which had previously overthrown the Qing Dynasty. Today, they are exactly what they previously fought against. Meet the new boss, same as the old boss.
The CCP is now the equivalent of the failing Qing Dynasty and the old KMT under Chiang Kai-shek. Xi Jinping is known to be aware of these parallels and it supposedly explains many of his harsh policies towards political rivals including the recently deceased Li Keqiang. This is why I believe the CCP is close to the end of their run even as the timing is impossible to predict.
Unlike the total chaos that usually accompanies major political change, I suspect China is going to fracture into regional autonomous zones as opposed to just a new boss in Beijing. Whether such decentralization allows the CCP to remain in power almost doesn’t matter at this point as the power will merely shift from bureaucrats in Beijing to bureaucrats at the local level.
If I’m right, the Pearl River delta region will ultimately rejoin the global economy even as the rest of China languishes. The people living in this region are more capitalist and focused on trade compared to the rest of the country.
Military Capability?
Regard your soldiers as your children, and they will follow you into the deepest valleys; look on them as your beloved sons, and they will stand by you even unto death – Sun Tzu
The PLA or People’s Liberation Army is NOT a homogenous organization; it’s largely regional with five theater commands shown below. It’s also more capitalist than communist. This is because Deng Xiaoping stopped funding them in the 1980’s and told them to pay for their equipment by operating profitable enterprises.
By Joowwww、Li Chao、解放的高加索、Bxxiaolin - ，translated it into English., CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=46775351
As odd as it sounds, I’ve read many reports over the years that suggest that military advancement is largely based on cronyism and Ponzi schemes whereby officers at lower levels pay up the channel for advancement. I’ve also read where military procurement is designed to allow officers to “dip their beaks” to extract bribes from major transactions such as weapons systems. It’s not what you would call a meritocracy but neither is Marxism.
In regards to the officer corps, there is a second dynamic inherited from the Soviet Union that will destroy their ability to fight against a western military and that is the existence of political officers. If you’ve ever watched the movie “Hunt for Red October”, you will see what I mean. Battlefield decisions are made by both the operational commander and the political commander. This contrasts with the operational authority that extends down to the individual soldier in US forces where the soldier is given rules of engagement but also relies heavily on each soldier’s individual initiative in battle.
Chinese soldiers are treated poorly, often enduring harsh punishments when operations go wrong therefore, it’s not surprising that they wait for clear instructions from superiors before engaging and those superiors include operational and political inputs. If we look at the battlefield as a series of feedback loops, western soldiers adapt to the battlefield far more rapidly and effectively than Chinese soldiers. When you combine this advantage with experience, superior strategies, and much better equipment, Chinese military forces are extremely overmatched versus the West despite size advantages.
Equipment
Most Chinese equipment, whether rifles, warships, or airplanes are based on copying Russian equipment adjusted for whatever western technology they were able to steal. We know it’s bad because few emerging nations are willing to purchase this crap despite cheap prices.
Their fifth-generation fighters are copies of the F-35, Su-57, and Eurofighter with engines that are poor copies of the engines in Su-57’s. Their stealth technology was gleaned from the downed F-117 Nighthawk in 1999 near Belgrade and is over 30 years old. The designers of the J-20 copied the Eurofighter’s forward ailerons because they were unable to maintain lateral balance in flight. The result is less stealth.
Worse, the turbine technology in their advanced fighter jets is roughly the equivalent to Western technology of the early 1980’s and leaves Chinese jets underpowered versus US jets. This shows up most noticeably in their inability to pick up fourth generation Western jets on radar from a distance. Most recently, a Taiwanese F-16V was able to get a firing lock on a Chinese jet long before the Chinese jet detected the F-16V in the Taiwan Strait.
It's the same thing with the PLA Navy and Spaceforce. China’s air defense missile system is based on the Russian S-400 which has had poor results in Ukraine. Foreigners avoid buying Chinese military equipment due to shotty quality standards and very poor post-sale service.
Chinese generals and politicians never learned the lesson from Sun Tzu quoted above, which is something Western militaries have mastered. With their demographic advantage rapidly depleting and the heterogeneous nature of the PLA working against cohesion, China’s window of opportunity in projecting global power has effectively slammed shut.
Demographics
Facts are stubborn, but statistics are more pliable – Mark Twain
I don’t believe China has 1.4 billion people; I suspect it’s closer to 1 billion. Like with their economy, regional governors have had incentives for decades to overstate births and understate deaths in order to receive greater subsidies from Beijing. Furthermore, I believe China experienced a far greater mortality rate from Covid than the rest of the world which explains the need to lockdown the country beyond any reasonable reaction to the pandemic. Staying on that topic, I suspect the mortality rate, in general, is far greater than admitted given the extraordinary level of pollution in their water, domestic food supply, and in the air.
In 2023, China had 9 million births versus 11.1 million deaths; this statistic is likely to get much worse over the coming decade. Marriage registration has been declining for 10 straight years; fewer women are choosing to have children. It is a worldwide phenomenon but it appears to be a trend on steroids in China.
China is aging very rapidly. Yet despite the retirement of millions of workers and falling population, youth unemployment is exploding higher, implying that employment has violently contracted. The CCP is keenly aware of this and the fact that they are graduating ever more students from college without prospects for employment. Young people with degrees appear more inclined to “get by” than to embrace blue-collar employment. The term they use for this trend is “lying flat” and it entails doing the bare minimum to survive. This trend is the direct opposite to the spirit that infused the Chinese people when Deng relaxed the Marxist controls of the Mao era.
The chart below shows a population in collapse. Young people aren’t forming family units as child rearing in China is insanely expensive. Without a social safety net, the declining number of young people will be stretched to support families and aging parents. This may prove to be the end of the China Dream.
By Rickky1409 - Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=115354127
The declining birth rate may prove to be a blessing because the agricultural policies of the CCP have destroyed China’s ability to feed itself.
Agriculture
So long as you have food in your mouth, you have solved all questions for the time being – Franz Kafka
China has roughly 20% of the world’s population with less than 7% of the world’s arable land, half of which has been degraded by unchecked urban development. In addition, at least 20% of this land is contaminated with various toxins. For instance, cadmium was discovered in the rice produced in Central China in 2013. It’s still sold to consumers, at a slight discount, every year despite being poisonous.
China is the world’s largest producer of chemical fertilizer as well as being the heaviest user of chemical fertilizer. On average, China uses around 400 kg/hectare, which is much higher than the world average of 225 kg/hectare. Chinese farmers use 4X as much fertilizer to grow crops as compared to US and European farmers.
In addition, China uses 47% of total world pesticides each year. The result is that Chinese topsoil has turned acidic, in general, which means that yields will continue to drop, even as fertilizer/pesticide use is increased.
It’s small wonder that China imports 20% of its food and it’s getting worse. According to China’s Academy of Science, China’s grain deficit will increase to 130 million tons by 2025. Here’s a chart of corn imports to illustrate the dramatic change in Chinese food security.
Corn is traded in US dollars and you can see from the chart above, China went from a net exporter to a heavy net importer. This represents a large and growing outflow of dollars each year, which further builds on my thesis that China is rapidly running out of US dollars in its reserve account.
Water
Water and air, the two essential fluids on which all life depends, have become global garbage cans – Jacque Cousteau
80% of China’s groundwater is contaminated. While it’s against the law to dump industrial waste into the ground, it’s common practice for Chinese industrial plants to inject toxic discharge into underground caverns. For industrial plants close to a river, the effluents are routinely discharged into the river. 60% of China’s population gets its drinking water from groundwater. There are “cancer hot-spots” all around the country.
Think of the sheer size of China and the amount of malfeasance necessary to pull off such a catastrophe. It’s so bad that the CCP has to admit it. The Ministry of Water Resources predicts a serious water crisis by 2030. Former Premier Wen Jiabao considers the water shortage a threat to the survival of the Chinese nation.
40% of China’s farmland is in close proximity to the Yellow River, which flows through the north and center of the country. It’s considered the most threatened river in all of Asia as its flow is just 10% of its flow rate in the 1940’s. Yet in spite of this decreased flow, it manages to cause massive flooding in most rainy seasons.
64% of China’s arable land is in the north where rainfall is scarce. Freshwater per unit of farmland in the North China Plain is a mere 15% of the country’s average. Southern China has 80% of China’s total water versus 20% for the north.
Northern China has been experiencing extreme water stress for decades, yet they continue to build. 1,700 cubic meters of water per person is considered by scientists to represent “water stress.” 500 cubic meters of water per person is considered “extreme water stress.” Beijing has 162 cubic meters, Tianjin has 122 cubic meters, Shandong has 222 cubic meters, and Shanghai has 252 cubic meters of water per person.
These cities have extracted so much groundwater that they are experiencing subsidence, where the ground collapses under buildings, roads, etc. Beijing and Tianjin are sinking by 10 millimeters per year. Shanghai has sunk by 2 meters over the past 20 years.
Subsidence isn’t just occurring in the north. Cities across the country experience this to varying degrees depending on how much they access groundwater. It’s especially acute in the cities around the Pearl River Delta in the south.
China’s rivers and streams are open sewers. In some parts of the country, fish jump out of the water following industrial discharge. When you combine scarcity with contamination, it’s clear that farmers are pumping toxic water onto crops and rural people are drinking toxic water. Everyone is eating food that is contaminated in some way. This is why I conclude that China’s true population is more likely close to 1 billion as opposed to the 1.4 billion official estimate.
Conclusion
The state can be and has often been in the course of history the main source of mischief and disaster – Ludwig von Mises
China is a disaster and yet it is a key cog in the global economy. I often read where people suggest that China is playing “the long game” and they will outlast Western decadence. There is no “long game” in China. They have effectively destroyed and salted the earth much like Scipio did to Carthage when Rome conquered it in 146 BC.
I believe China is in a Great Depression many times worse than what we experienced in the 1930’s despite the robotic reports of 5% GDP growth. The private sector is being obliterated and the people have embraced “the paradox of thrift” and have been banking their declining wages which explains why their banking system hasn’t yet imploded. Banks are hoarding this growing liquidity to offset rising delinquencies while retailers and restaurants shut down.
When Japan faced a similar domestic banking problem in the late 1920’s, they invaded Manchuria in the early 1930’s. This puts Taiwan squarely in the crosshairs but the difference is that 1930’s Japan was a competent military power while the modern Chinese military is staffed by grifters and incompetents. I consider the Russian military to be far better than the PLA.
Xi Jinping is betting his economy on green energy and electric vehicles even as Europe and the US move away from this economic mistake. He can build all the EV’s he wants, nobody will buy them.
I expect China to break apart within the next few years, perhaps sooner – nobody knows. When this happens, the economics of technology will change dramatically. Product cycles will elongate and institutions will slow their acceptance of new technologies. The payback period for technology companies will also lengthen which suggests that stock buybacks may be at a peak in the west, especially if they need to onshore more operating parts of the value chain.
People fixate on the property market and local government borrowings but the problems in China are far worse than these two focal points. My thesis is that China is running out of US dollars in their reserve account. For a country that imports 80% of its energy and 20% plus of its food, running out of currency reserves invites a humanitarian disaster of epic proportions. In short, the CCP is a blustering bully that is riddled with a metastasized cancer and China is like a horse that has been ridden to death.