China — The next decade
The “China Stall” is a pretty familiar story by now. In a word, it is the story of “overcapacity”, — the result of over-investment and under-consumption. “Over” anything inevitably results in “correction”. In China's case, its artificial (as opposed to organic) growth came to a screeching halt as a result of back-to-back policy errors. As of this writing in Q4, 2024, China is in serious deflationary depression (prolonged recession).
Millions have lost their jobs as hundreds of foreign companies pulled out in unison earlier in the year, out of concern over Xi’s new policies, — causing the closure of thousands of domestic businesses in their supply chains. Foreign capital inflow stopped (FDI has dropped by 90% since 2014 and now stands at a 30-year low). The domestic stock market crashed, eviscerating $6.5T of capital. Meanwhile, total collapse of the property sector (nearly 30% of the country's GDP) devastated the construction industry, sending millions of migrant workers back home to the countryside, causing massive de-urbanization.
Provincial governments can no longer self-finance through land sale, and had to impose wage arrears, layoff hundreds of thousands, and restrict bank withdrawals, — creating rapidly rising social unrest. Shops have closed and streets are empty in major cities. Everybody saves, nobody borrows, spends or invests in the face of extreme pessimism. Citizens and capital alike are finding ways to flee the country. Money velocity died in the economy, and the government is desperately trying to revive it.
Counterintuitively, part of all this is by intent. Since China’s draconian nationwide Covid lockdown, Xi’s worries have been far less about growth and far more about national security (controlling domestic social unrest, dealing with existential threats like rapidly aging demographics and sanctions/tariffs by the West, freeing China from the U.S. controlled global currency and payment system, etc.). Maybe he should have been more concerned about maintaining growth instead, because growth is what hides “bad underwriting standards” in an economy hyper-fueled by debt. Once growth stops, losses overwhelm capital positions in both the private and public sectors. This is formula for economic collapse and social unrest.
Belatedly realizing artificial GDP growth = Overcapacity growth is not a sustainable strategy, Xi preemptively choked off credit to the property sector via the “3 red lines” policy, causing a hard landing more than he bargained for. Now that the damage is obvious, he can't very well do a 180 and revert back to large scale debt-fueled growth. He can only throw money at the problem surgically to stabilize “outbreaks” (like bank runs) and mitigate extreme pessimism. The latest such effort was funding the resuscitation of a dead stock market to entice retail investors back in. What can go wrong?
A lot of westerners mistakenly attribute China’s imbalanced (over-investment and under-consumption) economy to poor planning. Truth is, the last thing Xi wants is to develop a (western-like) consumption economy. That would empower consumers to be the drivers of a free-market via supply-demand dynamics, thus weakening CCP command and control. History has proven that in free market economies, markets become more powerful than governments. Why would the CCP plant the seeds of its own demise?
Instead, Xi intends to keep China’s populace constantly feeling insecure, working ever harder and competing ever more fiercely to drive labor costs ever lower (ideally free, — like Uyghur or prison labor) so the regime can forever remain the “world’s factory” in all manufacturing sectors under central planning and control. The “Chinese characteristics” of this essentially 16th century European Mercantilism policy included the luring (with China’s enormous market) of Foreign Direct Investment and transfer of knowhow.
The West was duped into believing the prosperity it helps China achieve would naturally lead to permanent adoption of free market capitalism by the CCP. It misunderstood the CCP’s true intent all along: To permanently undercut foreign competition and rid of foreign presence in China as soon as itself becomes self-sufficient. The CCP never intended to integrate into the existing world order, but to create a new world order in its own image. It has been doing it by both hard and soft influence (e.g. penetrating western academia with “Confucius Institutes” and actively exert influence in social media).
As well, China’s own populace mistook China’s burgeoning middle class as a permanent condition for continued growth of a consumption-based economy. They didn’t realize that increasing consumption — which necessitates elevation of household income — is at the expense of local government income, which is against the CCP’s interest. The CCP wants income and power to accrue to local and central governments, not to households. Viewed in that light, the destruction of entire industries like private tutoring and banking (Jack Ma and the ANT Group), and the mass purging of successful and influential entrepreneurs among the populace now makes sense. The demolition of China’s middle class is no accident.
Mercantilism seeks to maximize production and export, and minimize domestic consumption and import. The plan is to stimulate strategic industries for either national security or export, — not for domestic consumption. The endgame is to have the world depend on China for everything (down to essentials like pharmaceuticals) and to have China depend on the world for nothing, thus giving the West a dose of its own medicine, — an upcoming century of humiliation (the motive of revenge is more visible by the day, based on China's relentless belligerence toward the West, — especially Japan).
Wiping out industries in America not only engenders America’s dependency on China but hollows out America’s middle class. Government tax receipts decrease with gross domestic income and government deficit-spending increases to pay for social obligations. This can only be funded by increased issuance of government debt (Treasury bonds). Once the biggest buyer of U.S. Treasury bonds, China is now massively selling Treasury bonds. Diminished demand will force the Federal Reserve to print money out of thin air to fund this ever-growing U.S. government debt. This will put the U.S. into a inflationary doom loop: Currency debasement (i.e. inflation) from money printing invites rise in interest rates (lenders demanding higher compensation for dollars worth less) causing the government to borrow still more to meet higher interest payments.
What China didn’t plan for is a much bigger deflationary doom loop of its own. Managing the bursting of its colossal $60T property bubble (financed by a huge amount of debt) is causing China to deleverage pro-cyclically, meaning scaling down non productive investments results in deflation (e.g. consumers not spending), which further scales down investment, in turn accelerating economic slowdown (e.g. massive restaurants closing). Just to get an idea of China’s gargantuan debt overhang:
So what can China do to cure itself of this deleveraging, deflation, and depression doom loop? Well, let's look at the options. Per capita income is way too low in China to consume enough overcapacity. As previously explained, the CCP has no intention of “correcting this problem”. Meanwhile, it cannot push more State-subsidized low-price export in the face of now tremendous international pushback (witness BYD’s cheap EV cars piling up on the dock in Rotterdam and Bristol). Elsewhere, China had already built enough ghost cities, vanity projects, idle airports and high speed railways, and bridges-to-nowhere to last a century (destroying trillions of capital in the process). So it cannot go back to building more infrastructure, especially when its population is in alarming decline (some predict China will have just 525 million people by the end of the century).
So Xi came up with building “high quality industries” as the only viable option. Problem is, that requires innovation and entrepreneurial spirit, — the stuff of Jack Ma. And we all know what happened to Jack Ma. Chinese tech companies are not nearly as monetized as their Western counterparts because the government owns a big chunk of these companies’ “action” (data, advertising revenue, hosting infrastructure, etc.). CCP personnel are on premise these companies and actively steering them per CCP agenda. This type of political intervention simply cannot tolerate entrepreneurial spirit and does not foster innovation. The system is by its very nature is self-limiting toward achieving its stated goal.
With property rights at risk (of being taken away by government intervention at will) and entrepreneurial spirit dashed, massive brain-drain and capital flight are now in motion and China’s remaining youth gave up. Morale inside China has devolved to “garbage time”. To boot, demographics are deteriorating in an alarming rate, for which Xi’s solution is to extend retirement age. But with extremely high unemployment, this begs the question “if you can’t even get a job in your 30s, how can you hold a job into your 60s?” Mounting anger is palpable and protests are on the rise, sure to be met by ever stricter government controls and crackdowns.
But that’s not the end of it. Notwithstanding the “China Miracle”, the one goal China has never been able to reach is food-independence. China has energy/food deficit and a dysfunctional water distribution system. It can source food from abroad, but it is running out of money. Nearly $800 billion of Xi’s $1trillion investment in incomplete and unprofitable BRI projects vanished, failing to bring in debt repayments and revenue streams. More and more emerging economy nations can’t and won’t pay China back fast enough, thanks to their own currency devaluation, inflation, and over-indebtedness. Few are enchanted with whatever infrastructure China has already provided, thanks to shoddy construction and cut corners, and are unlikely to buy more. The current depression is so severe that people can only afford the essential.
China seems to be at a fork of the road. Will China continue on the path toward its original Grand Plan after a mere stall? Or will the stall force China to drastically revise its Grand Plan and embark on a completely different path? Judging by the unceasing purging of high level personnel, one can surmise the stall is severe and far reaching, with considerable political infighting behind the scene. Logic would suggest the left side of the fork is the more likely path for China in the coming decade.
Indeed, with recession and credit crises taking their toll on the private sector (China’s 100 biggest companies had fallen to less than a third by June, 2024), State Owned Enterprises and the central government are increasingly taking over the running of a command economy. The Great Leap Backward is in progress. Xi is, after all, a Mao fan and openly advocates collectivization (letting the State decide wealth distribution and resource allocation). This is in contrast with Deng Xiao Ping, — whose “China Miracle” was rooted in marketization (letting markets rather than the government set prices), liberalized free trade (lifting tariffs and restrictions), and privatization (letting profit motivate innovation and entrepreneurship). Of course, Deng also encouraged deplorable levels of rampant corruption in the process, which Xi is ostensibly trying to eradicate. In any case, the “path of evolution” points to a zombie economy with protracted deflation, — likely more severe than Japan’s “lost decades”.
Alarmingly, “lost decades” in China will be a problem not just for China, but the world. China’s decoupling from the West which requires massive reconfiguration of supply chains. Disruptions from that will be inflationary for the world. Even more important is the currency issue: All sovereign deflationary doom loops eventually result in currency destruction. The weakest sovereigns (e.g. Nigeria, Egypt, Venezuela, Argentina, now Turkey)’ currencies fall first. The strongest (the U.S.)’ currency will fall last. In deleveraging its gargantuan debt overhang at 3X its GDP (see previous debt to GDP chart), China has to print a lot of money out of thin air. This will break the Yuan peg to the U.S. dollar at around 7:1. A falling Yuan won’t be China’s problem alone, but the contagion for problems all over the world, as explained below.
Since 2009, China has amassed between $2.5 trillion and $3 trillion worth of US dollar-denominated loans in the Eurodollar market, effectively hedging their $3.2 trillion of forex reserves. What originally looked like an intelligent move to insure against Federal Reserve profligacy, can now turn into a time bomb. A sharp drop in the Yuan against the dollar (from hyper “print”), coupled by further decline in US imports of Chinese goods, and the Chinese will find it difficult to service that debt. Writing down that debt will blow a massive hole in the global banking system. Global liquidity will decline with bank losses, causing financial market crashes everywhere.
So, if the “China Miracle” (roughly 2000–2020) was the first half of a Great China Cycle that supported the Great Moderation in the West, then a crashing Yuan will be the second half of the cycle, — the Great Reckoning for all, but especially China itself.
