A Paper Dragon
Can Peak China Ever Get its Fung Shui Back?
It wasn’t that long ago when we though another Asian power was gearing up for a hostile take-over of the US economy. It wasn’t Germany or Great Britain, which in the 1980s were one and two in the “foreigners buying America” category. We were terrified of number three: Japan. The buggers seemed just a little too well tuned to the coming digital age.
Then 1989 happened and America was saved from its vaguely racist fears. The wildly overextended Japanese asset bubble burst and things haven’t been the same since. Shares fell some 60% in three years and property values dropped for a decade. The deflationary spiral only ended after 25 years, and without covid scrambling the global economy, it’s not certain that it would have ever come out of it.
China’s economy is getting no such post-covid pop, its growth is now lower that it when the entire economy was in lock-down. Chinese companies have accumulated more debt, relative to the size of GDP, than Japan had at the peak of its bubble. And like China, the bubble was real estate heavy in a country geared to exports and unable to consume its own production. This raises the question of whether or not China, this generation’s Asian menace, will go the way of the last one. Is China looking down the barrel of their own lost decade of price deflation?
Starting with the fundamentals – it’s a hard “maybe.” Deflation spirals happen when there is a mismatch between too much supply and not enough demand. Big supply, limited demand, prices fall. Export driven economies are prone to deflationary blips, and they generally don’t cause too much trouble because in a balanced global economy, you just find another outlet for the surplus.
In China, the property sector was comically overbuilt on credit. Like the US real-estate bubble that led up to the subprime crisis, these apartments where not just homes, but investment vehicles and savings accounts for a population where no sane person trusts the money the government is printing. Now that home prices are falling, savings are being gutted so people are hoarding cash. That, along with a massively ageing population, (they old folks neither produce nor spend a lot) China will likely never jump to a consumption driven economy.
The huge difference between Japan’s situation in the late 80’s and Chinas in the early 20s is that Japan’s reaction to a debt crisis was to pare down its debt. This seems logical, but when everyone was doing it, it puts the breaks on corporate, government and household spending all at the same time. Japan’s population is about aging about generation ahead of China’s terrible demographics. This isn’t a problem for China because Beijing’s relationship to money is something a Westerner with a healthy appreciation for simple math and GAAP accounting would find baffling.
Whereas I think that money is something exchanged for goods and services and, if you’ve got a little pile left over you invest it for a reasonable return. The Chinese Communist Party thinks that money is spackling for social stability through jobs creation. And in a place like China, that requires a lot of spackling: Since the turn of the century China has increased the money supply by 800%. To put this into context, over the roughly the same period, the wildly extravagant US government cut checks for a 20 year War on Terror, a massive bailout of the financial system and injected enough covid stimulus into the system to trigger the worst inflation un 40 years, and “only” increased the money supply by 15%. For its part, the Chinese economy is driven on government investment that is largely generating negative returns and exports.
The exports are the next issue: China’s rise was fueled largely by dumping cheap wares on the West. The popular metaphor for all this is the iPhone – but the Chinese don’t make iPhones, they assemble them. The design, financing, marketing and distribution phases of manufacturing are handled in the US, so is the ordering of component parts, most of which are not manufactured in China (not the precision stuff, anyway). What the Chinese do is assembly. the only put the pieces together.
What China actually “makes” isn’t high-end and must be subsidized by the government. By some accounts the Chinese only figured out how to make an entirely home-grown ball-point pen in 2017 (although, they might not have been trying that hard.) Huawei was set to become the world’s largest telecom – until the US and the Europeans clamped down on intellectual property theft. Two years later, Huawei isn’t even in the top five. The Chinese educational system is dominated by the Communist party, and the CCP doesn’t not encourage out of the box thinking.
Even the low-end assembly stuff is predicated on trading partners that don’t hate you. By threatening the US, Europe and Australia, China is simply can’t address its surplus imbalance because the entirely of the Global South simply can’t absorb it. The only thing that China can do is wait for its population to completely collapse. Which is not that far off.
But that’s another kettle of fish.