(Continuation of the article: THE SEVERE CHALLENGES CHINA FACES, published in this blog)
China’s economy faces enormous headwinds that will first impede growth and then likely result in declining growth in the years ahead. Three of these headwinds — debt, demographics and geopolitics — I discuss below. The other critical factor slowing economic growth in China is low energy reserves.
China is in a debt bubble worse than even Japan or the United States. The extent of this debt bubble is obscured by the fact that trillions of dollars of debt are pushed down by the central government in Beijing to the level of provincial governments, state-owned enterprises (SOEs) and major banks.
All of this debt is de facto guaranteed by the central government; it’s naïve or disingenuous to believe otherwise. As a result, this diverse debt must be rolled up in order to analyze the impact of debt on growth.
Total debt in China (excluding banks) is about $47 trillion, which is 281% of Chinese GDP. Only about $5 trillion of this is household debt, leaving $42 trillion of government and corporate debt.
Much of the corporate debt is issued by SOEs, so it is tantamount to government debt. Even on a conservative estimate, government debt in China is at least 250% of GDP. If a bank bailout were required, it would cost about $1 trillion or almost 50% of China’s liquid reserves.
The evidence from numerous academic sources is overwhelming that higher debt levels reduce growth. A comfortable debt level is about 30% debt to GDP. At levels of 60% or higher, growth slows significantly.
Everyday citizens see the debt burden rising and adjust their behavior, often in the form of higher savings rates in anticipation of higher taxes or inflation that inevitably follow debt debacles.
At 90% debt-to-GDP levels or higher, what physicists call a phase transition occurs. Added output from an additional dollar of debt is less than the dollar borrowed. At lower ratios, a dollar borrowed will produce more than one dollar of growth. But the excess output will shrink as the debt level rises, an example of diminishing marginal returns.
At levels in excess of 90%, returns go negative so that each dollar borrowed produces less than a dollar of growth. Those negative returns increase as the debt level climbs. This is why you cannot loan your way out of a debt crisis.
China is well into this negative marginal return zone. China’s debt situation has gone through the looking glass into a bizarre world from which there is no escape except default, inflation or confiscatory taxation (or some combination).
In addition to a debt trap, China has fallen into an energy trap. Coal prices are rising because of expanding demand, cold weather and supply-chain disruptions. As a result, China imposed price controls on coal by setting a ceiling on price increases.
Of course, price controls never work. They may offer some short-term alleviation, but sooner than later consumers figure out substitutes or structured solutions or move to an outright black market.
China is faced with severe energy shortages now. There’s also good reason to expect a colder-than-average winter. The Chinese will be freezing in the dark in Manchuria and in other northern provinces. China is already closing factories on a large scale to conserve energy for residential light and heat. This will get much worse.
No political or economic event for the remainder of this century will have more impact on the world than the demographic disaster unfolding in China. Nothing like it has ever happened in world history, not even the Black Death of the 14h century.
The birth rate needed to maintain a population at a level size is 2.1 children per couple. If the birth rate is 1.0, the population will be more than cut in half in 40 years. The only exception to these ironclad rules is immigration.
Still, China and Japan are highly homogenous and anti-immigration. This means their birth rate will determine their destiny as a society.
China’s birth rate today is reported to be 1.7. However, there is good evidence that the actual birth rate is closer to 1.1. At that rate, China will lose 630 million people by 2100. Its population will drop from 1.4 billion to 770 million.
The phenomenon is not limited to China but is pervasive in developed economies including Japan, Western Europe, the U.S. and Canada. China simply seems to be the most extreme example (with the possible exception of Japan).
China will lose productive workers as society ages. The declining birth rate, crashing population and lost productivity will cause a crisis of confidence in the Communist Party and may precipitate regime change independent of other factors including the potential for war.
This will be the end of the “China Miracle.”
China is making blatant threats to invade Taiwan and is flying fighter jets and nuclear-capable bombers through Taiwanese airspace. China is laying claim to the entire South China Sea (which should be shared among six surrounding nations) and dredging the seafloor to create artificial islands. China then constructs airfields and ports on those islands for military operations.
China also launched a trade war on Australia because of Australia’s insistence that independent investigators get to the bottom of the leak of the pandemic virus from a laboratory in Wuhan. China also aimed vague threats in Japan when it voiced support for Taiwanese defense efforts.
In short, China is moving aggressively in all directions to establish itself as the sole hegemonic power in the Western Pacific and South Asia. Of course, this kind of hegemony means ejecting the U.S. from the area and turning Japan, Australia, and India into tributary states.
This aggressive posture has now triggered pushback rather than acquiescence. The U.S., Japan, Australia and India have formed the Quad, which is a four-power soft alliance to contain Chinese ambitions in the region.
A quick glance at a map reveals that the Quad controls all of the sea lanes and choke points in the Western Pacific and Indian oceans that can be used to cut off energy imports and manufacturing exports by China. China could be choked into ruin by sea in the same way that the Royal Navy choked Napoleon and continental Europe in the early 19th century.
Chinese aggressiveness and the allied response have inevitably triggered questions about the potential for war between China and the U.S. and its allies. This risk was described in a bestselling book titled Destined for War by Graham Allison.
Allison invokes what is called The Thucydides Trap named after the ancient Greek historian of the Peloponnesian War.
Thucydides viewed the Peloponnesian War as an almost inevitable conflict between a long-established military power, Sparta, and a new rising power, Athens. Allison’s thesis was that the established power and the rising power will have many competing interests and eventually come into conflict to see which one can emerge as the sole hegemon.
Allison identified sixteen cases of The Thucydides Trap in the past 500 years. Twelve of those cases (75%) resulted in war. That’s not an encouraging track record when it comes to the potential for a U.S.-China conflict.
The United States seems to be at one of its interim low points under the hapless leadership of Joe Biden. Still, China realizes it may be at peak power and will be economically and socially diminished in the years ahead.
If that’s the case, and if China wants to dominate its region, then the best time to start a war is now. It’s not that China has all of the power it wants. It’s the case that China has all of the relative power it’s going to get. This creates a now or never dynamic that can lead straight to war.
Let’s just hope it doesn’t.
Regards,
Jim Rickards
Comentários