Why China’s rise is coming to an end

Bloomie does history today:

In the years that followed, Hu and hundreds of millions of others left the countryside and set up businesses in cities or went to work in factories that propelled China to become the world’s second-largest economy. Deng’s reforms, officially launched 40 years ago on Dec. 18 at a meeting of the Communist Party’s Central Committee, precipitated one of the greatest creations of wealth in history, lifting more than 700 million people out of poverty.

…When President Xi Jinping assumed power in 2013, many hoped he’d turn out to be a leader in Deng’s reformist vein. But while Deng wanted his market-based reforms to make China rich, Xi has reasserted the control of the state in an effort to turn the country into a political and technological superpower.

…The confrontation comes at a critical moment for China as it tries to avoid falling into what economists call the middle-income trap, where per-capita income stalls before a nation becomes rich. Usually that happens because rising wages and costs erode profitability at factories that make basic goods like clothes or furniture, and the economy fails to make the jump to higher-value industries and services.

Only five industrial economies in East Asia have succeeded in escaping the trap since 1960, according to the World Bank. They are Japan, Hong Kong, Singapore, South Korea, and Taiwan.

To join them, Xi must oversee a transformation in China’s markets, injecting more competition in financial services, upgrading technology, and tightening corporate governance, while waging a trade war with a U.S. administration bent on containing the Asian nation’s rise. Xi’s challenge is compounded by an aging workforce, the mountain of corporate and local government debt, and an environmental clean-up that will take decades.

It is pretty clear today that China is going to fail. There are four main reasons why.

The first is size. Notice that all of the other nations that transitioned out of the high saving, high investment development model to the high income and consumption of developed markets, were small. Their transformation did not disrupt the ruling hegemony of US-led liberal capitalism. Indeed they largely reinforced it.

As a continental economy, China is too large. It can’t make the jump to higher value-add output without demolishing all other developed markets. That means it will implicitly threaten the existing standards of living of its largest Western competitors. It has already done so for several decades, taking their low-value exports and leading to the rise of restive working classes hostile to China.

This was hidden for a while from Western polities through falling interest rates and rising asset prices but that game is now over. Working classes want their work back. Next up it will be the white collar workers of the city and Western governments cannot allow that.

Second, add to the first that China is a dictatorship. That means if it were to succeed in capturing the world’s high value-add production it will also displace the ruling liberal democratic regime. Thus Western nations are now pushing back and looking to directly block Chinese progress.

The third reason it is going to fail is that with that outlet blocked it, China has had to rely overly long on its debt-driven capex-led growth to keep its people from throwing over its dictator. It’s not at all clear that Xi Jinping is a reformer. Indeed, he has now kicked the useless China building can twice since 2013 and will face the same test again next year. Remember, despite a very modest rebalancing towards consumption sectors, China is still building more useless stuff today than ever before:

This despite 60m empty apartments across the country, enough to house all future rural migrants.

We see an analogy here with the USSR which equally sustained its command economy model too long, over-investing in military capacity to keep its economy growing at artificially high levels. But, over time, that enormous capital mis-allocation killed productivity and income growth while raising an impossible debt load.

China is the same with its urbanistion model. Substitute rifles, subs and aircraft with empty apartments, malls and skyscrapers, and the end result is the same. Lot’s of useless shit that creates debt but not income while draining the wider economy.

We don’t think China will collapse like the USSR. It is too smart for that. But neither will it escape the middle-income trap. It will steadily bog down into it over the next decade without massive reform and we no longer believe Xi Jinping has the will for it. He looks to us like a classic dictator, feathering the nests of his family and mates via The Party, not some great Chinese patriot prepared to take the hard road to national success (which would involve eliminating himself!).

The fourth and final reason for the end of China’s rise is its terrible demographics which will see it grow old long before it is rich and make all three of the above factors worse.

We can expect China to keep oscillating wildly between deleveraging and stimulus as it slows and its growth becomes an ever more a wasteful mirage.

For Australia it means an ongoing slow motion bust in bulk commodity prices that will end some time in the 2020s with iron ore back at $20 as Chinese scrap metals rise. This is a pretty good result. If our own leaders were not so corrupt it would be a quite manageable adjustment as we would already have spent years transitioning ourselves to non-mining tradebales.

With corrupt leadership it will be harder, as it hangs onto China for far too long by placating interests. But we’ll still get there eventually as the AUD inexorably collapses.

The really good news in the fading Chinese outlook is that it will never seriously threaten US hegemony, meaning that Aussie democracy has better prospects than I feared even a year ago.

The end of China’s rise is the best thing that could have happened to Australia.

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