Jim Rickards tonic for Ray Dalio China bull

Jim Rickards tonic for Ray Dalio China bull, at the Daily Reckoning:

China’s shock currency devaluation last week begs the following questions: Is China a rising giant of the twenty-first century poised to overtake the United States in wealth and military prowess? Or is it a house of cards preparing to implode?

I made my first visits to Hong Kong and Taiwan in 1981 and my first visit to Communist China in 1991. I have made many visits to the mainland over the past twenty years and have been careful to move beyond Beijing (the political capital) and Shanghai (the financial capital) on these trips. My visits have included Chongqing, Wuhan, Xian, Nanjing, new construction sites to visit “ghost cities,” and trips to the agrarian countryside.

I spent five days cruising on the Yangtze River before the Three Gorges Dam was finished so I could appreciate the majesty and history of the gorges before the water level was lifted by the dam. I have visited numerous museums and tombs both excavated and unexcavated.

My trips included meetings with government and Communist Party officials and numerous conversations with everyday Chinese people, some of who just wanted to practice their English language skills on a foreign visitor.

In short, my experience with China goes well beyond media outlets and talking heads. In my extensive trips around the world, I have consistently found that first-hand visits and conversations provide insights that no amount of expert analysis can supply.

These trips have been supplemented by reading an extensive number of books on the history, culture and politics of China from 3,000 BC to the present. This background gives me a much broader perspective on current developments in China and a more acute analytical frame for interpretation.

An objective analysis of China must begin with its enormous strengths. China has the largest population in the world, about 1.4 billion people (although soon to be overtaken by India). China has the third largest territory in the world, 3.7 million square miles, that’s just slightly larger than the United States (3.6 million square miles), and only slightly behind Canada (3.8 million square miles).

China also has the fifth largest nuclear arsenal in the world with 280 nuclear warheads, about the same as the UK and France, but well behind Russia (6,490) and the U.S. (6,450). China is the largest gold producer in the world at about 500 metric tonnes per year.

China has the second largest economy in the world at $15.5 trillion in GDP, behind the U.S. with $21.4 trillion, and well ahead of number three Japan with $5.4 trillion. China’s foreign exchange reserves (including gold) are the largest in the world at $3.2 trillion (Hong Kong separately has $425 billion in additional reserves).

By way of contrast, the number two reserve holder, Japan, has only $1.3 trillion in reserves. By these diverse measures of population, territory, military strength and economic output, China is clearly a global super-power and the dominant presence in East Asia.

Yet, these blockbuster statistics hide as much as they reveal. China’s per capita income is only $11,000 per person compared to per capita income of $65,000 in the United States. Put differently, the U.S. is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis.

China’s military is growing stronger and more sophisticated, but it still bears no comparison to the U.S. military when it comes to aircraft carriers, nuclear warheads, submarines, fighter aircraft and strategic bombers.

Most importantly, at $11,000 per capita GDP, China is stuck squarely in the “middle income trap” as defined by development economists. The path from low income (about $5,000 per capita) to middle-income (about $10,000 per capita) is fairly straightforward and mostly involves reduced corruption, direct foreign investment and migration from the countryside to cities to purse assembly-style jobs.

The path from middle-income to high-income (about $20,000 per capita) is much more difficult and involves creation and deployment of high-technology and manufacture of high-value-added goods.

Among developing economies (excluding oil producers), only Taiwan, Hong Kong, Singapore and South Korea have successfully made this transition since World War II. All other developing economies in Latin America, Africa, South Asia and the Middle East including giants such as Brazil and Turkey remain stuck in the middle-income ranks.

China remains reliant on assembly-style jobs and has shown no promise of breaking into the high-income ranks.

In short, and despite enormous annual growth in the past twenty years, China remains fundamentally a poor country with limited ability to improve the well-being of its citizens much beyond what has already been achieved.

With this background and a flood of daily reporting on new developments, what do we see for China in the months and years ahead?

Right now, China is confronting social, economic and geopolitical pressures that are testing the legitimacy of the Communist Party leadership and may lead to an economic crisis of the first order in the not distant future.

In contrast to the positives on China listed above, consider the following negative factors:

  • Trade wars with the U.S. are escalating, not diminishing as I warned from the start in early 2018.
  • Trump’s recent imposition of 10% tariffs on the remaining $300 billion of Chinese imports not currently tariffed (in addition to existing tariffs on $200 billion of Chinese imports) will slow the Chinese economy even further.
  • China retaliated with a shock devaluation of the yuan below 7.00 to one dollar, a level that had previously been defended by the People’s Bank of China. Resorting to a currency war weapon to fight a trade war shows just how badly China is losing the trade war.
  • But, this currency war counterattack will not be successful because it will incite more capital outflows from China. The Chinese lost $1 trillion of hard currency reserves during the last round of capital flight (2014-2016) and will lose more now, despite tighter capital controls. The spike of bitcoin to $11,000 following the China devaluation is a symptom of Chinese people using bitcoin to avoid capital controls and get their money out of China.
  • The unrest in Hong Kong is another symptom of the weakening grip of the Chinese Communist Party on civil society. The unrest has spread from street demonstrations to a general strike and shutdown of the transportation system, including the cancellations of hundreds of flights.
  • This social unrest will grow until China is forced to invade Hong Kong with 30,000 Peoples’ Liberation Army troops now massed on the border. This will be the last nail in the coffin of the academic view of China as a good global citizen. That view was always false, but now even the academics are starting to understand what’s really going on.
  • International business is moving quickly to move supply chains from China to Vietnam and elsewhere in South Asia. Once those supply chains move, they will not come back to China for at least ten years if ever. These are permanent losses for the Chinese economy.
  • Of course, lurking behind all of this is the coming debt crisis in China. About 25% of China’s reported growth the past ten years has come from wasted infrastructure investment (think “ghost cities”) funded with unpayable debt. China’s economy is a Ponzi scheme like the Madoff Plan and that debt pyramid is set to collapse.
  • This cascade of negative news is taking its toll on Chinese stocks. This weakness began in late June 2019 when the summit meeting between U.S. President Trump and President Xi of China at the G20 Leaders meeting in Osaka, Japan failed to produce substantive progress on trade disputes.
  • Since then, the trade wars have gone from bad to worse and China’s economy has suffered accordingly. My expectation is that a trade war resolution in nowhere in sight and the trade war issues have been subsumed into a larger list of issues involving military and national security policy.

The new “Cold War” is here. Get used to it.

Comments

  1. “The path from middle-income to high-income (about $20,000 per capita) is much more difficult and involves creation and deployment of high-technology and manufacture of high-value-added goods.”
    How did Asstrailer move from middle income to high-income, when we just dig holes and sell the contents and reinvest it in sub-stand sky kennels that crack and threaten to burn? Where’s the high value-added jobs? Perhaps in flooring for $17k a week…..

      • Oh. Despite all the rhetoric about how great we are and a first world country, we are still stuck in the Middle income range. I enjoy Rikards posts, I think he works for Agora (Bill Bonner) publishing nowadays, there was some rumour he was a CIA asset, if so the article would make sense, though it just seems mostly factual despite the CCP assertions they are to become a great power.

      • I’d say we’re a fading market, or whatever good antonym for “emerging” you’d care to substitute.

  2. His point about production shifting to other countries is a good one. This will be Australia’s next future boom cash cow. Selling to Indonesia/Malaysia/Philippines/et al.
    More diversified customer base with lower political risk but still open to corruption, I mean business.

    We have to go through the crash of China first

  3. SnappedUpSavvyMEMBER

    i’m not surprised about how quickly the house of cards is coming apart, what is surprising me is how peoples once rosy views of chyna, specially the snowflakes amongst us, have changed so fast, everyone except the odd bogan with a girlfriend in Guangdong, is very negative about chyna, I didn’t expect that

  4. Jumping jack flash

    “Yet, these blockbuster statistics hide as much as they reveal. China’s per capita income is only $11,000 per person compared to per capita income of $65,000 in the United States. Put differently, the U.S. is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis.”

    This is the fundamental difference between productive and unproductive.

  5. What i am interested is the military technologies that China (and Russia) have developed. Whilst I am no weapons gun, my gut tells me that much of the so-called commercial SOEs in the tech space are fronts for military tech development and I often wonder if the US is fighting the last war where aircraft carriers where the king and falling behind where tech will be the queen slayer

  6. He is right that if China invades HK, then that is the end of China.
    I wonder if they are that stupid?
    Love how Trump is baiting them to invade.
    This China bashing by Trump is going to get him re-elected. He is on to a winner there.

  7. “…….now even the academics are starting to understand what’s really going on”.
    Finally they’re seeing past the $$ to see how much they’ve embarrassed themselves? Shame our Pollies don’t have any, well shame……

  8. John Howards Bowling Coach

    There is another problem that is being hidden in the fake numbers and is an even bigger reason that Australia is not that reliant on China economically. You see in fact the majority of the exports they buy from Australia are not owned or controlled by Australia. The mining industry is almost entirely foreign owned, we’re lucky to scrape off some royalties as their foreign owners rush our dirt offshore, transferring almost all profits virtually tax free, and the number of local’s employed by that entire industry is very very small.

    If we then start to really understand some of the other supposedly large export segments you can start to see the reality. Let’s take wine as an example. I was talking to one of the top 5 wine producers in Australia recently about their business to China. In fact they exclusively sell via a business which is a couple of Chinese people in Australia, reselling their wine to other Chinese in Australia, who are likely only buying the wine to export for the purpose of getting a Visa through the fake business channel which is completely dominated by Chinese applicants. So the winery, while exporting a lot to China only make a small margin and in fact do not actually know who is exporting their goods, or where it is going. The stock changes hands twice to Chinese living in Australia, before it even leaves Australia. Middle Men layered on Middle Men, none of them adding any value.
    This is a very typical example and as I said this is from one of the largest producers not just some small time player with a few acres of vines. You can also be sure neither layer of Middle Men declares a profit of significance or pays much tax at all in Australia, neither would the producers as they forego a good margin for the sake of supposedly having Chinese expert run that business, which on closer inspection turns out to just be traders skimming a margin and running a business with no strategy. The irony is the winery would never do that for their sales in Europe, but somehow the Chinese manage to hold almost all of the profits for trade going into that nation.
    If Australia was to lose all of the trade into China it would hardly represent any profits made here, because like the rest of the world we’ve been cheated into believing the profits will come with patience (they won’t)

    So the best we can do is be in control and own the sales channel where possible, certain we need to reverse the Aussie habit of selling the farm.

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