The Political Economic Bubble of Modern China & Why it will burst!

By Oliver Green

Over the course of this article I’m going to deliver the inescapable conclusions I have reached through my study and assessment of the alleged miracle of the early 21st Century, which is ‘The Great Chinese Economic Boom’. I will begin by describing the numerous and significant achievements China has reached over the past decade and more. I will then explain what the Beijing Government has done to have achieve this allegedly great and miraculous success, and what problems, inherent weaknesses, and grave imbalances have been caused by the creation of ‘China’s Political Economic Model’. I will conclude by describing how all these factors will culminate in the cause of a new Chinese East Asian Crisis, and will probably dwarf the previous East Asian Crisis of the late 1990’s.

No one can deny the tremendous speed with which China’s Economy has grown, with an average GDP growth rate of around 10% per annum over the previous decade. Partly due to the dramatic slowdown in the developed economies, China and the other emerging markets have accounted for more than 50% of global GDP growth over recent years, and China itself is the biggest exporter on the face of the planet. The purchasing power of the average Chinese citizen since the early 1980’s has gone from being one seventieth of the average American income per head to only five times poorer today. New Chinese cities are being put up as fast and as easily as we draw breath. Macau a specially administered region of China, which was returned from Portuguese control in 1999, has now become a world leading gambling city, larger than Las Vegas, and it is now a magnet for foreign currency exchange (but for the wrong reason I hasten to add).

China has also become the world’s biggest energy consumer (except for oil) and biggest importer of raw materials to fuel its construction boom. It is also the world’s biggest trading partner of the United States and holds the largest amount of foreign held US Dollar exchange reserves. Also, after 15 years of applying, China was re-admitted as a new member of ‘The World Trade Organisation’ in 2001 after having exited it back in the 1950’s under Mao. The country therefore became open to the markets and trade opportunities that the Chinese could only dream of up to then. China has now gone from being a predominantly rural population to a predominantly urban one, with more than 50% of Chinese citizens living and working in towns and cities for the first time. But most significantly is the fact that in 2010 China overtook Japan as the world’s second largest economy (or third if you include the European Union as a whole). Western Businesses and corporations have flocked from all over the developed world to set up in China and exchange their technological and business expertise for just a very small slice of China’s massive developing markets, including its e-commerce market, which now rivals America.

So why you say am I seeing one of the biggest bubbles in world history set to burst apart at the seams?

Why I am Not Seduced by the Chinese Economic Miracle

As pretty much all of us are aware, the first rule of economics and pretty much anything in life is that there is no such thing as a free lunch, or if it seems too good to be true, then it is. For every strong point or advantage, there is usually a corresponding disadvantage or weakness compensating for it. I’m a firm believer that every solution to a problem or set of problematic conditions creates a new problem or set of problematic conditions. All bubbles therefore burst due to the unique stresses and strains that each of them create for themselves.

So what stresses and strains have the Chinese created for themselves in their pursuit of this prolonged boom of hyper-growth and economic come-back after five centuries of lagging further and further behind the western world?

To answer this question I will now go through what they have done to achieve it and what the implications are which should bring it crashing down before too long. By far the single most defining factor behind China’s boom is their unrelenting monetary policy of creating and maintaining a massively under-valued currency, which has enabled them to monopolise much of the world’s manufacturing and export markets, by massively under-cutting the strong currencies of developed and rich nations. China’s Central Banks have done this in two main ways; the first has been loose monetary policy of massively over-printing paper Chinese Yuan or Redback as it is often referred to, and the second way has been to further leverage their position as America’s biggest trading partner, by buying up the world’s biggest foreign exchange reserve of US Dollars to make doubly sure that Chinese Yuan remain firmly depreciated against them. Thus this aggressive two pronged monetary policy has the dual effect of maintaining China’s huge export driven hyper-growth, and of keeping manufacturing jobs in China as opposed to the west and the rest of the world, which improves the purchasing power of Chinese workers at the expense of their western counter-parts. Consequently, China has become enabled to grow into the type of majority urban based population that it has never managed to be before.

However, this cheap export lead boom makes it impossible for the Beijing Government and China’s other employers to pay their workers the wages necessary to sufficiently boost consumption in order to develop China into a more stable, mature and balanced economy, and secure healthy growth for the long term. If they were to do this on top of their already massively under-valued currency, China would experience hyper-inflation, its economy would overheat and face severe stagflation as its tax revenues collapsed when its cheap labour fueled export market disappeared through paying the workers the much higher wages, plunging the economy into total meltdown. This therefore ensnares the Beijing Government into the classic catch 22 scenario. It is also this export lead hyper-growth which leads on to the next question of how the Chinese managed to sustain their 8-10% of annual GDP growth since the dramatic slowdown and drop-off of demand from the west as a result of the 2008 financial crisis.

So how have the Chinese managed to sustain their growth since 2008 and walk through the financial crisis completely unscathed?

Between 1995 and 2001, the Beijing Government adopted a widespread program of mass privatisations, reducing the number of state owned companies by around two thirds, and the proportion of urban workers employed by the state by almost half. However, these statistics are hugely misleading, as many of the allegedly private Chinese corporations owe their success in China to the funding and protections they receive from joint venturing with state departments. The true health and performance of China’s thrusting corporations and private sector is also gravely distorted by the Beijing Government’s rigid and narrowly determined policy of strict protectionism. China’s massive state backed corporations and private sector is therefore shielded from the genuine foreign competition of the thrusting dynamic corporate heavyweights of the western world, as no foreign owned companies are permitted to buy and own assets in China, or transfer Chinese Yuan out of the country themselves to convert into foreign currency.

The only way the masses of foreign western companies are setting up and investing in China today is through joint venture partnership arrangements, with the Chinese intermediaries who own the assets and lease them to their foreign partners in exchange for their technological or business expertise or intellectual properties. The Yuan profits are also paid to the Chinese partners who then transfer them to their own offshore accounts which their foreign partners are then able to withdraw from and convert into their own currencies. This is why the specially administered region of Macau, (similar to Hong Kong) which I mentioned earlier, is a magnet for foreign exchange and gambling for Chinese private companies and individuals. It is exempt from the strict currency control of the mainland, permitting its participants to convert their Yuan into any foreign currency of their choice (usually Dollars) for gambling and laundering to circumvent the oppressive currency controls of the mainland. But by far the biggest reason why the Chinese economy is still a massive government liability and monopolised by the state is a very simple one.

The biggest reason why the Chinese economy is still a massive government liability and monopolised by the state

All the crucial and deemed strategic elements of China’s domestic economy are all government owned and operated as government ministries. These ministries include China’s banking system, which includes China’s construction banks where the funding for the nations construction boom flows from, as well as China’s Telecommunications industry and its entire transport infrastructure. These state owned or backed corporations therefore dwarf the numerically superior private sector firms in terms of their overall share of Chinese GDP, which leads to corruption and wastage of public money, as many of China’s state backed fat cats pocket the bulk of allocated funds for themselves and sub contract on the cheap, sub-standard work from the squeezed private sector.

These state backed corporations also undertake huge white elephant projects of building massive new towns and public utilities, which Chinese families cannot afford to live in or use, creating numerous and vast ghost towns in order to justify asking for a continual flow of central government cash at the same level every year. In addition, public infrastructure right across the country is often built below standard, and corners are cut to ensure speedy completion to please government paymasters and receive increased perks, and cash. Meanwhile, western demand for Chinese exports has been declining since the financial crisis of 2008, as western governments too have been devaluing their currencies to reduce the costs of servicing their debts and renew growth through boosting their ability to export as unemployment rises, especially in America’s case, as the Federal Reserve has the unrivaled capacity to print dollars at almost unlimited quantity for the obvious reason of the US Dollar being the world’s reserve currency, which means they can keep printing Dollars without having to worry too much about debasing the currency, as the whole world not just the American people are using it. But China fans look on in awe at China’s sustained hyper-growth of around 7-8%, while the Beijing government also manages to keep inflation well under control.

So what is behind China’s sustained performance since the financial crisis and drop off in western demand?

It’s a sized and further calculated increase in government spending, and further currency devaluation that is behind this apparent miracle. State monopolisation and strict control of credit to keep the inflationary pressure at bay is also a key factor. It is not some great economic wisdom or philosophy that the Chinese are keeping close to their chest, and that the west somehow just doesn’t get, and neither is it the sheer numbers of work ethic driven and diligent Chinese workers, who are only relative to the required amount of government expenditure needed to sustain their state dependent growth in development and living standards as they save diligently and spend little. Thus the current phenomenon that is the ‘Chinese Economic Miracle’ is artificial, manipulated, unsustainable and at the expense of China’s future.

So how could it unravel?

So far I have identified two facets of ‘China’s Economic Miracle’, which create the illusion of the Chinese having their cake and eating it. The first such facet is the long term sustained hyper-growth, which as I have already explained is dependent upon massive and continual government spending and currency devaluation. The second such facet is the ability of the Beijing Government to keep inflation low and prevent China’s economy from overheating, (as booming emerging economies have traditionally tended to do) in spite of their extremely loose monetary policy and deliberately weakened currency. The reason for this is that the Beijing Government owns all of China’s banks and dictates to them intensely from the top down. It has therefore been extremely easy for them to restrict the flow of credit throughout the private sector economy to offset their loose spending and currency devaluation, and prevent high inflation and debasement of the Yuan.

Unfortunately for them, this credit tightening ability means that the restriction of credit flow has inevitably lead again to a state sector monopoly, where only the state owned or backed corporations have sufficient legitimate access to credit and cash flow to survive, grow and thrive. This is assured by the simple fact that they will have an unfair and unstoppable advantage over China’s small and medium sized private firms in securing credit, as China’s State Banks become increasingly unwilling to lend to the private sector and restrict the remaining flows of available lending to the much safer bet state owned or backed corporations, which have the backing, endorsements and guarantees of the Beijing Government, which won’t allow them to fail. There is also the added incentive of them being much larger than their private sector counterparts, and so requiring much more of the remaining credit flows, producing much higher returns for lenders. The effects of this have already fed through into China’s private sector as 60-90% of businesses are now estimated to be borrowing from loan sharks, and paying anything in the region of 30-60% interest to them, or trying to. But this will likely be a spark and a symptom of the decline of the unsustainable political economic model that the Beijing Government adopted, as opposed to the overall cause.

What will cause the true unraveling of this Chinese fairy tale will be the overwhelming amount of government debt and liability which is inevitably building up and up, and will force the Beijing Government to wind down its loose monetary spending spree?

But despite this, they will probably continue to manipulate their currency, although they will no longer be able to offset the reduced demand from the west, meaning that their tax revenues will fall as their level of debt begins to skyrocket. State subsidies for more and more construction projects, foreign contract bids, and foreign asset grabs across the underdeveloped world could dry up, culminating in an overall slowdown in the government spending needed to sustain the boom. This in turn will reduce the demand for the services and products of the small and medium sized private sector companies, meaning that more and more of them will experience a dramatic drop in sales and profits, fall behind in their 30-60% interest payments and collapse into oblivion. China’s tax revenues could therefore decline much further, causing the monopolised state sector credit to dry up, and push China into a new great recession, (or perhaps even a depression) making China the new Japan, basking in past glory.

Consequently, China will then have the desperation and economic hangover to become very aggressive in its foreign policy stance in the region and towards the western world, as it retracts under its own weight, and under the enormous costs of its golden era of hyper-growth. This is what the United States has been gearing up for as President Obama sent more than 2,500 troops to Australia and to start steering America’s new defence strategy towards bolstering and re-affirming America’s already strong presence in the East Asia and Pacific region. This will likely be achieved by reducing US troop numbers across the world back to their pre 2001 level, while significantly increasing America’s arsenal of navel strength and air-power.

China’s population of more than a Billion people means that they are desperate for vast resources and quantities of raw materials, energy, food and water, and have to maintain above average growth rates in their GDP just to maintain the standards of living and levels of urban employment the Chinese have come to expect, and keep their apparent “economic miracle” on track, and as their growth rate has already begun to slow the pressures and obstacles facing them will only increase, especially as their population starts to get old before it gets rich. It is projected that by 2050 the largest population in the world will be Indians and the second largest will be Chinese pensioners. So consequently, the Beijing government has pursued a prolonged policy of buying up assets around the world, including (but not exclusively) Africa, the Middle East, Europe, Asia, Latin and North America, and which may serve to cushion their economy from some of its long term structural risks.