BENCHMARKING CHINA / GEOPOLITICAL FUTURES

Benchmarking China

Thoughts in and around geopolitics.

By: George Friedman

For some time, China has been regarded as an economic miracle, a country whose rise would in due course put it atop the global economy. 

The justification for this expectation rested on the rate of growth China has enjoyed since Deng Xiaoping took over the chairmanship of the Chinese Communist Party and called on the Chinese people to enrich themselves. 

This marked the end of Maoism and ushered in an economic surge. 

It was and had to be what some call a dead cat bounce. 

If you throw down a dead cat hard enough, it will bounce. 

China is, of course, far from a dead cat, but in 1978 when Deng took over, it seemed like the economy was quite dead, if not a cat. 

China’s surge over the next decades was simply the economy’s response to being released along with the marginalization of Marxism-Leninism.

The growth was remarkable but not unprecedented. Similar stories occurred in the United States and Japan. 

This is a cycle I have written about before, but it is relevant to understanding China today. 

In 1890, the United States was 25 years removed from the Civil War. 

During that period, economic and financial instability reigned. 

The U.S. could manufacture, but the domestic market was limited, so the U.S. was forced to look abroad. 

Its exports surged until, in the early 1900s, the United States was manufacturing nearly half of all manufactured goods in the world. 

These exports built American industry, which benefited as well from World War I. 

This went on until the 1920s when the war had ended and Europe's ability to afford imported goods slumped. 

The U.S. faced the reality all countries that export face: It was hostage to the ability of its customers to buy. 

This led to the Great Depression, and recovery did not come until World War II ended and domestic demand resumed.

Japan went through a similar cycle. 

Its economy devastated by war, Japan began its recovery around 1950. 

It too was built on combining manufacturing skills and exports, starting with minor products. 

(“Made in Japan” tended to indicate low quality.) 

Its prime market was the United States. 

Over time, the quality and competitiveness of Japan’s exports surged. 

Japanese automobiles badly hurt the American auto industry beginning in the 1970s. 

In the U.S., political and economic resistance to Japanese imports swelled. 

The backlash, along with a banking system in Japan that lacked controls, created the Lost Decade, which forced a new model on Japan after a 40-year boom – about the same length of time as America’s boom decades earlier. 

I have no idea why 40 years is the number, but it seems to be.

China’s economic miracle began around 1980 following the Cultural Revolution, which was as brutal as any war. 

In need of reconstruction, China followed the American and Japanese models of relying on exports, first based on price and later on technical sophistication. 

China’s gross domestic product exploded, and it became the second-largest economy in the world. 

But there was a flaw in thinking of it that way, as its per capita GDP ranked 76th in the world. 

Because of its vast population, China can be relatively unproductive and still generate amazing numbers. 

This made China’s rise different from those of the U.S. and Japan, where the growth of GDP reflected efficient productivity.

Still, China grew until hitting a limit on rates of return on capital in the real estate industry and, of course, COVID-19. 

But this week, China reached another benchmark: deflation. 

We all hate inflation (except when we try to sell our house). 

But deflation reduces the value of all products, and it means the nominal value of assets and income falls while debts stay the same. 

This affects one’s ability to leverage a business, particularly real estate, which is a form of saving in China. 

Instead of banking their money, Chinese buy apartments and houses. 

Under deflation, the value of their property declines while their debt holds steady. 

It is not odd, therefore, that another major Chinese real estate company appears to be staggering. 

Deflation in China is not yet significant, but it is setting expectations as to what is going to come. 

Exports are falling in the face of a global downturn, which, as we have seen, really hits exporters. 

The single most striking number is that unemployment among Chinese 16-24-year-olds is at 22 percent. 

This is an explosive part of the population to be without a job and underscores the stagnation of business activity.

Another point is that while the local governments in China's interior have less than half the debt, they are the regions most likely to default. 

China’s interior is vast and poor, and when Mao wanted to overthrow the government, he went to the interior on the Long March to raise an army from among the people who lived there. 

They have benefited the least from the boom, and bitterness from this region is the most dangerous to Beijing. 

How Chinese debt is distributed matters a great deal. 

The U.S. had its civil war before an economic surge, and Japan had World War II. 

China too had a civil war, but it is not clear that it settled fundamental political matters.

The bad news in China’s economy goes on and on, and the U.S. is piling on by blocking its access to technology and investment. 

The direction China is heading resembles Japan and the U.S. but without the stable base and resources they had. 

It is possible that this is simply a cyclical event, but the political foundation in China is very different. 

Plus, we are at the strange 40-year point, which suggests that China will be a force in the future but that this current surge is ending.

The Philippines rudely rejected this week a Chinese demand to withdraw from a contested atoll in the South China Sea. 

Philippine rudeness is a decent measure of China’s decline.