A deal between Donald Trump and Xi Jinping will not last

Growing military tensions make the US-China trade dispute harder to settle

Gideon Rachman

Are you a Marxist, a realist or a believer in the accident theory of history? Each school of thought suggests a different way of analysing the crisis in US-Chinese relations.

A trade war is well under way between the world’s two largest economies, and talk of a new cold war is now common in both Washington and Beijing. The two countries have just had a frosty and unproductive encounter at the Asia Pacific Economic Co-operation meeting. But, at the end of this month, Donald Trump and Xi Jinping, the presidents of the US and China, will meet at the G20 summit in Argentina for crucial talks that could culminate in a new deal on trade — or a further rise in tensions.

A Marxist might expect that business interests will prevail, and that, as a result, there will soon be a truce in the trade war between the US and China. A follower of the “realist” theory of international relations would assume that an established power like the US and a rising power, such as China, are inevitably going to clash — and that therefore economic and strategic tensions will keep rising. And somebody who thinks that history is driven by accidents will tell you that no theory can explain how things will pan out since so much depends on unpredictable human beings.

One sign that several outcomes remain possible is the open infighting that has broken out between rival camps in the Trump administration, and the rather less open signs of tension in Beijing, as the Chinese government scrambles to find a way of appeasing Mr Trump.

There is a powerful camp of hawks in Washington who are actively pushing for a long-term confrontation with China. On the economic side, they include Peter Navarro, the White House trade adviser, and Robert Lighthizer, the US trade representative. On the strategic side, they include John Bolton, the president’s national security adviser, and Mike Pence, the vice-president, who recently gave an ultra-hawkish speech on China.

Set against them are the doves, led by Steven Mnuchin, the Treasury secretary, and Larry Kudlow, the White House’s chief economic adviser.

The doves want to see the current trade tensions swiftly resolved, while the hawks know that Mr Trump is both their biggest hope and their greatest potential weakness. He has already gone further than any other US president in confronting China, slapping tariffs on almost half of Chinese exports to the US and stepping up naval patrols through disputed waters in the Pacific.

But Mr Trump is also volatile and has a weakness for doing deals with autocrats. Some of his advisers are worried by the memory of June’s Singapore summit with Kim Jong Un, the North Korean dictator, when Mr Trump suddenly ended a year of dire threats and committed himself to dialogue. Since then, the US president has even tweeted about his “love” for Mr Kim.

Worryingly for the hawks, Mr Trump has long emphasised that he has the highest possible regard for Mr Xi. He has also shown a disconcerting tendency to claim imaginary breakthroughs. For example, the president recently claimed that China had abandoned its industrial policy, known as “Made in China 2025”, because he personally had found it “very insulting”. But there is no evidence of any such Chinese reversal.

The hawks’ anxiety was expressed by Mr Navarro in a recent speech in Washington, in which he accused “global billionaires” of acting as lobbyists for China. A few days later, he was directly contradicted by Mr Kudlow, his White House colleague, who said Mr Navarro’s comments were “way off base”.

Strategic tensions have increased, alongside the trade rivalry. American military strategists fear that China’s programme of building military bases in the South China Sea has changed the balance of power in the region. Admiral Phil Davidson, the head of America’s Indo-Pacific command, told Congress recently that “China is now capable of controlling the South China Sea in all scenarios short of war with the United States”.

To demonstrate that the US has not tacitly accepted Chinese dominance of these waters, the US has stepped up naval patrols, with ships from the two navies recently coming dangerously close to a collision. Some Washington hawks also want the US to persuade its allies — in particular Japan and South Korea — to allow America to deploy short-range nuclear missiles in the region. In theory, this would be to deter North Korea; in reality, the message would be directed at China.

These military tensions make the US-China trade dispute much harder to settle than the Trump administration’s trade arguments with Mexico and Canada, neither of which are strategic rivals to the US.

It is this geopolitical dispute — rather than the economics — that make me think that the “realist” assessment of US-China rivalry is most likely to be vindicated. So even if the G20 summit sees Mr Trump agreeing to defer his plans to increase tariffs on China, a trade truce may not last for long given this backdrop of growing superpower rivalry.

But the personality and impulses of the US president make all firm predictions dangerous. If there ever was a walking, talking embodiment of the “accident theory” of history, it is Mr Trump.

Ten-year hangover

What China talks about when it talks about stimulus

Excesses from its 2008 push limit options today

THE CAREER of China’s biggest property tycoon can be divided into two stages. Xu Jiayin started slowly, focusing on Guangzhou, a southern city. Then came the global financial crisis and the government’s response, a giant economic stimulus, launched a decade ago this month.

For Mr Xu it was a signal to become far bolder. His company, Evergrande, now has projects in 228 cities. Last year it completed enough floor space for 450,000 homes, up from 10,000 the year the stimulus began. It has bought a football club, built theme parks and entered the insurance business.

Yet expansion has come at a cost. Evergrande’s debt has soared to nearly $100bn. Short-sellers regularly target its stock. So far Mr Xu has defied the naysayers. But the market bears are taking another run at him. Evergrande’s stock is down by more than a third this year. Last month it struggled to sell new bonds, until Mr Xu bought $1bn worth with his own cash. As one of the richest people in China, a billionaire many times over, at least he can afford it.

For China as a whole, the government’s decision in 2008 to rev up investment was also a dividing line. Growth rebounded, while it sputtered elsewhere. Before the crisis China had a 6% share of global GDP; today it is closer to 16%. Yet there was a big downside. The economy became much more reliant on debt.

On the tenth anniversary of its big stimulus, China is again confronted by flagging growth, as Mr Xu can see from a recent slowdown in housing sales. The government has started dropping hints that a new stimulus is on the way. But the excesses from 2008 constrain it today. China knows it cannot afford another binge.

That caution reflects a change. Officials were almost uniformly positive in their initial verdict on the stimulus. Exports had plunged but growth was back to double digits within a year. In 2011 Wen Jiabao, the prime minister, said that not only had China been first in the world to recover from the crisis, but it had also laid a foundation for long-term growth. Now there is widespread recognition that the foundation was less solid than it appeared.

China’s steep rise in total debt, from 150% of GDP in 2008 to more than 250% today, is the most obvious problem. Such increases in other countries have often presaged trouble. Much of the debt was channelled through institutions outside the formal banking system, which are less transparent and more lightly regulated. Though some borrowers, such as Evergrande, profited from easy money, many others struggled. Dozens of industries, from solar power to steel, are grappling with overcapacity. Bai Chong’en, a former adviser to the Chinese central bank, has argued that one consequence has been a permanent decline in productivity.

As a result, stimulus has almost become a dirty word in policy circles. Li Keqiang, Mr Wen’s successor, has sworn off what he calls “flood-irrigation stimulus”, a reference to the farming practice of soaking all the soil, not just the crops. Over the past couple of years the government has tried to mop up the mess. It has aimed to slow the rise in debt, closing shadow banks and curtailing excess capacity.

But the resolve to tackle financial risks was easier to summon when growth was strong. In recent months it has sagged. With investment sluggish and the trade war rumbling on, headwinds are getting stronger. Many analysts think growth will dip towards 6% next year, which would be China’s weakest since 1990. For firms that had based their plans on sustained high-speed growth, even a mild slowdown hurts. Corporate-bond defaults in China have reached nearly $10bn this year, a record. Markets are braced for worse: borrowing rates for China’s high-yield issuers of dollar bonds have almost doubled, to 11%. Evergrande was forced to offer 13.75% on its bond in October.

It is against this jittery backdrop that investors are speculating about a new stimulus. The government, despite its vows to be prudent, has form: besides the massive stimulus in 2008, it also propped up the economy when growth softened in 2012 and 2015. As a first step officials appear to be relaxing their campaign to clean up the financial system. After a quarterly meeting on October 31st, the Politburo omitted a prior pledge to reduce debt.

Simply describing this as a shift to stimulus is too crude. Larry Hu, an economist with Macquarie Securities, separates China’s policy easing into three. First, fine-tuning, including doveish language. Second, more direct measures, such as interest-rate cuts. Third, all-out support, with infrastructure spending cranked up. Mr Hu reckons that China is now between the first and second, good for the stockmarket but not enough to stop the economy’s slide.

Can China find a way to shore up growth without falling back on debt-fuelled stimulus? It does have options, though they are likely to provide less of an immediate boost. The central bank could reduce benchmark interest rates, which have stayed unchanged since 2015. The finance ministry has scope to cut taxes more aggressively, especially for companies. Where borrowing is the only option, it is trying to make it safer. It is making it easier for officials to pay for infrastructure via bonds rather than shadow banks. Xi Jinping, the president, could also take long-delayed steps to lessen the clout of state-owned companies, giving private firms more leeway to invest in sectors such as energy and finance.

One thing China is likely to avoid is a significant change to its property policies, a crucial part of the stimulus in 2008. Mr Xi has repeatedly said that homes are for living in, not for speculating on. A thicket of restrictions has cooled the market, slowing purchases and choking off loans to developers. If Mr Xu of Evergrande is upset, he is not showing it. In a speech published this year he credited his firm’s success to government policies. Long a beneficiary, he has the sense not to turn critic.

Falling Corporate Earnings Will Fuel The Next Leg Of The Bear Market

If corporate earnings rise in 2019 like Wall Street analysts expect, stocks are a screaming buy at these bear-market levels. But earnings won’t rise and stocks are not a buy, says money manager Michael Pento:

Earnings Recession of 2019
President Trump’s plan to stimulate the economy, known as The Tax Cut and Jobs Act, was signed into law at the end of 2017. It ushered in a massive and permanent tax cut for corporations, along with a temporary reduction in rates for individuals.  
Consequently, earnings growth has soared this year when compared to the same period in the prior year. Companies in the S&P 500 grew their earnings by 25.6% in the third quarter of 2018 compared to the same period in 2017, according to FACTSET. And earnings growth is set to rise by 19% in the fourth quarter of 2018 y/y. 
But things aren’t looking nearly as good for next year’s comparisons. EPS growth for the S&P 500 in the first quarter of 2019 compared to 2018 is estimated be–by the, it’s always sunny outside crowd on Wall Street–to be 9.5%. But this guestimate might very well turn out to be extremely optimistic. 
During the second quarter of this year the economy grew at a 4.2% Q/Q SAAR. The third quarter growth in the U.S. saw the economy decelerate to 3.5%. And, according to Bloomberg, the estimate for fourth-quarter growth of this year will be 2.7%. Keeping with this trend in slowing growth, Q1 2019 is projected to post growth of just 2.4%–there is no doubt that the U.S. economy is in the process of decelerating. 
Given the strong headwinds hitting the global economy right now, and the fact that no economy exists on an island, it seems very likely that U.S. corporate profit growth could struggle just to remain in positive territory during 2019. Those headwinds include: The Fed continuing along its interest rate hiking path, while it also removes $600 billion from the financial system. Global central banks that have turned hawkish, causing the amount of QE to crash from $180 billion per month in recent years, to zero. Corporation are seeing profit margins shrinking from rising wages, much higher interest rates expenses and a stronger dollar. The end of trade war front running, which caused a huge inventory build and a temporary boost to growth. Emerging Markets turmoil is worsening. The U.S. is posting trillion dollar deficits and that amount of red ink is only getting bigger, and finally, the debt-disabled global economy is rolling over hard, causing stock market collapses and putting downward pressure on consumers worldwide. 
In addition to all those factors, corporate profits face extremely difficult comparisons due to the lapping of the repatriation of foreign earnings, along with the tax stimulus package. 
This year started off with an extreme level of investor optimism. Equity markets were supported by the outlook for a continuation of synchronized global growth.  
Nevertheless, the global economy is now weakening, as global monetary policies are tightening into record levels of debt. 
This is causing turmoil in currency, bond and equity markets across the globe. In this environment, it seems highly likely that S&P 500 earnings will struggle to grow at all.  
Indeed, the level of earnings for the S&P could find it difficult to remain at the $162.48 level that is projected by FactSet for calendar 2018. Therefore, investors need to reprice the rosy forecast of $177.90 for TTM 2019 that is currently hoped for by Wall Street. 
Not only is it the case that EPS growth will be far less than the 25% seen earlier this year; it is very likely that there will be an earnings recession next year. If this is indeed the case, the market will be forced to place a much lower multiple on that plunging growth rate of earnings. 
The current forward multiple on the S&P 500 EPS is 15.6. But this considers a robust growth rate that is near double digits. If the EPS number next year comes in closer to the same low $160’s EPS level seen in the trailing twelve months of this year, the multiple on those earnings should be closer to 14x…at best. Hence, if this assessment is anywhere near correct, the S&P 500 should trade around 2,240 at the end of next year. That would equate to a drop of nearly 20% from the current level. 
It is of paramount importance to note that those EPS figures are grossly overstated due to a decade’s worth of debt-fueled stock buybacks that have been prompted by near zero percent borrowing costs. Therefore, the fair value of the S&P 500 would only be achieved from a plunge much greater than 20%. 
The last earnings recession occurred during calendar year 2015; where EPS for the S&P 500 dropped by 0.3% over the year prior. During this timeframe the return on stocks was essentially flat. However, if earnings undergo another year over year decline next year, the market may not fare nearly as well. This is because global central banks were busy printing nearly a trillion dollars’ worth of QE during the last earnings recession in order to pump up asset prices. In sharp contrast, during 2019 the amount of money printing, on a net global basis, is projected to become negative. 
Such a dramatic plunge in asset prices should come as no surprise. What other possible outcome could be expected given that global central banks printed $14 trillion ex-nihilo in order to manipulate every major asset class into an unprecedented bubble.  
But, now inflation has forced them to reverse course on monetary policy, or risk having long-term interest rates spike out of control. Investors should already have their portfolios prepared for the third collapse of equity prices since the year 2000.

Why Central Bank Digital Currencies Will Destroy Cryptocurrencies

Leading economic policymakers are now considering whether central banks should issue their own digital currencies, to be made available to everyone, rather than just to licensed commercial banks. The idea deserves serious consideration, as it would replace an inherently crisis-prone banking system and close the door on crypto-scammers.

Nouriel Roubini

business digital code transfer

NEW YORK – The world’s central bankers have begun to discuss the idea of central bank digital currencies (CBDCs), and now even the International Monetary Fund and its managing director, Christine Lagarde, are talking openly about the pros and cons of the idea.

This conversation is past due. Cash is being used less and less, and has nearly disappeared in countries such as Sweden and China. At the same time, digital payment systems – PayPal, Venmo, and others in the West; Alipay and WeChat in China; M-Pesa in Kenya; Paytm in India – offer attractive alternatives to services once provided by traditional commercial banks.

Most of these fintech innovations are still connected to traditional banks, and none of them rely on cryptocurrencies or blockchain. Likewise, if CBDCs are ever issued, they will have nothing to do with these over-hyped blockchain technologies.

Nonetheless, starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.

As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system.

By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services. Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.

If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.

Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.

The main problem with CBDCs is that they would disrupt the current fractional-reserve system through which commercial banks create money by lending out more than they hold in liquid deposits. Banks need deposits in order to make loans and investment decisions. If all private bank deposits were to be moved into CBDCs, then traditional banks would need to become “loanable funds intermediaries,” borrowing long-term funds to finance long-term loans such as mortgages.

In other words, the fractional-reserve banking system would be replaced by a narrow-banking system administered mostly by the central bank. That would amount to a financial revolution – and one that would yield many benefits. Central banks would be in a much better position to control credit bubbles, stop bank runs, prevent maturity mismatches, and regulate risky credit/lending decisions by private banks.

So far, no country has decided to go this route, perhaps because it would entail a radical disintermediation of the private banking sector. One alternative would be for central banks to lend back to private banks the deposits that moved into CBDCs. But if the government was effectively banks’ only depositor and provider of funds, the risk of state interference in their lending decisions would be obvious.

Lagarde, for her part, has advocated a third solution: private-public partnerships between central banks and private banks. “Individuals could hold regular deposits with financial firms, but transactions would ultimately get settled in digital currency between firms,” she explained recently at the Singapore Fintech Festival. “Similar to what happens today, but in a split second.” The advantage of this arrangement is that payments “would be immediate, safe, cheap, and potentially semi-anonymous.” Moreover, “central banks would retain a sure footing in payments.”

This is a clever compromise, but some purists will argue that it would not solve the problems of the current fractional-reserve banking system. There would still be a risk of bank runs, maturity mismatches, and credit bubbles fueled by private-bank-created money. And there would still be a need for deposit insurance and lender-of-last-resort support, which itself creates a moral hazard. Such issues would need to be managed through regulation and bank supervision, and that wouldn’t necessarily be enough to prevent future banking crises.

In due time, CBDC-based narrow banking and loanable-funds intermediaries could ensure a better and more stable financial system. If the alternatives are a crisis-prone fractional-reserve system and a crypto-dystopia, then we should remain open to the idea.

Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.


Should investors diversify away from America?

Even global indices are still heavily exposed to the country

IN THE MID-1980S Carol Goland spent two years in the Andes. The subsistence farmers she studied in Cuyo Cuyo, in Peru, planted as many as 20 fields scattered around the mountain.

They used up precious calories going back and forth between each field. Yet on closer inspection, this pattern had a logic to it. Crop yields varied widely from field to field, because of erratic microclimates. By spreading their bets the farmers reduced their risk of starvation.

The farmers knew the penalty for failing to diversify. That lesson ought to be heeded in investing, too. But it isn’t. Three-quarters of equity funds in America are held in shares listed there, according to Morningstar, a data-tracking firm. American stocks have beaten a broad index of other rich-world stocks in seven of the past ten years. Even so, it is a lot of eggs to have in one basket. Those who seek to diversify by buying a global index find they are still heavily exposed to America. American-listed stocks account for 55% of the value of the MSCI All-Country World Index, a widely used benchmark.

When the harvest in one place has been consistently good, people are reluctant to look elsewhere. But wiser investors follow the practice of Peru’s mountain farmers and spread their bets far and wide. America’s stockmarket cannot outperform forever. When the investment climate changes, a heavy tilt towards a single country can be costly.

In principle, investors would be best off holding a broad range of equities from many countries.

In practice, they have a tendency to favour their domestic market. This “home bias” is a puzzle. Domestic equities are a poor hedge against one of the biggest hazards to wealth—the loss of a job due to a faltering economy. Of course, many firms listed in America have substantial foreign earnings. But the risk-diversification they offer is still limited. Home bias, it seems, is mostly a quirk of behaviour. Investors think of foreign stocks as more risky than they really are.

In any event, it is not so easy to follow a spread-your-bets approach. MSCI’s global index is weighted by the market value of its constituents. America looms large in it. This is in part because the world’s most valuable stocks are listed there. But it also reflects the nature of business ownership. In America big companies tend to be public. In other places many are family-owned. How open a country is to investors must also be allowed for. China’s weight is tiny because its market is less accessible.

And the same question invited by those field-scattering Peruvian farmers also arises. Why bother? After all, it is America’s stockmarket that makes the global weather. Were it to crash, it would take down other markets, too. Research by Cliff Asness, Roni Israelov and John Liew of AQR Capital Management finds that in a panic, all markets get trampled. In October 1987, when American stocks fell by 21.4%, a global portfolio of 22 equally weighted equity markets fell by 21%.

Over time, however, returns are driven by fundamentals in each economy, and the global portfolio performs better than the worst-hit individual market. A portfolio that is weighted by market capitalisation, like the MSCI index, is a less potent diversifier. But it is still far better than being over-exposed to one bad market.

Those seeking the ideal balance of risk and reward should prefer to own shares of firms in proportion to their importance to the world economy. But ordinary investors should also like to keep things fairly simple. A good investment rule, then, might be to allocate a third of an equity portfolio to American stocks, a third to an index of stocks listed in other rich countries and a third to emerging-market shares. Such a portfolio would better reflect the make-up of global GDP. It would cap exposure to any one bloc. And it would anticipate a secular shift. As more emerging-market stocks are added to the global index, says Victor Haghani, of Elm Partners, America’s weight will diminish.

Investors following such a rule must sacrifice some of the ease of buying and selling American equities for somewhat less liquid markets. The other big drawback is that when American stocks do especially well, a more diversified portfolio has lower returns than the global benchmark. Peruvian farmers would be prepared to live with that. By spreading their bets, they suffered lower yields than they would have had they only planted in the best field. But they could never have been sure in advance which was the right field to pick.

The Bleak Fate of the Amazon

Brazilian President Jair Bolsonaro’s environmental approach can be summed up in one word: exploitation. This will be devastating not just for Brazil – where tens of millions of citizens depend on the Amazon for food, transportation, and livelihoods – but also for the rest of the world.

Paulo Artaxo

Amazon burning forest

SÃO PAULO – Last month, a deeply divided Brazil voted to elect its next president. Faced with a choice between Fernando Haddad of the leftist Workers’ Party and the right-wing extremist Jair Bolsonaro, Brazilians chose the extremist – an outcome that will have far-reaching consequences for the environment, among other things.

With solid backing from the wealthiest 5% of Brazilians and rural landowners, Bolsonaro secured broader popular support by playing on people’s prejudices and fears. In his campaign, he targeted vulnerable groups and pledged to reduce or eliminate protections for minorities, women, and the poor. Meanwhile, he intends to loosen Brazil’s restrictive gun laws, claiming that allowing average citizens to arm themselves will stem rising crime.

As for the environment, Bolsonaro’s plans can be summed up in one word: exploitation. For starters, he wants to reduce or eliminate environmental protections in the Amazon, the world’s largest tropical rainforest. And he intends to reduce substantially the protection of indigenous lands belonging to the descendants of the Amazon’s original inhabitants. He will ease environmental restrictions on the use of pesticides and on licensing for infrastructure development.

“Where there is indigenous land,” Bolsonaro once said, “there is wealth underneath it.” With that in mind, he has declared that no more indigenous reserves will be demarcated, and existing reserves will be opened up to mining.

Bolsonaro’s agenda will hasten environmental degradation dramatically. Imazon, a Brazilian NGO, reported 444 square kilometers (171 square miles) of clearing this past September, an 84% increase over September 2017. The 12-month total amounts to 4,859 square kilometers, the highest level since July 2008. Brazil’s national space research agency, INPE, also reports an uptick in deforestation – about 50% year on year in September.

As it stands, many of the farmers or loggers who exploit the Amazon do so illegally, risking fines or sanctions. The expectation that the new government will not enforce laws prohibiting such activities is probably already emboldening them to intensify their activities. Once those laws are weakened or abolished, deforestation can be expected to accelerate considerably. The government’s apparent inclination to boost activities like gold mining in the Amazon will only make matters worse.

There is little reason to believe that Bolsonaro will not be able to follow through on his destructive environmental agenda. After all, far-right representatives allied with powerful business lobbies dominate Brazil’s new congress.

To make destroying the environment even easier, Bolsonaro has pledged to merge the environment and agriculture ministries, though he has since backtracked on this issue. He is now looking for an environment minister who is allied with the ruralistas, or large landowners, and has appointed a minister of agriculture who wants to lift restrictions on the use of dangerous chemical products in agriculture.

Bolsonaro also promised during the election campaign to withdraw Brazil from the 2015 Paris climate agreement. Though he has since backed away from that pledge, he has just appointed a climate-change-denying, anti-science diplomat as foreign minister. That will present certain difficulties for Brazil’s bid to host the UN Climate Change Conference (COP25) next year.

Beyond increasing the vulnerability of Brazil’s natural resources to commercial exploitation, the inevitable cuts to the environmental budget under Bolsonaro’s leadership will undermine the country’s ability to respond to disasters like forest fires. Brazil has already had an uptick in such fires – and fire-related destruction – owing to the expansion of agriculture, weaker oversight and surveillance, and the dismantling of fire brigades. Bolsonaro’s plans will exacerbate the problem.

And this is not the only problem that Bolsonaro’s agenda will worsen. Socioeconomic inequality will increase. As the government hands more power over the rainforest to large business owners, ordinary citizens – including smallholder farmers and poor urban dwellers – are bound to suffer.

But Brazil’s ecosystems matter for more than just that country – it is the guardian of the planet’s largest tropical rainforest, a repository of ecological services for the entire world, where most of the Earth’s biodiversity is concentrated. The Amazon is home to more species of plants and animals than any other terrestrial ecosystem on the planet, and its rainfall and rivers feed much of South America. Moreover, its hundreds of billions of trees store massive amounts of carbon.

Over the past 100 years, Brazil has reduced the Atlantic Forest by more than 90%, and cleared 50% of the Cerrado and almost 20% of the Amazon. At a time when the Intergovernmental Panel on Climate Change is warning that we need to make urgent progress in reducing greenhouse-gas emissions, Bolsonaro’s plans will achieve just the opposite. Unfortunately for Brazil and the rest of the world, there is no reason to believe that he cannot or will not implement them.

Paulo Artaxo is Professor of Environmental Physics and Head of the Department of Applied Physics at the University of São Paulo. He is an expert on the climatic effects of aerosols, particularly in Amazonia.

Taxes, Depression, and Our Current Troubles

Tariffs, rising state and federal taxes, and currency devaluation ruined the 1930s, and they could do the same today


The 1930s has become the sole object lesson for today's monetary policy. Over the past 12 months, the Federal Reserve has increased the monetary base (bank reserves plus currency in circulation) by well over 100%. While currency in circulation has grown slightly, there's been an impressive 17-fold increase in bank reserves. The federal-funds target rate now stands at an all-time low range of zero to 25 basis points, with the 91-day Treasury bill yield equally low. All this has been done to avoid a liquidity crisis and a repeat of the mistakes that led to the Great Depression.

Even with this huge increase in the monetary base, Fed Chairman Ben Bernanke has reiterated his goal not to repeat the mistakes made back in the 1930s by tightening credit too soon, which he says would send the economy back into recession. The strong correlation between soaring unemployment and falling consumer prices in the early 1930s leads Mr. Bernanke to conclude that tight money caused both. To prevent a double dip, super easy monetary policy is the key.

While Fed policy was undoubtedly important, it was not the primary cause of the Great Depression or the economy's relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy's relapse in 1937.

In 1930-31, during the Hoover administration and in the midst of an economic collapse, there was a very slight increase in tax rates on personal income at both the lowest and highest brackets. The corporate tax rate was also slightly increased to 12% from 11%. But beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25%. (That's not a misprint!) The corporate rate was raised to 13.75% from 12%. All sorts of Federal excise taxes too numerous to list were raised as well. The highest inheritance tax rate was also raised in 1932 to 45% from 20% and the gift tax was reinstituted with the highest rate set at 33.5%.

But the tax hikes didn't stop there. In 1934, during the Roosevelt administration, the highest estate tax rate was raised to 60% from 45% and raised again to 70% in 1935. The highest gift tax rate was raised to 45% in 1934 from 33.5% in 1933 and raised again to 52.5% in 1935. The highest corporate tax rate was raised to 15% in 1936 with a surtax on undistributed profits up to 27%. In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years. Finally, in 1937 a 1% employer and a 1% employee tax was placed on all wages up to $3,000.

Because of the number of states and their diversity I'm going to aggregate all state and local taxes and express them as a percentage of GDP. This measure of state tax policy truly understates the state and local tax contribution to the tragedy we call the Great Depression, but I'm sure the reader will get the picture. In 1929, state and local taxes were 7.2% of GDP and then rose to 8.5%, 9.7% and 12.3% for the years 1930, '31 and '32 respectively.

The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I'd give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1%, their highest level since 1991; the Bush tax cuts are set to expire in 2011; and additional taxes to pay for health-care and the proposed cap-and-trade scheme are on the horizon.

In addition to all of these tax issues, the U.S. in the early 1930s was on a gold standard where paper currency was legally convertible into gold. Both circulated in the economy as money. At the outset of the Great Depression people distrusted banks but trusted paper currency and gold. They withdrew deposits from banks, which because of a fractional reserve system caused a drop in the money supply in spite of a rising monetary base. The Fed really had little power to control either bank reserves or interest rates.

The increase in the demand for paper currency and gold not only had a quantity effect on the money supply but it also put upward pressure on the price of gold, which meant that dollar prices of all goods and services had to fall for the relative price of gold to rise. The deflation of the early 1930s was not caused by tight money. It was the result of panic purchases of fixed-dollar priced gold. From the end of 1929 until early 1933 the Consumer Price Index fell by 27%.

By mid-1932 there were public fears of a change in the gold-dollar relationship. In their classic text, "A Monetary History of the United States," economists Milton Friedman and Anna Schwartz wrote, "Fears of devaluation were widespread and the public's preference for gold was unmistakable." Panic ensued and there was a rush to buy gold.

In early 1933, the federal government (not the Federal Reserve) declared a bank holiday prohibiting banks from paying out gold or dealing in foreign exchange. An executive order made it illegal for anyone to "hoard" gold and forced everyone to turn in their gold and gold certificates to the government at an exchange value of $20.67 per ounce of gold in return for paper currency and bank deposits. All gold clauses in contracts private and public were declared null and void and by the end of January 1934 the price of gold, most of which had been confiscated by the government, was raised to $35 per ounce. In other words, in less than one year the government confiscated as much gold as it could at $20.67 an ounce and then devalued the dollar in terms of gold by almost 60%. That's one helluva tax.

The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that's the story.

The lessons here are pretty straightforward. Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon.

My hope is that the people who are running our economy do look to the Great Depression as an object lesson. My fear is that they will misinterpret the evidence and attribute high unemployment and the initial decline in prices to tight money, while increasing taxes to combat budget deficits.

Mr. Laffer is the chairman of Laffer Associates and co-author of "The End of Prosperity: How Higher Taxes Will Doom the Economy—If We Let It Happen" (Threshold, 2008).

The Brilliant and the Absurd in Vienna

A geopolitical journey into the city that was once the intellectual and cultural center of Europe.

By George Friedman        

I first came to Austria when I was six months old and left a little over a year later. Oddly, I can’t seem to recall it, but in college and the years that followed, I visited many times. Austria was the borderland of the Cold War and where many journeys started. It bordered Czechoslovakia, Hungary and Yugoslavia. It also bordered Germany and Italy, as well as neutral Switzerland – allowing access to France and beyond. And since it was neutral and weak, people from all over the world could get to Austria and, from Austria, to the rest of Europe.

Vienna was a place where chaos and intrigue were easily stirred. Soviet intelligence used it as the gateway to the West. Western intelligence used it as the gateway to the East. Others used it as a way to simply get somewhere else. The cafes at the outer rings were filled with people who knew someone who knew someone who might get something done, for a fee. Nearer the center of the city were more official-looking, well-dressed men, pretending to know far more than they actually did. There were also extremely attractive women looking for official-looking men to cause them to commit a massive error in judgment.

Vienna was the city in which OPEC met to plan the oil crisis of the 1970s, and where Venezuelan terrorist Ilich Ramirez Sanchez, known as Carlos the Jackal, kidnapped 60 OPEC representatives and their staff in 1975 and flew some of them to Algiers with a plane provided by the Austrians. He was working with the Popular Front for the Liberation of Palestine and had close ties to the KGB. He found refuge and a base of operations in Budapest, right across the border. Needless to say, Western intelligence was operating intensely in Vienna, looking for him and his KGB handlers, as well as other terrorists.

Vienna, then, resembled the movie “Casablanca.” Everyone who came to the city wanted to go elsewhere and was prepared to make deals with the devil to get there. St. Stephen’s Cathedral, gray and disapproving, stood in the middle of this buying, selling and renting of souls. The cathedral is still a pillar the Catholic faith, which is very much alive in Vienna. It once brooded over denizens of the unredeemed plotting. Today, it is surrounded by the unredeemed named Giorgio Armani, Mont Blanc and Michael Kors. (I asked my wife who, in their right mind, would spend that much on clothes, pens or pocketbooks. She informed me that her handbag was from Michael Kors, that she had a coat from Armani, and that I had a pen from Mount Blanc. My point made, I let it slide.)

What I didn’t get to see was the Vienna I had heard of in my graduate school days: This was the Vienna of the last years of empire and the time between imperial collapse and Anschluss. This was a time when Vienna was the intellectual and cultural center of Europe. It was the time of Wittgenstein, Freud, Klimt, Schoenberg and Schrodinger. Put another way, it was the time of philosophy, psychiatry, art, music and physics. Vienna broke open new ways of thinking, brilliant insights and preposterous ideas that couldn’t and shouldn’t survive. Great moments are filled with a handful of brilliance and a great deal of trivia. Vienna became the center of European intellectual life, but that life was aborted by the most powerful and preposterous idea of all: Hitler’s vision of the world he wanted to create. Ideas can kill, and his did.

The coming of Hitler had another consequence. The brilliance and absurdity of Vienna was adopted by other countries, particularly the United States. The influence lasted. In graduate school, I wrote on Freud and Wittgenstein, declared myself incapable of tolerating atonal music and wasn’t smart enough to understand quantum mechanics. Still, the degree to which Vienna fed American intellectual life was stunning. Even later, when I came to Vienna and sat for long hours with the heirs of this tradition, I had a sense of inadequacy. They were part of the tradition of Viennese intellectuals, and I was not.
Wealth and Power
Why do certain cities have these extraordinary moments of efflorescence? One reason is wealth. Supporting intellect requires leisure, and leisure requires wealth, whether through rich families or grants. It also, like Paris in the 18th century, requires confidence. France was powerful, and intellectuals fed off that sense of power. There must also be migrants and a culture of travel – something to drive home that the laws of your city are not the laws of nature. And there has to be, from this dissatisfaction, a sense that conventions are arbitrary and that new things are needed. Intellectual uprising walks a narrow tightrope between disruption and collapse.

Vienna had all these things. It was wealthy, or wealthy enough to create leisure for some. It was powerful, though its power was fading. It was a city of Hungarians, Serbs and all the random wanderers of Europe, looking for a drink and a warm bed. And it contained those who harbored deep dissatisfaction with conventions, which became more rigid as the empire declined. Empires, once great and now on the edge, make for these moments.

Among the great empires was the Habsburg Empire. It was a dynasty that once dominated Spain and came to rest in Vienna. Its tentacles spread to Mexico, where a member of the House of Habsburg, Maximillian I, became the emperor in the 19th century, only to be executed by Mexican revolutionaries. The Habsburgs’ greatest moment came in 1683 when the Ottomans, having conquered Budapest, moved west, past the Danube, to capture Vienna. From Vienna, they could have moved south to the Italian Peninsula, which was already under attack by the Ottoman navy. This would have given the Ottomans effective control of the Mediterranean, as well as access to Spain and France. It could have also made American history very different than what it turned out to be.

But the Ottomans were defeated, largely through an alliance between the Habsburgs and other European powers. This accomplished two things. It stopped Ottoman expansion in Europe, and it began the Ottomans’ long retreat that ultimately led to World War I and the current reality. In the Balkans, the Ottomans’ control was fractured. The Serbs – the Ottomans’ most stubborn resisters – did not want to become a colony of the Austro-Hungarians. This was in part due to national pride and in part due to religion. The Catholics and Orthodox played a complex game with Muslims in the Balkans. Serbian opposition to both Turks and Austrians led to the assassination of Archduke Franz Ferdinand, and the rest, as they say, is history.

The Habsburg Empire buffered all of Europe against the Turks, and it was, to a great extent, configured for this purpose. Unlike other empires that aggressively demanded the subservience of client states, the Habsburgs were far more liberal. They did not seek to exploit the regions under their control economically, preferring them to be relatively well-off. This way, they were prepared to stand against the Turks, having as much to lose at the Turks’ hands as the Habsburgs themselves. And when the Hungarians demanded independence in the 19th century, the Habsburgs made them equal to Austria. There are two kinds of empires: the kind that rules through ruthless exploitation, and the kind that seeks to induce allies into defending themselves through economic incentives. The Habsburgs did not pioneer this. But the came close to perfecting it.
Return of the Past
Some in the region still speak nostalgically about the Habsburg Empire, as if it did what the European Union has tried but failed to do. And some want to turn this nostalgia into policy. Take the Three Seas Initiative, for example. The initiative promotes integration of European countries stretching from the Baltic to the Black and Adriatic seas, including Austria, Hungary and several Eastern European nations. It’s seen as a supplement or even an alternative to the EU. Some proponents believe it could be a way to block Islamic migration and even Turkish influence on the Continent.

In my own life, I have seen examples of the eternal return of the past in Europe. In the winter of 1944-45, my mother was taken to build roads in the Austrian town of Lichtenworth. The death camps were clogged, and bombers were attacking roads. My mother and her three sisters had the good fortune to be sent south of Vienna. Two of the sisters died; two lived. (It must not be forgotten that Hitler was Austrian, and that the Austrians greeted unification with enthusiasm. They fully participated in Hitler’s exploitative empire, emptying Vienna of Freud and the rest.)

Yet my mother also took refuge in Austria after I was born. She said the Austrians were both distant and kind. There was no sense of residual loathing or even resentment. Perhaps Hitler was just a bad dream we all had and then woke up from. Given that history always returns in Europe, perhaps the Habsburgs will come back with an empire ruling through indifference. And as the Austrians insist, they will speak German but will not be Germans.

On Sunday, my wife and I attended a show at the Spanish Riding School featuring Vienna Lipizzaner performing horses. The horses are interesting because they are born black and turn pure white as they mature. (They reminded me of John le Carre’s “A Most Wanted Man,” in which bank accounts used to launder black money are referred to as Lipizzaners.) For my wife, this was a trip of a lifetime, as she grew up in Australia loving horses and riding her own horse. I, meanwhile, grew up familiarizing myself with money laundering. So, we both could appreciate the show.

I was taken less by the horses than by the horsemen and horsewomen. Their discipline and perfect sense of place was extraordinary, particularly when saluting. The riders raised their arms to the brim of their hats with slow and utter control while sitting on a horse. They paused for a second at the brim of the hat, removed their hats in unison to the perfect point, and then together placed them back on their heads. It reminded me of superbly trained troops at a moment of significance.

The grace displayed by the riders was magnificent beyond anything I had seen. It’s not enough to make one forget about Austria’s past, following Hitler down his path of destruction, either enthusiastically or through resignation. But it was a beautiful thing to see. As is St. Stephen’s Cathedral towering over the banal brands around it.

Vienna is quite ordinary today. Like most cities since World War II, it has grown more similar to all the others than different. But it has a complicated history, magnificent and terrible. It sat on the edge of Europe and blocked the surge of Islam. It sat on the edge of the Third Reich and helped make it what it was. It nurtured the most extraordinary thoughts and bred nonsense as genius. It was the place where much of the Cold War was fought. The desire to be less than magnificent for the moment can be forgiven. It is decent, and in Europe, that is not a trivial thing.

miércoles, noviembre 28, 2018



Part 1

The Land That Failed to Fail

The West was sure the Chinese approach would not work. It just had to wait. It’s still waiting.


     Photographs by BRYAN DENTON 

In the uncertain years after Mao’s death, long before China became an industrial juggernaut, before the Communist Party went on a winning streak that would reshape the world, a group of economics students gathered at a mountain retreat outside Shanghai. There, in the bamboo forests of Moganshan, the young scholars grappled with a pressing question: How could China catch up with the West?

It was the autumn of 1984, and on the other side of the world, Ronald Reagan was promising “morning again in America.” China, meanwhile, was just recovering from decades of political and economic turmoil. There had been progress in the countryside, but more than three-quarters of the population still lived in extreme poverty. The state decided where everyone worked, what every factory made and how much everything cost.

The students and researchers attending the Academic Symposium of Middle-Aged and Young Economists wanted to unleash market forces but worried about crashing the economy — and alarming the party bureaucrats and ideologues who controlled it.

Late one night, they reached a consensus: Factories should meet state quotas but sell anything extra they made at any price they chose. It was a clever, quietly radical proposal to undercut the planned economy — and it intrigued a young party official in the room who had no background in economics. “As they were discussing the problem, I didn’t say anything at all,” recalled Xu Jing’an, now 76 and retired. “I was thinking, how do we make this work?”

The Chinese economy has grown so fast for so long now that it is easy to forget how unlikely its metamorphosis into a global powerhouse was, how much of its ascent was improvised and born of desperation. The proposal that Mr. Xu took from the mountain retreat, soon adopted as government policy, was a pivotal early step in this astounding transformation.

China now leads the world in the number of homeowners, internet users, college graduates and, by some counts, billionaires. Extreme poverty has fallen to less than 1 percent. An isolated, impoverished backwater has evolved into the most significant rival to the United States since the fall of the Soviet Unión.

China today might be unrecognizable to its Communist founders, but the past still holds a powerful allure. “Red tourism” is a big industry. 

It is less worried now about catching up to the West. Instead, it wonders how to pull ahead.

The country leads the world in the number of internet users and college graduates. It is now working to land a person on the moon. 

Gone are the days when the state decided where everyone worked and what every factory made. 

The world thought it would change China, but China’s success has been so spectacular that it has changed the world.

An epochal contest is underway. With President Xi Jinping pushing a more assertive agenda overseas and tightening controls at home, the Trump administration has launched a trade war and is gearing up for what could be a new Cold War. Meanwhile, in Beijing the question these days is less how to catch up with the West than how to pull ahead — and how to do so in a new era of American hostility.

The pattern is familiar to historians, a rising power challenging an established one, with a familiar complication: For decades, the United States encouraged and aided China’s rise, working with its leaders and its people to build the most important economic partnership in the world, one that has lifted both nations.

During this time, eight American presidents assumed, or hoped, that China would eventually bend to what were considered the established rules of modernization: Prosperity would fuel popular demands for political freedom and bring China into the fold of democratic nations. Or the Chinese economy would falter under the weight of authoritarian rule and bureaucratic rot.

But neither happened. Instead, China’s Communist leaders have defied expectations again and again. They embraced capitalism even as they continued to call themselves Marxists. They used repression to maintain power but without stifling entrepreneurship or innovation. Surrounded by foes and rivals, they avoided war, with one brief exception, even as they fanned nationalist sentiment at home. And they presided over 40 years of uninterrupted growth, often with unorthodox policies the textbooks said would fail.

In late September, the People’s Republic of China marked a milestone, surpassing the Soviet Union in longevity. Days later, it celebrated a record 69 years of Communist rule. And China may be just hitting its stride — a new superpower with an economy on track to become not just the world’s largest but, quite soon, the largest by a wide margin.

The world thought it could change China, and in many ways it has. But China’s success has been so spectacular that it has just as often changed the world — and the American understanding of how the world works.

There is no simple explanation for how China’s leaders pulled this off. There was foresight and luck, skill and violent resolve, but perhaps most important was the fear — a sense of crisis among Mao’s successors that they never shook, and that intensified after the Tiananmen Square massacre and the collapse of the Soviet Union.

Even as they put the disasters of Mao’s rule behind them, China’s Communists studied and obsessed over the fate of their old ideological allies in Moscow, determined to learn from their mistakes. They drew two lessons: The party needed to embrace “reform” to survive — but “reform” must never include democratization.

China has veered between these competing impulses ever since, between opening up and clamping down, between experimenting with change and resisting it, always pulling back before going too far in either direction for fear of running aground.

Many people said that the party would fail, that this tension between openness and repression would be too much for a nation as big as China to sustain. But it may be precisely why China soared.

Whether it can continue to do so with the United States trying to stop it is another question entirely.

Apparatchiks Into Capitalists

None of the participants at the Moganshan conference could have predicted how China would take off, much less the roles they would play in the boom ahead. They had come of age in an era of tumult, almost entirely isolated from the rest of the world, with little to prepare them for the challenge they faced. To succeed, the party had to both reinvent its ideology and reprogram its best and brightest to carry it out.

Mr. Xu, for example, had graduated with a degree in journalism on the eve of Mao’s violent Cultural Revolution, during which millions of people were purged, persecuted and killed. He spent those years at a “cadre school” doing manual labor and teaching Marxism in an army unit. After Mao’s death, he was assigned to a state research institute tasked with fixing the economy. His first job was figuring out how to give factories more power to make decisions, a subject he knew almost nothing about. Yet he went on to a distinguished career as an economic policymaker, helping launch China’s first stock market in Shenzhen.

Among the other young participants in Moganshan were Zhou Xiaochuan, who would later lead China’s central bank for 15 years; Lou Jiwei, who ran China’s sovereign wealth fund and recently stepped down as finance minister; and an agricultural policy specialist named Wang Qishan, who rose higher than any of them.

Mr. Wang headed China’s first investment bank and helped steer the nation through the Asian financial crisis. As Beijing’s mayor, he hosted the 2008 Olympics. Then he oversaw the party’s recent high-stakes crackdown on corruption. Now he is China’s vice president, second in authority only to Xi Jinping, the party’s leader.

The careers of these men from Moganshan highlight an important aspect of China’s success: It turned its apparatchiks into capitalists.

Bureaucrats who were once obstacles to growth became engines of growth. Officials devoted to class warfare and price controls began chasing investment and promoting private enterprise. Every day now, the leader of a Chinese district, city or province makes a pitch like the one Yan Chaojun made at a business forum in September.

“Sanya,” Mr. Yan said, referring to the southern resort town he leads, “must be a good butler, nanny, driver and cleaning person for businesses, and welcome investment from foreign companies.”

It was a remarkable act of reinvention, one that eluded the Soviets. In both China and the Soviet Union, vast Stalinist bureaucracies had smothered economic growth, with officials who wielded unchecked power resisting change that threatened their privileges.

Mikhail Gorbachev, the last leader of the Soviet Union, tried to break the hold of these bureaucrats on the economy by opening up the political system. Decades later, Chinese officials still take classes on why that was a mistake. The party even produced a documentary series on the subject in 2006, distributing it on classified DVDs for officials at all levels to watch.

Afraid to open up politically but unwilling to stand still, the party found another way. It moved gradually and followed the pattern of the compromise at Moganshan, which left the planned economy intact while allowing a market economy to flourish and outgrow it.

Once an impoverished backwater, China is now the most significant rival to the United States. Wuhan, a former river town, has swelled into a metropolis of over 10 million.

A businessman stretched before a round of video golf at a hotel he built in Kunming.

       Rising incomes have turned China into a nation of consumers.

        In cities like Shanghai, Chinese schoolchildren outperform peers around the world.

Western economists doubted that innovation could take place under China’s rigid bureaucracy. They were proved wrong.

Party leaders called this go-slow, experimental approach “crossing the river by feeling the stones” — allowing farmers to grow and sell their own crops, for example, while retaining state ownership of the land; lifting investment restrictions in “special economic zones,” while leaving them in place in the rest of the country; or introducing privatization by selling only minority stakes in state firms at first.

“There was resistance,” Mr. Xu said. “Satisfying the reformers and the opposition was an art.”

American economists were skeptical. Market forces needed to be introduced quickly, they argued; otherwise, the bureaucracy would mobilize to block necessary changes. After a visit to China in 1988, the Nobel laureate Milton Friedman called the party’s strategy “an open invitation to corruption and inefficiency.”

But China had a strange advantage in battling bureaucratic resistance. The nation’s long economic boom followed one of the darkest chapters of its history, the Cultural Revolution, which decimated the party apparatus and left it in shambles. In effect, autocratic excess set the stage for Mao’s eventual successor, Deng Xiaoping, to lead the party in a radically more open direction.

That included sending generations of young party officials to the United States and elsewhere to study how modern economies worked. Sometimes they enrolled in universities, sometimes they found jobs, and sometimes they went on brief “study tours.” When they returned, the party promoted their careers and arranged for others to learn from them.

At the same time, the party invested in education, expanding access to schools and universities, and all but eliminating illiteracy. Many critics focus on the weaknesses of the Chinese system — the emphasis on tests and memorization, the political constraints, the discrimination against rural students. But mainland China now produces more graduates in science and engineering every year than the United States, Japan, South Korea and Taiwan combined.

In cities like Shanghai, Chinese schoolchildren outperform peers around the world. For many parents, though, even that is not enough. Because of new wealth, a traditional emphasis on education as a path to social mobility and the state’s hypercompetitive college entrance exam, most students also enroll in after-school tutoring programs — a market worth $125 billion, according to one study, or as much as half the government’s annual military budget.

Another explanation for the party’s transformation lies in bureaucratic mechanics. Analysts sometimes say that China embraced economic reform while resisting political reform. But in reality, the party made changes after Mao’s death that fell short of free elections or independent courts yet were nevertheless significant.

The party introduced term limits and mandatory retirement ages, for example, making it easier to flush out incompetent officials. And it revamped the internal report cards it used to evaluate local leaders for promotions and bonuses, focusing them almost exclusively on concrete economic targets.

These seemingly minor adjustments had an outsize impact, injecting a dose of accountability — and competition — into the political system, said Yuen Yuen Ang, a political scientist at the University of Michigan. “China created a unique hybrid,” she said, “an autocracy with democratic characteristics.”

As the economy flourished, officials with a single-minded focus on growth often ignored widespread pollution, violations of labor standards, and tainted food and medical supplies. They were rewarded with soaring tax revenues and opportunities to enrich their friends, their relatives and themselves. A wave of officials abandoned the state and went into business. Over time, the party elite amassed great wealth, which cemented its support for the privatization of much of the economy it once controlled.

The private sector now produces more than 60 percent of the nation’s economic output, employs over 80 percent of workers in cities and towns, and generates 90 percent of new jobs, a senior official said in a speech last year. As often as not, the bureaucrats stay out of the way.

“I basically don’t see them even once a year,” said James Ni, chairman and founder of Mlily, a mattress manufacturer in eastern China. “I’m creating jobs, generating tax revenue. Why should they bother me?”

In recent years, President Xi has sought to assert the party’s authority inside private firms. He has also bolstered state-owned enterprises with subsidies while preserving barriers to foreign competition. And he has endorsed demands that American companies surrender technology in exchange for market access.

In doing so, he is betting that the Chinese state has changed so much that it should play a leading role in the economy — that it can build and run “national champions” capable of outcompeting the United States for control of the high-tech industries of the future. But he has also provoked a backlash in Washington.

‘Opening Up’

In December, the Communist Party will celebrate the 40th anniversary of the “reform and opening up” policies that transformed China. The triumphant propaganda has already begun, with Mr. Xi putting himself front and center, as if taking a victory lap for the nation.

He is the party’s most powerful leader since Deng and the son of a senior official who served Deng, but even as he wraps himself in Deng’s legacy, Mr. Xi has set himself apart in an important way: Deng encouraged the party to seek help and expertise overseas, but Mr. Xi preaches self-reliance and warns of the threats posed by “hostile foreign forces.”

In other words, he appears to have less use for the “opening up” part of Deng’s slogan.

Of the many risks that the party took in its pursuit of growth, perhaps the biggest was letting in foreign investment, trade and ideas. It was an exceptional gamble by a country once as isolated as North Korea is today, and it paid off in an exceptional way: China tapped into a wave of globalization sweeping the world and emerged as the world’s factory. China’s embrace of the internet, within limits, helped make it a leader in technology. And foreign advice helped China reshape its banks, build a legal system and create modern corporations.

The party prefers a different narrative these days, presenting the economic boom as “grown out of the soil of China” and primarily the result of its leadership. But this obscures one of the great ironies of China’s rise — that Beijing’s former enemies helped make it possible. 

President Xi Jinping has shown no sign of abandoning what he calls “the great rejuvenation of the Chinese nation.” The observation deck of the Shanghai Tower, the world’s second-tallest building.

A Communist Party Congress. Mr. Xi seems to believe that China has been so successful that the party can return to its authoritarian past. 

China tapped into a wave of globalization and emerged as the world’s factory. Advertising for day laborers in Shenzhen.

A fashion design employee at a bridal wear exhibition in Beijing may have taken the opportunity for a break, but no one calls China a sleeping giant anymore.

Installing solar panels on a 47-story residential development. China succeeded by leaving a planned economy intact and allowing a market economy to flourish and outgrow it.

The United States and Japan, both routinely vilified by party propagandists, became major trading partners and were important sources of aid, investment and expertise. The real game changers, though, were people like Tony Lin, a factory manager who made his first trip to the mainland in 1988.

Mr. Lin was born and raised in Taiwan, the self-governing island where those who lost the Chinese civil war fled after the Communist Revolution. As a schoolboy, he was taught that mainland China was the enemy.

But in the late 1980s, the sneaker factory he managed in central Taiwan was having trouble finding workers, and its biggest customer, Nike, suggested moving some production to China. Mr. Lin set aside his fears and made the trip. What he found surprised him: a large and willing work force, and officials so eager for capital and know-how that they offered the use of a state factory free and a five-year break on taxes.

Mr. Lin spent the next decade shuttling to and from southern China, spending months at a time there and returning home only for short breaks to see his wife and children. He built and ran five sneaker factories, including Nike’s largest Chinese supplier.

“China’s policies were tremendous,” he recalled. “They were like a sponge absorbing water, money, technology, everything.”

Mr. Lin was part of a torrent of investment from ethnic Chinese enclaves in Hong Kong, Taiwan, Singapore and beyond that washed over China — and gave it a leg up on other developing countries. Without this diaspora, some economists argue, the mainland’s transformation might have stalled at the level of a country like Indonesia or Mexico.

The timing worked out for China, which opened up just as Taiwan was outgrowing its place in the global manufacturing chain. China benefited from Taiwan’s money, but also its managerial experience, technology and relationships with customers around the world. In effect, Taiwan jump-started capitalism in China and plugged it into the global economy.

Before long, the government in Taiwan began to worry about relying so much on its onetime enemy and tried to shift investment elsewhere. But the mainland was too cheap, too close and, with a common language and heritage, too familiar. Mr. Lin tried opening factories in Thailand, Vietnam and Indonesia but always came back to China.

Now Taiwan finds itself increasingly dependent on a much more powerful China, which is pushing ever harder for unification, and the island’s future is uncertain.

There are echoes of Taiwan’s predicament around the world, where many are having second thoughts about how they rushed to embrace Beijing with trade and investment.

The remorse may be strongest in the United States, which brought China into the World Trade Organization, became China’s largest customer and now accuses it of large-scale theft of technology — what one official called “the greatest transfer of wealth in history.”

Many in Washington predicted that trade would bring political change. It did, but not in China. “Opening up” ended up strengthening the party’s hold on power rather than weakening it. The shock of China’s rise as an export colossus, however, was felt in factory towns around the world.

In the United States, economists say at least two million jobs disappeared as a result, many in districts that ended up voting for President Trump.

Selective Repression

Over lunch at a luxurious private club on the 50th floor of an apartment tower in central Beijing, one of China’s most successful real estate tycoons explained why he had left his job at a government research center after the crackdown on the student-led democracy movement in Tiananmen Square.

“It was very easy,” said Feng Lun, the chairman of Vantone Holdings, which manages a multibillion-dollar portfolio of properties around the world. “One day, I woke up and everyone had run away. So I ran, too.”

Until the soldiers opened fire, he said, he had planned to spend his entire career in the civil service. Instead, as the party was pushing out those who had sympathized with the students, he joined the exodus of officials who started over as entrepreneurs in the 1990s.

“At the time, if you held a meeting and told us to go into business, we wouldn’t have gone,” he recalled. “So this incident, it unintentionally planted seeds in the market economy.”

Such has been the seesaw pattern of the party’s success.

The pro-democracy movement in 1989 was the closest the party ever came to political liberalization after Mao’s death, and the crackdown that followed was the furthest it went in the other direction, toward repression and control. After the massacre, the economy stalled and retrenchment seemed certain. Yet three years later, Deng used a tour of southern China to wrestle the party back to “reform and opening up” once more.

Many who had left the government, like Mr. Feng, suddenly found themselves leading the nation’s transformation from the outside, as its first generation of private entrepreneurs.

Now Mr. Xi is steering the party toward repression again, tightening its grip on society, concentrating power in his own hands and setting himself up to rule for life by abolishing the presidential term limit. Will the party loosen up again, as it did a few years after Tiananmen, or is this a more permanent shift? If it is, what will it mean for the Chinese economic miracle?

The fear is that Mr. Xi is attempting to rewrite the recipe behind China’s rise, replacing selective repression with something more severe.

For decades, China has veered between openness and repression, including of the ethnic Uighur minority. 

Since the Tiananmen movement, the government has been vigilant about crushing potential threats. Surveillance cameras in Beijing. 

China’s high-speed rail network, the largest in the world, has changed the way its people move. In Hangzhou, passengers waited outside the railway station.

As China opened up, farmers were allowed to grow and sell their own crops, while the state retained ownership of the land. Greenhouses filled with bok choy and yellow cabbage abut investment properties and golf courses.

Under Mao, many educated Chinese were sent to “cadre schools,” where they did manual labor. In May, these real estate agency employees went for a morning run as part of a company team-building exercise.

The party has always been vigilant about crushing potential threats — a fledgling opposition party, a popular spiritual movement, even a dissident writer awarded the Nobel Peace Prize. But with some big exceptions, it has also generally retreated from people’s personal lives and given them enough freedom to keep the economy growing.

The internet is an example of how it has benefited by striking a balance. The party let the nation go online with barely an inkling of what that might mean, then reaped the economic benefits while controlling the spread of information that could hurt it.

In 2011, it confronted a crisis. After a high-speed train crash in eastern China, more than 30 million messages criticizing the party’s handling of the fatal accident flooded social media — faster than censors could screen them.

Panicked officials considered shutting down the most popular service, Weibo, the Chinese equivalent of Twitter, but the authorities were afraid of how the public would respond. In the end, they let Weibo stay open but invested much more in tightening controls and ordered companies to do the same.

The compromise worked. Now, many companies assign hundreds of employees to censorship duties — and China has become a giant on the global internet landscape.

“The cost of censorship is quite limited compared to the great value created by the internet,” said Chen Tong, an industry pioneer. “We still get the information we need for economic progress.”

A ‘New Era’

China is not the only country that has squared the demands of authoritarian rule with the needs of free markets. But it has done so for longer, at greater scale and with more convincing results than any other.

The question now is whether it can sustain this model with the United States as an adversary rather than a partner.

The trade war has only just begun. And it is not just a trade war. American warships and planes are challenging Chinese claims to disputed waters with increasing frequency even as China keeps ratcheting up military spending. And Washington is maneuvering to counter Beijing’s growing influence around the world, warning that a Chinese spending spree on global infrastructure comes with strings attached.

The two nations may yet reach some accommodation. But both left and right in America have portrayed China as the champion of an alternative global order, one that embraces autocratic values and undermines fair competition. It is a rare consensus for the United States, which is deeply divided about so much else, including how it has wielded power abroad in recent decades — and how it should do so now.

Mr. Xi, on the other hand, has shown no sign of abandoning what he calls “the great rejuvenation of the Chinese nation.” Some in his corner have been itching to take on the United States since the 2008 financial crisis and see the Trump administration’s policies as proof of what they have always suspected — that America is determined to keep China down.

At the same time, there is also widespread anxiety over the new acrimony, because the United States has long inspired admiration and envy in China, and because of a gnawing sense that the party’s formula for success may be faltering.

Prosperity has brought rising expectations in China; the public wants more than just economic growth. It wants cleaner air, safer food and medicine, better health care and schools, less corruption and greater equality. The party is struggling to deliver, and tweaks to the report cards it uses to measure the performance of officials hardly seem enough.

“The basic problem is, who is growth for?” said Mr. Xu, the retired official who wrote the Moganshan report. “We haven’t solved this problem.”

Growth has begun to slow, which may be better for the economy in the long term but could shake public confidence. The party is investing ever more in censorship to control discussion of the challenges the nation faces: widening inequality, dangerous debt levels, an aging population.

Mr. Xi himself has acknowledged that the party must adapt, declaring that the nation is entering a “new era” requiring new methods. But his prescription has largely been a throwback to repression, including vast internment camps targeting Muslim ethnic minorities. “Opening up” has been replaced by an outward push, with huge loans that critics describe as predatory and other efforts to gain influence — or interfere — in the politics of other countries. At home, experimentation is out while political orthodoxy and discipline are in.

In effect, Mr. Xi seems to believe that China has been so successful that the party can return to a more conventional authoritarian posture — and that to survive and surpass the United States it must.

Certainly, the momentum is still with the party. Over the past four decades, economic growth in China has been 10 times faster than in the United States, and it is still more than twice as fast. The party appears to enjoy broad public support, and many around the world are convinced that Mr. Trump’s America is in retreat while China’s moment is just beginning.

Then again, China has a way of defying expectations.

Philip P. Pan is The Times’s Asia Editor and author of “Out of Mao’s Shadow: The Struggle for the Soul of a New China.” He has lived in and reported on China for nearly two decades.

Jonathan Ansfield and Keith Bradsher contributed reporting from Beijing. Claire Fu, Zoe Mou and Iris Zhao contributed research from Beijing, and Carolyn Zhang from Shanghai.

Design: Matt Ruby, Rumsey Taylor, Quoctrung Bui Editing: Tess Felder, Eric Nagourney, David Schmidt Photo Editing: Craig Allen, Meghan Petersen, Mikko Takkunen Illustrations: Sergio Peçanha