The Bear’s Lair: China’s coming Austrian collapse
“The coming collapse of China” has been predicted many times. Indeed, an excellent book of that title was a best-seller back in 2001. Yet the fictitiousness of Chinese economic statistics remains, and the over-leverage in the economy worsens. Like several other successful non-market economies, China has successfully sought rents from other countries through flaws in the global economic system. Thanks to President Trump, that is now changing, and the result for China will not be pretty.
Conventional wisdom is that China is the most successful growth story ever seen, that it will overtake the United States in terms of GDP in the early 2020s and (for some China optimists) that it will overtake the U.S. in terms of GDP per capita by 2050. Certainly, that’s what Xi Jinping is aiming at, with his removal of the limits on his tenure and his attempt to dominate the world’s intellectual property by 2025.
There is just one problem: China’s economic statistics are largely fictitious, and the gap between statistics and reality is growing ever larger. If the statistics are nonsense, then probably the economic power is nonsense as well.
The most egregious flaw in China’s statistics is the savings rate. For decades we have been told that the Chinese people are extraordinary savers, with a savings rate of some 46% of GDP, according to the latest figures, compared with around 6.8% of GDP (Itself a figure recently and dubiously inflated by the Bureau of Economic Analysis) in the United States. Touchingly sentimental pictures are painted of the noble impoverished Chinese, earning one fiftieth of a Western wage but nevertheless saving nearly half of that pittance, seven times the American rate of saving, because of the country’s notorious lack of social services for the elderly.
If China really had a savings rate of 46%, the economy would look quite different. There would be very little debt in the system; the banks would have a very low loans to deposits ratio and low leverage, like banks in nineteenth century Britain. Consumer debt would be almost non-existent, while the Chinese market would have an enormous variety of saving and investment schemes, to take care of all the accumulated wealth. New company formation would be very high, but “venture capital” would be very scarce, because new companies would be capitalized from the savings of the founders’ relatives and friends. Overall, China might well have a rapid growth rate, but it would be a very contented, stable economy.
A recent Financial Times examination of China’s economy illustrates the problem; it shows consumer debt almost doubling as a share of GDP, from roughly 20% to 40% in the last five years and tells pathetic stories of young, highly educated Chinese who max out their credit cards, desperately hoping to boost their earnings sufficiently to pay that debt back. But Chinese elite youths brought up in a society with a 46% savings rate would have neither the desire nor the need for heavy credit card usage. First, they would have been brought up in families with a fanatical devotion to deferring consumption, so would regard the over-indebted Western Millennial lifestyle with undiluted horror. Second, because of their families’ savings habits, such elite youths would be beneficiaries of very substantial trust funds from their relatives, and so would have no need of credit cards.
If the savings rate is fiction, then so are all China’s economic statistics. GDP is at least one third lower than claimed, to account for the missing savings, and growth rates over the last decades correspondingly lower, On the other hand, China’s foreign debt is all too real, and most of the domestic debt also appears to be solid, so China’ s gross debt, already alarmingly high at 299% of GDP according to the Institute for International Finance, is in reality about 450% of true GDP, substantially higher than that of any other country. With such a level of debt, China is not about to overtake the West, it is in imminent danger of collapse. Indeed, it is at first sight something of a mystery why it has not collapsed already under the weight of its excesses.
As often in these questions, some history is useful here. China is not a market economy, nor anything close to one. Instead it is an economy that has been benefiting from two sources of unearned foreign increment: the “unequal deals” it has been able to impose on Third World countries that provide it with raw materials and seizure of Western intellectual property without paying for it.
There are three previous examples of societies that appeared to become very successful by non-market looting of foreigners, two of which used military means to achieve it and the third used a mixture of military and economic means. Those societies were Napoleonic France, the Third Reich and the Soviet Union. Of those examples, the Third Reich is not very relevant to modern China because its looting was mostly (though not entirely) military and its economic hegemony was remarkably brief and probably not sustainable.
Napoleonic France is an interesting precedent. This is a society that has been excessively admired by recent British conservative historians, yet the Empire’s economy rested on looting its subject states and Napoleon himself was economically illiterate, dismissing Jean-Baptiste Say, one of the two best French economists ever (no, the other is not Thomas Piketty!) from the public service.
However, the great Lord Liverpool noticed in 1809 that Napoleon’s Empire was unstable; it relied upon loot from a continued supply of new victims to maintain itself. Consequently, a steady and moderate pressure, as applied by the economically stable Britain through the Peninsular War, caused Napoleon to adopt the desperate expedient of invading Russia, after which the Empire collapsed, economically and militarily. Nevertheless, Napoleon’s Empire had been a very impressive structure at its peak, apparently wealthier and more powerful than its rivals, an excellent example of how an exploitative state run on non-market economics can dominate for a time.
The Soviet Union was in many ways an even more impressive example; its apparent strength and prosperity around 1970 has vanished down the memory hole of history. It relied in the early post-war years on exploiting the industry and technology of the fallen Nazi Reich and other countries of its Eastern European empire. Later, it borrowed from the over-liquid international banking system, relying on never having to pay the money back. With its statistics calculated on the basis of prices set by its own central planners, Soviet growth in 1945-70 was rapid; by 1970 the Soviet Union claimed to have around 65% of the GDP of the United States, according to calculations accepted by both sides. Since its population was 20% greater than the United States in 1970, GDP per capita was over half the U.S. level.
Unhappily for Vladimir Putin’s dreams of glory, when capitalism impinged on the former Soviet Union after 1991, its economic strength was proved to be an illusion. Per capita GDP fell to around one tenth of the U.S. level, although it has recovered somewhat since 2000. There was a certain amount of real impoverishment of the Russian people in the 1990s, but in truth much of the Soviet Union’s 1970 wealth had been illusory, a result of using prices divorced from international levels. Nevertheless, for most of the 1970s, the Soviet Union had more megatons of nuclear missiles than the United States, so in terms of both wealth and throw-weight it appeared highly globally competitive. As with China today and Napoleonic France, people talked of it overtaking the United States altogether by 1980 or so.
Napoleonic France, the Soviet Union and today’s China rely on easy money and dozy adversaries to build up their power on an exploitative basis. In China’s case, entry to the WTO in 2001 and its gross abuse of Western intellectual property built its strength artificially, as was the case with the 1960s Soviet Union and Napoleonic France. However, as Liverpool showed from 1809 and Reagan showed in the 1980s, a determined adversary, who is aware of the exploitative games played by the would-be economic hegemon, can force it to abide by market rules, at which point its over-extended economy will collapse, or at least shrink back to a level sustainable from its domestic finances and capability.
As with Reagan confronting the Soviet Union after 1981, the United States now has a President in Donald Trump who will prevent China from taking advantage of the international trading, intellectual property and credit system by non-market means. To achieve this, he must tighten intellectual property rules, as he is doing, and ensure that China’s flouting of “level playing field” WTO norms is met by equal barriers from the U.S. and ideally from the West as a whole.
Then (and this will be difficult for a convinced easy-money man like Trump) he must tighten the international money markets sufficiently that liquidity is not available ad infinitum to finance China’s “Belt and Road” and other expansion schemes. China must not be allowed to take over economically a strip of countries between itself and Africa, including much of the Middle East, thereby giving itself more resources to exploit in its non-market economy. Much of China’s investment in the last quarter-century, domestic and international, has been “malinvestment” in the Austrian economists’ use of that term; and must be liquidated for the economy to regain its health.
With these initiatives, China will soon be faced with a massive credit crisis, as it can no longer borrow to prop up its fictitious shell of an economy. Like the Soviet Union and post-Napoleonic France, it will emerge healthy, but economically a third of its former size. By forcing this, Trump will perform a massive service for the United States and its Western allies, but also in the long run for China itself and especially for its industrious but not pathologically frugal people.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)