China's Development: Assessing the Implications (2003+)

CPDS Home Contact Structural Incompatibility Puts Global Growth at Risk   Are East Asian Economic Models Sustainable?   Babes in the Asian Woods  Beyond 'The China Choice' Reading China's Mind?   Comments on Australia's Strategic Edge in 2030  Friction between China and Japan: The End of the Asian 'Century'?   Competing Thought Cultures   Factors Affecting China's Future: A Brief Overview  'Art of War' Speculations about North Korea's Threats   The Dali Lama's Search for Moral Wisdom  Parting the Bamboo Curtain ... A Bit  The End of the 'Asian Century' Seems to be Coming into View   China's Reform Map Unclear   China as a Dominant Power    Debunking One Myth about the Chinese Economy  The Problem is Financial, Not Currency, Manipulation   Asian Authoritarians Can't be Contained without Understanding How They Exert Power   Are Service Exports to Asia Australia's Best Economic Options?   China's Strategic Approach to its Economic and Political Problems: A Speculation   Understanding East Asia Requires More Than a Study of Confucian Values   International Regulation of Lending Standards  Chinese Influence in Australia Don't Accuse China of Maoism or Capitalism: Neo-Confucianism is the Go   Toeing the Party Line?   Australia Must View Chinese Investment and Other Activities Through a Geo-political Lens  Keep Calm and Rethink China  Will China Again Become the 'Middle / Coordinating / Organizing Kingdom'?  Global Implications of Corruption in China  The Need to Understand China's Lack of Principles  A Different Financial Crisis in Asia?  Where to Start Changing Philosophy  The Western Path to Progress   Alternative Geo-political Assumptions  Donald Trump is Not Alone in Facing Dilemmas  Putting China-US Tensions in Context    China's Desperate Need for More Foreign Investment  Can President Trump Contain China's Hierarchical Authoritarianism?  Take a Closer Look at China   We Have to Understand China's 'New World' Ambitions   Will Donald Trump Unofficially Accept China as the 'Middle Kingdom'?    Christianity is the Necessary Foundation for Applying Rational Thought in Practice   Should Anyone Bother Going?  We Must Understand the World, Especially China
Introduction +




China has been achieving an impressive rate of development of its economy and increase in its regional / global economic and political influence. There has been speculation about its future potential to act as a major driver of the global economy, and whether its methods will provide the model that others will now seek to emulate.

In relation to this, the present document will suggest that:

  • China's accomplishments have been remarkable since the late 1970s, especially when considered in the light of its history. That history needs to be understood to appreciate both how China has achieved progress and its prospects of continuing this;
  • acting as an 'engine' of the global economy would be impossible unless China fundamentally changes its primarily mercantilist goals. Economic progress has been viewed mainly as a means for increasing national power. The economic methods which have underpinned its recent progress have involved unproductive use of capital and protecting financial institutions with bad balance sheets by maintaining a current account surplus (both in China and in many of its economic 'tributaries');
  • cultural features affect China's aspirations and ability to achieve an economic transformation;
  • if China were to be the pacesetter for the future of the world, this would be a world founded on practices that are incompatible with the principles that Western societies have sought in influencing the international order in recent centuries (eg individualism, individual freedom, a rule of law, increasing citizen's welfare as the goal of economic growth, coordination of economic activities through financial outcomes, democracy, and universal ethics which value all people rather than a particular group);
  • China's rapid export / investment driven growth is likely to prove to be a 'bubble' because of its: state-driven economy reliant on administrative methods for managing economic and financial outcomes; dependence on exports and on others' ability to productively use its financial 'waste'; exposed banking institutions; environmental stresses; a fast aging population; and an unstable political climate;
  • changes in the international environment resulting from the global financial crisis imply that economic models like that China's rapid growth relies upon have passed their 'use by' date. Thus China's leaders, having no market-oriented way to further increase their power, may turn to assertive nationalism as an alternative though suggestions about fundamental reforms also emerge from time to time..

September 2002  - and amended October 2003 and from November 2007

China's History and Recent Accomplishments

China's History and Recent Accomplishments

China has achieved spectacular recent progress in the face of immense difficulties.

Some History

China has the longest continuous national history (something like 4000 years) and was politically, militarily and economically dominant in its region (and also globally significant) for most of that period.

For much of that period, this was based on a system of imperial regimes - administered by Confucian bureaucracies who sought wisdom from a study of the past.  This seems to have been based on views about the nature of knowledge, society, power, economic goals and governance that are quite different to those of Western societies (see East Asia: The Realm of the Autocratic and Intuitive Ethnic Hierarchy).

In overly-simplistic terms China was apparently held together through cultural conformity (backed by force) [1]. 'Harmony' and learning were idealized under Confucian traditions and achieved through a form of centralized soft-power ('thought control'). Under the examinations system the Emperor (the 'chief examiner') determined which of the best students the education system produced he favoured to control administration, and the bureaucratic elite then exerted state power primarily by inculcating desired ideas and behaviours in the their subordinates in hierarchical social networks.

China's traditional regimes seemed incapable of coping with the more decentralized initiative and empirical (ie does it actually work?) knowledge of European powers during the latter's period of economic, military and political expansion from the 15th to the 19th centuries. The 'wisdom' which the bureaucratic elite tried to use to guide their subordinate's responses to European influences was based on a study of history and was hopelessly inadequate in dealing with societies that had economic and military strengths based on cultural traits that China had never encountered before.

In 1911, China emerged from its feudal order - and then experienced decades of instability. It was governed to 1949 mainly by the Nationalist Party in the face of conflict with: imperialist warlords; Communists (at times); and expansionist Japan. The Nationalists favoured building China on the basis of traditional values and Confucian administration but were forced out in 1949 by the Communists led by Mao Zedong - who favoured a Cultural Revolution to break down the traditional Confucian social order and adoption of a Marxian version of Western methods. Mao's 'cultural revolution' largely deprived the country of its traditional Confucian intellectual capital (and made initiative impossible for ordinary people) - resulting in widespread suffering and economic setbacks.

Recent Progress

It was only after the liberalization reforms and a neo-Confucian cultural counter-revolution in the late 1970s (under Deng Xiaoping initially and possibly / probably with assistance from Japan and the factions aligned with the former Nationalist Party), that China made appreciable progress.

A View of Confucian Revival

By the time of the Beijing Olympics in 2008 China had been been transformed from a sporting also-ran to the most powerful sporting nation. Beijing was found to be efficient - but to lack unfettered internet access, freedom of speech, concessions to human rights. The media concluded that China was hopelessly oppressive. But others (eg John Harms and Gerard Weatley) suggested that few understand China, and most tend to view the world through notions of Western superiority. There is no concept of what China has been over its long history. Harms' views are informed by Dr Gao Jia (Melbourne University) who hoped that the Beijing Olympics would mare a turning point for China from the trauma of the Opium Wars. Gao sensed the revival of Confucianism ('He') in the 1990s. The Olympics opening ceremony features the artistic expression of children painting (symbolic of the Confucian tradition). Confucian revivalism comes from the top (eg Li Ruihuan and Jiang Zemin). President Hu Jiantoa has sanctioned the return to Confucianism. Zhang Yimou, ceremonial master of One World One Dream would have required Hu's approval. Western journalists would not understand the subtlety. The political elites has used proxies such as 'Li' and Renmin University in Beijing (a centre of learning on Confucianism, which is now openly advancing its research on Confucius legacy).  'He' translates into gentle / mild kind; being harmonious and on good terms. From this derives the notion of peace / being on good terms. The world has too long seen imperial dominance. Confucian China will rid the world of a confrontationist approach to international affairs (Boey K., 'Confucius lost in the fireworks', Online Opinion, 17/9/08)

See also Competing Thought Cultures (2012); A Simple View of Confucianism and Communism Versus Confucianism: The Continuing Contest in China .

Massive external (manufacturing) investment was first attracted based on education and cheap skilled labour, while equally massive internal investment has more recently been mobilized in modern infrastructure and urban (including consumer) facilities especially in major cities. Despite China's intense population pressure, there was no shortage of land as traditional uses were simply demolished to make way - and existing residents apparently compensated with an apartment and better job prospects (though this process frequently generates dissatisfaction [1]). In China all land belongs to the state, and occupants only own the structures erected on it.

A key feature of China's rapid growth is seen to have been its ability to reform its economy very quickly to become more efficient [1]. Techniques that encourage and support policy initiative within hierarchies have been developed [1].

In China's recent progress it is possible to see lessons learned from (a) Singapore's experience in building a modern 'Chinese' city with foreign investment (b) Japan's neo-Confucian 'industry policy' methods and disregard of Western financial disciplines (c) the Nationalist Party's preferred cultural alternative to Mao's version of Communism and (d) Taiwan's adoption of some US techniques. China seems to be attempting to implement a system of socio-political economy that has been little studied and probably can't be understood in terms of Western analogies or cultural assumptions (for reasons like those outlined in Structural Obstacles).

The short-term result has been an unprecedented and impressive rate and magnitude of gains in China's real economy [1, 2, 3, 4, 5, 6, 7, 8, 9], and a perception that it has excellent future prospects - even recognizing that it suffers structural defects [1, 2, 3]. Moreover some analysts have recently seen China as a 'safe haven' for investors concerns about a US asset bubble, and the structural problems facing Japan and Europe [1].

It is also argued that that China is playing, and will continue to play, a key role in promoting regional and global collaboration [1, 2].  It is seen to be challenging Japan's status in Asia, and to be the only country able to sustain a view of the world which is different to that of the US [1].

China has also been seen as a rising power that will force others to adjust because of factors such as: its huge human resources and markets; the emergence of a high class education system; and the external resources of Greater China which will provide the skills to allow its structural problems to be overcome [1]. A China-centred 'Confucian Union', similar to the EU, has been speculated for Asia [1]. 

China-led Asia has been seen to be returning to its historical role at the centre of affairs - which has had a huge impact on the global economic system similar to the long rise of Europe (and its American offshoot) to pre-eminence 500 years ago. [1] Its emergence has (as also in the case of India) been suggested to be simply a restoration of the position which had existed for most of recorded human history [1, 2]. The take-off by these two poor countries which account for 1/3 human population will make a huge difference to the global (and especially Australia's) economy. [1]

China has shifted from a unilateral stance in opposition to global institutions to working (often with great effectiveness) within those institutions [1]. A 'Chinese consensus' has been suggested to be a better alternative to the (so called) 'Washington consensus' (free societies and free markets) for developing economies [1].   The 'Beijing consensus' is seen to be characterized by putting political stability and development before (democratic / human rights) reforms [1].

Some have even argued that China is 'the future of the world' [1] - undergoing a rapid developmental process, building infrastructure and industrial capabilities that will put it into a position of immense power in 20 years - and replace the US as the world's dominant power by 2050 [1].  It has been suggested also that China's role as an economic engine shows that the 'Asian century' has already arrived [1]. 

China is seen to have features which are quite different to earlier challenges to the US's 20th century global dominance (eg Soviet Union, Japan) and to have the potential to create a future Asia-centred economic regime which others including the US can either be part of, or be excluded from [1].

A popular image now seems to be presented within China of a trendy, super-modern consumer society that will eventually be able to satisfy every material desire.

Though there are obvious environmental and political problems behind this image and China's model for socio-political economy may prove financially / economically un-sustainable, China's leaders present a confident face to the world and to Chinese people.

China as the 'Engine' of the Global Economy? (2002+)

China as the 'Engine' of the Global Economy? (2002+)

It was long speculated that (because of accumulated debts) the United States was losing its ability to provide a strong source of demand and by doing so to support the growth of the global economy.

This was considered in Structural Incompatibility puts Global Growth at Risk, which also argues that the US current account deficits party have an external source (ie an unsustainable potential deficit in global demand now exists because of the way in which the monetary and financial systems of major East Asian economies are managed - a deficit which the US has temporarily filled by creation of credit and foreign borrowings).

It was also argued that East Asia, China in particular, must in future provide the demand to sustain growth in the global economy [1, 2 3,  4]. 

In relation to this, it is noted that:

  • a massive infrastructure development program (perhaps equivalent to the US New Deal in the 1930s) was undertaken in China to stimulate domestic demand in the face of the 1998 Asian financial crisis and the bursting of the dot-com' bubble in 2001 [1]. While this couldn't be sustained indefinitely, public spending could be eased as foreign investment drives growth [1];
  • China's emphasis on export-driven growth was described as self-defeating [1]. Similarly its continued growth was seen to be at risk unless domestic demand (which contributed only 26% of its overall growth) increased  [1]. After decades of export driven growth, China's next stage in development will be driven by consumer demand [1];
  • domestic demand has, in fact, been increasing in East Asia - and led investors to be more positive about the region's prospects [1];
  • China has been seen to be already playing the role of an 'economic engine' - as its trade growth has stimulated and stabilized growth elsewhere (especially in Asia) [1, 2, 3, 4, 5, 6, 7]. In particular the World Trade Organization supports such a view [1];

Furthermore the World Bank has outlined a process whereby East Asia might shift to the next stage in development (ie based on innovation) - a shift which amongst other things requires boosting demand [1]. And China has ambitions as a global leader in innovation and defining technological standards [1]

However a counter view has been that:

  • current levels of consumption in Asia are too low for this to be globally significant - so Europe will have to fill this role when US becomes incapable of doing so [1].  Poor Asia-wide outlook for demand growth has likewise been seen as a critical constraint [1];
  • China's growth has been very highly dependent on US demand growth [1];
  • 41% of China's GDP was being derived from exports in 2004 - up from 26% in 1996 [1];
  • China's domestic demand growth seems mainly to be due to massive investments in infrastructure and urban facilities by state institutions - which have been generating bad debts in the banking system [1];
  • China's investment driven growth has been too fast to be sustainable [1, 2, 3] - and a substantial economic slowdown is likely due to overcapacity [1];
  • the expectation that Asian demand could could take over from the US in driving global growth seems already to have lost credibility [1];
  • China's potential as a consumer is likely to be limited because rapid population aging (related to the one child policy) will make it 'old' before it becomes 'rich' [1].

Furthermore, despite the gains which China has achieved from opening to external market influences, there appear to be significant  political influences still favouring a closed, state-driven economic system [1]. Also China has reportedly decided to:

  • abandon its 'growth at all costs' strategy in favour of reducing internal inequalities [1, 2]; and
  • significantly slow investment and growth to avoid economic overheating [1] - an action that was needed not only in 2004 but again in 2007 [1].

More will be said about the latter (and its difficulties) below.

It has seemed that China's ability to act as a regional or global economic 'engine' depends on a strong US economy to provide export demand and on massive domestic capital spending which is ultimately likely to be unsustainable.

In 2004 there was also an expectation that Japan would be able to take the role of driving global growth because of its expansionary macro-policies [1] - a hope that clearly was not realised.

In 2007 global financial instability (which started in the US) was accompanied by expectations that 'decoupling' of the global economy from that of the US (with growth driven in future by emerging economies especially China - and also India) would allow strong global growth to continue [1].  However:

  • though China's dependence on exports to the US might be reducing, there are much more complex requirements for real decoupling, the most important of which relates to success in the 'symbolic' economy rather than to outcomes in the 'real' economy (see Decoupling: A New Urgency); and
  • the most likely consequence of any failure by US financial institutions would be a  failure of China's economic model (see China: Victor or Victim?)

By 2009, financial instability had translated into a global financial crisis and an economic crisis , and (as noted below) this seemed likely to have closed off market-oriented options for continuing China's economic growth and thereby increasing it's power.

Cultural and Financial System Considerations

Cultural and Financial System Considerations

Despite the emergence of growing consumer demand [1, 2], It was culturally implausible that East Asia generally (or China in particular) would ever be more motivated or capable than Japan had been to develop a sufficiently strong economy to provide a primary source of support for either domestic or global demand. 

Societies in East Asia whose cultural traditions have historically been heavily influenced by China (as many have) tend have a quite different economic goals to Western societies.

An attempt to describe these critically important characteristics is presented in Competing Civilizations. This refers to a tightly linked package of traditions founded on intellectual styles quite different to those of Western societies which are the basis of economic systems which are communitarian and mercantilist (ie oriented towards building the strength of an ethnic community - and its social elites in particular [1]) rather than oriented towards earning a return on investor capital by satisfying the demands of individuals as consumers. The power-building (rather than consumer-welfare) goal of economic activities is closely linked with the fact that (because of diverse other cultural assumptions) social 'harmony' depends on the ability of elites to suppress dissent.

The way in which these characteristics have been developed in the case of Japan's more highly unified political and economic systems are explicitly outlined in Why Japan cannot deregulate its financial system.

These characteristics could be changed. However doing so would require a very long time. Thus it may be wishful thinking to expect that economically-dynamic East Asian societies might be able to quickly shift from a mercantilist focus on increasing the power of ethnic communities and their social elites to being consumer oriented (a focus which results in an unbalanced emphasis on economic production - as seems to be the case in continental Europe also for different reasons and to a much lesser degree).  

A broadly-based consumer economy might be economically advantageous in East Asia - but it would: subject the economy to the discipline of market / consumer demands rather than of nationalistic elites; and undermine the social, economic and political order (which has been based on communitarian interpersonal obligations rather than earning income).

However the most critical practical constraint on China's ability to support global demand growth involves the 'skeletons in its financial closet' which arise from its economic traditions. As noted  in Competing Civilizations, characteristics of East Asian business models tend to include:

  • an orientation to maximizing 'real' production rather than return on capital (eg to emphasize market share rather than profitability) - which thus generates financial losses in the banking system;
  • a preference for coordinating economic outcomes through social relationships rather than through financial outcomes (ie doing business depends on 'guanxi' (connections) rather than financial calculations). Moreover there seems to be no Chinese word for 'unprofitable' [1];
  • a heavy reliance on financing business through debt rather than equity (which results in only a limited 'buffer' being available in the event of economic shocks)

This model creates a predisposition towards financial crisis (as shown by Japan's stagnation in the 1990s and the 1997 Asian financial crisis).  In China's case the problem is compounded by its large and loss making state industries, and by the high levels of state-driven economic growth [1].

It used to be generally recognized that capital has been used very wastefully in China [1]. And, despite efforts to improve the situation and claims of success, the problem remained (see below).

The assumption that wasteful use of capital is a residual effect of socialist history (ie that banks fund state-owned institutions who can usually ignore profits) is an oversimplification - see Structural Incompatibility Puts Global Growth at Risk. The reality is likely to be that the banking system directs funds to well-connected projects - a category in which state industries are merely an example. Firms who are not well connected have to pay black-market interest rates [1].

The IMF has argued that China's pile-up of foreign exchange earnings reflects deep structural problems - as these lead to overinvestment, overcapacity and falling prices. [1]

Moreover where profitability is not seen as important, the economic system can only be stable if the financial system is isolated from the international financial system by holding large foreign reserves (and by strict regulation in Japan's case). Confucius' instruction to become rich by saving and avoid consumption [1] provided a means of protecting financial institutions with dubious balance sheets.

China was stable through the 1997 Asian financial crisis (despite the dubious balance sheets of its financial institutions) not because of its fixed exchange rates against the US [1], but because financial institutions were able to draw capital from China's foreign exchange reserves [1], rather than having to establish a sound international credit rating.   The same was not true of 'Asia' as a whole - which had run a current account deficit in the early 1990s, and many countries could not protect their unsound financial institutions.

China shifted into current account deficit as its economy transitioned from its solely export-driven growth phase. Furthermore by late 2004, the growth of exports (which had built up the foreign reserve buffer for China's financial system) was slowing rapidly [1].

Moreover, while foreign exchange reserves may offer protection against a financial shock in the short term, they can be of little long term value because drawing down such reserves to cover a current account deficit that had emerged would reduce the ability of other countries to purchase China's exports, and thus further increase that deficit.

Before (say) China could increase demand enough to act as a real 'engine' of the global economy:

  • it would have to increase domestic demand to the point where it has a substantial current account deficit which would steadily erode its accumulated foreign reserves; and thus
  • the balance sheets of its financial institutions would have to be sound enough to be able to borrow in international capital markets - which must be impossible if the basic mechanisms of its economic / enterprise management remain biased against achieving positive financial outcomes. 

In reality, despite efforts that have been made at reform, China appeared to be at more risk of suffering a financial dislocation than it did of curing the balance sheet problems facing its institutions and driving global growth.

China's reported shift in early 2006 towards boosting consumption (rather than exports) to drive growth [1] (and the weakness of US demand associated with its 2007 financial problems) seemed likely to eventually expose China's 'skeletons'.

Looking Ahead: By 2011, little progress had been made in boosting economic reliance on domestic consumption (because the global financial crisis, which was partly a result of demand deficits in economies such as China's, had forced China to rely heavily on construction and perhaps contributed to a property bubble) - see China as a Bubble. Though ever increasing commitment to reform has been announced progress seems to face significant constraints (China: Impact of the GFC especially Change Driven by China's Rising Generation and Heading for a Crash or a Meltdown?)

China's 'Future of the World' Ambition - 2003+

China's 'Future of the World' Ambition - 2003+

An even more ambitious view has been that China is 'the future of the world', and will be be the world's dominant power by 2050 - a view which paralleled 1980s' expectations about Japan.

Moreover a case could be made, from the viewpoint of Asia's nationalists, that Western economic and military strength must decline.

An address by China's president Hu Jintao to Australia's parliament in October 2003 laid out what may be seen as the high-minded and constructive principles which China would support in continuing its rise. It gained many very favourable reactions [1, 2, 3, 4].

Outline: President Hu's address raised critically important issues about the future of international relationships - and did so in a generous way in relation to the specific situation of China and Australia. Amongst the significant issues raised were:

  • China's long term awareness of, and interest in Australia - and its strategic approach to developing relationships;
  • future international relationships should be based on:
    • putting aside differences, and building on points of agreement (ie respect);
    • economic complementarities - bringing in capital and know-how to exploit mutual comparative advantages;
    • cultural interchange - drawing upon the strength's of others;
    • security built on mutual trust, cooperation and equality - involving democracy in international relations (especially multilateralism through UN and Security Council)
  • China has:
    • promoted domestic democracy, rights, freedoms and a rule of law; 
    • a large stable market - which has complementarities to Australia;
    • managed the relationship amongst many different ethnic groups, benefited from interchange with the wider world and recognizes Australia's multiple cultural origins;
    • has a sound relationship with Australia - and shares an interest in regional stability and opposing terrorism;
    • an irresolvable intent to incorporate Taiwan;
  • Australia was (in effect) offered an opportunity to seek a respected status in the 'Asian' region under the patronage of China's rulers.

The address was also significant as an expression of China's recognition that humanity faces severe challenges - to which force of arms is not a viable solution (see also Risks in a Clash with Islamist Extremists, and The Second Failure of Globalization?).

However there are unstated aspects of this proposal that also need to be considered. These include: China's radically different approach to universal values and human rights; the practical consequence of cultural differences (including the unfamiliar character of China's 'market' economy); and China's efforts to re-establish its historical dominance in Asia (perhaps now including Australia?) through behind-the-scenes influence over individuals and organizations who may not understand the broader implications.

For example:

  • President Hu presented one traditional Chinese approach to the relationship between cultures. He argued for putting aside points of disagreement, and concentrating on practical (commercial) gains. This reflects (not just pragmatism but) a traditional perception that all beliefs merely reflect the particular history and circumstances of a community and that the Western goal of seeking universal 'truths' or values has been foolish. This approach (which is adopted because differences in beliefs are seen as the main cause of conflict) has advantages in promoting harmony and creates opportunities for 'learning by doing'. It also reflects the undoubted fact that all cultures have strengths. However the assumption also has disadvantages, as:
    • culture appears to be the principal determinant of peoples' ability to be materially successful (see Competing Civilizations) - and very few cultural traditions provide the necessary environment for the reliable production of goods and services, and for economic change (see Towards a Comparative Study on Development Policies: Indonesia and Australia). There are serious constraints on one's ability to help disadvantaged peoples if the effect of cultural assumptions is disregarded;
    • the search for 'truth' can also confer social and political advantages (see Competing Civilizations). For example:
      • one can not value the welfare of all people (which has been the Australian ideal) and simultaneously treat all cultural traditions as equal, because there are many cultures in which social inequalities are intrinsic;
      • where there is no search for public 'truth' there is no basis for contesting the opinions of the powerful, so autocratic government is unavoidable (as is traditional in East Asia and as has recently been recognized to be an unwanted side-effect of the spread of 'post-modern' assumptions in Western humanities faculties). And in turn autocratic government both:
        • increases the risk of disharmony through abuses of power; and
        • is seen as essential to promote harmony by suppressing dissent;
      • where there is no 'public truth' there can be no egalitarian culture (another Australian ideal) because hierarchy is vital to hold a society together.
  • the differences in cultural assumptions (which President Hu suggested putting aside to concentrate on commercial benefits [1]) have significant implications [1, 2]. For example:
    • a social, political and governance order has traditionally been supported in China which involves: prescriptive rules for interpersonal relationships; a particularistic rather than a universalist set of ethics (ie one that only values those with whom one has a direct relationship); consequent acceptance of racism as natural (and a ruthlessness towards weak outsiders); a rule of man (especially of bureaucratic elites who are the real power behind nominal rulers such as emperors, presidents or elected officials) rather than a rule of law; and a concept of human rights which values community, but not individuals; 
    • the (so called) 'Beijing consensus' about socio-economic development places emphasis on political stability before development and (democratic / human rights) reforms.  [1];
    • the preference for government by Man, or virtue, rather than by law is based on Confucius' view of a major weakness of the rule of law (Little R. The Confucian Renaissance). The Analects stated: "Lead the people by laws and regulate them by penalties and the people will try to keep out of jail but will have no sense of shame. Lead the people by virtue and restrain them by the rules of decorum, and the people will have a sense of shame and moreover, will become good". The problem with this view is that:
      • those who purport to lead others by virtue suffer human failings. Moreover the moment 'virtue' is accepted as the basis for unquestioned power, every thug and power-seeker will put on a virtuous 'face' - whilst remaining a thug or power-seeker;  
      • like legalism, virtuous leadership only creates the appearance of becoming good while others are watching - rather than affecting a person's inner being. Thick Face, Black Heart (Chu C.) discussed the consequences in terms of a willingness (behind an impenetrable 'face') to accept the necessity to do evil. The acceptance of organized crime as a element part of society reflects acceptance of the necessity to do evil. It was probably no coincidence that Japan's organized crime gangs (Yakuza) instigated the Meiji restoration to modernize Japan to resist Western influence, as a rule of law would have transformed them most specifically from 'respected' citizens into outlaws; 
      • Confucius did not recognize the revolution in the concept of a rule of law Jesus of Nazareth introduced when he prescribed adherence to the spirit (rather than the letter) of Jewish law through an internally-driven 'put-others-first' ethical ideal (see Competing Civilizations). Without this a simple rule of law must, as Confucius said, be morally inadequate (eg as illustrated by the social dysfunctions that have accompanied the widespread abandonment of that ideal in Australia);
    • China's democracy is to be subservient to the rule of the intellectual elites who make up the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) - a fact which needs to be considered while noting the dysfunctions sometimes associated (a) with immature democracy and (b) with autocracy. In practice democracy has been repressed more than developed [1, 2], and proposals for creation of mechanisms which would reduce elite power are difficult to implement [1].  [One observer in Beijing suggested to the author that it is the People's Liberation Army which still ultimately holds power];
  • China's economy is not a 'socialist market' system as such words would be understood in the West - because China's 'socialism' involves: the elites comprising the most-educated (rather than collectives of ordinary people or their elected representatives) making consensual judgments about what is best for the community; and the 'market' involves networks created and managed by those elites. This arrangement:
    • is a market (rather than a planned) economy, but it is certainly not free;
    • involves corporatism (ie economic dominance by state-linked organisations) rather than capitalism (where economic control resides with those who seek profits and are independent of the state);
    • is best viewed as a neo-Confucian system - involving autocratic rule by highly educated elites even though those elites are organized under the label of a 'Communist' Party.  The 'neo' element involved the introduction of Daoist concepts about the nature of knowledge (which has links with Shinto and provided the base for learning from others as the way of achieving change) to the tradition of learning strategy mainly from the study of history - the traditional Confucian assumption which had led China to centuries of stagnation (See Transforming the Tortoise);
    • involves mercantilist goals of increasing the power of an ethnic community (and its social elites in particular [1]), because (as noted above) various cultural assumptions create a situation in which social harmony can only be assured where elites are strong enough to suppress dissent;
    • is revealed in practical terms in China's approach to support for nation building in SE Asia, which involves establishing economic capabilities and relationships with limited concern about financial outcomes [1];
    • has been described as a Confucian 'worker caste system' which is a future better alternative to the 'merchant caste system' in which capital has been the source of power. It is seen as superior because it would be run by bureaucrats / technocrats whose productivity 'merchants / capitalists' otherwise constrain  [1]; 
    • has been described as the basis for a 'Chinese consensus' about a better way of achieving economic development than the (so called) 'Washington consensus' in an analysis which entirely ignored China's poor financial institutions [1];
    • seems to have resulted in possibly the world's most unequal distribution of wealth [1] because elites have taken advantage of their positions to enrich themselves and their families [1];
    • can be viewed favourably despite the associated censorship and authoritarianism - eg on the basis of lives of ordinary people and the concern for their welfare demonstrated by authorities  [1]
  • a case for the universal relevance of Confucian traditions has been made (see The Abduction of Modernity). However as noted in comments on that article, there are aspects of that model which others need to consider. For example, Western societies are seen to be 'barbarians' because their development of advanced weapons allowed common folk to equal their aristocratic superiors;
  • China's perceived economic success leaves its elites with no pressure to transform eventually from its authoritarian political model to some form of democracy [1];
  • the market opportunities that seem to exist may well be a mirage (see below) - unless (a) the global economic system changes to a 'social market' model under which economic transactions are coordinated by relationships amongst neo-Confucian elites, and financial outcomes are treated as unimportant and (b) such an alternative system is found to be sustainable.  In this case, Australia's economic and financial system would need to be re-built from the ground up on a 'Asian' model;
  • China's Diaspora have reputedly gained significant behind-the-scenes political influence in many nations in SE Asia (eg see Seagrave S 'Lords of the Rim') - a fact which has led to friction (and even conflict at times).  The extension of those networks might constitute one of the 'strategic' elements in the development of China's relationship with Australia. In other words the 'strategic' element in the development of China's relationship with Australia is likely to involve Australians in influential positions becoming directly or indirectly dependent on patronage (eg in terms of providing information / contacts) on Chinese elites:
    • Australian leaders who are subject to such influence could be expected to have good Chinese connections and also perhaps exhibit 'Confucian' characteristics, such as: (a) intellectual elitism (and perhaps an effort to enmesh politically with intellectual elites [1]); (b) a focus on history; (c) seeking moral authority by quoting respected ancient sages (eg Christ in Australia's case); (d) an autocratic approach to using power; (e) valuing society above individuals; and (f) a concern for concrete / material (rather than abstract / spiritual) outcomes;
    • it has emerged that a Chinese businessman (Chau Chak Wing) has been the largest source of donations to political parties in Australia and has developed close and supportive relationships with aspiring Australian political leaders [1];
    • the wife of an ALP backbencher (with good connection to China and Australia's PM) established a land development company with land holding in Queensland just before a Chinese company (a subsidiary of state-owned Chinalco) announced an intention to make a $2bn investment nearby [1] ;
    • a journalist alleged in 2009 that there might be something 'fishy' about the support that 'China Inc' seemed to be providing to ALP MPs in Queensland [1]
    • in 2013 it was claimed that the political department of China's PLA conducts systematic programs to influence / deceive foreign leaders:

Tony Blair gave a feel good speech in Beijing in which he declared himself an old friend of China and expounded on how a wealthier China would ensure a society with more love and care, But his speech was hosted by front organisations for the department of the PLA that runs psychological warfare and covert influence operations against foreign leaders. This illustrates the scale and ambition of China's influence-peddling - and its willingness to deceive top decision makers in government and business to achieve its ends. Blair's host was the China Association for International Friendly Contact which Chinese-language military documents show is a tool of the general political department of the PLA and functions as a deception operation [1]

  • China has been seen to be re-establishing its ancient 'tributary' system as the basis for renewed imperial dominance of the region [1];
  • the rapid development of China's military capabilities - and its need to defend its resource supply chains - require a comprehensive reconsideration of Australia's planning  [1];
  • recognition needs to be given to the unfamiliar characteristics of East Asian 'Art of War' strategies;
  • negotiations with China about a Free Trade Agreement can not be straight forward, eg
    • Australia is entering FTA negotiations with China without understanding China's negotiating methods [1]
    • China's traditional method of dealing with conflict involves psychological weakening of perceived enemies rather than over use of force [1];
    • amongst the conditions associated with closer economic collaboration with China by Australia were:
      • applying a 'free market' label to China's economy [1] - which seems simply not true [1]  . though not all agree [1]. Ultimately such a concession had to be made simply to get negotiations started [1]
      • managed resources trade between Australia and China (ie limiting price rises, locking out China's competitors for Australia's resources) [1]. [To some extent this would transform Australia into a Chinese 'colony']
      • making concessions to 'dumping' [1];
      • acceptance of its territorial claims in Taiwan [1];
      • ignoring its dubious human rights record [1, 2];
      • making no public comment on China's human rights record [1]; and
      • suppression of political dissent [1, 2];
    • diplomatic pressure has been applied to Australia to:
      • ignore Australia's ANZUS Agreement with the US in relation to Taiwan [1];
      • suppress Falon Gong demonstrations in Australia [1] - whose significance is speculated below;
      • support China politically [1]
    • Australia has had great difficulty in dealing with application for political asylum from a Chinese diplomat - because China is a regional hegemon which defies the rules of liberal democracies [1]
    • It has been suggested that China is seeking to use economic power to force Australia to give ground on security and human rights issues [1]
    • Australia will not gain from China an agreement that economic outcomes should be determined by ability to compete. Such concessions from China would only be obtainable through the WTO which is being sidelined [1]
    • there is a critical question about whether contracts should be enforceable [1]
    • concessions in relation to upstream investment would be a condition of contracts for resources [1]
    • intrinsic difficulties in developing closer relationships with China include: its command economy (which results in wastage of resources);  governance by China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party) which allowed large scale corruption); its lack of legal infrastructure to underpin a market economy; lack of transparent codified laws [1];
    • the key issues in Australia's foreign policy environment are that China is now the gatekeeper on Australia's relationships with Asia - and is also preparing for a war with Taiwan. [1]

The suggestion that the 'Beijing consensus' (which emphasizes social / political stability enforced by autocratic elites) would be an alternative to the 'Washington consensus' (which emphasizes liberty) as the basis for a model of socioeconomic development is undoubtedly valid. However both suffer from the limitation that they can not be extended globally without transmission of the cultural characteristics which are required for them to work.

The Western model (typified by the 'Washington consensus') requires (for example) individual liberty as an essential feature because it is at the level of individuals that rationality / abstract analysis can be most effective in making economic decisions.

Similarly the 'Beijing consensus' is contingent on specific cultural features, in particular "the ancient Chinese philosophical outlook that makes little distinction between theory and practice" [1]. This is essential for the model to work, because where economic theory is separated from practice, theory oversimplifies reality (because of the huge complexity of economic reality) and thus results in poor decisions. This is the foundation of the neo-liberal view of economics - which is embodied in the 'Washington consensus' and ultimately based on Hayek's recognition that it is impossible for any central authority to assemble the information required for correct economic decisions (see 'The Use of Knowledge in Society', 1945). When there is little distinction between theory and practice (ie where elites encourage decision making by practitioners, rather than themselves making decisions on the basis of abstract analysis), this difficulty can be reduced. However in countries which lack this cultural feature, attempts by authoritarian elites to guide development must result in economic and political failure.

Outside East Asia, adoption of the 'Beijing consensus' would (as for the 'Washington consensus') only be successful if the cultural foundations on which it is based were also adopted by others;

[Note: see also Is China Headed for a Crash or a Meltdown? in relation to the boost to to the view that emerged from various sources after 2008 that China would be the 'future of the world'].

China as an Economic Bubble? (2004+) +


China as an Economic Bubble? (2004+)

As noted above, China has achieved spectacular progress in the face of immense difficulties, and this reflects immense creativity and effort.

However, rather than regional and global leadership in economic and political affairs, the most probable ultimate outcome is that China's future prospects will be limited by economic, financial, environmental, demographic and political challenges such as those outlined below.

The possibility that rapid growth could be disrupted due to economic overheating was recognised in 2004. Efforts to avert this (and seriously deal with other constraints) were redoubled, but may have been inadequate.

Global financial instability in 2007 added to China's risks despite official confidence in its invulnerability. It also made the possibility of real 'decoupling' of emerging economies (especially China's) from economic conditions in US a matter of considerable global economic importance (see Decoupling: A New Urgency - which addresses in particular the apparent dependence of East Asian economic models on strong financial institutions in other countries, eg US).

It has been the present writer's suspicion that China's rapid progress can not be sustained though when and why the economic 'bubble' would burst was unpredictable.


Economic Constraints

The Chinese economy appears to work on neo-Confucian dynamics which are a different version of the (supposedly 'non-capitalist market' economy) that Japan practiced.  Government influence is strong in all aspects of society, and this arrangement is perceived by elites to be as it should be [1].

In particular China retains a 'state-driven' economy and has experienced highly unbalanced development. For example:

  • many sectors (eg agriculture, mining, basic manufacturing) remained backward in the 'growth at all costs' emphasis on infrastructure and foreign 'high tech' investment [1] - and as this imbalance is recognized and the most obvious backward sectors / regions are addressed, new backward sectors must emerge if the economy remains state-driven;
  • serious infrastructural deficiencies have emerged [1]. Energy industries have been developed on the basis of national self-sufficiency rather than market requirements [1]. Huge losses were incurred (related to poor corporate governance) when state enterprises engaged in futures trading [1, 2]. Fuel shortages have emerged because local oil prices were not allowed to rise when global prices increased [1].
  • growth has been export dependent - because a current account surplus has been needed to protect financial institutions from the need to borrow internationally - as the latter would lead to a financial crisis because of their poor balance sheets (see above);
  • growth is overwhelmingly driven by investment, rather than consumer demand [1]. Investment has mainly been by state institutions (eg in infrastructure) and foreign investors. The former have been adding to bad debts in the banking system (see below). Very high rates of industrial investment could have created an overcapacity which could have a deflationary impact [1]. Most of that capacity has been created on the basis of expected:
    • strong export demand [1]. In practice this can not be maintained unless the growth of demand elsewhere allows the US current account deficit to be reduced. And there does not appear to be anywhere else for that demand to arise (see Structural incompatibility puts global growth at risk). Moreover, in late 2007 financial / economic difficulties facing the US economy seemed likely to reduce consumer demand for China's exports (see Financial Market Instability: Two Sides of the Story).
    • domestic consumption - which is constrained (for reasons outlined above);
  • there have been major changes in the structure of China's growth since 2000. Corporate profits were 20% of GDP in 2002 but had increased to 30% by 2007 through state manipulation (ie artificially cheap land, allowing profit reinvestment, stalling financial reforms to limit investment choices, preference for state-owned enterprises, rewarding officials on raw GDP / production numbers). Employee's share of GDP fell correspondingly - especially as non-farm job growth was only 3.4% pa from 2000-2007 [1]
  • growth has been driven by investment (funded by transfers from China's consumers;), a tactic which is both limited and difficult to change [ see outline and comments in China can't be properly understood in terms of Western economics ]

In 2004 China apparently concluded that its investment-driven economy had become overheated because of:

  • fast growth of steel, aluminium, cement and property industries; accelerated fixed investment; shortages of coal, power, oil, transport; fast money supply / credit growth; potential inflation; and the failure of banks to follow instructions to curb lending [1];
  • overcapacity which emerged in many industries [1].

Many observers suggested that government actions to slow growth would lead to a 'soft' landing [1, 2, 3, 4] - though not all agreed [1] - and in fact little slowing occurred.

'Blunt' tools are all that are available to manage economic growth. Altering interest rates will not do so as these are not main mechanism used to ration credit, and provinces (who control much infrastructure investment) apparently resist central government economic directives [1, 2]. Restraining high risk investment by state companies in the face of an uncertain economic environment seemed to remain a problem for government in 2007 [1].

Furthermore it is hard to anticipate the consequences of administrative controls on credit (eg it is easy to over-correct, while targeting specific sectors for slowdown will create unpredictable repercussions for other activities that depend on them).

Economic history does not suggest that administratively orchestrated investment is likely to be sustainable. For example:

  • the Soviet Union experienced very rapid investment-driven growth in the 1950s but subsquently stagnated economically because investments determined by socialist administrators often turned out to be in things that were not really needed
  • in the 1980s Japan's success with state orchestrated exports led to economic triumphalism and a massive investment surge overseen by neo-Confucian with little regard for profitability. This ended badly, and Japanese observers have suggested a parallel with China's current situation [1]

China's private sector (which operates in parallel with large and traditionally unprofitable state-owned-enterprise) is weak. Industrial growth has mainly been achieved on the basis of foreign investment, rather than by creating an environment which would support the initiative of indigenous firms [1, 2]. Moreover historically China's mandarins and cadres have always given low status to domestic enterprises - and favoured foreign businesses [1]. Rather than enhancing the environment for private indigenous firms, efforts in recent years to improve China's economy have focussed on raising the productivity of state enterprises and claimed achievements in this may be based (at least in part) on 'cooking the books'


  • those who have become rich in China are well connected politically. There is confusion between ownership and management. Those who control and personally gain from assets may never have paid for them - but argue that previously the assets belonged to the people, and 'we are the people' [1];
  • while foreign investment has a significant role in driving growth, it has typically been unprofitable for investors [1, 2, 3, 4]. Many firms have invested not because of current profit expectations, but because of hope for future profits [1].  China has a reputation for demanding much, and giving little - and for foreign partners gaining much less, and spending much more, than they expected [1, 2]. As this may not be a transitional situation but rather reflect the the communitarian / nationalistic nature of the business environment (featuring a preference for thin margins and accumulating wealth through savings rather than profits, as well as subsidies for those with connections [1] and a desire to make sure that foreigners do not profit), a high rate of ongoing foreign investment appears uncertain - though there are claims that this situation has started to change [1]. But, though profits have increased in recent years, profit levels remain well below those gained elsewhere [1].
  • based on slender evidence as the subject does not seem to have been studied, it seems that an industrial development system has been deployed - which has parallels with that in Japan and has mainly had the effect of accelerating (without directing) change by engaging social elites in intelligence gathering and networking through various institutional arrangements;
  • emphasis is traditionally given to 'real' production, rather than to profitability (see above), and this is reflected in the losses incurred by banking institutions;
  • there is a critical sustainability difference between economic activity which is driven by the volume of business (ie by market share, as has apparently been the motive in Japan and now China) as compared with that driven by the value-added. Profitability is a much more discriminating indicator for efficient resource allocation, than is turnover. Even though the latter initially yields impressive results through increased (low cost) inputs, growth can only be sustained in the long term if it is based on productivity (value-added) growth. Other indicators of this constraint involves a reported heavy emphasis on investing in 'things', rather than in human capital [1].
    • It has been suggested that China's growth could be surpassed by India because of the latter's emphasis on domestic businesses rather than on foreign investment, and on business profitability [1, 2]. India's balanced approach also involves greater reliance on growth of domestic demand [1], and on R&D [1]. Moreover India is globalizing in services and these offer far better margins than manufacturing, and with an effective legal system and financial system it is much easier for others to work in. [1]
  • the measurement of economic growth is subject to uncertainty [1, 2, 3] - because 'financial' statements about what is being achieved don't necessarily mean much;
  • China's competitiveness ranking is not high - given concerns about state industries and corruption [1];
  • currency controls have stabilized the exchange rate against $US and directed resources to production rather than consumption. Such controls may have been damaging [1, 2] by:
    • limiting imports which are a major part of the gains from trade - through providing (a) access to goods and services which would otherwise not be available, or be more costly; and (b) the stimulus of competition to domestic producers;
    • increasing domestic money supply (as hard currency inflows have to be exchanged for yuan or government debt) leading to inflationary pressures, and to an unsustainable expansion of public sector debt. The availability of surplus cash is seen to have created bubbles in automobile purchases, real estate and steel [1];
    • minimizing pressures on government for policy reforms;
    • increasing the risk of inflation [1] - which in 2007 was becoming a major problem.

The World Bank pointed out that China's growth pattern is based on cheap capital - and this is unsustainable. Rapid gains in manufacturing productivity and stagnant agricultural productivity drive inequality. Growth, it suggested, can't be sustained without household demand and service industries and reduced emphasis on exports and resource inputs. [1]

Other observers have noted the difficulty that emerging economies have in transition to higher income levels.

Example: Many countries have achieved rapid initial growth which they failed to sustain. China has passed an important milestone with incomes averaging $US7000 pa, which has often been a turning point. Beyond this, annual growth rates have tended to slow 2.8% pa because consumption spending rises and investment falls. One country that survived this and continued growing was South Korea. Its government reduced power of chaebol - the state-linked debt-laden conglomerates that were seen to be too big to fail. This injected competition into the economy, while imports were liberalized and the financial system deregulated (Baker P. 'China: the rise before the fall', Australian Financial review,  8/12/10)

Financial Constraints

China seemed to be becoming a new economic 'bubble' at risk of bursting eventually (and creating renewed Asia-wide / global financial turmoil) because:

  • a huge fiscal stimulus (ie high public spending and deficits) was required for years to achieve a sufficient rate of growth to absorb labour force growth and workers displaced from failed state enterprises in the face of international economic weakness [1, 2].
  • investment has accounted for a very high percentage (eg > 50%) of output and mainly involved development of infrastructure and urban facilities by state institutions financed (often unprofitably) by banks drawing on local savings - and generating bad debts [1];
  • China's growth appears to be being driven largely by massive investments with limited concern for return on investment [1]
  • the banking system has been a disaster area in terms of non-performing assets, and technically insolvent institutions [1, 2, 3]. The IMF warned of the risk of a financial crisis [1]. This system transforms the savings of China's people into bad debts. As argued above this seems more likely to be a consequence of cultural traditions rather than the residual effect of a socialist history. It was not subject to internal reform pressure or to external checks because China finances itself internally (and has generated large foreign reserves) - but there are no precedents suggesting that these contradictions can be continued indefinitely.  External financial institutions have to be allowed entry by 2007 under WTO requirements [1]. The value of China's bad debts exceeds its foreign exchange holdings [1] - and some foreign exchange holdings are already committed. The possibility of a financial crisis is considered further below;
  • there is uncertainty about the financial viability of massive housing investments - as the average price / household income ratio is three times greater than normal [1]
  • China's economy has grown rapidly but not been very productive - as shown by bad debts in the banking system and huge government debts. It may be seeking to correct decades of economic mismanagement through pressures imposed by seeking WTO membership but there is little room to manoeuvre and time is running out [1]
  • emerging private areas of the economy also have limited concern for profitability - and a significant economic downturn could emerge if banks are forced to tighten up on credit conditions [1];
  • the buffer of foreign reserves which has protected China's perhaps-insolvent financial institutions started to be eroded by:
    • a current account deficit which emerged - as growth was increasingly driven by urban / infrastructure investment rather than exports, and imports of components of goods to be exported increased from elsewhere in Asia;
    • weakening of export growth [1];
    • the need for Chinese companies to make mainly-defensive foreign investments (which may result in losses because of management difficulties and paying too much in an economic / resource boom) [1];
    • drawing upon foreign reserves to recapitalize insolvent banks [1];
    • drawing upon foreign reserves in a $20bn bid by CNOOC (a state owned company) to buy Unocol to increase China's oil security [1].
  • also China's balance of payments surplus depends on continued high rates of foreign investment - given reduced current account surpluses - and this is not assured because of such investment is frequently unprofitable and would not be maintained if export demand faltered.
  • there is a further risk of very large foreign reserve losses if the US current account deficit is not reduced and financial markets devalue the $US (in which most foreign reserves are held) at some time after the Yuan is untied from the $US;
  • massive overcapacity, and a collapse in profits, have emerged in vehicle production by investment on the assumption of continued 70% pa growth in domestic demand which has not eventuated [1]. A low level of capacity utilization (around 60%) appears (in mid 2005) to have emerged in many industries - and this will increase the exposure of banks to bad debts;
  • much urban investment is simply being wasted - and there is vast industrial overcapacity and low returns [1]
  • problems that create the risk that the bubble may burst include: artificially high property prices; a weak banking system; poor corporate regulation; an immature legal system; and official corruption [1];
  • intense competition within China could lead to a classic business downturn. As margins are small and pricing power is nil, weak profits could lead to low investment / growth. [1]
  • China's economy is unbalanced - with 45% of GDP invested (suggesting over-investment). Its low interest rate policy (a bye product of $US currency peg) has led to property speculation - which could bust. High reliance on exports could halt growth as the world will not indefinitely tolerate its mercantilist exchange rate policy. China's growth has not been due to productivity improvement but to huge investments in bringing part of its rural labour surplus into a market economy - and it won't achieve high rates of productivity gain without adopting free market economic principles [1]
  • China has made significant progress since opening in 1978 - but liberalization has stopped before dealing with financial sector. Investment funds are channeled through state banks, while equity markets are dominated by state-owned enterprises. Financial repression has created a sea of bad debts; mis-allocation of capital; overinvestment in the state sector and private under-investment; politicisation of decisions; widespread corruption; poor stock-market performance; undervalued real exchange rate; and stop-go monetary policy. Financial reform is vital for development to continue [1];
  • Chinese people are seeking profits through stock market and real estate investment which is like a pyramid scheme. It seems similar to Japan's asset bubble. China like Japan at that time has a loose monetary policy - which favours asset booms. China's growth is supported by foreign investment - that assumes that the currency is undervalued. This can't be corrected without large losses in China's $1.4tr in foreign exchange reserves [1];
  • while China's share-market does not reflect the real economy, companies have come to depend on it and on property as a major source of profits - alongside their core businesses in which profits are increasingly squeezed [1];
  • economic openness has increased the potential for instability within China's financial system [1]. For example:
    • large foreign capital inflows to China [1] (by investors seeking to reduce $US exposure in 2007 [1]) was seen as a risk of further over-heating (say) property markets, and China attempted to prevent foreign investment in such sectors [1].
    • falling US interest rates, while China's rise, makes it harder in 2007 to prevent rapid growth in property / stock prices in China. Continuing international turmoil encourages capital to flow to China, and strains it financial / regulatory system [1]

Blunt tools also appear to constrain China's ability to reform its financial system. For example:

  • reforming China's financial institutions by making them act more commercially is problematical (as suggested above) if their characteristics are not (as Western observers apparently tend to believe) a product of socialism / communism but are rather a product of a communitarian / mercantilist economic regime which has deep cultural roots (eg emphasizes the 'real economy', rather than financial, outcomes - and involves economic coordination by 'connections' rather than by calculation of financial outcomes). Reform could disrupt the basic dynamic of China's rapid growth and development (as perhaps occurred in Japan); 
  • government instructions to the banking system in 1999 to behave more commercially were apparently ignored [1];
  • China's economic progress to date has been achieved by eliminating the most extreme obstacles to markets but the next stage (creating the institutions required for fair and stable markets will be much harder), and political changes needed to contain community demands for liberty could lead to instability [1]
  • China has the most restricted capital market in Asia - and this has huge costs. Development can't continue unless capital restrictions are loosened - but such liberalization would put the current governing regime at risk of losing power  [1]
  • problems in reforming China's financial institutions might be solved by privatization, and obstacles to this (eg lack of methods for setting values, and negative net worth) have been reduced by establishment of a State Asset Supervision and Administration Committee [1]. However this may not be an easy option if state ownership of banks is seen as essential for a 'socialist' economy [1] in an environment in which a (so-called) 'Chinese consensus' (a form of autocratic corporatism) is being promoted as a superior alternative to the 'Washington consensus' (free financial markets) as a path to economic development [1].

There have been ongoing financial reforms (as mentioned below), and possible progress. For example:

  • amid rising input and wage costs, China's corporates are making best gains and efficiencies in sectors with strongest wage and material-cost pressures (which have been absorbed with little price rise, and profits contribute to high levels of corporate savings). Profit growth is high (37% yoy). China is now importing less intermediate goods from elsewhere in Asia - and this could improve the profitability of Chinese companies [1]

There are also plausible suggestions that reform has often been only superficial [1, 2]. Furthermore;

  • while reform of its banking system is China's top priority because of the risk of a financial crisis, this may not be possible [1];
  • while China is striving to present a number of major financial institutions (eg Bank of China) as financially sound and worthy of foreign investment and offshore listing, this seems likely to be being achieved by 're-arranging the deck chairs' rather than by solving structural problems [1]. In particular one major bank was recapitalized by drawing upon foreign reserves which merely transferred losses to China's central bank [1]. And in attempting to write off the bad debts of banks, it appears likely that state-owned companies (under no pressure to make a profit) would out-bid foreign investors [1] - and this outcome would (of course) merely 're-arrange the deck chairs';
  • 'red chip' firms are experiencing rapid growth in China by buying up other firms - but their operating position is poor. Profits seem to come from financial engineering rather than performance [1];
  • corporate profits have been boosted at least partly by squeezing workers' share of national; income. Wages' share of GDP fell to 41% in 2005 from 53% in 1998 [1]
  • some observers have expressed concern about China 'cooking the books' in order to be able to present statistics that constrain social discontent by making performance appear much better than it is (eg present unemployment as 20m rather than 50m) [1]

Various other observers have have identified the potential for a serious China-centred financial dislocation [1] or suggested that this is inevitable in the next few years - and that this has the potential to turn an economic downturn into a global depression [1]. It can be noted that in the event of a banking crisis, it would China's government, rather than its (insolvent) banks, which would borrow heavily [1]. However China's government also has very high debt levels due to past public spending to sustain growth.

Environmental Constraints

China seems likely to follow the USSR as a place where (with the help of 'Soviet trained planners') the 'limits to growth' are transformed from an ecologist's theory into a nasty fact. For example:

  • China has a huge population. Its cities occupy 50% of the countryside in fertile areas.
  • it has immense constraints on soil and fresh water - which seem to be near their limit.  The water table drops 1.5m pa in major grain growing regions in North China [1]
  • traditional sustainable agricultural practices have been traded for 'industrialised' agriculture;
  • in 2006 China's environmental challenges (eg energy and water shortages, water and air pollution, cropland and biodiversity losses) were seen to be escalating [1].
  • industrialization adversely affects people's health (eg air pollution has a wide impact) and the environment (eg loss of vegetation causes concern about desertification [1, 2]);
  • the UNEP has argued that China could never achieve a high level of consumption due to environmental and resource constraints [1];
  • as in the USSR very real environmental hazards have been ignored by autocratic government in the push to industrialize (eg the Three Gorges Dam project [1] was driven apparently by Li Peng, an influential Soviet trained engineer). Similar (smaller) projects in China have failed to live up to expectations due to silting - while international experience and experts on the environmental and economic impact of large dams suggest a more cautious approach);
  • in the past China's motto was to 'conquer nature' in the belief that development should be emphasised with pollution cleaned up later. Though this is changing fundamental changes in development model and administrative system are urgent [1];
  • many people suffer diseases caused by pollution which have been ignored so as not to disrupt economic growth [1]
  • China's environmental problems are mounting and pose a risk to economy and to public health. The economic miracle could end due of this - officials have warned. Central government has announced measures to address these problems, but it has little influence in the provinces. Solving this problem requires revolutionary political reforms.[1]
  • the People's Republic of China traditionally neglected the environment (as well as worker safety and public health problems). Pollution leads to major health problems. Energy efficiency is low. Chinese people face obstacles to speaking out about such problems. However in recent years the situation has been improving [1];
  • Four areas have been identified by the China State Environmental Protection Agency and the ADB as requiring urgent attention: pollution of air, water, land; water shortages and land degradation; environmental accidents; energy efficiency; and GHG emissions [1]
  • while China has moved to end its previous neglect of environmental issues, it will need to review its emphasis on economic growth as the prime policy goal, and address the conflicts that emerge because government is both the main polluter and the environmental regulator [1]

Furthermore the world does not yet have (and has no guarantee of ever having) a way of meeting China's escalating energy needs. It seems inevitable that global conventional oil production will peak sometime over the next decade - leading to shortages and rapidly rising prices. Fossil fuel usage really could become problematical given the possibility that global climatic change could be more severe and rapid than traditionally assumed [1]. Alternative energy sources seem to remain unproven. China's economy uses energy very inefficiently in relation to GDP [1].

There were signs in early 2008 that the 'peak oil' phenomenon - and priority being given to the production of biofuels - could give rise to famine in vulnerable regions (and that China might be vulnerable) [1].

A radical change in China's economic model has been seen to be needed if growth is to continue [1].


China will face the most severe 'aging population' challenge in the world around 2030 because of its one child policy, and even now is suffering shortages of skilled young workers in its major cities (partly because lower educational standards in rural areas make rural migration an ineffective solution to the cities' problems) [1]

Political Constraints

China's political system is autocratic - and sits on top of a seething mass of minor potential local 'protests' - which constantly need to be suppressed [1] and which could get out of control if for some reason they were to gain critical mass [1, 2].

Moreover, the growth-at-all-costs approach has led to increasing social unrest [1] and problems in rural regions [1].

  • China is planned economy - ruled by a single party.  Since Tiananmen Square great efforts have been made to ensure that educated elites are enmeshed with party - but this is not true of the masses [1];
  • China has been seen to be close to revolt in regional areas because: population growth has reduced size of holdings; desertification has reduced arable land (just 14% of China); deforestation and pollution have reduced water available for irrigation; officials have imposed heavy taxes; and only 20% of farmers can access credit for productivity improvement - at the same time that urban middle class is entering an era of conspicuous consumption. [1]
  • potential instability across Asia as a whole is seen as possible because rapid economic growth has not been matched by jobs growth, and unemployment rates are very high [1];
  • there are now vary large numbers of affluent consumers who are not included in the one-party state [1]. In the absence of political reform economic growth can lead to instability, because of demands of rising middle class [1].
  • Traditional authority structures (based on a Confucian 'merit-aristocracy') may not be viable because:
    • to some extent power requires access to superior information to influence subordinate's thinking and this is at risk because of widespread access to the Internet - as demonstrated by heroic efforts that have been made to devise an Internet system which allows censorship of disruptive ideas [1]. Such efforts to suppress access to information must inevitably prove futile in a networked society;
    • the neo-Confucian bureaucracy's practice of making no distinction between news and propaganda in the information which is released [1] is unlikely to work if a more knowledge-based economy is eventually to emerge;
    • Japan's economy stagnated for a decade, because of its traditional 'merit-aristocracy' - whose economic leadership promotes mercantilist goals (ie excessive 'real' production without ensuring financial profitability so as to accumulate US paper assets despite the insolvency of its bureaucratically-controlled financial institutions - see Scenario).  Writing-off the bad debts that Japan's financial institutions accumulated in the 1980s' asset bubble was vital to their future financing role, but this would have required a loss of status and control of the banking system by the elites descended from the Ministry of Finance (and also by the nationalistic gangsters (yakuza) who provide the discipline in Japan's social order [1], and control the often-technically-insolvent construction industry);

China has been suggested to have had a 3000-4000 year history of repeated conflict between the commercial and materialistic cultures of South China and the rural and spiritual cultures of North China (see Seagrave S., Lords of the Rim  ). Conflict between these was suggested to have seen the merchants driven out of China in many waves - to become the offshore Chinese who are economically powerful, politically influential and supported by 'private armies' (the Triads).

Seagrave presents a version of China's history from 1100 to present - a tale of scandal, war, politics and money making. It is said that 'To be rich is good'. However his book is also an account of the enormous power wielded by 55m offshore Chinese in SE Asia (and increasingly elsewhere). They financed the boom that has made China a major economic power - and have the greatest stake in China's political directions [1]

Seagrave presents an impressive account of the Overseas Chinese who down through the ages have become a major force in SE Asia and now on West Coast of North America. This started in about 1100 when the repressive, puritanical and anti-business Chou dynasty first drove the merchant class from north China. The latter established commercial beach-heads everywhere in East Asia except Korea and Japan. The 55m offshore Chinese have enormous income and wealth. A significant proportion of their income is derived from drugs and prostitution - and they are frequently involved in bribery, partnerships with government officials and other forms of corruption. The loyalties of these groups are to their ancestral villages in China rather than to the communist Chinese Government [ 2]

If China's commercial drive falters then the 'northern' influences concerned with 'higher' values may well again mobilize to suppress the 'greedy' merchants who dominate in the 'south'.  The potential for a new civil conflict is suggested by:

  • the perceptions that public morality has collapsed in China in recent years [1, 2] and that East Asia now exhibits many of the worst elements of Western modernization [1];
  • north-east China's continued status as a huge economically under-developed region [1];
  • the emergence of Falun Gong in 1992 in the tradition of the White Lotus Society, which has been the source of earlier grassroots attempts to gain political power in China [1];
  • the apparent incompatibility between the bureaucratic neo-Confucian methods that have been used by the (so-called) 'Communist' Party (which are built on a social hierarchy) and the social equality aspirations of China's nominal communism (see Communist Communism Versus Confucianism: The Continuing Contest in China);
  • an extreme level of income inequality which is above that that can result in social unrest. Income inequality has been rising rapidly in China (according to University of Michigan study). Gini coefficient is a measure of inequality, This is now 0.55 - almost doubling from 0.3 in 1980, and above the 0.45 in US. Anything above 0.4 is seen as indicating potential social unrest. [1];
  • claims (of unknown validity) that economically-significant amounts of capital have been moved off-shore by corrupt officials

The situation is further complicated by reports of official concern in China about the extreme levels of corruption in the PLA [1]

Tensions have also grown over Taiwan [1] which could, if not resolved, have an adverse effect on foreign investment into China.

It has been suggested that China now promotes unity through a religious concept in politics. In imperial China this had involved a Confucian state - whose ideal was harmony. It presumed that conflict would disappear if people conformed to a particular set of beliefs (including moral codes). The ruled would naturally obey the ruler. Communism as an alternative was 'bookish', introduced a modern moral orthodoxy and promised harmony. The shift to market economy in 1980s created an ideological vacuum. This was filled by Chinese nationalism - under one party rule. The so-called 'Communist' Party is seen to reflect China's potential as a great power - so any dissent would be unpatriotic. Those who rule according to a shared belief can't afford to negotiate with dissidents, as this would undermine the shared belief [1


There have been indications that China has been getting serious about the constraints it faced.

Indicators include:
  • comments on China's energy and environmental challenges [1, 2, 3];
  • a peaceful transition of political power was achieved in 2004 [1];
  • courts have been used in attempts to constrain arbitrary state power [1];
  • the World Bank's positive assessment of the political and economic outlook - which also argued in 2003 that there is a very long way to go especially in relation to breaking export dependence and reforming financial practices [1];
  • the leverage which WTO membership will provide to force structural reforms - though not all agree that this can be managed [1]
  • the possibility of economic [1, 2], political [1] and social [1, 2] reforms;
  • the IMF's argument that China had a strategy to build a sound financial system [see also 1, 2,] This appears to involve an intention to make China's banks 'real' and act commercially [1] and privatize them [1]. Some of the bad debts of China's banks are to be sold to foreign institutions [1]. Rules have been tightened making transactions more transparent - resulting in a significant decline in non-performing loans [1]; 
  • efforts have been made to: boost domestic demand; use market mechanisms to manage economy [1]; and clean up the balance sheets of two major banks to attract foreign participation [1];
  • a reported decision to abandon the 'growth at all costs' strategy in favour of reducing internal inequalities [1, 2] - a decision which (as noted above) seems inconsistent with acting as a regional / global economic 'engine';
  • wages have been raised in rural regions in order to inhibit movement to the cities [1] - a strategy which will also favour economic development if the skill base is raised by discouraging investors interested only in cheap labour;
  • Government has sought to reduce taxes on farmers. Also higher spending on health, education and the environment will increase socio-political stability [1]
  • efforts have been made to boost consumption (rather than exports) to drive growth [1, 2].

Whether such reforms will prove sufficient is unknown.

Is Optimism Justified?

A case can be made that China's growth and development is assured despite the many constraints it faces. For example:

  • China has huge human resources and potential markets. It has a high class education system, and can draw on external resources (Greater China) for the skills to allow its structural problems to be overcome [1];
  • past obstacles have been successfully navigated, and (as above) this process is continuing;
  • China's response to indications of over-heating in 2004 were satisfactory because (a) the problem was addressed by administrative controls rather than raising interest rates and (b) despite the bad debts of its banking system, China has large international reserves, a more-or-less balanced current account / a modest fiscal deficit and a closed capital account which prevents capital outflows [1];
  • the 2007 credit crisis illustrates China's strength. A $1.3tr cash reserve has been built up in the 10 years since the Asian financial crisis - and the Peoples Bank of China believes that this provides insulation against crises elsewhere. Entrepreneurs have flourished in China, and the stock market has risen rapidly. There has been a flight of capital to Asia because of the credit crunch. The US / UK economies are heavily dependent on financial services - and these are in doubt [1]

There appears to be a very high level of confidence amongst China's leaders, and the message given to the people is that China's rise to world prominence / dominance is assured. The political consequences if this does not eventuate could be severe.

Crisis Scenarios

However China's prospects are uncertain because of the constraints outlined above, so its spectacular growth could be derailed at some time.

Potential sources of crises have included:

  • economic imbalances - especially:
    • very fast growth driven mainly by investment by the state and foreign investors without adequate concern for return on state capital, and limited profitability of foreign investments directed towards China's consumers;
    • dependence on strong economic conditions and financial systems elsewhere to provide demand for exports;
    • the unsatisfactory environment for domestic businesses, which seem vital to filling the economic gaps left by foreign and state investors and so creating a balanced economy;
    • overheated markets (eg an apparent property bubble) that are at further risk from capital flows as a result of global financial instability in 2007
  • the poor balance sheets of financial institutions, the dependence on strong financial markets elsewhere to productively invest the current account surpluses which are needed to protect those institutions and prevent currency appreciation; and the uncertain claims about improved productivity by state-owned enterprises;
  • the blunt 'administrative' tools that are mainly used (and are all that are really available without extensive further reforms) for managing potentially-unstable economic and financial systems;
  • environmental / resource obstacles to long term growth; and
  • potential political instability

Moreover the interactions between such risk factors make government into a difficult juggling act. For example:

  • the current account surpluses that are needed to protect financial institutions contribute to the global financial imbalances that put export demand at risk. Moreover the foreign exchange reserves that protect them are subject to other demands;
  • the dependence on export demand can't safely be overcome without improving the balance sheets of financial institutions, and the latter seems to be constrained by cultural features (see above);
  • there is a fundamental incompatibility between maintaining strict political control and reforms of financial systems to comply with internationally accepted practices;
  • seeking to create a 'private sector' to fill economic gaps while maintaining political control has resulted in 'entrepreneurs' who tend to be crony capitalists and whose 'success' breeds domestic resentment.

It has reasonably been suggested that, though China is implementing reforms that are headed in the right direction (eg reducing environmental degradation and social inequality and reigning in overheated sectors), they are too slow - and China faces huge risks because its economy is now open and exposed to external shocks [1].

For example, with an overheated economy in early 2008 which needed to be slowed by higher interest rates while others were reducing rates to stimulate growth, there was a risk of rapid revaluation of the yuan - which would erode competitiveness and lead to large losses in foreign exchange holdings (perhaps the 'financial tsunami' an Australian Treasurer warned about?).

This could arise because hot money inflows (attracted by higher interest rates and the prospects of currency appreciation) added to the already significant problem of sterilizing current account surpluses by acquiring ever more foreign exchange reserves  (see more).

The US argued that unless China implements much deeper reforms of its economy it would be unable to sustain rapid growth [1].

Because of the apparent inability of the problem solving methods that are the basis of economic 'miracles' in East Asia to ensure success in terms of financial outcomes, the control of global financial systems seems likely to be an ever more important source of international disputation (see Friction over global financial systems).

China: Impact of the GFC (2008+) +


China: Impact of the GFC (2008+)

In March 2009, there appeared to be uncertainty about China's response to a severe economic shock (see Global Financial Crisis: The Second Test of Globalization?).

China's economy was impacted very severely. In part this was due to a sharp fall in exports and foreign investment as a bye-product of the global financial crisis (GFC). However, as exports had only accounted for about 10% of GDP, other factors were important in China's economic slowdown and rising unemployment including:

  • a collapse in some of the investment which had accounted for 60% of GDP.  Property investment, which had enriched those with close connections to the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) , had been funded by state controlled banks with limited concern for profitability - and the property bubble ultimately seemed unsustainable. Property investment thus collapsed as did industrial investment related to developing the factories needed for both exports and the materials required for property development;
  • losses on foreign investments by Chinese companies.

An Apparently Inadequate Stimulus [<]

In the December quarter of 2008, China's GDP growth was reportedly essentially zero [1]. However in March 2009, China's premier announced that his country would achieve 8% growth in 2009 because it needed, and had the ability, to do so [1]. But he did not state how this would be achieved beyond vague references to 'doing whatever was necessary' and exhortations for China to 'change its development pattern and realize structural adjustment' and 'promptly and creatively implement the policies and plans of the central government' including 'boosting domestic consumption' [1].

Another official suggested that stimulus measures announced previously were appropriate and working [1], while another source suggested that the solution lay in 'confidence' and the fact that all officials were aware of the vital need for 8% growth [1].

The World Bank suggested that China's 2009 growth would be 6.5% because of the first stimulus package and the expected property recovery in late 2009 [1]

However many economic analysts had believed that this growth goal would only be achievable with a large additional economic stimulus as China's first round stimulus of (about) 2% of GDP in November 2008 was seen to be inadequate. By early 2009 there had been a strong rise in public fixed asset investment (roads, railways, power plants, bridges and apartments) - as a result of government stimulus package. But  private property investment was stagnant, and developers were going bankrupt [1]. Moreover:

  • China's current account surplus had collapsed to $4.8bn per month in February 2009 [1] - thus raising the prospect of deficits if China's growth was faster in the face of global contraction. Deficits would create problems because of the weakness of China's financial system (see China: Victor or Victim?);
  • there was very limited prospect of significantly increasing domestic consumption because of extreme imbalances in the distribution of wealth and the limited role consumption had played in China's economy in the past.

In June 2009, it became apparent that in addition to the national stimulus program, additional stimulus measures had involved (a) reduced constraints on bank lending (see below) and (b) heavy borrowing by local governments in the expectation that tax revenues would increase with recovery to allow increased debts to be repaid [1].

While a turn-around from 0% growth to 8% would be very difficult, something like 8% is vital to keep up with the growth in China's labour force and maintain political stability.

Export-Oriented Industrialization Strategies are Now Impractical [<]

One problem is that export-oriented industrialization reliant on traditional markets (especially the US) won't be feasible as the primary driver of Asian growth and development in the post-GFC era (see  New Economic Strategies)

This problem appears to have been recognised in Asia (op cit), though initial responses seemed unlikely to produce sustainable growth. The US did little to boost its supply capability, and China's stimulus mainly increased production capacity.

In initially responding to the economic crisis, governments have done little or nothing to address the need for a more balanced international financial system.

For example, the US (and other current account deficit countries like Australia) have done nothing to promote structural economic changes - ie to boost production capacity, rather than demand, so as to reduce the global financial imbalances that were linked with the easy money policies that led to the GFC.

Likewise China's first-round fiscal stimulus package tended to go mainly into boosting production [1] (for which there is currently no assured market other than China's government itself). For example:

  • China's growth model in the face of the global financial crisis is based on government spending [1];
  • while China forecasts 8% growth in 2009, the World Bank projects 6.5%. 4.9% of this will result from a massive government stimulus package. Also though new state bank lending surged in February, as industrial growth and private investment stagnate. Also World Bank forecasts assume that China's exports will pick up as global recovery emerges in late 2009 while IMF forecasts global economic decline of over 0.5% in 2009 [1];
  • China, because of the modest size of its fiscal expansion, is clearly expecting that economic recovery will be driven by external demand [1];
  • analysts had doubted China's ability to rapidly resuscitate its economy - but this under-estimated the advantages of a semi-command economy. Banks pumped money into state controlled companies, and they expanded investment. 75% of China's expected 6.5% growth in 2009 will come from government investment and consumption. Going beyond this will be harder [1] ;
  • while private investment had provided most of China's rapid jobs' growth in the past, it is now investment by state enterprises that is driving growth. The fact that lending has exploded at the same time that market conditions are contracting suggests an increase in future non-performing loans and over-capacities [1];
  • China is 10% of global output, but suffered severe slowdown in late 2008 which may recover to 5-6% pa growth in early 2009. Better outcomes depend on US / global recovery (in 2010?). Risks include: inadequate stimulus / overcapacity. Growth is based on aggressive fiscal / monetary policy - as measures to boost domestic consumption have been slow. Government is well placed to fund deficits, but gaps between China's 8% growth goal and external weakness is large. When US recovers it will rely more on increased exports than on ongoing imports and consumption [1];
  • China 's stimulus program is to invest heavily in the development of 4G telecom technologies - and was seen as potentially setting standards in this area [1];
    • Comment: this seems potentially hazardous as, without strong consumer demand, such development would be driven (as in the former Soviet Union) by the guesses of technologists and industrialists without the ultimate direction being set by users (ie consumers) which is necessary for successful innovation.
  • China is likely to rapidly recover from its economic downturn because the official decision to launch a 4tr yuan stimulus package concentrated  leaders at all levels in China on boosting growth - so huge amounts of additional spending resulted from local governments and business who had needed nothing but a release from government controls [1];
  • China's aggressive stimulus has steadied its economy, but it has not made the deep structural changes needed for growth after available funds run out [1]
  • China is investing heavily in solar energy technologies - and achieving efficiencies that make solar energy competitive with coal. This may reflect the fact that China's coal reserves are not as large as often believed, and due to concerns about air pollution [1]

There is also concern that stimulatory spending may have mainly gone into stocks, and that excessive liquidity (credit created in the first half of 2009 equally 45% of GDP) is causing bubbles [1]. Also concern has been expressed about the effect of rescue packages on adding to already severe overcapacity [1].

Some observers further expressed concern [1] that:

  • China is 'cooking the books' in order to be able to present statistics that constrain social discontent by making performance appear much better than it is;
  • stimulus efforts through state owned banks are seen to have created bubbles in stock, real estate and commodity markets - in the expectation of recovery by export markets. If this doesn't happen China will be in serious trouble

Moreover,  in the development of a solar cell industry China seems to be applying traditional techniques (ie subsiding production in order to gain huge global market share) [1] a tactic which implies an expectation of large scale ongoing international financial imbalances.

Measures to boost domestic consumption in China were taken involving a social safety net,  consumer subsidies and dubious statistics.

Efforts are being made to promote domestic demand:
  • some indicators emerged of a shift in China's emphasis from hard to soft infrastructure (eg to health care and education); a willingness to downsize existing production capacity; and improvements in China's safety net in ways that would reduce China's high, but ultimately destabilizing, savings rate [1].  Indications have also emerged of vouchers being provided to citizens allowing them to buy appliances [1]
  • data has been presented suggesting a rapid increase in the number of cars being sold to consumers in response to a demand stimulus package (reduced taxes and subsidies). However observers have noted that other data sets suggest that this is 'happening' at the same time that the number of engines being produced is declining [1]. Other data suggested a 15% increase in retail sales in China in the first quarter of 2009 - though there may have been uncertainties about this [1].
  • China is to boost the production of electric cars, by providing large subsidies to consumers for buying them [1];
  • China's growth is increasingly self-generating and domestically-driven despite the perception that recovery has been entirely the result of government spending [1]
  • China may have scope to increase domestic demand because prior policy actions had been taken to reduce it - ie constraints could be taken off bank lending [1]
  • China's 7.9% yoy growth in the June 2009 quarter was seen to suggest that it can take the role as the customer of last resort in driving export-led growth in the rest of the world that the US took prior to the GFC [1];
  • China's spending splurge and US parsimony are a recipe for global economic stability - because in many areas demand growth in China is outstripping that in US [1]

However the effect has been modest, and huge social and political reforms would be needed to make China's economic growth sustainable through such reforms. None-the-less by August 2009 China's economy was seen to be growing from internal consumption  [1]. In early 2010 however caution was expressed about consumer-driven growth based on large subsidies (which simply transferred future consumption to the present) and the severe difficulties of generating consumer-driven growth without simply relying on subsidies (eg the need to boost private enterprises at the expense of state owned firms) [1]

In 2013 it was suggested that China will be unable to conform to the world's rebalancing expectations because of its demographics. It will become ever more dependent on exports and foreign asset income. It will be unable to run a sustainable external deficit to smooth out global imbalances. In the near term there is also a risk of a credit bubble. China's M2 money supply is 180% of GDP (about double that in the US) [1].

Economic Reforms on Western Principles were Absent [<]

There are serious structural obstacles in the economic model that China appears to have adapted on the basis of Japan's pre-19990 rapid growth to achieving the macroeconomic balance needed for growth based largely domestic demand (see Are East Asian Economic Models Sustainable?). For example, the lack of serious attention to the profitable use of capital creates the risk of financial crises if growth were based on domestic demand. Others noted that Chinese state-owned companies have high savings rates because they had no one to pay dividends to [1]

Thus China's leaders may believe that they are unable to engineer market-oriented economic changes based on Western principles that would allow continued growth in the global economic environment that must emerge as a consequence of the GFC. They do not, for example, appear to envisage Western-style reforms to China's financial systems [1] - any more than Japan did following its financial crisis in around 1990. Moreover emphasis continues to be place on state-owned-enterprises which are not noted for the profitable use of capital.

Doing China's Own Economic Thing?  [<]

One interpretation of the vagueness of China's premier about future GFC responses is that it is recognised that further economic stimulus (which mainly boosted the supply side of China's economy would be pointless), and that something radically different is intended.

One initiative suggesting this involved diversifying perhaps 50% of China's $2tr+ foreign exchange holdings away from $US - perhaps into commodities and other assets with reduced current values. While this could be rationalised as seeking protection against an expected $US collapse [1, 2, 3], it would appear to make US-led global economic recovery more difficult and thus: (a) increase the demands on China's foreign exchange reserves - and the risk of a medium term financial crisis; and (b) put at risk the value of the alternative assets that China acquired.

Implications of Diversification from $US

If correct (and other reports mention China's rush to build up coal stockpiles at almost any price) this could be taken to imply that China either expects, or  is trying to ensure, that the financial crisis will result in a crash in value of $US. However this outcome would be counter-productive.

Why: China might ensure access to the resources needed to manufacture (say) hybrid cars - but, if a general run on US Treasuries prevented the US from funding its stimulus / bank rescue packages and budget deficits without simply printing money and crashing $US value, then there would be no short term global economic recovery or much market demand for whatever China intends to manufacture - so that the value of industrial commodities purchased with proceeds of selling US Treasuries would also fall.

However China may not simply be shifting its foreign exchange holdings because of concern about the prospective collapse of $US, but because the GFC has highlighted the structural challenges facing China's own capital account that are implicit in its past strategies.

China's previously solid current account surplus had reportedly essentially disappeared in February 2009 [1]. China had record surpluses from November 2008 to January 2009 and the World Bank forecast a $400b current account surplus for 2009 (because lower commodity prices would partially offset the impact of the global demand shock) [personal communication].

However the World Bank's forecast seemed to depend on a substantial improvement in the global economic situation in late 2009, ie that the world emerges from recession even though:

  • the IMF forecast a decline of 0.5% or more in global GDP in 2009;
  • the World Bank forecast a 9% fall in world trade in 2009 [1];
  • the OECD has forecast a 4.3% contraction in developed world's economies in 2009 [1];
  • any benefits China gained from lower commodity prices would be offset to some extent by reduced capacity elsewhere to buy its products; and
  • despite the optimism US authorities express about the potential for recovery, the challenge of funding the US budget deficits this requires would seem to be severe (eg because of the risk of a post-flight-to-safety bond market crash similar to that which apparently occurred in 1931 as cashed-up investors, believing the crisis was being resolved, shifted their money in other areas).

Thus (if China is to achieve 8% growth in the face of global recession) it will probably have to finance growth by drawing down its foreign exchange reserves. However China can't safely do this for long (as its financial system is not able to cover future deficits by borrowing).

Moreover "protecting" China's now-critical foreign exchange holdings by withdrawal of capital from $US may damage the global economy and thus be counter-productive for China in particular (because global demand could further weaken, and falling exports would merely accelerate China's slide towards a financial crisis). .

For these reasons steps to attempt to avoid this constraint in the medium term  (see Creating a New 'Confucian' Economic World?), may have become urgent - even though there is no guarantee of their ultimate success.

China has also indicated a desire for radical change by expressing concern about dependence on US markets and the $US. For example, a case was made for the creation of an an international currency based on IMF Special Drawing Rights. And a Chinese analyst called for significant increases in US savings [1], a change which would severely disrupt China's export-led economic strategy.

Other Chinese economic initiatives include:

  • using foreign exchange reserves to: (a) make loans to key trade partners; (b) acquire businesses; (c) stockpile commodities; and (d) acquire future key energy / commodity inputs;
  • restricting machinery imports, and exports of rare earths that are essential to some advanced technologies;
  • seeking to upgrade established industrial regions on China's coast to succeed on the basis of independent innovation - while transferring traditional low-cost industries inland;
  • proposing the development of Shanghai as a international financial centre with 'Chinese characteristics' - perhaps including better stock market regulation
  • encouraging use of the Yuan as international trade currency ;
  • encouraging diversification of export markets away from North America and Europe;
  • officially supporting companies that refuse to honour derivatives contracts;
  • increasing emphasis on state-owned (rather than private) enterprises;
  • proposing to give preference in government purchasing contracts to products incorporating indigenous innovation;
  • attempting to make economic growth more sustainable by closing the most environmentally damaging industrial operations
Indications of other initiatives include:
  • in May 2009 it was suggested that China was seeking to become a hard-asset republic (with a preference for conducting trade in RMB; currency swaps in Asia and acquiring energy / resource assets). Walking away from $US slowly - so as not to hurt its $US holdings was seen as a way to help rebalance the world economy [1]
  • China's competitive strengths have been improved as a result of the GFC. It is using cash to acquire natural resources and friends. Its economic stimulus package will retrain workers, increase R&D and provide infrastructure which reduces transport costs. Bank lending has increased rapidly. The slowdown has also solved persistent inflation problem, reduced shipping costs and wages. China's companies are buying foreign businesses [1];
  • China provided $25bn loans to SE Asia. Industrial production rose 8.3% yoy to March 2009. Crazy amounts of iron ore are being imported and boosting stockpiles. All China's neighbours are being boosted. Most new activity comes from government stimulus [1];
  • China has made arrangements for its currency (Yuan) to be used in international trade with South Korea, Indonesia, Malaysia and Argentina (as an alternative to $US [1]. Others have suggested that China has taken many steps to promote the Yuan as an international currency and as a reserve currency [1, 2, 3].
  • China has reportedly strongly promoting its leadership in SE Asia, while (a) criticising the global dominance of developed economies (b) offering to invest in the region and to use the yuan as a trade currency (c) complaining about dependence on US markets - which is said to be needed because of $US hegemony and (d) advocating use of available resources - including China's huge foreign reserves - to promote growth [1].
  • China has reportedly envisaged that (a) it could refuse to finance US deficits (with the expectation that the $US would then collapse) without adversely affecting its own prospects and (b) its own currency could be floated as the basis for an independent market-based financial system [1];
  • China's sustained growth was seen to potentially come from: (a) economic spin offs from the government stimulus; and (b) innovation within China that significantly improves its productive strengths [1];
  • China will no longer 'hide its capability'. Using $2tr foreign exchange reserves: industrialists have locked in energy resources; infrastructure investments have been committed, as well as projects to bridge wealth gap. China's success formula is its state banking system - which has plenty of cash allowing increases in consumer / capital spending. State controlled banks take compulsory savings of all employees. Once child policy forced parents to save. China has started to internationalize its currency. China's premier argued that financial crises in recent years have resulted from clash between needs of country issuing reserve currency and international fiscal requirements - and argued for a super-sovereign reserve currency managed by a global institution. US leaders will in future need to concede that they are losing financial power to regions such as China [1];
  • China owns several large banks, all well capitalized, and has many companies that are going public on HK and Shanghai exchanges. Its growing middle class will encourage more sophisticated financial services sector. China's financial system is simpler than US / UK but this may be an advantage. China could link HK and Shanghai banks and transfer know-how from former colony. Beijing has declared Shanghai will be major global financial centre - and there is growing cooperation with HK. Common regulations could be established [1];
  • while foreign banks are frustrated about many aspects of doing business in China, they are making profits (which in one case came 80% from holdings of Chinese financial institutions, while losses were incurred on consumer banking). China is offering them room to pursue business despite tight overall restrictions. China has promised pro-market rules, new products, technological advances and lower taxes in an effort to boost Shanghai's role as a global financial centre that retains Chinese characteristics. Shanghai has been seen to face many obstacles as a financial centre because of: state involvement in everything; uncertain legal, tax and media structures; and lack of a convertible currency. On the other hand China's restrictions allow banks to charge premium fees (a form of tax on users) [1];

    • however the fact that foreign banks in China are becoming profitable seems to reflect something like the market rigging through cartels that allegedly [1] allows state-favoured enterprises to appear profitable at the expense of the economy generally.
  • as well as trying to change the international rules by blaming $US's position for global crisis, China is seeking to become a hard-asset republic (with a preference for conducting trade in RMB; currency swaps in Asia and acquiring energy / resource assets). It is seeking to walk away from $US slowly - so as not to hurt its $US holdings. This may help rebalance the world economy [1] [Comment: The short term risk with such a strategy would be a collapse in economic output]

  • China's regulators are seeking to remove scams associated with stock market in the past [1]
  • China's leaders have suggested different ways of responding to decline in exports - eg government support for cheap-labour exports or new industries Wang Yang (Communist Party Secretary, Guangdong) suggested Party was advancing with the times and can communicate with West, but West doesn't understand China and this is needed. He suggested that economic transformation and industrial restructuring must be based on 'scientific perspectives on development' (a party slogan for maximizing growth and also addressing rural-urban imbalances and environmental issues). The model used for 30 years is no longer viable - because (a) it neglects costs of resources / environment / worker health; (b) it depends on external demand. The obstacle to economic change is seen to lie in dealing with vested interests (eg those who have become wealthy through renting land). Plan is to enhance independent innovation, transform traditional industry and set up modern industrial systems. This will open wider markets. Local industry will be upgraded while low-cost manufacturing is transferred inland. Guangdong would become the shop-front for manufacturing elsewhere in China. Transformation of Guangdong into a centre for independent innovation poses risks in facing chaos of marketplace [1]
  • a new market for $US denominated bonds to be issued by non-financial firms has been announced [1];
  • though China has benefited most in recent years from trade, bans were imposed on the purchase of foreign equipment in investment projects - a more restrictive version of the US's 'Buy America' clause - which threatens to generate reactions elsewhere [1];
  • reportedly placing the Ministry for State Security in charge of economic dealings [1]

  • China has officially supported companies that refused to honour losses incurred under derivatives contracts - a move which was viewed in the West as breach of contract and increase in sovereign risk, but seen a defensible by China on the basis that the products peddled by Western banks had triggered the global financial meltdown [1];

  • there has been a shift away from private enterprise and greater emphasis on state-owned enterprises [1]. The private sector has been seen to be under attack in China. It was sidelined by massive stimulus efforts, can't get credit and faces trend towards re-nationalization by government [1]. Private operators in steel industry have been forced to sell assets below fair prices to large state operations. Renationalization is also affecting coal industry. The lesson of history is that without private enterprise past efforts to modernise China's economy went into dead ends [1]

  • China has sold first batch of sovereign bonds in yuan to foreigners [1]

  • China has made its continued growth prospects more sustainable by diversification of its exports away from US and Europe (where growth is likely to be weak) towards, Mexico, South America, Latin America and Australia [1]

  • in August 2010 it was suggested that China "is now diverting its reliance on the debt-straddled US-consumer, and focusing its future growth plans on the Chinese consumer. This is a radical change that will take years, but is already taking place. In the meantime this week's figures also pointed out that China is currently making plenty of money sending most of its exports to other emerging economies" [1].

  • China ordered 2000 polluting factories to close [1]

  • In early 2011 it was suggested that China needs to move its focus from exports to domestic consumption - and that this is likely to follow from: government efforts to increase household incomes and cut the savings ratio; increasing wages (eg due to labour shortages and population aging). Government is also promoting new strategic industries to move China up the technology and service industry value chain [1]

  • enabling Renminbi held offshore to be used to buy equities in China [1]

In October 2009, China's government and financial institutions were concerns about the risk of economic overheating - and recognised the need to shift away from reliance on exports and government spending [1]. In December indications of undesirable outcomes from the way stimulus funding and credit have been used were increasing, and the difficulties of a rapid increase in domestic consumption were apparent - leading to expectations about a major reform initiative [1]

Beyond Export Dependence: Creating an 'Asian' Economic World? [<]

The steps that were being taken by China seem to make little sense within an international order based on Western political and economic practices.


Any attempt to use the Yuan as an international trade currency generally (in the way the $US is used) would result in its revaluation, and a decline in China's international competitiveness and create hazards in the longer term in the absence of significant changes to China's financial systems.

Seeking to establish Shanghai as a major global financial centre (perhaps in parallel with Hong Kong) [1] can not in itself solve the difficulties that China faces in growth based on domestic demand (ie the need to borrow in international markets to fund growth). The ability of banks in such a centre to counter-balance a substantial Chinese current account deficit depends not on the practices of those banks and their regulatory framework, but on the practices of the entities within China that they would invest in.  

Likewise seeking to reduce dependence on the $US by acquiring hard assets (which, in some ways, would reproduce the tactics of European mercantilists in the 18th century and arguably result in a collapse in global demand) would not result in the emergence of a balanced / efficient economy within China.

Stimulating growth in trading partners who lack sound domestic financial practices so that they could allow export-led growth to continue in China would also be futile.

The possibility of redirecting surplus savings (from East Asia and oil exporting nations) into investment in developing countries through international institutions created by the IMF has also been raised [1]. This could (in principle) allow China to continue with an export-led development strategy by shifting the excess demand from the US to developing countries.

However developing countries who participated in this scheme to permit export-led development in East Asia  would have to run large current account deficits, the financial institutions managing the offsetting capital flow would need to be able to guarantee sound financial outcomes - and this is not characteristic of developing economies. Moreover 'everyone' now apparently wants to copy the 'successful' export-led strategy that allowed East Asia to avoid the risk of financial crises.

Achieving profitable outcomes has been difficult / impossible within the framework of socially-coordinated East Asian economic models, Thus borrowing in international markets to fund growth has been impossible. Economic strategies have thus been dependent on large domestic demand deficits and export markets (mainly to the US). This is no longer feasible - and the problem is recognised in East Asia.

It is possible that China's leaders do not understand their medium-long term economic predicament under a Western political / financial global order (and are suffering a case of 'pride before a fall').  It is also possible (noting provocative statements about the US increasing its savings to avoid risk of a further economic crisis [1] - a step which, while necessary, will probably make past East Asian economic models unsustainable) that China expects that a catastrophic economic crisis is unavoidable and is trying to make a point about who should be blamed.

However it is more likely that there is a long-developing plan to create an international economic, political and financial system with 'Asian' characteristics (an order that Japan first sought in the 1930s). It may be hoped that a combination of innovation, growth in domestic consumption, developing non-traditional markets (eg in emerging economies whose growth might be less affected by the GFC), rigging markets through cartels to make major state-supported enterprises and banks 'profitable' at the expense of other parts of the economy, undermining international institutions operating on Western-style political principles and creating machinery to handle 'international' financial transactions under government control could overcome the growth constraint in a uniquely Chinese / Asian basis. This possibility is speculated in Creating a New 'Confucian' Economic World?.

As noted in the latter speculation this option would seem risky. It would involve a race against time (ie to create alternative markets within a China-centred trade / tribute regime before foreign exchange reserves became depleted). It would demand a great deal of ordinary Chinese people, mainly to ensure control by traditional social elites. And in the long term, the lack of enterprise whose profitability depends on meeting customer demands (ie of effective capitalism) would probably make it impossible to balance supply and demand.

The shift in export emphasis from US consumers to emerging economies is fraught with dangers as many of those economies had copied East Asian economies in seeking export led growth and maintaining current account surpluses in order to protect their financial systems from the need to borrow in international markets (see Leadership by Emerging Economies?). Given the inability of the US to perpetually remain everyone's 'consumer of last resort', China's emphasis on exports to emerging markets must put weak financial institutions in the latter at risk of financial crises.

Discord / Conflict? [<]

Thus another possible interpretation is that there is internal discord about China's future directions, and thus no current consensus.

China has faced constant internal social political unrest (with a reported 100,000 mass incidents pa) and has an extremely imbalanced income distribution. Thus despite China's overall economic growth internal political shifts are not impossible - even though they may be unlikely.

The ever-present tension (noted above) between what might simplistically be called 'north' and 'south' China could be significant - as the rural 'north' apparently favours a military approach to developing China's strength, while the commercial 'south' favours economic tactics.

'South China' has dominated in determining strategy for China's growth and development since the post-Mao economic liberalization in the late 1970s - a dominance which funded the military aspirations of the 'north'. However the 'southern' tactics may be no longer sustainable, and have caused many domestic concerns within China (eg about the distribution of wealth and abuses of power)

Thus, in an environment in which the West's strengths in financial services have been undermined, it could be that a resurgent 'north' might be gaining more influence in advocating both traditional socialism and aggressive nationalism. The potential for virulent anti-Western nationalism (based on both pride in China's achievements and resentment of its historical treatment by Western powers) was exposed by grass-roots responses to widespread Western demonstrations against China's actions in Tibet during the 2008 Olympics [1].

If maintaining GDP growth is vital, and it was believed that little could be achieved by market-oriented adjustments, at some time spending on armaments and militarily-significant infrastructure (for which the state would be the 'customer') could be emphasised to boost GDP and create jobs, while nationalistic drums were beaten to blame 'foreigners' for the economic crisis and thus divert attention from domestic defects. Needless to say such an intention would not be overtly stated - not least because such a change in tactics could generate internal conflict.

It can be noted in passing that:

  • China's military spending is reportedly to increase 14.9% in 2009 - and the details of what this involves are being kept secret [1];
  • China was seen to respond belligerently in a dispute with Japan [1];
  • China's view of history focuses on its past humiliation by foreign imperialism (rather than on its subsequent domestic difficulties, eg under Mao), and the so-called 'Communist' Party is presented as having thrown off the yoke of foreign oppressors [1] ;
  • in March 2012 it was reported that the person who is expected to be China's president next year (Xi Jinping): (a) rejected US president Obama's proposal for a serious dialogue between US and China's armed forces; (b) is seen to tougher, more nationalistic and closer to the military than his predecessor (Hu Jintao); and (c) won't resist those who press for China to be tougher as the US is seen to be heading for inexorable decline [1]

Another 'Tiananmen Square' Moment for China's Regime? [<]

In July 2009 China arrested Stern Hu, the senior executive in China of a major mining company (Rio Tinto), on changes of stealing state secrets that had damaged China's economy.

One observer suggested that China's use of what seems to be 30 year out-of-date Cold War tactics would raise concerns in the world business community about doing serious commercial deals in China [1] (noting the context of China's displeasure about Rio's rejection of a large share purchase by a state owned company (Chinalco) and the outcome of iron ore price negotiations, and indications [1] that Rio may be planning to seek $9bn compensation payments from Chinese steel mills for breach of contracts).

While it is possible that Rio Tinto may have benefited from obtaining commercially-confidential information about China's negotiating position, the fact that smart business tactics can become 'national security' questions highlights what is different about the character of China's economy. Corruption is understood to be quite common. Laws exist prohibiting this which carry severe penalties but are only enforced against those who act contrary to the wishes of the regime.

Moreover, (unless evidence can be presented to justify espionage charges against Hu) this action may be symptomatic of the fact that China's authoritarian regime is under a lot of stress and may be facing another Tiananmen Square moment (ie a threat to its existence).

The regime is under diverse internal stresses perhaps because of:
  • separatism in peripheral regions such as Tibet and Xinjiang province;
  • frequent 'mass incidents' reflecting local dissatisfaction related to corruption and abuse of power;
  • dis-satisfaction with the income inequalities that have resulted from the combined effect of economic liberalisation and crony capitalism - and continued preference by some for the equality of the Mao era;
  • spiritual movements such as Falun Gong - which were suggested to the present writer by a Chinese contact to have a political aspiration of restoring China's Imperial system;
  • advocates of democracy;
  • tension within the regime itself between the currently-dominant factions (apparently from 'southern' China, including the Diaspora) who favour commercial options for advancing China's power, and those who may favour alternative (eg Cold War style) options.

The real problem however may be that China seems to be headed for serious economic problems - and the 'legitimacy' of the present regime in the face of its domestic competitors depends on their ability to maintain economic gains.

China needs to achieve rapid economic growth (eg 8% pa) in order to prevent unemployment escalating. However, despite expectations to the contrary in mid-2009, the 'world' (and especially the US which has provided a large share of demand for China's exports) faces a lengthy period of economic stagnation because of unresolved financial system problem (see False Dawn).

While China might seem to have options for more domestically driven growth, this would require empowering China's people at the expense of China's regime. Moreover strong domestic growth in a stagnant global environment implies that China's current account surpluses would reverse and so start to run down China's accumulated $2tr foreign exchange reserves - and eventually expose China to the risk of a financial crisis because its financial system has not in the past been able to justify borrowing to cover current account deficits (see China: Victor or Victim?, and Unsustainable Economic Models).

In the post-GFC era the global financial imbalances which have been essential to the financial stability of creditor countries will no longer be able to be supported by US and other debtor countries, and massive real-economy adjustments (which have not yet really even been started) will be required before macroeconomic conditions can allow global growth to be sustained. The demand deficits that are essential to protect against currency crises in emerging economies can no longer be counter-balanced by excess demand in US and other debtor countries.

In response to this challenge it seems that China may be seeking to develop a new international 'Confucian' economic order (similar to the trade / tribute regime that prevailed under China's control prior to the arrival of European influences), as a means to avoid the breakdown of its economic model. This possibility, though anything but certain, seems compatible with China's initiatives since the global financial crisis started seriously impacting on Asian economies.

However the failure of the takeover attempt of Rio Tinto may have revealed a fundamental weakness in what might have been hoped to be China's escape route. China seems to have made determined efforts to acquire behind-the-scenes political influence in Australia. In SE Asia (where crony capitalism has been well established) political influence translates into the ability to do 'commercial' deals to suit political interests. However this did not work in Australia in the Rio Tinto case - and demonstrates a serious limitation on the notion of an international 'Confucian' economic order in true market economies.

Arresting ethnic Chinese Rio Tinto executives may be symptomatic of the need which China's regime feels to enforce 'disciple' within an intended 'Confucian' empire.

Another observer suggested that this event signals a major re-alignment of how China managed its economy - and that spy and security agencies have been promoted to top strategic positions (specifically that the Ministry for State Security had been put in charge of economic dealings [1]. If this is correct, it: (a) suggests a rising sense of fear within China's regime about the economic future; and (b) is likely to alarm trading / commercial partners, and potentially trigger a reversal of the gains China achieved as a result of its 1979 economic opening to the external world.

In mid 2011 it was noted that as China celebrates the 90th anniversary of the founding of the 'Communist' Party: (a) it has a lot to celebrate as the world's most successful 'Communist' party; (b) democracy has not come to China, and the 'Communist' Party is not interested in this; (c) the Mao cult is being revived as a sign of increasing nationalism;  (d) the Chinese state has been astonished and appalled by democratic uprisings in Middle East and elsewhere - as the leadership genuinely believes in the superiority of authoritarian government; and (e) extensive control of the internet is maintained to prevent information about developments elsewhere being disseminated [1]

Political Change and Potential Instability: The Continuing Saga   [<]   

Political instability has, and remains, a feature of China's history (see Political Constraints above). The latter referred to:

  • periodic civil wars over thousands of years perhaps between the commercially oriented south China and the more rural / spiritually / militarily oriented north. Factions from southern China have repeatedly been driven out to become the commercially oriented Chinese Diaspora across SE Asia. Though there was more involved, the 1949 Mao-led Communist victory on the Chinese mainland over the Nationalists can be seen as a continuation of this process, while China’s market liberalization in 1978 under Deng can also be seen as a resurgence of influence in mainland China (through behind-the-scenes takeover of so-called 'Communist' Party) by the commercially-oriented Diaspora;
  • relative economic under-development in NE China;
  • the need to and difficulties in enmeshing educated elites and the masses in the so-called 'Communist' Party;
  • perceptions of a collapse of morality;
  • high levels of official corruption;
  • near-revolts and the suppression of about 100,000 'mass incidents' annually;
  • constraints on China's traditional authority structures;
  • the incompatibility between the social equality aspirations of China's nominal communism and the neo-Confucian social hierarchy that has been required for its economic success.
  • attempts to promote Confucian religious concepts to ensure harmony.

It was noted in early 2008 that China's regime has persecuted Falun Gong since 1999 - presumably because it is afraid of it. It was introduced to China in 1992 involving not only slow-moving exercises but also self-cultivation towards spiritual perfection. It was instantly popular. But in 1999 it was being persecuted and by 2008 there were 3000 documented cases of practitioners being killed. The Party claims that it is superstitious, foreign driven, tightly organised, dangerous. Some Western observers said that China was worried because it seemed like past religions-turned-rebellions (though the latter had been violent whereas Falun Gong was not). What scared the Party seemed to be that Falun Gong was popular and across social strata. A government report estimated that it had 70m members - comparable with Communist Party. The Party had often persecuted groups outside itself or with different ideologies - as Falun Gong did.  Doing so was also an excuse for sharpening the state security apparatus. [1]

In early 2010, speculations were put forward by John Lee in Australia suggesting that China's younger leaders who were just on the point of assuming power might take their country in new directions (eg away from its state-driven export-led economy and towards stronger roles in global / regional institutions).

Outline: A significant development will occur  in 2012 when a rising generation of leaders with no memory of the turmoil / hardship of Mao years starts to take power. This might allow new options to be pursued. China's leadership has focused on fine-tuning Deng's state-led development model for past 15 years. But this model is not likely to be viable much longer (because of dependence on inefficient state-led fixed investment and export-led growth rather than domestic consumption.  Progress in currency / capital account liberalization, weaning state-controlled industries off state capital has been slow. Also since mid-1990s China's foreign policy has been cautious not bold - based on Deng's 'hide capacity and nourish obscurity' idea.  Leaders fear that big-picture reforms will bring disruption and chaos (noting how Mao took China in the wrong direction, Tiananmen Square and urban labour unrest). All elites see China as Asia's natural leader with US as recent interloper - and giving US an excuse to 'contain' China causes concern. The next generation (without experience of past problems) may be more confident / assertive. Some already see reform as too slow. Many (especially those educated in Western graduate schools) are concerned about China's weak strategic position in Asia and in global / regional institutions. When new leaders take power China will be much less predictable than it is now [1]

Similar suggestions have been made by others.

China's economic growth has been driven by: (a) a huge labour force; (b) economic reform which unleashed private entrepreneurship that now accounts for 70% of China's GDP (and ICBC, Bank of China and China Construction Bank are amongst the world's best in terms of market capitalisation, while large state-owned enterprises are now profitable); (c) opening to foreign investment; and (d) natural resources. These factors will diminish in future (eg export surplus will decrease; FDI will fall; labour shortages are emerging; population is aging; resource limits are approaching; environmental damage has been high). Future gains could come from: removing discrimination against private sector;  further reform state enterprises; and promoting innovation [1] (Comment: It is noted above that market rigging may be a factor in the reported profitability of China's major banks and state owned enterprises)

Nobel peace prize winner, Liu Xiaobo, suggests that people in China are no longer willing to simply accept the 'party line', and that China's system which is run to benefit the elite is no longer acceptable  [1]

While such options are be worth consideration, they arguably face severe structural obstacles. For example,

  • shifting from state-led growth (which is ultimately dependent on maintaining current account surpluses to protect China's financial institutions) encounters the same structural obstacles that existed in East Asia generally at the time of the 1997 Asian Financial Crisis (see Understanding the Cultural Revolution - needed for success under Western-style financial regimes, 1998). The latter referred (for example) to the obstacles to shifting from 'communitarian' investment to that driven by capitalistic expectations of profit that arise from: fundamental differences in the way information is used; the need to change economic goals from economic 'power' to financial returns; the inseparability of economic issues from questions of social / political power; and the lack of appropriate legal systems: Similarly
  • China's role as Asia's 'natural leader' is based on Confucian traditions for exercising power (arational / intuitive consensus amongst the subordinates of social elites), rather than on the Western-style traditions of rational policy debate amongst elected community representatives that applies in prevailing international institutions. It is difficult to see the former simply being expanded to take a stronger role in the latter environment, or being relevant in contexts where others don't accede a dominant status to China's social elites (because of expectations about a rule of law) or expect decisions to be based on rational analysis.

In late 2010 statements by China's premier, Wen Jiabao, suggested directions for reform in China (ie to reduce the risks implicit in inflation and corruption [1] and to boost freedom of speech and democracy [1]) - at a time when trade frictions with the US were increasing so that appearing to become like a Western democratic capitalist society in future might be be hoped to result in a less antagonistic stance.

China has raised expectations of reform at 'Communist' Party summit - at a time of intense internal pressure (from intellectuals) to lift censorship and hasten reform. China's 12th five year plan will extend to administrative, political, social and cultural restructuring. China's premier laid the ground work for reform in a string of speeches [1]

Economic plans of China's Communist Party have been railroaded by forces outside its control. Agenda considered by 200 members of China's wealthy and cosseted Communist Party elite will now consider political reform - following series of speeches by China's premier [1]

[Preliminary comment]: The possibility that the political reform proposal may be a ploy is supported by the fact that: (a) Japan has put on a democratic 'face' without apparently changing the reality of government by bureaucratic elites equivalent to China's so-called 'Communist' Party; (b) change under China's system does not traditionally come from the centre, but from communitarian consensus, and tends to be announced after it has already been put in place; (c) deception and holding up a 'mirror' so that others see a reflection of themselves, is a traditional Art of War tactic; (d) controlling information flows is the essence of the way power is exerted under East Asian traditions - and while means may have been put in place to provide advantages to China's elites in achieving this (eg stronger state controlled media, Internet censorship) true democracy could unleash forces that tears China's system apart. . The present writer suspects that rather than moving in the directions suggested above (which would boost international harmony, but face severe internal structural obstacles) China's leaders, even those well-educated in Western ways, may be forced by their traditions more in the disharmonious directions speculated in Creating a New 'Confucian' Economic World?.

In March 2011, it was suggested that China's new 5 year plan incorporated elements to boost the role of consumption and reduce reliance on exports and investment. Features of the plan included: (a) a shift from manufacturing to labour intensive services; (b) boosting wages; and (c) building social safety nets (Roach S., 'Consumers key to China's brand new plan', AFR, 1/3/11)

[Preliminary Comment]: There is some complementarity within different elements of this plan - because increased wages and a social safety net would boost demand for services (or which the most labour intensive seem to be education, health and welfare). There are also precedents for increasing wages as a means for transitioning from low quality labour-intensive industries (a technique that was used by Singapore). However unless and until there are changes to the techniques for political and economic management of such changes, the financial imbalances that China's distorted financial systems require (and their adverse effect on the global economy) will not moderate (eg see comments below)

However in mid 2011 indications of pressures for political change and of radically different views of China's future were emerging:

China's Communist Party is now the world's most powerful organisation. It is an essential partner to Australia's economic prosperity. Yet it is little understood (in terms of funding / selecting leaders). The Party has given authoritarianism new currency - with Western business in particular.  But the Party (with 80m members who are the wealthiest and most powerful in China) lacks legitimacy. It's right to rule is based on victory over nationalist government worn down by fight against invading Japanese. Power comes from the barrel of a gun, according to Mao. Since Mao's death its legitimacy comes from material catch-up to others in Asia. The Party incorporates the flag, the state symbol, national heroes, public rhetoric and the PLA (which is responsible to the Party leadership). China's constitution entrenches the Party's dominant role in the state. The standing committee of the Party outranks the state council (the highest arm of executive government). The last attempt to separate the Party from the state was made by Zhao Ziyang in the 1980s - but response to 1989 protests resulted in his being placed under house arrest. No significant political reforms have been attempted since 1989. Economic reform has slowed to a crawl since premier Zhu Rongji took China into WTO a decade ago. But China's financial system is an empire in itself designed to prevent anyone taking a position opposite to that of the government (according to Carl Walter and Fraser Howie in Red Capitalism). The CCP has become the party of stability, power and tradition - tentatively embracing Confucius, denigrated by party's founders as an arch-reactionary. But though a statue of Confucius was placed in Tiananmen Square, it was later shifted to a museum. The Party has become a dynasty. Its top leaders are cut off from ordinary life. Those who founded the Communist Party would be perplexed by what has happened. The 250 year old Qing Dynasty had fallen a decade before they met, and Sun Yat-sen was seen as founder of modern China. The Russian revolution in 1917 had been a powerful catalyst. The Party initially tried to build credibility within the nationalists, but this founded as Chiang Kai-shek took over. Mao then focused on establishing soviets (communal groups) in his rural Hunan homeland - a quite different approach to that in Russia. Decades later China again set out in a new direction - engaging with global business. When nationalists encircled communists, Mao former a guerrilla force. he then purged all dissent, as the nationalists lost ground to invading Japanese. China's republican era from 1911 to 1949 brought rapid modernisation, a start to elections and engagement with the world. Many gifted people returned from overseas to help. But Mao purged them, communalised farming, seized private property and developed a class consciousness derived from Marx's European theory. Mao launched his Great leap Forward to industrialize China and 30m died, mainly of starvation. After pragmatists (Liu Shaoqi and Deng Xiaoping seized power) Mao launched cultural revolution to dislodge them. After Mao died Deng seized control, and announced the open door era. This was first restricted to economy, but has since been broadened so long as people do not challenge the party. In the first half of the Communist era, China went backwards under Mao, but in the second half China started to reclaim its role as a superpower. It retreated from reliance on charismatic leadership to governance by committeemen. Deng's 'contract' with China's people has been fulfilled (ie we will improve living standards if you let us rule). The Party is being challenged by: corruption; a wealth gap,; frustration about lack of rule of law; and a growing sense of entitlement rather than gratitude amongst the young. The Party is likely to reach its centenary. The cadres rule people whose tastes, interests and experience are changing faster than theirs [1]

 China's communist party officially held its first meeting in Shanghai in 1921. The meeting room is a shrine to Marxism, Leninism and the Great Helmsman, Mao, but is surrounded by consumerism. China's rulers take mandate from 1949 revolution, not from democracy. Party has reasons to celebrate - having overseen China's ascent. But this comes at expense of individual freedom. No dissent is allowed, but rising wealth could undo authoritarianism. Party believes the Chinese model of communism is new - and better than Western democracy - socialism with Chinese characteristics (combining freewheeling capitalism with an iron rule). The Party is enmeshed in China's society. There is little dissent, because this would lead to trouble. The Arab spring shows that the Party is in an unusual position. People don't talk of democracy - but value wealth and stability they have gained. But more now pay tax, and want a say in how it is spent. Young people have little spiritual feeling for the Party, and are more materialistic. The Communist Party changed from an underground guerrilla organisation to controlling the fastest growing economy. People join the Party to advance their careers. CEOs of most big Chinese companies are Party members, with his deputy being in charge of operations. Mao persecuted 'capitalist roaders' - but eventually entrepreneurs were allowed into the party. Online comments favour the Party - because dissent leads to trouble. 'Red tourism' is thriving - visiting sites associated with Party history. Party has ruled out anything resembling multi-party democracy. The Party ensure peaceful transfers of power - which were not usual in imperial times. People's biggest concern with Party is that some are corrupt, and the problem is getting worse. The number of 'mass incidents' resulting from abuses of power is escalating  (287,000 last year up from 85,000 in 2005). The big question is what happens when growth slows or inflation rises. Confidence in the Party is high, though it must constantly reinvent itself to keep people onside. How long it can continue doing so is the big question [1]

Communist Party 'princelings' (ie children of past Party leaders) are seeking to establish their status - but their interests are diverse. In order to establish their positions they need to cut Deng Xiaoping down to size. His 1992 'no debate' edict is being challenged (from the left, by sabre-rattling generals, and by pro-democracy advocates - ie democracy within a one-party state). The 'no debate' era is ending [1]

In particular there appeared to be tension between between the social equality aspirations of China's nominal Communism and the inequalities implicit in the neo-Confucian social hierarchy that has been the framework on which China's rapid economic modernisation has been built (see Communism Versus Confucianism: The Continuing Contest in China). 

In some respects these seemed to re-raise the motivations under-pinning the Mao-led 'cultural revolution' in the 1960 to free China of traditions that blocked the adoption of his version of Western-style socialism. Without at least 'cultural evolution' now it seems unlikely that China's international economic and political influence can continue increasing harmoniously.

These controversies were given public expression (which is unusual in China) by the efforts of Bo Xilia to promote social equality (and state economic institutions), and the efforts to block his rising influence on the basis that Bo had used dubious methods (though these seem to be typical of the methods used by the elites in China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party) generally).

It has been suggested that China's Confucian order in 2011 can in some ways be seen as like that which revolutionaries overthrew in 1911.

China's 1911 revolutionaries might recognise the system they fought as being like today's communist China.  Once celebrations of China's communist party focused on workers, peasants and soldiers. Now they refer to science, technology and modernity. However 2011 is centenary of 1911 overthrow of Qing dynasty and 2000 years of imperial tradition. This is being downplayed. It was not organised by Communist party, and lacked ideology. Some blamed Manchu emperors for China's problems, or backward looking Confucianism with its stress on social hierarchy that ended in stagnation. A democratic republic was the aspiration. Now Communist party's rule resembles the system the 1911 revolutionaries overthrew: a large privileged bureaucracy; hereditary privileges in ruling elite; a mass of toiling workers and farmers; and the embrace of Confucius. In January a large statue of Confucius appeared in Tiananmen square, but disappeared in April. Confucian influence remains. The official doctrine is now harmony, not class struggle. While the Maoist era is publicly celebrated, in the party schools it is being refashioned.  It is still a Leninist party - dedicated to perpetual rule, but one where the Party and business are closely linked. Now Confucius is embraced over both Marx and Mao [1]

Bo Xilia was Communist Party Secretary in Chongqing (the main instrument of central government control) til last week. He is one of China's princlings, and was Minister for Commerce until he conflicted with Hu Jintau. He was responsible for crackdown on corruption that netted police chief, members of the local mafia, and many officials / businessmen. He was helped in this by new police chief. Bo wanted to return to power (ie to Standing Committee). he promoted Chongqing model which featured leftist 'red' ideals - but was imposed on the population. He used the 'clean up' to get rid of factional enemies. His investigations also showed how local corruption was linked to Beijing. Bo's main rival is Guangdong leader (Wang Yang) who seeks reform, and does not favour hard-line leftist policies. Police chief sought refuge in US Consulate - and this might have been part of larger power play to damage Bo's prospects. Factional enemies in Beijing have evidence of corruption and persecution of Falun Gong by Bo and his police chief. To save himself, Bo set police chief adrift, and the latter then threatened to expose BO. The police chief then feared that he would be killed, and sought refuge. Bo was forced to resign, but will never be charged with corruption because: this level of power is never touched by corruption allegations, and the law is manipulated for people's own ends. But Bo has evidence against members of Standing Committee - in China the rot goes to the top. Thus Bo is still a player, despite his demotion. His main ally is Zhou Yangkong (head of Political and Legislative Affairs Committee), and supervisor of Falun Gong persecution. Police chief's flight has opened window on internal machinations in Communist Party. ideology is dead, all that matters is shared lust for power / enrichment in leadership group. This is likely to be the beginning of the end of totalitarian Communist Party rule in China.  [1]

The removal of Bo Xilai (who had promoted a broad 'red revival' movement) has disrupted an delayed the once-in-a-decade leadership transition in China [1]

In March 2012, Li Keqiang (who is expected to be China's next premier) highlighted the need for market-based change after sacking of an ambitious provincial leader who wanted a bigger state role in economy. Reforms would focus on: brisk / balanced growth and stable prices. Market forced would play a bigger role in resource allocation. This followed removal of Bo Xilai, who had turned Chongqing into a bastion of Communist-revolutionary inspired 'red' culture and egalitarian growth and won national attention for cracking down on organised crime. IMF has speculated about reserve currency status for yuan, given financial market liberalisation [1]

China's premier referred to serious divisions within the Communist Party, and to the 'deadly chaos of the cultural revolution and the continuing influence of feudalism'. This is most unusual, as normally differences are resolved internally and a united face presented externally. Normally the cultural revolution and Mao's distortion of reality are not mentioned. The Communist revolution was supposed to have done away with feudalism, yet Dictatorship of Proletariat is feudal in practice. The CCP and government rule like emperors they replaced. There is no equality in China. Power cascades from king / emperor / president, to provincial level barons and thence to local lords (who are the meanest and most corrupt). All others are modern day serfs. Yet China's second most important man warns of the risk of another cultural revolution, and points out that China's feudalism remains. Whichever faction gains power in China will rule for next 10 years. Moderates and reformers want a more socially fair and environmentally responsible society - or else gains of past 30 years could be lost. The radicals want to extend power of central government and its control over people's lives. This would be a great leap backwards. Bo Xilai (Party Secretary from Chongqing) has experimented with this model. China's future hangs in the balance [1]

Rumours circulated of an attempted coup in Beijing - perhaps organised by Bo Xilia's supporters in March 2012, and of uncertainties about who was actually running the country [1]

Until March 15 Bo was the top official in Chongqing, and poised to join the Politburo. Then his political fortunes vanished, and his wife was charged with murder. This is a major shift for couple seen as China's Kennedy's. Rumours have circulated in Beijing that this represents a concerted effort to halt Bo's rise based on the 'Chongqing model' - a top down push for social equality (with a strong government role and huge infrastructure projects). Many saw Bo promoting a cult of personality - and a return to the Cultural Revolution was feared. The real story is that China's political system is trapped in the past (ie in closed-door deliberations, backroom deals and purges) in the face of an internet culture that makes it impossible to control the news. Bo's situation shines a light on massive gap between the rich elite and the poor. To thrive China must now stop transferring income from households to the state - but elites may not allow this. The obstacles to reform increase the risk of a hard landing for China, and political instability [1]

China will face another cultural revolution organised by the left wing of the Communist Party if the economy stagnates [1]

This contest needs to be considered in the light of the apparently substantial grass roots support for the sort of equality (even in the absence of wealth) that China had under Mao.

When the present writer visited China in 2003 there was a constant queue of hundreds of people waiting to visit Mao’s tomb, and a guide explained that this was due to their  desire for Mao-era equality.

[She also suggested that Falun Gong is not just a spiritual movement but is vigorously suppressed because it is seeking to restore the position of China’s emperor – and thus to challenge the elites linked to the 'Communist' Party].

It was the pro-Maoist mood that Bo Xilai was building on that recently led to recognition of potential instability at top level in China (see above) – and considerable official nervousness about what side China’s army would support.

Comments (in August 2012) by a resident Western observer on changes in China in recent decades provide a view of the adjustment challenges that are faced, including:

  • indications that China's current political and economic system may have eroded the 'communalism' (ie the willingness of Chinese to put the interests of the whole community first) on which it has been critically dependent for reasons suggested below;
  • an apparent break in trust between the Communist Party and China's people, when both China's political and economic decision making is organised on an hierarchical neo-Confucian basis within the Communist Party as 'representative' of China's people generally;
  • China's traditional 'Asian' approach to education, which establishes conformity rather than an ability to 'think', and thus presumes the continuance of an economic model built around a social hierarchy centred on the Communist Party;
  • the incompatibility between the vengeful nationalism the Communist Party has engendered in China's people, and the expectation being promoted elsewhere that China will take a global leadership role in the 'Asian century';
  • the incompatibility between the neo-Confucian leadership style (which forces subordinates to decide) and the expectation of a leading Chinese role in international affairs (see also Eurocentric Aspirations in a World of Rising Asian Influence);
  • the lack of realistic investment options available to increasingly wealthy Chinese - who thus are virtually forced to invest in what seems to be a property bubble.
I have wanted to to live in  China for 16 years, but now want to leave. Despite China's progress, the dream that has existed since coming as a student in 1986 is broken.  China then was communist, and backward. It was also optimistic. A free market was emerging (with inflation which was also viewed as progress). There was a sense of social obligation - generating selfless socialism / unity. Deng Xiaoping was responsible for that optimism. He also ordered the tanks to Beijing in 1989, creating a a damaging legacy for the Communist Party. On returning to China in 1996 there was still optimism, but a whiff of commerce. Deng had offered people material wealth, providing they didn't ask for political change. If the party was trusted, everything was supposed to be all right. But now it is not. My business has encountered ongoing difficulties - due to a state owned competitor (enemy). But personal considerations are not the basis for these comments on China's problems. China is now focused only on making money. Family culture has become a 'me' culture. Communities do not act together. Social status is linked to displays of wealth. This upsets those who have little. Investment options are limited to property (or under the mattress). Stock markets are rigged, and banks are non-commercial. The powerful transfer their wealth overseas but other can only buy property - creating the biggest property bubble in history. Home ownership has become unaffordable for young urban workers, and vast residential developments continue to be built purely as investments. When the bubble bursts / deflates the Communist Party's promise of wealth to the people will have been broken. If this coincided with other social stresses, there could be real trouble. The government is now scared of the people, and doesn't lead them. Local issue passed up to Beijing, are passed back saying 'You decide'. The Party only intervenes when its power or personal wealth is affected. The country is ruled behind closed doors. The current / outgoing prime minister (Wen) is a puppet. His proposals are good, but won't be implemented. To get to the top you must be grey - with no strong ideas. Those who are supposed to control the Chinese Century are faceless. China is supposed to be merely regaining its former / rightful position. But there are two problems with this. China was only ever powerful because of its size. And the world over which China presided did not include the US or enlightened Europe. China defeated invaders from the north - because they consumed them from the inside. Believing they are unique, Chinese can't empathise. Controlled by people with conflicting interests, China's government can't make decisions about domestic or foreign issues. A world leader must offer more than supremacy (eg the end to slavery that the British Empire offered, or democracy that the US offered). A China that led the world would not offer the chance to become Chinese - because this is impossible. And China's leaders tolerate slave-like working conditions domestically. China can't lead the world because the Communist Party has encouraged anti-foreign sentiment since its inception. Fevered nationalism is a cornerstone. Chinese are regularly told to feel aggrieved at what others (ie Western societies and Japan) have done to them (over the 100 years from Opium Wars to 1949), and expect the Communist Party to extract vengeance. There is a real prospect of upheaval in China - eg sparked by a property crash. This will bring an end to China's record-breaking growth - and hopefully can be handled with generating external conflicts. Personal risks in China include: having my business taken away; unhealthy air and food; poor education for children (which does no seek to produce future leaders / innovators); and propaganda. There are many in the Communist Party who understand that there is a problem, but time to solve this is short and the challenges are immense. (Kitto M., 'You'll never be Chinese', Prospect, 8/8/12)

It can also be noted that:

  • the post GFC need to shift to domestic demand to drive future growth and the apparent decline of 'communalism' arguably make the neo-Confucian methods that have been used domestically, and might need to be used in international relations in future if China's global influence is to increase, unsustainable. For example:
    • China's economy has grown rapidly partly because of non-capitalistic financial systems associated with Neo-Confucian systems of socio-political-economy involved elites coopting national savings from state-controlled banking systems to finance state-linked businesses activities that: (a) were coordinated by social relationships (ie by connections rather than by the calculation of profitability by independent enterprises); and (b) allowed the elite (but not households) to become rich. Those systems not only depended on the willingness and ability of trading partners (especially the US) to run large current account deficits and increasing debt levels. They also depended on the willingness of ordinary Chinese to allow high rates of national savings to be achieved at the expense of consumption so that they could be invested with limited regard to profitability;
    • lack of feedback between domestic supply and demand in the absence of a profit-driven approach to investment (see Balancing Supply and Demand);
    • the most plausible model whereby China could take a significant international role would involve an arrangement similar to the 'trade-tribute system' that existed in Asia prior to the spread of Western influence (see Creating a New International 'Confucian' Political and Economic Order), and this depended critically on the willingness of ordinary Chinese to work hard for limited reward, so that net material benefits can be provided to 'tributaries' in exchange for accepting the primacy of China's social elites.  
  • this difficulty is compounded by both the need for a more highly educated workforce and the emergence of Internet-based social networking - as these make it much harder to exert control through the traditional Confucian method of controlling access to information and thus of subordinates' thinking. However, China's education system seems to be geared to producing a just-do-it society largely comprising people who are conditioned to not thinking for themselves (see Competing Thought Cultures). This has arguably been appropriate to China's past economic model but: (a) seems likely to be the reverse of what will be needed in future; and (b) will take a long time to re-engineer;
  • Bo Xilai’s rise in Chongquin could well be only the 'tip of the iceberg' in terms of a gathering reaction to the non-capitalist neo-Confucian system of socio-political-economy established through the so-called Communist Party since 1978 – because in East Asia nothing tends to be visible or announced (as Bo Xilai started to do) until a lot of ground-work has been done.

In April 2012 reports emerged of concern in China about extreme levels of corruption in the PLA [1]. The PLA is thus both: (a) apparently expected to provide support to the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) as it is challenged by 'redder' elements; and (b) part of the reason that the latter would object to China's current directions.

And different / incompatible interpretations of China's political reform options were suggested, eg: a shift to democracy; renewal of Confucian virtues as a non-democratic source of legitimacy; subjecting the 'Communist' Party to the constitution, a rule of law and an independent judiciary; making the law even more firmly a tool of the 'Communist' Party; or severe crack-downs on those who protest against inequalities.

China's 'communist' party is said to face a legitimacy crisis - because of Bo Xilai scandal. In the West non-democratic regimes are seen to lack legitimacy. But China's people are not dis-satisfied with the regime. Problems are mainly seen in lower levels of government, China's regime gains legitimacy from: (a) performance (eg from reducing poverty); (b) meritocracy (ie the perception of above average ability to make morally-informed judgments - a tradition with long historical roots. China cares more about having high quality politicians than the procedural arrangements involved in their selection); and (c) ideology (especially nationalism - rather than communism which few now support). These sources of legitimacy could be lost in future. Performance will be judged in ethical / intellectual terms when poverty is eliminated. Lack of virtue (the basis of Confucian moral legitimacy) is already being lost (as Bo case highlights). China's leaders are also held responsible for moral state of the whole country - and this is in a poor state.  Nationalism is a changing goal - as the past emphasis on defence is inappropriate when fear of being bullied shifts to the possibility of being bullied. Confucian reformists argue for more human nationalism (based on benevolence harmony) [1] [See comment in Confucian Renewal in China]

Reformers in China's 'communist' Party are seeking to exploit ousting of Bo Xilai to  make constitutional and political challenges - according to party leaders. Bo had opposed reforms proposed by Wen. For the party to save itself it must make itself subject to the constitution / law. There is doubt that the party can manage another peaceful transition. Bo's allies were main opponents of Western-style democratic reforms and an independent judiciary. Wen seems increasingly convinced of the need for democratic reforms to maintain social, economic and political stability (eg by gradually expanding from village elections, and making judiciary independent). Without serious political reform, the party's grip on power will be at risk [1]

Options for a shift to democracy over 10 years were suggested by a social science professor [1]

Removal of Bo has shown how ruthless politics is in China. Such purges happen periodically. His strong ego-driven personality was seen as likely to upset the consensus model. Few 'princelings' had chosen to got into politics, many preferring to use their position / influence to get into senior positions in business. Connection between party and business was sealed when former president Jiang allowed business people into the party and its senior advisory bodies. Bo had risen through the ranks to gain senior positions in Dalian. He became minister for commerce - and he hoped to get a vice-premier job. Some (eg Chen Li at Brookings institute) see Communist Party as 'one party two factions'. But Wang Zhanyang (Beijings Central Institute of Socialism) suggests that, while there are personal relations and ideological affiliations, reformers / conservatives and those at the centre all give precedence to 'stability maintenance'. This phrase was created by Deng Xiaoping and was meant to be temporary - but has become permanent. Some suggest that Bo's fall will see new burst of Deng-like enthusiasm for opening / reform. Others suggest that his removal merely rebalanced equilibrium of Hu-Wen administration - under which reform had slowed / stopped. Some wish to use Bo's downfall to crack down on officials who move from the centre. Zhou Yangkang (China's domestic security chief) argued that the law must serve the Communist Party (ie strengthen its ruling status). Clearly some are pushing for more than a simple smackdown of adversaries. Hu and Wen's power base for reform in Communist party has never been stronger [1]

Little is really known about events in China (eg bring down of Bo Xilai and accusing his wife of murder). Nothing has been proved. Things always get interesting in China before a National People's Congress. Leadership change in most democracies is transparent - though behind the scenes deal making is also a factor (especially in Japan). But everything in China is out of sight. Public spectacles are often used to resolve political conflicts. Bo gave the appearance of a gangster boss - like most party bosses in China (corrupt, ruthless, rich, behaving as if above the law). Bo was unusual in having open ambition - where China's party bosses like Japan's politicians and mafia dons are supposed to be discrete in seeking power. This upset others - and required a public scandal. A disgraced wife is a common tactic. Sine Bo presented himself as a critic of Chinese capitalism and promoted Maoist ethics, his natural enemies would be the more 'liberal' bosses who favour free-market capitalism and perhaps political reforms. Bo's fall might lead to a more open society, or to the reverse (ie to increased crack-downs on dissidents the more protests about disparity in wealth occur). This would not be to protect communism - but rather the Communist Party's version of capitalism [1]

In May 2012 it was argued that behind the scenes struggles at top of Communist Party related to purging of Bo Xilai could delay for three months handover power at coming party congress [1]. Maoists also claimed that authorities have fabricated their case against Bo Xilia in order to suppress his political ideas [1]

In September 2012 (just before a change of leadership to create the framework for future policy was due to occur) it was clear that uncertainty remained - see China's political tensions.

In October 2012 it was suggested that:

  •  charges against Bo Xalai would carry the death penalty because 'liberal' Communist Party leaders want him out of the way so as to make it easier for them to defeat hardline factions. Rumours had circulated that Bo had plotted with security supremo (Zhou Yongkang) to usurp power and install a government of hardliners. Reformers were concerned when anti-Japanese demonstrators in China recently held portraits of Bo alongside Mao chanting 'Bo belongs to the people' [1];
  • China's Communist Party is to move towards dropping references to Mao in party communiqués. This change (which is illustrated by the fall of Bo Xilai) implies more Dengism and less Maoism [1];
  • China's Communist Party has warned of the need for bold political and social reforms - though it offered no specifics on what this might mean. Others suggested that meaningful reform would be difficult because of the same obstacles that have existed over the past 10 years [1];
  • China's premier, Wen Jiaboa has been attacked because of the riches that his closest family members amassed over the past 10 years at the same time that his political opponent Bo Xalai has been kicked out of the party and prosecuted for corruption. Discrediting him would undermine the political reforms that he has been advocating. China's internet suggests that the Bo faction has hit back at Wen with these allegations. The left of the Communist Party and Bo have seen Wen as their main enemy and his relations wealth was a rallying point. Illicit riches have always been a tool to bring down senior politicians in China - but Wen has little to fear as China has no tradition of investigating retired politicians [1]

When details of China's new Politburo was announced, it was variously suggested that:

  •  this laid the basis of a future economic crisis because it was dominated by conservative hardliners rather than those who might have followed through on the political and economic reform agenda of China's retiring president Hu Jintao.
The influence of Jiang Zemin has thwarted reform in China. The Politburo has reportedly been packed with conservatives (as the acolytes of Jiang, who rose to influence after Tiananmen, gained positions), Hardline dominance would require rethinking China's future. Jiang instituted the Patriotic Education movement - which whipped up anti-Japanese nationalism. His new influence comes at a time when Japan and China are seen to be one error away from war - which the US could become involved in. Prospective members intended to avert China's 'middle income trap' by following through on Hu Jintao's reform proposals gained no positions. Hardliners who claim that tight party control of banks and key industries shielded China from the problems in global capitalism in 2008 - though China's continued growth reflected a large stimulus and 30% pa growth in credit. China's risk is like that Japan faced after it brushed off the US's 1987 crash with apparent ease. Wen Jiabao argued that China's economy is 'unsustainable, unbalanced, uncoordinated and unsustainable' and his allies in the China Development Research Centre with World Bank highlighted the need to move from export-led growth model. The forces that facilitated China's rapid growth are fading, and a 'middle income' trap is visible. Manufacturing wages have risen 16% pa - outstripping productivity. Gains must come from inventive dynamism - which is impossible in a top-down system / government planning. The state of official finances is not really known - but there are serious problems. There are only 10 more years before China's democratic crunch. [1]
  • this new group included five experienced individuals and two potential reformers who would learn but have little influence for the next five years, but then dominate when the older group retired [personal communication];
  • the process of selecting leaders remains complex and non-transparent [1];
  • recent events revealed the increased difficulties of maintaining China's behind-closed-doors political system [1];
  • the new group confronts the fact that its predecessors largely failed to deal with the political and economic challenges that China faces [1];
  • political reform remains the largest challenge the new group faces. Five years ago 'democracy' was being widely touted by China's then president. Though many in China have argued the need for this, those who might have advanced this were not advanced into Politburo. There have been moves towards open intra-party democracy (behind closed doors) in Vietnam and Myanmar  - and these could be a precursor to more general democracy in China also. But discussion of this has been suppressed in China. Few expect the new group to be more successful than their predecessors in dealing with China's problem [1]

In May 2013 it appeared that the 'vision' that would guide China's development for the next decade could be of a Spartan / martial society (see Does Anyone Else Support the 'China Dream'?). This suggested that: (a) China had undergone a peaceful transition from dominance by the 'commercial south' to the 'spiritual / militaristic north' (see above); and (b) that China's future was unlikely to be a continuation of its recent past.

In June 2014 it was suggested that the reforms brought in by Xi Jinping had little to do with economic liberalization (as many had expected) but rather were primarily political and involved the recreation of something like China's ancient elite-dominated regimes - see The Resurgence of Ancient Authoritarianism in China .

Other views of China's new regime were also expressed.

Bo Xilia's fall revealed a great deal about the distribution of power in contemporary China. It was the first leadership change without a central strongman such as Deng Xiaoping. The new elite is the first building block in an interlinked system of patronage, tribalism, factional and institutional links that reach out from Beijing into the five-levels governmental structures of China, through the 84m Communist Party and into China's society as a whole. The long term legitimacy of this is uncertain. The key question is the nature of the Communist Party. It came to power through revolution - and lives uncomfortably with its violent past. Tough questions have been asked (eg by Yang Jisheng) about how power has been exercised over the past 60 years. there was an enormous death toll from famines in the 1960 - due to blind following of destructive policies. The Cultural Revolution has become tboo - as those who cut their political teeth in this era 9eg Bo Xilia) have gained power. Xi Jinping gained power in 2012. His life during Cultural Revolution was influenced by marginalization of his father. Thus he is a member of party royaly due to his father, but also worked as a man of the people. Problems in explaining what happened before China's opening are paralled by difficulties in explaining what happened since. Mao had a utopian vision of a Socialist heaven on earth. But perhaps Party is just about pragmatic national goals - rather than about having grand ideas for the future. Perhaps it simply allows space for people to thrive and prosper. or does it have a coherent belief system. The Party seems focused and tangible - but also brittle / fragile. The only way to understand is to look at the people in it. Membership of the Politbureau has immense spiritual as well as material meaning. They not only seek to lead China but also to represent its values and identity. China can perhaps be seen as what Mikhail Bakhtin called a 'carnival' society [1 ] - see comment in It Isn't Just Networking in China

The inclusion of Liu Yunshan was a surprise when China's new leadership was announced in 2012. His career had been in journalism and propaganda. He holds the ideology portfolio. Liu needs to be studied to understand modern China. He articulates a pure orthodoxy that was learned from Ding Guang'en. Managing though is seen to be increasingly difficult / dangerous in China. Liu was part of Maoist program of late 2000s to bring many statues of controversial leader into Beijing. Liu's Maoist bent is less strict than that of Bo Xilia - but it has been influential. It is revealed in Xi's strong words on Mao's 120th birthday anniversary and his drive fro a purer vision of party membership behaviour. Liu's vision is of a party that is more than a political force. Liu emphasises the 'splendid culture' of China and links this the Party's mission. The Party is seen as putting the people first - and being a cultural as well as a political entity. Liu has supported clampdowns on the media. Those who want to understand China are seen to need to come to terms with the Party - its history / mode of operation / people-focus / global role / culture. However do China's people see the Party as a quasi-religious entity supplying them both materially and spiritually. Profound cynicism across China seems to dash that hope. The biggest problem will arise if growth slows. For now it is all about control [1]

A Chinese writer (Yu Jie) sees Xi Jinping as 'China's godfather' - implying that he is a stronger more ruthless leader than China has seen since Mao. However the days when individuals could exert such control have gone - as the the institution (ie the so-called 'Communist' Party) is now all important. Perhaps the Party could be seen as China's godfather [1]

What is happening in China in October 2014 could affect China for years. Economic data is to be released showing whether China's economy is on course to normalization. Politically the Fourth plenum of the Communist Party is discussing the legal future of the country (ie discussing governing according to law'). If the economic numbers are good, the Party will allow the economy to slow as it has been. But there are indications that the numbers will be bad. This will result in economic policy responses. However there is another issue at stake - China's sense of itself. It it going to remain a country dominated by the Party elite - or even more increasingly by those connected with Xi Jinping, or is it going to legitimate an equitable rule of law. The Party has proposals for expanding the rule of law. But there have been troubling trends. One observer suggested that China is turning in on itself. The regime seems to want to change China from the top down. This would involve a shift towards China's traditional ancient legal culture. China will continue to embrace capitalism - but not foreigners or foreign ideas. New Party slogans stress 'traditional' culture and values. The language of Confucianism is being invoked to legitimize a new dynasty of red emperors. State researchers are being warned against foreign collaboration. Liberal public interest lawyers are being subjected to crackdowns. Christian churches are subject in one province to selective demolition. Pro-democracy media in Hong Kong are subject to intimidation. Xi is seeking to eliminate 'corruption' from China. But will this put the 'red emperors' on a more equal footing with others - or thin their ranks to only those who agree with Xi?  [1

Is China Heading for a Crash or a Meltdown? (2010+)



Is China Heading for a Crash or a Meltdown? (2010+) [<]

Very early in the 21st century China faced significant economic, financial, environmental, demographic and political constraints. Crisis scenarios could be identified though avoiding them was possible (see above). In response to the 2008 Global Financial Crisis (GFC) China faced significant economic disruption and difficulties in identifying future strategies (eg because export-dependent growth no longer seemed reliable). Changes were made that made little sense in terms of Western economic principles. Rural groups in north China gained influence relative to the commercial south and reportedly favoured military over economic tactics to boost China's power  And there was serious internal political discord that put the regime at risk.

In July 2010 a Chinese ratings agency (Dagong Global Credit) gave China a higher credit rating than the US - which is the opposite of the position taken by Western-based ratings agencies [1]. This follows complaints by Beijing that Western ratings agencies fail to give China full recognition of its economic strength [1], because of an ideological bias in favour of the West [1]. This presumably implied that the Chinese rating agency bid not accept financial criteria (which are central to Western economic decision making but much less important in East Asia - see evidence) as the major basis for a credit rating.

In the face of severe difficulties facing both Europe and the USA as a consequence of the GFC there was also a perception that those difficulties would mark the end of 500 years of Western global predominance (eg see In China's Orbit, 2010). Similar views have been expressed by other observers.

In August 2011, as a consequence of a sovereign debt crisis in Europe (involving risks to quite large economies, ie Spain and Italy) and difficulties in containing US government debts led to the loss of its AAA credit rating, there were again pronouncements about this signally the future global dominance of China. However the issues were far more complex than commentators who failed to consider the origins of major international financial imbalances seemed to realize.  Such commentators' typical implication (ie that China's main risk from the US credit downgrade) was losses on its $US holdings was grossly simplistic - see It's Serious for China.

An Australian expert on 'Asia' has periodically argued for raising Australia's standards to meet the higher levels of aspiration and excellence that exist in 'Asia', on the assumption (apparently shared by a prominent Australian political leader) that the Western institutions and methods that have been dominant over the past 2 centuries will no longer be relevant (see Learning From, Rather than About, Asia).  However such suggestions about the superiority of Chinese traditions are not accompanied by any clear explanation of what those traditions are (presumably because clarity of understanding is incompatible with those traditions) or of the incompatibility between the authoritarianism that those traditions imply and the liberal values that have underpinned Western societies.

In March 2013 a 'Chinese' view of future international relations based on peaceful development was expressed by China's ambassador to Australia - an aspiration that was both noble and replete with uncertainties (see Creating a New International on China's Terms).

However the issues involved in postulating China's future global predominance seem more complex than such views indicated (see Ending the West's Global Predominance?).

For example: One point of particular importance is the expectation that 'Asian / Chinese' capital would be able to finance development elsewhere or meet the needs for borrowing by heavily indebted governments elsewhere. because ‘Asian capital’ is not able to be provided on the basis of the balance sheets of financial institutions, but rather draws upon cash flows generated by high-turnover production with limited regard to profitability and enforcing a high rate of national savings. As the domestic demand deficits and international imbalances this strategy requires were getting close to disrupting global economic growth, ‘Asian capital’ would cease to be available to anyone (because, if the strong cash flows abate, there would be no basis for providing capital).

Rather than being economically strong China seems to face the risk of a severe financial crisis due to unwise investment, and in the longer term structural difficulties affecting its social, economic and political systems appear to create the risk of an implosion. And at the same time China's attempt to Create a New International 'Confucian' Financial, Economic and Political Order (which would allow its unaccountable elites to rule as the center of a 'middle / coordinating / organizing kingdom' like that from which Asia was administered prior to Western expansion) may not actually work or be widely accepted. After all Mao's cultural revolution involved an attempt to drive Confucian influences from China because they were seen to have been oppressive (even though Mao's alternative authoritarianism was no better).

An Investment-driven Bubble?

In 2010 it was first being argued that China could be headed for trouble because of wasteful spending to counteract the effects of the GFC - which was seen to have generated a property bubble much worse than that in the US.

Disruptive events ('black swans') such as 911 and the global financial meltdown can send history in totally unforeseen directions - yet these events don't seem to have disrupted shift in locus of global wealth for Atlantic countries to Asia Pacific - noting China's ability to sustain 10% pa growth. If China's economy becomes bigger than US, because of China's large population it would still be relatively poor. However increasing wealth brings military power, political leverage and diplomatic influence - perhaps allowing China to 'rule the world'. Beijing's handling of GFC supports such projections. But some now see a 'black swan' in China's future. To avoid social unrest, China has directed a torrent of money to state owned enterprises and local governments - and used this to fund wasteful projects. This has created a real estate bubble much greater than in US. A deep and sustained recession could have severe political and strategic costs to China (Friedberg A., 'Black swan haunting China's future', The Australian, 21/7/10)

China faces major challenges in reinventing its economy. Beijing model seems to be succeeding (ie maintaining about 10% pa growth) just as policy-makers in US / Europe seem to have run out of ideas. Complacency about China's model (Beijing consensus of state-controlled capitalism versus Washington consensus of free-market capitalism). Yet China faces many constraints on sustainable growth, eg heavy local government debts; property bubbles; rising labour costs; changing demographics; high energy consumption / pollution associated with growth; a need for tax reforms. China recently noted strong growth in foreign investment - but didn't mention that domestic sharemarket is not doing well. While there are short term uncertainties facing China, it has consistently show the ability to overcome constrains. Requirements now seem to include: restructure economy to emphasise consumption; revamp social welfare; reform taxes to fund local governments; and extend private property rights (Ryan C. 'The China model gets a workout', AFR, 17-18/7/10)

China's growth could be faltering - as a result of external supply disruptions and internal tightening, though the notion of a hard landing was dismissed.  However some see China's economy as like US in 1929 (with massive wealth disparities; rapid industrialisation and displacement of labour; opaque / misleading financial / economic data; massive borrowing by rising 'middle class'; bubbles in housing / infrastructure investment; accelerating and uncontrolled rise in disintermediated credit; expected transfer of growth to domestic demand; and wage / price spiral). China is seen to have lost control - as desire to placate masses with growth has created inflation that will lead to social unrest. It risks a deflationary collapse. Others seem China and emerging economies caught in price / wage spiral that can't be controlled through traditional monetary, fiscal and legislative control - because of wage inflation. Faith in China driving growth will be lost - and the world will be left with deflationary adjustments starting in US and then Europe [1].

An asset bubble is China's main short-term obstacle to economic growth - though a hard landing may have been prevented [1]

A large bail-out local government because of bad debts incurred by provincial banks may be needed [1]

There is near universal agreement that developing economies , led by China, will growth at double the rate of developed economies. China has set the pace for the past 2 decades, and most fast-growing developing economies have adapted China's export-led development model. But China's model has meant that is a net exporter of capital, not an importer. It has funded internal investment with high savings and low household consumption. Foreign direct investment has been allowed with strict conditions involving technology transfers that allowed rapid productivity growth. Portfolio investment has been controlled and limited. Thus financial proxies have emerged as the way of riding China boom (eg Australia's financial markets). Asia's future is bright, but the no-brainer of Asian portfolio investment may be over. Controlling inflation is proving difficult. Electricity rationing was introduced, and then scrapped. China's one-child policy is rapidly reducing pool of rural labour migrating to cities - and this could shift earnings from companies to employees [1]

The bailout of local governments in China will be equivalent to 150% of the TARP program required in the US - and thus that China has 150% of the 2008 financial crisis ahead of it [1]

There are signs that China property bubble is starting to deflate. China's economic growth could slow rapidly and adversely affect global economy. Real estate is foundation of China's rapid growth for two decades, and is crucial to construction / steel / cement industries. It is also favoured investment in China, because of poor bank interest rates, and critical to local authority budgets (as property sales fund infrastructure spending). Property construction in China was 13% of GDP in 2010, twice the level of 1990s. Many other countries have come to depend on this. Some cities have 20 months inventory of unsold properties, and suffer declining prices. Ordinary citizens can no longer afford to buy properties. In 2006 average apartment cost 32 years average salaries, but this is now 57 years [1]

China's post-crisis economy is built on 10,000 local government investment platforms which are in turn based on unsustainable rivers of debt. China has had competing needs for slow credit growth to contain inflation / asset prices and resource misallocation, and short term pressure to complete infrastructure and develop real estate. New credit had to keep flowing to meet repayment obligations on old bad loans. China has responded to the need to slow credit growth by blocking credit to private sector. Municipal owned companies accumulated $2.1tr debts (35% of GDP) - with 75% of this over the past 2 years. This may be unsustainable, but not be resolved for a long time because China does not really have a banking system - as the banks that hold local government debt are just arms of Communist party enterprise - and they can be topped up by other parts of this cashed-up enterprise at any time. Also local governments are finding new ways to raise capital - through bonds.  China's local debt is however a systemic problem - as there are limits to which households can be gouged, and thus likely political constraints. Land is current constraint - as used for loan collateral and this requires ever increasing land values (and coercion to hold down compensation payments from the dispossessed). The battle for land is where China's economic and political crises intersect [1]

 Problem loans from China's 2009 stimulus are about to hit China's banking system - and could require a rescue effort (about 7% of GDP) that is bigger than US TARP program. Government encouraged banks to lead to prevent recession in 2009 and a significant percentage of this went to local government borrowers, of whom 25-30% went bad. Also China established asset management companies (AMCs) in 1999 to absorb and dispose of bank bad debts. However they have not done so quickly, and rather than winding down they have continued to carry forward bad loans. Absorbing the new bad debts would compound problems in their balance sheets. Much of China's debts are held off balance sheet - ie nominally debts are only 20% of GDP, but actual total is about 80% of GDP. A large part of China's economic miracle has been built on ill-considered lending and accounting slight-of-hand [1]

There is increasing concern about China's debt levels. Local government debts are stated to be 27% of China's GDP (but may actually be 42%), and 20-30% of these loans are at high risk of souring. Defaults are emerging. The central government will need to assume responsibility for this - and most analysts see central government debt as 70% of GDP. However if contingent liabilities are also included the figure would be 150% of GDP. The bigger problem could be high levels of debt in economy - as many SOEs are now highly diversified, especially in areas where cheap capital gives them advantages (eg real estate and high tech). Chinese companies have incentives to borrow heavily and bulk up (eg better executive remuneration and political connections). China's investment driven growth model may be leading to unsustainable increase in debt. There is now a need to reduce growth dramatically or risk even worse increases in debt levels - though at least another two years of high-investment driven growth are likely [1].

 China may need a recession - though its leaders and international investors would not want this. There has been growing concern about debts of China's local governments - that spent heavily as part of response to GFC. Borrowings were estimated at 27% of GDP - but are probably more. Few loans are reported as non-performing - but as much debt was incurred with little regard to repayment, a great deal could turn sour. China is unlikely to face a debt crisis. Most loans are owed by one state-owned entity to another - so government carries any losses.  China's eagerness to keep joblessness at bay papers over the hole in the balance sheets of local governments - and this prevents banks operating on commercial terms. Corruption and fraud is not exposed. Problems with China's high speed rail network raise questions about whether spending was prioritised over quality control. China needs a recessionary bust to clear the way for a new boom  [1]

China is facing a hard landing (because of excessive credit growth and attempts to control the consequences). Moreover, as Europe and US experience economic problems, China will not be able to again boost spending to boost its domestic economy - and demand from economies that supply it with inputs [1]

China's private sector was born in Wenzhou (and entrepreneurs flourished). But problems arise. The city spearheaded China's manufacturing. But the trust based financing structures that replaced banks and fuelled its binge are collapsing - given slowing exports. The city has many problems. The cities financial-industrial model is unraveling. Wenzhou is defined by one-industry clusters, and never depended on foreign investment (as China's other boom cities do). 2m of the cities population live offshore, and are the basis of trade links. Wenzhou capitalised on non-bank financing, where relationships matter more than collateral. Traditional methods for channeling money to friends and family were massively expanded. But lending has ceased, because of risks [1]

In late 2011 a report (whose reliability can not be confirmed) quoted a Chinese source (who appeared critical of China's regime and was supposed to be commenting in private) as suggesting that China faces very severe fiscal and economic problems (Chinese TV Host Says Regime Nearly Bankrupt)

There seems to be a discrepancy between China's official 8.9% pa growth rate in the final quarter of 2011, and other (real economy) data indicating negative growth [1]

61% of global investors surveyed in December 2011 expected that China would experience a banking crisis because of misallocation of resources (as well as serious political and economic instability) in less than 5 years. Only 10% expected that China would escape trouble [1]

China is seen as likely to be the last country to experience the effects of financial / economic crisis, because of its massive surge in investment. But it is also likely to be the last to experience recovery. The dominant role of SOE's in the post results in wastage of resources. Huge profits are earned because their monopoly power is exploited. Economic vitality is being stifled and wealth is concentrating in the hands of a few [1].

China has not rebalanced towards consumption in 2011, and debt continues to rise quickly. This will not lead to a crisis, as it would simply be rolled onto government balance sheet. Financial Times reported that China has allowed banks to roll over loans to local governments. China's response to GFC allowed banks to lend $1.7tr to local governments (25% of GDP). As principal is not repayable, banks are now extending the loan terms. China has growing amounts of unrepayable debt - and most will wind up on government's balance sheet. Some suggest that the problem is only one of structure (ie using bank loans rather than bonds), but debt is debt. The problem was not perceived because of opaque financial system. The problem can only be solved by eliminating loss-making investments, yet China's growth is kept high by borrowing, misallocating the proceeds and allowing debts to rise. Household income is too low to be used to subsidize debts - so government will need to provide the transfers (eg by privatising assets or absorbing debt). Japan chose the latter. Now its debt is escalating, and there are risks of capital flight, high borrowing costs, falling currency / stocks and central bank needing to pump cash into local banks. Japan's government borrows more than it raises in taxes and has $10+tr debts. China can choose to absorb debts, and it would take many years before doing this becomes unsustainable. China is likely to have much slower growth and rapidly rising debt for most of the next decade - because privatising assets is hard. World Bank suggestions about doing so (in the context of pointing out the difficulty of China's economic transition) have encountered resistance. Increasing SOE dividends to the state would not solve the problem, as total SOE profitability is less than 1/5 to 1/8 of direct and indirect subsidies transferred from households [1].

China's headline GDP growth has been 8-10% of GDP. However this has been driven by new lending averaging 30-40% of GDP - of which 20-25% is likely to prove to be non-performing. Thus losses of 6-10% of GDP arguably need to be deducted from China's nominal growth. So China's real growth is much lower [1]

China's economy has slowed since mid-2011 - with electricity consumption growth down; a property bubble; local government debt overhang; and eurozone crisis. Despite reported strong 2011 growth, stock-market is down - indicating waste and limited value adding. China hasn't moved from quantity expansion on supply side and government investments / exports on demand side. Waste has escalated. This increases inflation. Banks have increased liquidity to sectors other than property, which will prevent the liquidation of inventors needed for a bottom. Chinese businesses face high / arbitrary taxes - with 45% of labour costs going to government, and low employee wages. Most demand is government-driven. China needs to boost competitiveness. It has now reached average $5000 per capita income, but is one of the last Asian countries to do so. While China's growth has been strong over the past 3 decades, it has few strong companies. Competitors elsewhere in Asia do much better. Multinational companies have all structured their operation to take advantage of China's cheap labour while protecting their own technologies / know-how. No other country has developed with such dependence on foreign companies. China's industrial policy has failed [1]

Xianfang Ren (IHS Global Insight) suggests that land sales account for 30% of central government tax revenues and 70% for local government. Property construction accounts for 10% of jobs directly and 20% indirectly. Residential property investment (12% of GDP) is above to 9% usual maximum for developing economies. Though minimum down payment is 30%, house prices are 16-18 times incomes in major cities. Financial system has much greater real estate exposure than it seems (especially weak are real estate trusts and non-bank lending). Small developers are cash flow constrained and will need to reveal defaults quickly. China's demographic crunch has arrived - percentage of children and elderly has reached minimum (28%). urbanisation has passed 50% when growth in developed economies starts to slow. Edmund Phelps suggests that China can no longer increase productivity enough by importing western technology. Productivity growth will be like that in west in 10 years, but at much lower levels. China can bail out banking system (given deposits, government revenues, sale of state assets, and foreign reserves) - unless it is simultaneously hit by external shock (as Japan was). [1]

In May 2012 there were signs (especially in M1 deposits, electricity output, lack of orders in shipyards, housing starts) that China is headed for a hard landing in late 2012 [1]

China seems to be facing a deflationary collapse. Prices have been falling; China faces a fast aging population and has excess factories. Credit has grown explosively . Loans doubled to 200% of GDP between 2006 and 2011. This is double the rate of loan growth (50%) before Japanese and US problems. There is near universal assumption that China can set off fresh credit boom, but loan take-up has been falling rapidly. China has, however, a lot of scope for fiscal largess (which the West lacks). If China experiences deep downturn and seeks to flood the world with cheap goods, the world could suffer a deflationary downturn [1]

In July 2012 it was suggested that China (and surrounding economies) are facing a severe recession - and that China has abandoned plans to reform its economy (ie to switch from unsustainable investment towards domestic demand) and is preparing large stimulus measures which will create further problems for its banking system [1]

In September 2012 it was noted that funding state pensions is becoming a major challenge for China given: its fast aging population as a result of the one child policy adopted in the 1970s; a corresponding decline in the working population; reduced willingness / ability of children to support aging parents; and expectations that China's growing wealth will be more equitably shared [1]

Private sector credit was seen to be laying the groundwork for a new financial crisis in Asia (especially Hong Kong, China, Vietnam) - according to Capital Economics. The credit explosion in Hong Kong, for example, was seen to be similar to the situation in Ireland before its financial crisis. Vietnam's property bubble seems to be bursting [1]

In China's non-bank lending now exceeds that by China's banks. A 'shadow banking' system now offers high returns to investors through very risky lending - and this is again feeding a red-hot property market (and creating risks of a crisis like that in the West) despite official efforts last year to cool the property markets by tightening credit.  The government turns a blind eye to this (and merely seeks to limit risk in banks) because it is desperate for growth to be maintained [1]

GMO (Edward Chandler and Mike Monnelly) argue that China's economy depends on ever larger quantities of credit - and looks like a bubble. This is like Indonesia at end of Suharto regime and Japan in late 1980s. Markets however can't get enough of China. GMO suggests China's credit / GDP ratio rose 60% to 190% between 2007 and 2012. This is more than Japan in late 1980s and US prior to Lehrman Brothers collapse. This could be a problem if credit market freezes - eg when there is a major default in Asian high-yield bond market. This is most likely in wealth management products. This shadow banking system emerged as Chinese savers tired of negative interest rates. Dumb money chasing yield is a formula for for band investments. These funds direct investment to real estate and companies that big four banks won't touch as they are seen to be too risky. If Chinese lost confidence in the shadow banking system there could be a full blown crisis. Some defaults have already occurred, and some trusts use new money to pay out earlier investors - which chairman of the Bank of China describes as a Ponzi scheme. Many of the products resemble the collateralized debt obligations that were sold prior to GFC. Products are sold as low risk, even though components are very risky. While the Chinese government might stand behind the trust, the economic effect of a crisis could be significant [1]

China's rapid growth may have created the largest housing bubble in history. State driven growth has focused on real estate and construction - creating cities with no one in them [1]

Zhou Xiaochuan (China's central bank governor) has been one of the few voices advocating genuine economic reform in China. He has been calling for a reduction in capital and opportunities available to SOEs and warning about the threat posed by the hundreds of $bns of loans to local governments to invest in property markets since 2009 (which continue to pose a systemic threat) [1]

China's premier warned 6 years ago that its economy was unstable, unbalanced, uncoordinated and unsustainable. And since then China has continued with the economic model that led to that concern (ie heavy reliance on investment in roads, factories and infrastructure). After the GFC such investment was further stimulated by fiscal spending and credit creation (which is now 4 times greater annually than in 2007). China's public / private debt now exceeds $200% of GDP - which is unprecedented for any developing country . This is not seen as a cause for concern - though attempts to understand the origin of financial crises suggest that this is false. The rate of increase in debt (particularly private debt) matters more than total debt. BIS found that 6% pa growth in debt higher than the rate a decade earlier implies major risk. In China this difference is now 12%. IMF found that if private debt grows faster than GDP for 3-5 years financial distress is likely. China's private debt has grown faster than GDP since 2008 - and has risen to 180% of GDP. China is assumed to be immune to risk because it owes little to foreigners - yet studies of the 79 financial crises in major economies over 140 years show that crises are just as likely in countries reliant on domestic savings. Also while Asian countries with high savings and few foreign liabilities did avoid crises after credit booms, growth fell sharply. Thus China is likely to experience rapid growth slowdown. To 2007 China created $1 of growth for $1 of debt - but now requires $3 of credit - which is what happens at late stage of a credit binge. China's exports and manufacturing are slowing while money flows into real-estate speculation. A more stable growth model requires promoting consumption. However while consumption has grown at 8% pa ((faster than in other miracle economies and as fast as possible) consumption is still falling relative to GDP because investment has grown faster. Thus China must cut back investment to rebalance and accept slower growth [1]

Fears that China could experience a hard economic landing have been renewed - because of skyrocketing property prices, mounting credit and GDP growth slowdown. China's economy is seen to parallel symptoms that led to 2008 financial crisis [1]

There has been increased speculation of a financial crisis in China. Nomura has suggested that China looks like US before sub-prime mortgage meltdown. The problem is seen in massive amount of credit that is extended off bank balance sheets (by contracting with less regulated financial vehicles or by property developers raising credit through friends). Such activity is opaque and largely fuelling speculation. Most comment has focused on how exposed China's banks are and whether government can recapitalize them. But the more important point is that off-balance-sheet activity is a good thing in China - because China's banking system does its job very poorly. Savers receive negligible returns, and banks direct money to SOEs - the least efficient firms. While off-balance-sheet activity generates risks, this is part of a process for fixing defects in the existing system [1]

One of China's top auditors has stopped approving local government requests to increase their debt levels, and warns that China faces a financial crisis bigger than that in the US and Europe unless debt levels are brought under control [1]

Possible responses to these challenges have been suggested to lie in gradual appreciation of emerging economy currencies and increased reliance on domestic demand. This seems to underestimate the difficulties of achieving such as transition - see Avoiding a Hard Landing in China .

Other Perceived Structural Problems

China's problems are arguably more fundamental than the immediate risks associated with wasteful spending and property bubbles in response to the GFC.

China has long had to struggle against economic, environmental, demographic and political constraints as suggested above (eg economic imbalances; wasteful investment; blunt economic management tools; pollution; limited soil and water resources; a soon-to-be rapidly aging population and need for massive state aged-care spending as a result of the 'one child' policy ; wealth imbalances; and frequent protests about official actions and corruption).

However in recent years observers have drawn attention to other structural problems, such as:

  • a fragile and distorted financial system;
  • lack of innovation / creativity;
  • the dependence of local government finance on maintaining a property bubble;
  • inflation being generated by an undervalued exchange rate;
  • failure to actually increase domestic demand though rising wages are undermining China's industrial competitiveness;
  • an inadequate education system;
  • breaks in social harmony - as income inequality was rising rapidly and was well above the level that would normally indicate a risk of social instability;
  • falling demand for construction (for which huge capacity exists) as income shifts to households;
  • over-reliance on investment;
  • the parallels between Japan's and China's property / investment bubbles;
  • a potential precipitous decline in working age population after 2020 [1] - a problem is likely to compound China's export-dependence in an environment in which the import demand from the aging populations in developed economies is likely to be weak;
  • the inability of China's political system to respond fast enough to achieve major adjustments needed to sustain growth;
  • possible capital flight.
 Observers' comments on structural problem's China faces ....

In September 2010, questions were being asked about China's financial system.

There is concern that Chinese banks may be involved in a pyramid-style capital structure after domestic arm of China's main sovereign wealth fund raised $8bn through bond sale (to recapitalise China's state owned banks) and those banks were the biggest buyers of the bonds [1]

Moody's has expressed concern that China is powering its economic growth by raising the gearing of its banking system in ways that could leave the country exposed if outlook darkens. CIC borrowed $8bn to recapitalise three state-owned banks using debt, rather than genuine equity. There is concern about the opacity of China's banks [1]

In late 2010, a prominent Chinese academic also suggested that China faced serious structural risks.

 China's growth model is unsustainable and sudden slowdown is likely without radical economic and political reform - according to prominent academic and former member of People's Bank of China's monetary policy committee (Yu Yongding) writing in state controlled China Daily. Threats were seen in: social tensions; pollution; lack of public services; over-reliance on exports and investment (particularly in real estate). This comes at a time when many expect China to overtake US eventually - though there is current concern about rising inflation.. A transition in power to younger people is likely in 2012, and Yu's article reflects debate preceding this. Yu expressed concern about lack of innovation / creativity; inefficient use of capital (with investment over 50%) resulting in too many luxurious buildings. Yu also called for political reform - to break the alliance between politics and business. China's institutions require meritocratic government, but this is being eroded by sycophancy and cynicism. If China can't end current 'capitalism of the rich and powerful', then social tensions will lead to serious backlash. This investment is about    [1]

In early 2011, it was argued that China faced great difficulties in rebalancing its economy despite the announced intention of its neo-Confucian bureaucracy (ie the so-called 'Communist' Party) to achieve this.

China's premier spoke of rebalancing China's economy. But the role of the state in China's growth is a major problem. China is too reliant on unsustainably high levels of fixed investment to maintain growth. Fixed asset investment has risen 20-40% pa for the past decade - and this is not justified by urbanisation which grows only 1-1.5% pa. Such investment is about 55% of GDP - much above the 25-30% of GDP in Japan and Korea at a similar stage in their development. Bank lending has risen rapidly, and over the past 14 months Beijing has tried to restrain this. 3/4 of credit goes to SOEs through thousands of local bank branches. This creates obstacles to rebalancing. Local governments can't borrow - so they create state-owned commercial entities which invest in property market, rezone land (often illegally) to make this profitable and then sell. 50% of local government revenues come from property - so government tax revenues depend on perpetuating property bubble. Thus officials only pay lip service to central directives to curb lending. Also local officials (who have influence in banks) favour SOE dominance as it allows them to dispense patronage. Economic and social elites are Party's main supporters. Though returns from SOEs are poor, funding them is vital. Non-performing loans on books of China's banks could be 70% of GDP. Bias towards SOEs gives them 15-20% increases in revenues annually - but means that household income only increases 1-3% pa. This is why domestic consumption is weak (30% of GDP, the smallest level in any major economy). China can't reform its unbalanced and unsustainable economic model until the Party releases its grip on economic power  (Lee J. 'Party needs to loosen its grip', AFR, 9/3/11)

Australian Treasury warned about risks to global recovery associated with inflationary pressures in emerging economies. China and others in Asia are trying to quell inflation without doing anything about the accelerant of their undervalued exchange rates. Countries that tie their currencies to $US are importing monetary policy designed for an economy with low inflation and where private demand is weak. This is creating conditions like those prior to Asian financial crisis. Inflation is significant in China despite the fact that wages incomes are still falling as a percentage of GDP [1]

China has experienced an economic miracle, but three contradictions are emerging. China's leaders hope to slow growth and thwart inflation while raising wages and benefiting the masses. However wages have falling share of overall income, and gap between rich and poor is widening. There are many retail stores, but people look without buying. Wages are rising - but this seems to be diluting the competitiveness of manufacturers. There is thus a need to migrate to more sophisticated manufacture's and services. However this requires a better education system (as current one suffers from Soviet style management of science, and is shunned by China's elites). Second, China wants to internationalize the yuan - so that in a future economic crisis it could borrow in its own currency (as US does) - but this won't be possible unless economy is subjected to global markets. Low interest rates in China are driving asset bubbles - because people have no alternative investments. Third there is distrust between people and elites (eg Internet restrictions, wealth imbalances) [1]

Social management is the new buzz phrase in China's propaganda. Increasing public protests show why this is needed. The cracks in China's economic miracle are starting to show. China's president has called for social management to ensure harmony and stability. This is a belated rationale for crackdowns on most public critics. China has a 'Great Firewall' and an army of cyber-warriors - but this threatens to be overwhelmed by a home grown system like Twitter. Social management has led to efforts to silence lawyers, agitators, writers, artists. Beijing was worried by unrest in Middle East, and reacted harshly - but this may prove counter-productive. The origin of discontent is often in injustice - yet the role of lawyers in China is limited. The Communist Party prevents some matters being considered by the courts, and prescribes findings in others. The harmony China seeks has been hard to find [1]

The Bank of China issued a secret memo tightening the way mandatory reserve requirements for banks are calculated. This is an attempt to curb run-away lending by thousands of state-owned bank branches (which has boosted investment in China and commodity prices). However it is unlikely to be effective in the short term - because local banks are hooked on such lending and (with economic weakness in developed economies) it is hard to maintain growth without high levels of investment. Because of the bias towards SOE, China's private sector has shrunk - so there is ever more reliance on SOEs to create jobs - and building things is mainly all they know how to do. China's reliance on fixed investment guarantees that it will eventually have a hard landing [1]

The President of the World Bank argued in September 2011 that there are structural problems in the world economy which make monetary and fiscal policy solutions to economic growth constraints inadequate, and that significant changes to China's economic growth model (which has been based on exports and domestic investment) would be needed as a result [1]

In late 2011, a parallel between the bursting of Japan's 1980s investment bubble and China's current situation was suggested [though without mention of the cultural features that have arguably have given rise to this].

In China, industrialization as always, combines, progress with problems - though China differs in scale and cultural and entrepreneurial history.  China has many: large cities; rich people; university graduates; mobile phones; TV stations; patent filings (though no respect for others intellectual property); declining infant mortality; high speed trains (based on others technology, now localised); and outbound tourists. China's renaissance is as much cultural as economic, Chinese people are entrepreneurial, creative, energetic - who have been contained for centuries by domestic dynasties or foreign occupation. But prosperity brings problems - such as overconfidence - and the business cycle reflects this. China is not different except in scale, Australia's dependence on it and in the source of debts. Western business-cycles are consumption led, yet China's are investment driven. There are untold projects (eg cities built for a million people) that can never earn a return. The loan for one project costing $185m was guaranteed against land valued at $1.5m acre - the same as land values in richest parts of US where household incomes are $250,000 pa though in China the average was only $2,300 pa. 10,000 special purpose vehicles have been set up by China's local governments for such projects over the past 10 years - and $US2.2tr invested in them, of which 1/3 is estimated to be unrepayable. Central authorities tried to stop this, so local authorities established corporations to handle the transactions. Two of China's largest banks are estimated to have problem local government loans that amount to 30% of their book value, as well bad debts emerging from exploding corporate bond market. Since WWII consumers have driven growth in most Western economies. China has no consumer society. Rather it is an investment society. Consumption has fallen from 50% of GDP in 1980 to 35% . Investment has taken a reverse trend (ie from 35% of GDP to 50%). US consumption / investment figures are 71% and 15% respectively. This is why coal / iron ore / concrete prices has boomed. Since 2007 67% of increase in China's GDP has come from investment (the reverse of US situation). US bailed out the banks, while China embarked on massive government-driven investment program. US GDP stagnated, while China's increased 30% over the period. Michael Pettis (Peking University) argues that high levels of municipal debt are symptoms of underlying problems (ie repressing price signals, distorted investment incentives and heavy reliance on investment to achieve growth). In history this always tend to push growth too high and become unsustainable. However China can now only get growth with ever riskier increases in debt - and this must eventually be stopped resulting in many years of poor economic performance. Developing countries can initially find many profitable investments, but this eventually becomes harder - and when momentum takes over the system loses its ability to discriminate between profitable and loss-making investments. Strong GDP growth masks this problem until the bubble bursts. Japan's experience in 1980s and since illustrates the problem. To early 1990s Japan's GDP increased rapidly as share of global GDP (from 7% in 1970, 10% in 1980 and 17% in 1990) - but since then it has reversed (to 9% of global GDP). China is more likely to experience a Japanese style lost decade than Europe of the US.  Japan produced attractive, low cost products to achieve huge trade surpluses - using cheap labour and low exchange rates. The resulting surpluses caused concern to trading partners, and were used to invest / modernise. Ordinary Japanese paid for this (via low wages; a declining GDP share; low interest rates; escalating property values; and expensive imports). This is the model, not a by-product of the model . Eventually land values collapsed. poor investment decisions were exposed, and Japanese banks faced bankruptcy - and the economy entered recession from which it has yet to fully emerge. Peter Hartcher (in The Ministry) argues that though Japanese companies understand about return on capital, they would spend cash without worrying about the return.  In 1988 Japan's real estate boom paused, and speculators who were used to ever-increasing prices felt problems. But banks continued lending - and the boom continued. China did the same in the 1990s - and offloaded bad debts into state-run asset management companies. This allowed banks to claim 1.8% bad debt ratio in 2009. In 2002 one yuan of GDP needed 0.17 yuan of debt. Now it needs 0.30 yuan. Banks are forced to fund suspect government projects at excessively low rates, so bad debts will be high. China's banks are now facing a liquidity crisis - though this is invisible because the bad stuff has been taken off balance sheets. China seems likely to follow Japan. Edward Chancellor (in China's Red Flags) argued that China had all the features common to bubbles over the past 300 years. Half of China's millionaires reportedly want to emigrate - because of fears about future stability. The crisis may be a few years away, but investment-led growth must end. Government-induced slowdown is already occurring. But a shift to consumption-led growth is not on the horizon. Property values will continue falling. China's rulers have implied social contract with people since 1989 - sacrificing political freedom in return for economic gains. This may now crack. For China to change its economy, political and economic power must be devolved, yet elites don't readily give up power. ('The Coming China Crash', Intelligent Investor, December 2011)

In early 2012 a crisis was seen to be arising because: (a) high levels of investment are needed to sustain growth, though this also generates inflation; and (b) China's political system is not able to respond rapidly to the major adjustments that are required to maintain growth.

Concerns arise about China's economy (property deflation, weaker exports to Europe, cut-back on infrastructure investment). Since GFC China's economy has been driven by investment. High capacity has been created, which external demand won't support. There is a recognised need to shift to domestic demand, but China's system is geared to direct resources away from households towards investment. This would need to reverse rapidly - but more likely outcome is fall in investment. China's official economic statistics are not reliable (as shown in 2009 when 6.5% pa growth was reported yet 'real economy' data (eg electricity consumption) was contracting). Now all sectors seem to be contracting yet this is not officially reported, Most people see 5% pa GDP growth as 'hard landing' - and it seems to be current reality. If China built again everything it did in 2011 and everything else was unchanged, its GDP would fall 2% (to about 4.5%). Fiscal / monetary policy options are constrained. There is a need to grow over bad debts. Credit in system is fully occupied on existing projects, and POBC is wary about increasing credit because of inflation risks. Money supply expanded 2/3 over recent years, and was invested. Thus fiscal policy is now being considered. But China's nominal low debts (30% of GDP) is understated because of contingent liabilities (ie for debts of state institutions). This makes debt / GDP 100-200% already. It is likely that government spending will be increased and it will be revealed that past monetary stimulus was just disguised fiscal spending - as bad debts have to be covered. Spending will increase, but investment boom can't be maintained. Bubble probably can't be re-ignited. Diverting resources to consumption might help - but there is also a possibility that money just leaves the country. Capital leaving is now tending to offset China's current account surplus. If China's growth slows, devaluation will be sought - but this could provoke international reaction. If exchange rate is not adjusted, then inflation in China will increase. If exchange rates rise then producers bear the burden, whereas inflation hits households. Exporters are now being hit by rising costs in China. Some tried to adjust by getting into financial dealings, and again got burned. China's economic pattern is unsustainable given export / investment dependence. Leadership changes at present make adjustment impossible - as no one can afford to upset powerful constituencies. New leader will then take a long time putting protégés into key positions before radical changes can be implemented. Economy will require action much faster. Elements of hard landing are already occurring. Fiscal stimulus will help for a little while. But in mid 2012 hard decisions will be needed. A lot of debt needs to be rolled over. Tension between investment driving growth and driving inflation has reached a crisis point - given problem of bad debt. Bad debt is going to absorb credit. 300-400m Chinese are on internet, and complaining. Officials are concerned about social stability. Any hint of organised protests would result in crackdown.  But social media has changed the game - as everything that happens in shared / spread. Government is struggling to cope. Some favour social media as letting government know about community concerns. (Robini N and Chovanec P., 'China: How much stress can the system take?', Economonitor, 8/2/12)

CPDS note: Both of the above sources contained hints of possible capital flight from China. Similar suggestions appeared in Cash Exiting China (Duy T., EconoMonitor, 31/5/12; Frangos A etal 'In Reversal, Cash leaks out of China', WSJ, 15/10/12), and the rapid escalation of gold purchases by individuals in China (see Lee J. China's twitchy gold bugs, BusinessSpectator, 17/2/12) might also have similar implications.

China's leadership was seen to be very worried about the future in December 2011 - even though many other countries are worried about China's competition. Their focus is on internal problems (eg dependence on high growth driven by exports to maintain social tranquillity; resistance to currency manipulation; inequality; the need for shifting to domestic demand; inflation and housing bubble; political transition in near future; pollution; aging population; protests; international isolation; [1]

Constraints are emerging on the expansion of China's international influence in support of its expanding economic roles [1]

More analysts are starting to understand constraints on China's growth model. It is predicted that: (a) China will be the last country to emerge from GFC - because those problems resulted from great trade and capital imbalances to which contributed with a massive savings rate which it has continued increasing, rather than reducing; (b) China's consumption will stagnate / decline until existing growth model (which depends on transfers from households to subsidise growth) is abandoned; (c) financial repression is the heart of China's problem; (d) investment is being misallocated on a massive scale, as a fundamental feature of the economic system; (e) debt is rising at an unsustainable pace, and this can't continue; (f) attempts to deal with debt problems will fail because the debt problem is systemic; (g) while privatisation is a forbidden topic, it will soon start to be considered; (h) a fundamental political split is likely between those demanding reform of China's growth model and those who want to maintain control of resources; (i) China's government debt will continue to escalate; (j) China's average GDP growth for 2010-20 could be 3% pa; (k) if China rebalances successfully growth in household income will be similar to GDP growth; and (l) non-food commodity prices will collapse over the next 3-4 years because these have been critically dependent on Chinese investment [1]

The IMF published Is China Over-investing and Does it Matter which argues that China is over-investing - as this accounts for over 50% of GDP and is most unusual relative to other countries. Households and SMEs have been forced to subsidise growth at a cost of 4% of GDP (or perhaps 5-9%) - and this explains collapse in household share of GDP. China has to eliminate that subsidy (and thus abandon its current growth model) if it hopes to get household / consumption shares of GDP to increase. China's investment has to fall by 10-20% of GDP, and this will adversely affect those who have benefited from over-investment. Moreover bringing the investment share of GDP down is very difficult [1

Obstacles to China's efforts to use its currency as the basis for international trade were suggested to arise because: (a) China still has a more-or-less fixed exchange rate with $US; (b) there is not much use for yuan outside China (and thus little point in holding the currency); and (c) all lucrative sectors in China are reserved for SOEs (except export-oriented manufacturing and participation in JVs to allow technology transfer into China). Until China opens its markets there is no good reason to hold yuan [1]

Japan shows the risks that China faces in shifting to a lower-growth model. China expects its growth to slow over the coming decade. This can be seen as either a reflection of the 'middle income trap' or of catching up with advanced economies. Indicators of this include: slowdown in infrastructure investment; falling returns on investment due to overcapacity; labour supply growth has fallen sharply; urbanisation is decelerating; and risks are growing in local government / real estate finance. A case can also be made for a more optimistic view - because China's income levels are currently much lower than when such transitions occurred elsewhere. However China is much bigger than other economies, so the world can provide it with relatively less opportunities, and its growth has often been seen as 'unbalanced, unco-ordinated and unsustainable'. High dependence on investment creates the biggest problem. A growth slowdown could be associated with a collapse of investment from 50% of GDP to 30% - and, if rapid, this would lead to depression. Real estate investment has led to a large rise in credit - and in risks of bad debts (leading to a more fragile financial system - especially because of growth of 'shadow banking' system). There may not be a decline in household savings to accompany falling investment. China hopes to manage the transition smoothly - but Japan showed that it may not succeed [1]

China's claims of strong export-led economic recovery (ie 19.8% year on year to the end of February 2013) appear dubious because of a discrepancy between China's claims of exports to Hong Kong (($US94.9bn) and Hong Kong's data on imports from China ($US58.7bn) [1]

China's 30 year economic miracle may be near exhaustion.  China's prime minister has asked the State Council to clamp down on excesses of the regions - as local government finances are out of control. China's growth could be at a safe 7%. Vested interests in state industries are seeking to prevent this. Catchup growth in the western hinterland has more years to run, but overall growth may be below 7%. There has been doubt about China's statistics. National Bureau of Statistics now says that regional data overstates GDP by 10% - because of growth-claim incentives facing officials. Some expect China's future growth to be much lower - eg because of population aging - and perhaps not much more than renewed US. Thus charts showing China tearing past US may be wrong. The 2008 banking crash was a nasty shock to US financial system but not to its creative enterprise. It was however a crippling blow to Europe and a subtle blow to China in many ways. US Council of Foreign relations (Richard Haass) sees US as doing well in many areas. It has a large debt hangover - but so does as state banks let rip during downturn. Total credit has jumped from $9tr to $23tr over the past 4 years. US has moved in the opposite direction with loan-to-deposit ratio around 0.7 - the biggest safety margin in 30 years. US Treasury debt has jumped - in ways normally seen in wars from which recovery has been possible in the past. China is facing 'middle income trap' which have affected many rising economies. China needs to shift from state-driven industrialization and cheap exports to free markets. Innovation at the technological frontier is incompatible with government planning.  However even if this change is made, population aging will significantly reduce China's growth. Surplus workers will be replaced by a shortage - as happened to Japan 20 years ago. More credit can keep the game going for a time - but this just increases the risks. The 'China Dream' of a post-American empire has a dated feel  [1]

Rather than reducing China's reliance on investment, detailed figures for last year show that investment increased as a percentage of China's economy in 2012 [1]

A credit rating agency suggests that China's shadow banking system is out of control as borrowers struggle to roll over short term debts. The scale of credit was so great that China could struggle to grow its way out of these excesses as it had been able to do in the past. Credit-driven growth is falling apart - and could feed into aver-capacity and potentially a Japanese-style deflation. The shadow banking system lacks transparency (in terms of who borrowers / lenders are, and quality of assets). The official non-performing loan rate of 1% means nothing as irregular lending makes up half of new credit and bad assets can be offloaded through the system [1]

There seems to be a contradiction between China's intention in November 2013 to announce sweeping economic reforms at Party's Third Plenum (involving an assault on SOEs and Party patronage machinery) and simultaneous reinforcement of a one-party, one-ideology authoritarian state. This contradicts core finding of DRC- World Bank report which suggested that China could not jump to next stage of economic development (and would languish in 'middle income trap' unless it embraced modern 'free thinking. Countries need to increase productivity through innovation. China is running out of cheap labour, faces severe demographic change, has picked easy economic options (cheap labour / investment led growth / catch-up growth) [1]

China is facing a new economic crisis - namely family business succession. China's economy is not dominated by SOEs as many believ. Private enterprise accounts for about 2/3 of China's economy - up from zero decades ago when private business was outlawed. Most such enterprises started 3 decades ago - and now simultaneously face succession issues. This is happening at the same time that China's privately controlled manufacturing has to move away from its low-wage labour intensive methods. Also there are major cultural differences between first generation business owners and their children. The first generation had little and limited education. 88% of their children have degrees and 52%studied overseas. The latter often clash with their parents over corporate management. The children favour advanced Western management systems - and parents believe that this is incompatible with the reality of doing business in China. Western educated children don't like dealing with government officials, which is vital in the Chinese business world. There is concern that they have been influenced by foreign culture / beliefs. In the US people have beliefs (eg in Christianity). While China has Buddhism, few people really believe it in their heart [1

In 2015 it was noted that the richest man in US politics (with almost $500m in family wealth) would only rank 166th in China [1]

Moreover the limitations that Western observers perceive in China's political and economic systems are only part of the story (eg see China can't be properly understood in terms of Western economics). The structural problems that China faces are escalating because of factors that require reasonable Asia-literacy to appreciate. For example: 

  • East Asian systems of socio-political-economy have created and depended on favourable international financial imbalances (ie on the willingness and ability of trading partners to sustain ongoing current account deficits and ever rising debts) - see China may not have the solution, but it seems to have a problem.

Similar points are explored in China can't fix the global currency crisis without economic disaster (and in Another 'sting' driving Japan's urgency?). China lacks the ability to sufficiently reduce these imbalances that: (a) played, and continue to play, a central role in global financial instabilities; and (b) if uncorrected must eventually make global economic growth unsustainable. Those imbalance will soon lead to a decline in external demand and thus create crises for non-capitalistic financial systems when / if reliance on domestic demand creates a requirement to borrow externally.   The possibility of total failure of China's financial system is explored below (see China's Super-Ponzi-like Financial System and Preparing for a Con?);

  • assumptions that seem to be made by China about the economic benefits of large scale industrial / infrastructure investment with limited regard to profitable use of capital in specific investments (ie benefits associated with synergies and side effects) appear likely to be false - and likely to generate a financial crisis because of the massive levels of sovereign debt that that assumption has apparently caused to be accumulated .
A source which the present writer suspects is based on realistic briefings about China's economic tactics suggests that there is an assumption underpinning large scale investment with limited regard to profitability in specific projects can have net overall benefits eg because:
  • those investments can generate synergies / side effects; and
  • providing cheap capital facilitates the rapid growth of capital-intensive production.

Synergies / side effects can be real and economically valuable. The present writer's 'take' on this is outlined in Fixing Economics (2012) and A Case for Innovative Leadership (2009+). These suggest that accelerating the development of industry clusters / economic systems as a whole can generate additional economic benefits - while Developing a Regional Industry Cluster (2000) suggests methods whereby this could be achieved in a democratic / capitalistic environment without eliminating the need for productive use of capital in relation to specific investments).

However without the latter constraint there is doubt that the economic benefits will compensate for the steady build-up of debts / bad bank balance sheets that is likely to occur in parallel because:

  • it is difficult to know the productive value of such potential synergies / side effects - and thus how much build up of bad debts this may justify;
  • where nationalistic / mercantilist goals (eg building economic / military power) are a significant element in any process, the costs could well greatly exceed any economic spin-offs;
  • the individual interests of those participating in a process intended to promote community-level overall benefit cannot be entirely excluded - so the process can not be guaranteed to be unbiased - no matter how much 'self-criticism' the neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  may try to impose on its members;
  • there is a limit to which any organisation / organism can deal with complex issues. There are in nature many large organisms and many complex organisms. But there do not seem to be very large / very complex organisms - because the problem of managing complexity becomes overwhelming.

Furthermore while a high savings rate and abundant capital can achieve rapid growth in the production of capital intensive goods, most growth in developed economies comes from the deployment of knowledge. There are limits to growth merely from increasing inputs of labour and capital - and unless those limits can be passed an economy risks being caught in the (so called) 'low income trap. And the reported shift in China's education system towards encouraging just-do-it compliance (rather than abstract understanding) through starting with rote learning of Chinese classics strongly suggests that knowledge intensive economic development is not envisaged (see Competing Thought Cultures).

  • there is an incompatibility between the social equality aspirations of China's nominal Communism and the Confucian-style social-hierarchy that was vital for the methods for rapid economic modernisation that Japan had demonstrated and which it has been suggested: (a) were pioneered by Japan's military in Manchuria in the 1930s; and (b) China's post-Mao leaders were persuaded to adapt as 'socialism with Chinese characteristics' in the late 1970s. That incompatibility has the potential to lead to serious political tensions and perhaps even to a civil war.

China's history has been littered with civil wars. As noted above it has been argued that these civil wars featured contests between 'commercial factions' in southern China and rural / spiritual / militaristic factions that dominate in northern China – which resulted usually in the southern ‘commercial’ interests being driven out to become the Chinese Diaspora across SE Asia.

Tensions between such factions can be seen to have played a role in China's more recent history. 

Confucian-style hierarchy had been targeted for elimination by Mao's cultural revolution as Chinese 'Communism' favoured social equality, but was (apparently secretly) reintroduced after Mao's death by factions whose power base was southern China (Shanghai) who have arguably been the architects of China's modernisation using a variety of the neo-Confucian systems that were the basis of Japan's post-WWII economic miracle - see also Communism versus Confucianism: The Continuing Contest in China). The role that an elite neo-Confucian bureaucracy had taken in Japan was taken by the so-called 'Communist' Party itself - presumably because under Mao the Confucian bureaucracy had been successfully demonised as oppressing the masses.

Tensions were exacerbated by the massive personal wealth that many at the top of the socio-political hierarchy took the opportunity to acquire for themselves and their families (noting that the average wealth of the top 60 (2%) of the National People's Congress is reportedly $US1.4bn [1]).

This ultimately produced deep divisions within China's so-called Communist Party (illustrated by the Bo Xilia case mentioned above) apparently between: (a) the south China / commercial neo-Confucian factions who have provided the engine of China's rapid modernisation through a non-capitalistic / mercantilist / financially-repressive market economy built on relationships within an hierarchical and autocratic social elite; and (b) the 'redder' elements who favour social equality, but would not seek or be able to maintain a market economy (Political Change and Potential Instability: The Continuing Saga ).

In this context it is worth noting that (after China's system had been seen to be unbalanced and unsustainable) China was promoting both: (a) economic / financial liberalisation; and (b) potentially incompatible changes in China’s education system which would create a community that complies with social elites but would not be successful in a liberalized economic environment (see Financial and Educational Reform in China: Headed in Opposite Directions?).

Given China’s likely financial, economic, social, environmental and political tensions another revolution in China (revolting against the so-called-Communist-but-actually-Confucian factions in power) is neither impossible nor certain.

Even if the immediate threats to China’s political and economic stability are suppressed, these issues won’t go away, and anything that disrupts the social inequalities that have been essential to China’s post-1970s' neo-Confucian system of socio-political-economy is likely to disrupt China's ability to have a competitive market-oriented economy. Thus the vague 'China dream' endorsed in 2013 by the secretary of China's so-called Communist Party (Xi Jinping), which apparently included reducing the extremes of wealth that those with so-called Communist Party connections had achieved probably has major economic implication;

  • the China-centred neo-Confucian international order that seems likely to be envisaged (which could from one viewpoint be viewed as a realization of Japan's 1930's aspirations for a 'Greater East Asian Co-prosperity Sphere') is incompatible with the demands now being placed on China to take the prominent role in global leadership within prevailing Western-style international institutions that is needed because East Asia's economic methods have partly incapacitated traditional global leadership. The Chinese state (which seems to be geared to mobilizing China's people for nationalistic endeavours to obtain vengeance for what China suffered from the time of the Opium Wars in the mid-19th century and as a result of Japan's actions from late-19th to mid-20th centuries) is structurally limited in its ability to operate in a Western-style international arena. The purpose of providing information under Confucian traditions is to induce others (eg students, subordinates, outsiders) to do things that would benefit one's ethnic community, rather than to enable them to understand. Thus diplomatic dialogue can not involve a serious attempt to resolve problems (see The Limits to Dialogue and Time May not be on China's Side). The latter also notes the difficulties being experienced in promoting ethical behaviour, and the uncertainty of resolving such problems by re-emphasising Confucianism;
  • various other structural arrangements seem incompatible with the competing pressures that China is facing from the external world, and from its own people (eg apparent erosion of grass roots confidence in China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  and of the willingness of China's people to sacrifice for national gains; an education system that primarily prepares people to operate within a social hierarchy rather than to take independent initiative; poor domestic investment options; and vengeful domestic nationalism that is incompatible with providing the constructive international leadership that others now hope to see).  Many owners of China's 'private' businesses are retiring, and their university / overseas educated children have been influenced by foreign ideas - including doing business in ways that are incompatible with the state-orchestrated way in which business has been done in China (see above)

These structural difficulties are primarily a by-product of the neo-Confucian methods that were used to accelerate economic modernisation in China (as in Japan and elsewhere in East Asia) - and it is not at all clear that those problems can be resolved by the continued use of the methods that gave rise to them.

The supportive reactions of a Chinese American to suggestions similar to those outlined above may be noted.

Proposals for Reform i / Financial Obstacles / Increasing Aggressiveness (2012)

Proposals for fundamental economic and political reform that were being advanced to China's leadership from late 2012 in relations to these challenges included:

  • curbing the power of state firms; increased emphasis on market in setting interest and exchange rates; and tax reforms (as local governments do most spending while central government gains most revenue. Emphasis is being placed on developing a national consensus on reforms, rather than reliance on Beijing sources [1];
  • political reform and a greater emphasis on law-based governance without adopting a Western-style democratic style of government. Greater emphasis would be placed on 'how the Communist Party exercises leadership and governance to ensure that it leads the people in effectively governing the country' [This constituted an endorsement of neo-Confucian style leadership / governance]. Emphasis was also given to boosting China's: maritime power; social ethics; socialist market economy; and domestic demand within a framework of 'socialism with Chinese characteristics' [ie a neo-Confucian system of socio-political economy]  [1].
  • proposals from a Central Economic Work Conference for short and long term measures to enable stable growth. Continued socialist market reforms were indicated and (for the first time) clearly stated plans for reform, to overcome suspicions that government was not serious about reform. [1]
  • proposals for sweeping reforms to avert an economic crisis were being prepared for consideration by the Communist Party Congress by Liu He (Central Leading Group on Financial and Economic Affairs). This included proposals for: changes to financial system that directs cheap finance to SOEs but not to households; financial deregulation; fiscal reforms (related to central government transfers and effective property and consumption taxes); land transfer / usage systems; urbanisation; reducing income inequality; cutting red tape; and imposing market prices on coal, oil and other resources. No consideration was however being given to the sorts of institutions needed for transparent markets [1]

However, as the rest of the world stagnates economically because of failure to deal with international financial imbalances (see Too Hard for the G20?), China (like Japan) has seemed likely to lose the strong cash flows from exports that are needed to allow strong domestic growth without having to borrow in international financial markets. If this happened the balance sheet of its institutions would be called into question - and this could expose the 'Ponzi-like' character of its economy.

Diverting China's exports to emerging economies (as China has seemed to be seeking to do since late 2010) can not avoid this problem as many emerging economies (like China) can apparently only avoid financial crises by preventing current account deficits through export-led growth dependent on (mainly) US consumers (see Leadership by Emerging Economies?).

China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  has perhaps created an economy on the basis of a financial system that has many of the characteristics of a Ponzi scheme (ie one dependent on ongoing injection of new cash to delay exposure of problems in an undertaking's balance sheet that result from not earning enough to cover the ever increasing amounts owed to those whose savings were invested).

It is possible (though not certain) that the increased aggressiveness that China displayed from late 2012 was a reaction to the difficulties of its situation (as suggested in Friction between China and Japan: The End of the Asian 'Century'?). And, though the situation is anything but transparent, other late 2012 indicators of China's intentions included:

  • the lack of any clear intentions to implement political / economic reform in the membership of the new Politburo;
  • the apparent intent of China's education system to produce a just-do-it population that would be compliant with elite guidance in matters of politics and the economy (see Competing Thought Cultures) - a goal that suited China's past economic tactics, but would be incompatible with significant political and economic reforms;  and
  • early indications [1] of an intention to continue China's GFC era economic tactics (ie an emphasis on property development and infrastructure investment).

Arguably China's wild (and desperate?) spending and credit creation in response to the GFC merely amplified a fundamental feature in non-capitalistic neo-Confucian East Asian systems of socio-political-economy generally (ie the lack of attention to profitability in the use of savings) - and thus increased the risk of a financial crisis when trading partners find or decide that they can no longer continue increasing their debt levels indefinitely.

Preparing for a 'Financial Con'? (late 2013) [<]

As observers have long pointed out, China seems to face increasingly severe debt problems.

Brief outline of earlier examples (drawn from Investment Driven Bubble above).

  • to avoid social unrest China has directed a torrent of money to fund wasteful projects ;
  • China's economy is like US in 1929. China has lost control. A desire to placate masses with growth has created inflation that will lead to social unrest;
  • China faces an asset bubble and a need to bail out provincial banks' bad debts;
  • the future bail-out of China's local governments will have 150% of the effect of post-2008 TARP bailouts in US;
  • China's property bubble has been critical to economic growth (and to others' ability to share the benefits), but is starting to deflate;
  • China's post-GFC economy is built on 10,000 local government investment platforms - and these rest on unsustainable debts. New credit has to be created to meet repayment obligations on old bad loans. China does not have a real banking system - as 'banks' are just arms of the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) ;
  • Local government debts are 27-42% of China's GDP - and 20-30% are at risk. Central government debts are 70% of GDP - 150% if contingent liabilities are considered, Chinese companies also have incentives to borrow heavily. Investment driven growth is leading to unsustainable debt levels;
  • Local government debts cause increased concern. Few non-performing loans are reported, but loans were often taken without intent to repay. Most debts are owed between state-owned entities - so government carries losses;
  • China won't be able to ease problems associated with excessive credit growth - because US / Europe also face problems and can't boost China's economy
  • in 2011 it was suggested (with unknown reliability) that China is nearly bankrupt;
  • 60% of global investors surveyed expected China to face a banking crisis due to misallocated resources;
  • China is likely to be the last country to experience the effects of GFC - and the last to recover. Dominance of SOEs results in wasted resources. Huge profits are earned by exploiting monopoly power;
  • China has not rebalanced towards consumption. China's GFC response involved allowing banks to lend 25% of GDP to local governments. Principle was not repayable. Banks are now extending loan terms. Opaque financial system conceals but does not eliminate the problem. Government needs to absorb losses by privatising assets or increasing debt. Japan did the latter - and is now in serious trouble;
  • China's 8-10% GDP growth has been driven by new lending of 30-40% of GDP - of which 20-25% is likely to be non-performing.
  • Loans in China doubled to 200% of GDP between 2006 and 2011 - double the rate of loan growth before Japanese and US problems;
  • Private sector credit was seen in 2012 to be laying the basis for a new financial crisis in Asia (including China);
  • non-bank lending now exceeds that by China's banks. This offers high returns through very risky loans - which feed a likely property bubble;
  • China's economy depends on ever large quantities of credit - and looks like a bubble. Shadow banking system is causing problems. It directs loans to real estate that major banks find too risky. Some defaults have occurred with new money being used to pay this out - officially described as a Ponzi scheme;
  • China's central bank governor has warned about systemic threats;
  • China's premier warned some years ago that China's model was unsustainable - yet that model remains;
  • One of China's top auditors warned that China faces bigger financial crisis than US unless debt levels are brought under control
Late 2013 examples

In September 2013 China showed improved economic growth - reversing a politically serious mid-year slowdown. This was the result of reverting to infrastructure led investment. Net asset investment was 56% of GDP. Many observers have been concerned about China's dependence on investment. China is repressing domestic demand to build state-directed infrastructure - much of which does not produce economic returns. Bad debts are being avoided only by taking on more debt to pay interest bills. In September 2013 China's total system credit growth was $230bn ($2.3tr for the year to date). This massive credit growth is causing an asset price boom. It has not deflated yet because of ever increasing credit growth. This is a Ponzi scheme. In 2013 China's credit growth is likely to be 35% of GDP - leading to mal-investment. There is no certainty when this will end, but problems are likely eventually. The price of money has been faked globally by reserve banks, and the $US-renminbi exchange rate manipulation has led to excessive construction and manufacturing capacity in China. [1]

Borrowing by all government levels in China is unprecedented and one of the world's highest. Overall government budget deficits were 9.7% of GDP last year. But despite this massive stimulus growth has slowed. China's loan growth has taken total to 200% of GDP - leaving little scope for further budget stimulus. Recent growth has been driven by heavy state-led industry. But money growth is now lagging indicating problems in 6 months time. China bought $70bn of foreign bonds last month to hold down the yuan. China does not seem to be able to overcome dependence on export-led growth promoted by artificially cheap currency [1]

A few years ago it was suggested that the credit dynamics of China's growth involved an unsustainable increase in debt - which would ultimately undermine the banking system. This was disputed on the grounds that: (a) debt was directed to investment - and was thus not necessarily rising faster than debt service capacity (a view that few now support); (b) China's debt doesn't matter (being funded domestically / guaranteed by government - and China dealt with debt problems successfully before); and because foreign exchange reserves are available to recapitalize banks. A recent article noted that China credit situation has parallels with US before GFC. However it then suggests that there is no problem because of China's massive savings rate and foreign reserves (which would allow government to recapitalize the banks). Because banks are government guaranteed and people have no savings options apart from banks, China won't face a system-wide bank run as long as guarantee remains credible. There thus won't be a Lehman-style crisis. But neither will there be the advantages of such a crisis (ie quick resolution of the problem - that is possible in countries with sound financial / political institutions).  Rather there could be a Japanese style rebalancing which has much higher economic cost. Foreign exchange reserves can't be source of refinancing for banks - because there are merely assets on a ledger that are balanced by liabilities (ie the renminbi that the China's government had to borrow locally to borrow foreign reserves - in order to prevent currency appreciation). It has long been rumoured that PBoC would be insolvent if its liabilities were correctly marked. If foreign exchange reserves were used to recapitalise banks, PBoC's assets would thus be reduced, while its liabilities remained unchanged. Bailing out banks is no different to transferring their debt to central government. Some have suggested that because China's debts are hidden - those debts don't matter. But hidden debt eventually matters (as Greek and Italian situations have recently shown). This is because those debts must continue to be serviced.  If the assets funded by debt don't create enough wealth and borrower does not default, then there must have been a transfer from some other entity. In China this has typically been the household sector - eg via very low interest rates. But such transfers are China's problem. If any entity covered by central government can't service its debt - the difference must be paid by someone else, and this reduces demand and thus slows economy. If such transfers continue to come from households, then households' ability to increase consumer demand will be low. However if the state seeks to cover the difference in other ways then it creates difficult political problems - in assigning costs to influential interest groups. Debt must be paid by someone - and China's rapidly rising credit implies that growth must be slower in future - and that rebalancing will be increasingly difficult [1]

China's banks are amongst the world's healthiest and most profitable according to their financial statements. But investors are not convinced. Bad debts account for less than 1% of loans - but price-to-book values have been falling reflecting concerns about declining credit quality. Credit quality trends are not trusted. Banks tend to extend, restructure or sell loans to borrowers - rather than admit that they have gone bad [1]

There has been concern about China's local debt problem - and China's National Audit Office has recently reported on this (though the results are not public). Local governments have used innovative financial structures to raise debt. Auditors have clashed with local governments about debt classification. China's local debt problem is guessed to be between 10-50 tr yuan. The last official pronouncement was 10.7 tr in 2010 before explosive growth of shadow banking system. Total lent to local financing vehicles is about 10tr (in early 2013). This is 30% up from end of 2009 - reflecting 4tr fiscal stimulus package. Much of this was funded by debt from China's banks to local governments. 36 provincial capitals were surveyed. They have 3.85tr collective debt - and for about 1/3 debt-to-GDP ratios are over 100%.  There are problems in that a lot of local debt will be due in 2014. China's local debt problem (40-60% of GDP) is serious - but won't cause a crisis because governments have adequate financial resources (given large foreign exchange reserves, income tax of 10 tr yuan pa (which increases rapidly), and domestic financing of China's debt [1]

China's local government debt reportedly reached 20 tr yuan ($US3.7tr) in late 2012 - having almost doubled over two years - and has kept rising. Beijing is increasingly concerned with such liabilities - and this has driven a credit crunch. Total debt (consumers, companies, governments) has reached $20.8 tr - more than double GDP. Local government accounts for 80% of all government spending - yet only receives 40% of revenues. Debts of central and local governments had totalled $4.5tr at the end of 2010. Some local governments have been found to be taking on new debts to repay old ones. Incomes for such bodies are below their debt service obligations - and they hope to cover the difference with land sales.  (Callick R., 'Mixed messages on mountain of debt confuse China's markets', Australian, 30/12/13)

A blast of money from China's central banks has not stemmed growing cash crunch - as liquidity dries up and struggling lenders hoard funds. One-week borrowing costs rose over 1%, and the crucial 3 months rate rose 80 points. Fitch ratings argues that China's wealth management products (a hidden second balance sheet of banks worth $2tr) is the biggest risk . 50% of all liabilities have to be rolled over every 3 months - and a further 25% every 6 months. If rates remain at current levels, weak funds could be caught as Lehman Bros was. Central bank is also trying to rein in dangerous credit surge. Hot money has been pouring into China following optimistic response to reforms promised in November [1]

In October 2013 it seemed possible that China was hoping to 'con' the world in relation to its financial position. For example, there were suggestions that:

  •  financial liberalization in China would significantly boost the global economy because a 'wall of money' from wealthy Chinese would be available for external investment [1];
  • China's banking system was being cleaned up in October 2013 by 'huge' (ie a total of $4bn) write offs [1].

This seemed like a potential 'con' because (for example):

  • the 'wealth' of elites connected to China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party) is simply a component of the 'wealth' of the Chinese state; and
  • the 'huge' write offs by the China's major banks involved about $US4bn relative to the claimed increase in credit in China (a significant fraction of which was perceived to be suspect) of $US2300bn to that point in 2013. It was estimated  in 2011 that the rescue effort that China's banking system required would be about 7% of GDP [1]. In October 2013 China's GDP was estimated to be about $US8,000bn. If the time discrepancy is ignored this implies that China's banking system (effectively a branch of the so-called 'Communist' Party) requires something of the order of a $US560 bn  rescue package (not a $4bn write-off).

In July 2013 it was noted that China's economy has been and remains highly dependent on external support from global companies that are based in advanced economies.

China frightens the west, but there is a need to consider how west looks to China. Peter Nolan, Cambridge Uni, pointed out that China is not buying the world. The West is in China, not the other way around. The world economy is dominated by major (systems integration) companies rooted in advanced economies. Such companies can raise finance for large projects, invest in R&D, buy state-of-art IT and leading edge human resources. As they invest across borders, such companies lose national characteristics and become harder to tax and regulate. China's success has been built on its willingness to allow its workers to the world's producers. Significant percentages of China's output results from such companies. China has far more inward than outward foreign investment. China's firms are seldom involved in major international mergers / acquisitions. China has few globally significant companies. Thus China sees itself as heavily dependent on others' know-how.  [1]

 In October 2013 China's people were reported to be wondering why China had acquired so much US debt - a question that pointed directly towards the need for reform of China's financial system - see comment in (Why China had to Buy US Debt).

Or Maybe There is No Real Problem  [<]

On the other hand it has also been suggested that China has no real problem:

  •  China does not really need to change because a lack of attention to profit in the use of capital confers economic advantages because: investment makes the economy more productive and thus generates positive side effects (including taxes); a broader view of the economy is taken which sees capital as only one component; and there are more protections than are generally understood [1]. See comment on this view in China: Sustaining Growth by Neglecting Profitability?
  • China's financial system is sufficiently protected from the risk of crises because: (a) its banks are being used to fund what elsewhere would be government spending; and (b) any potential problems in its banks can be covered by the government which has low debt levels and large foreign exchange reserves

[Comment: this involves claiming that a poor balance sheet for a country as a whole can be ignored by claiming that this is a matter of sovereign risk, and that sovereign risk is not an issue for a country with large foreign exchange reserves. This certainly seems to be what has been assumed - yet: (a) this protection can only be available so long as it is not necessary to borrow in international markets - which requires trading partners who are willing and able to continue indefinitely with current account deficits and rising debt levels; and (b) poor balance sheets are likely to be a symptom of badly directed investment - see also China's financial challenges are not limited to its banks and Resulting Interchange with Yukon Huang ].

  • China's economic reform agendas will create a basis for sustainable growth
An economy that starts process of modern economic growth can never stand still. China has been undergoing change since 1978 decision to pursue market-oriented reform and integrate into international economy. Changes, that amount to a new growth model, are now being forced by labour scarcity; rising wages; changes in resource allocation / income distribution / environmental impacts; and rates of growth / savings / investment / international capital flows. From 2004 China's old model suffered from wages rising above productivity and from decline in working age population from 2012. The old model's involvement with large current account surpluses was of concern because of its possible role in 2008 GFC. Uninhibited investment growth was also approaching limits. income inequality was becoming a source of social tension. There was international concern about China's contribution to greenhouse gases buildup. Corruption was also seen as a source of instability. Thus China entered transition to advanced modern economy - with a declining share of GDP associated with investment; heavy investment in education; higher quality education; expansion of consumption / services; reforms needed for legal and institutional basis for advanced market economy; structural change to technologically sophisticated industry. These changes reduced the contribution to growth by labour and capital - and increased the effect of institutional improvements. this requires less use of fiscal and monetary expansion - and acceptance of moderate slowdown without Keynesian response. Higher priority is attached to environmental amenity; energy savings; reduced carbon intensity. Rising wages are reducing income inequality. Government payments for rural education, health, transport, communication and an income safety net have increased. Measured inequality has started to fall.  [1]

The reforms announced by China' Third Plenum involved: (a) top level backing; and (b) a full market system. Reform would rely on top-level design rather than 'crossing the river by feeling the stones'. The most important statement is tht wherever market mechanisms work to allocate resources government should not intervene. This transition is leading to slower growth and rebalancing. Higher wages cut into profit margins, investment returns and export competitiveness - but increase household income. External surpluses decline. But there were also proposals for financial liberalization. The effect on rest of world will be to reduce China's contribution to external growth and perhaps increase risk of inflation. Expectation of a China collapse should be viewed with caution. China's outward foreign investment will provide opportunities. The privileged position of monopoly SOEs is coming to an end. China will remain a strong market for food and resources - and increasingly for consumer goods. China will rise up economic ladder with increasing innovation.  By 2020 China should be a market economy, a high income economy, the world's biggest economy and a vibrant consumer market [1]

  • while there is concern about possible defaults in China's bond market, this risk is minimized by the ownership structure of the companies that issued the bond (ie many are owned by the Chinese government) [1] [CPDS Comment: All segments of China are ultimately subsets of the Chinese state. The question that needs to be asked concerns the financial viability of the whole system. The Chinese state ultimately inherits bad debts associated with the banking system, local government and SOEs all of whom have problems]

Or Maybe There IS a real Problem (2014+) [<]

At the start of 2014 the prospect of a financial crisis in China (a consequence of the escalating debt problems outlined above) was finally gaining observers' attention as an economic threat.

China's local government debt ($3tr) is now seen as the biggest 'known unknown' threat to global financial markets. China's spiraling credit addiction is a major problem as it struggles to maintain growth and avoid a financial crisis. Local government debt has risen 70%. Local governments borrowed heavily to maintain China's growth after GFC by spending on special projects. They were unable to borrow from banks - so special investment vehicles were established. Many investments may not produce enough return to pay interest / principal. Local government debt is now about half of China's total $5tr public debt. Cutting lending would have severe economic impacts - but QE could be used to deal with the problem. US government debts are about $17tr. China's government needs to relax their grip on liquidity, tighten control on state banks and control shadow banking sector. China's biggest advantage is that US is now growing 4% pa [1]

China's financial system is in danger of being too big to bail out. Official bank lending has more than doubled since the GFC - growing twice as fast as economy. The shadow banking system is a bigger problem -as it allowed companies / individuals (often with political connections) to borrow from state-controlled banks at low interest rates and re-lend at higher rates to private businesses desperate for credit. Now Communist Party has sought sweeping financial reforms. Markets will play major role in directing economy. Interest rates will be liberalised, cross border investment welcomed and regional / bureaucratic protectionism curtailed. Modest changes are already causing turbulence. Central bank had to back off to avoid stress on banking system as vested interests objected to paying more for what had been cheap loans. Efforts are being made to raise interest rates to reduce credit expansion. Market-driven interest rates have soared twice - though not for long. Tightening will induce de-leveraging. A complex / loosely regulated network of financial go-betweens has sprung up to profit from repackaging / reselling China's new mountain of debt. These investment products (which pay higher interest rates) have become popular with ordinary investors. But such products can be risky. The final users of the money will not be able to earn enough in slowing economy to repay loans. There is an expectation that Chinese people could withdraw money from banks - out of concern for stability - and thus make it impossible for them to continue funding SOEs and politically connected individuals (even where such loans are to repay existing loans). China's banks have been profitable despite lending at low rates, because they paid even lower rates on deposits - and savers had few alternatives until recently.. Real estate prices are now stratospheric relative to incomes; sharemarkets are distrusted; and shadow banking businesses require periodic intervention. Total credit in China (though growing fast) remains slightly below that in the West relative to GDP - though the percentage of non-performing loans could be higher and China's poorly regulated financial system may be harder to bail out than others  [1]

China's banks are now set to seek overseas bond buyers to provide cash. They need to raise $370bn from share / bond sales over 5 years. With growing levels of bad debts they can no longer rely on share issues to raise capital [1] [Comment: Avoiding the need to borrow in international profit-focused seems vital to protecting against financial crises where profitability is not sought in the use of capital];

Soros argues that China has become the major source of global economic uncertainty. Its past growth model is unsustainable - and current policies contain profound contradictions. It has been necessary to emphasise growth over structural reforms - to avoid a deflationary downturn, Growth has been highly dependent on expanding credit. There will be a need for political reforms to overcome China's problems. There is a strong parallel between China's situation now and the US in 2007 - though a big difference is that in China the state has control over the financial and economic systems, while in the US financial markets are independent [1]

China's national audit office has released results of country-wide survey of government debts. Local government debt growth has averaged 20%. Total debts rose 3.9tr yuan ($US720bn) to 10.6tr yuan over past 3 years. . They also guaranteed 2.7tr in others debt, and must cover 4.3 tr yuan in other liabilities. Total local government liabilities are 19.6tr yuan - about 1/3 of GDP. Central government debt is 9.7tr yuan. Total government debt is about 54% of GDP. This total debt level is concerning - but not an immediate risk. The biggest problem is the rate of debt growth while China's growth slowed. Also some areas face much greater debt risks than others. Moreover  history shows that in a crisis current government debt levels can escalate rapidly [1]

[CPDS Comment: It is unrealistic not to include the liabilities of China's banking system and shadow banking system - which are extensions of the neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  - as part of China's government debt. It has been noted that China's banks are used to undertake quasi-fiscal expenditure (ie undertake spending that elsewhere might be funded by government) and that the associated losses are not seen as a risk to the banks because government will cover the cost. Credit creation by the shadow banking system has also grown rapidly - and apparently often been associated with dubious investments.]

The rise in shadow banking has been a major reason that China's debt has soared at a pace similar to the US and European nations before they crashed. Since 2008 domestic debt has ballooned to 216% of GDP from 128% and could climb to 271% by 2017 if not corrected - according to Fitch Ratings. 34% of local governments' debts came from non-bank sources [China to rain in shadow banking', The Australian, 8/1/14]

China has set up arrangements to address the bad debts of its financial institutions [1]

China does not really know the extent of local government debt - according to China Beige Book International. China's state auditor came out with a figure - but this could only have been a wild guess - as the data is simply not available [1]

China faces major problems with debt. A cash crunch is looming. Affordable credit is being rationed. Foreign buyers are obtaining nearly completed buildings at severe discounts from distressed developers. Shadow banking system rose from 20% to 30% of all lending over past year (though some say it could be 50%). Growth generated from each extra yuan of credit has collapsed from 1 to 0.25 over past 5 years. China is now trying to deleverage without economic collapse. Money supply is 120tr Yuan - but inadequate as velocity of money is very slow and interest rates are rising. China might manage the problem because all contracts can be re-negotiated. Stock market is not a real market - as it is wholly government controlled. But efforts to limit speculation cause more speculation. When China opens its capital account, there will be a rush of money offshore - and perhaps trigger disorderly fall in real estate prices. defaults by financial institutions are looming. China is riding a $24tr debt tiger that it can't control. Loans have risen from 120% of GDP to about 220-250% since GFC. This is unprecedented for a large state. There will not be a banking crash as financial system is an arm of the state. Its ending will be quite different [1]

[CPDS Comment: The 'difference' in the ending of China's debt crisis could be that it beings down the whole Chinese state, not just the financial system]

 Most analysts expect China's economy to continue to grow - but China has had rapidly rising debts. Only 5 developing countries have had similar credit booms and all have suffered credit crises and economic slowdowns. China's 'credit gap' - increase in private sector credit as proportion of economic output - has risen 71% to 240% over past 5 years. Over the past 50 years 33 countries with the top credit gaps (42% or more) - and 22 of these suffered severe credit crisis. Many believe China will be different. Rate of credit growth (not total level of debt) seems most significant - because this increases risk of wasteful investment. This seems to be China's problem. Five years ago $1 of debt generated $1 of economic growth - now this requires $4. One third of new debt goes to pay off old debt. China is seen to have protection against a debt crisis in the form of foreign exchange reserves and a current account surplus - but this is no protection against a domestic credit crisis.  Other countries with large reserves and current account surpluses (eg Taiwan and Japan) have suffered crises. China may avoid a credit crisis - but this is unlikely [1]

Trust and bond defaults are expected in China in 2014 given the number of debt-plagued companies near the edge. 1/3 of outstanding ($836bn) trust loans mature in 2014 - which many struggling firms rely on for capital. Construction / property companies are heavily dependent on debt-laden local governments. About half of local government debts ($17.9tr yuan in mid 2013 up 67% since 2010) comes due in 2014. Maintaining China's growth will be increasingly difficult. Other countries reliant on supplying inputs to China are feeling difficulties also ['China's leaders signal growing unease as overseas producers feel the pain', The Australian, 6/3/14]

China's exports fell 18% in February 2014 (rather than increasing 7.5% as expected) while imports rose more than expected. This led to expectations that China will be unable to achieve planned growth rate and to iron ore price falls. New bank loans in China fell by 50% in February [1]. It is possible that this fall in exports might reflect the ending of previously inflated data - as capital was slipped into China disguised as exports [1]

Very weak data from China and Japan led to a sharp sell-off in Asian markets and a significant decline in iron ore prices in March 2014. Lending through China's shadow banking system had ground to a halt in February 2014 (down from $160bn in January) - at about the same time that China experienced its first corporate default. It is very hard to engineer a soft landing for China as it accounts for half of the $30 tr increase in world debt over the past 5 years [1];

Falls in copper / iron ore / and China's currency values reflect more than poor trade numbers. The issues go to heart of China's banking system and the activities of hedge funds. Copper is more than a simple commodity for China's banks. It has been used as collaterale for bank loans to property developers - and thus became part of the banking system. China's banking system is stressed. Credit increase by $13tr to $15tr over past 5 years. Much of the funds (especially recently) have been borrowed in $us - - to take advantage of US QE. But this now gives Chinese banks exposure to falling yuan. Declining yuan thus has negatives for China rather than simply increasing trade competitiveness. Rapidly rising lending has been accompanied by strange bank lending deals (eg like copper based real estate funding). China's steel mills are under pressure because of falling steel prices - but were given letters of credit to fund iron ore purchases and this assisted in getting bank loans to keep steel mills afloat. This created artificial demand that boosted iron ore prices. Now falling iron ore prices place huge pressures on China's steel mills and banks. Hedge fund shorting has compounded the problem - by targeting copper and iron ore to further force prices down. This accentuates the problems facing those exposed to those commodities. China's government or central bank will need to fix this problem [1]

China's present government inherited a dangerously unbalanced economy - which had been sustained by government-sanctioned spending on construction. AS this starts to be unwound, cracks are appearing (eg in steel sector where loss-making producers had long been supported by government subsidies). Some are now likely to default - and government expects that such failures can be localised and not have system-wide consequences. But China's economy has been accustomed for years to huge quantities of government cash which have funded massive projects (eg empty cities and over-capacity property development). Without this stimulus, and given necessary tightening, bank lending will slow and substantial segments of real economy will be in difficulties. In some regions entire towns depend on industries that are no longer needed [1] -

China faces the biggest ever property default as credit curbs threaten to break the property boom and leave a string of ghost towns (now likely at 10 sites, not just the 2 previously well recognised). Developers are running out of cash. This is undermining land sales needed to provide local government revenues. China's residential property investment to GDP ratio reached 9.5% in 2012 higher than peaks in Japan and Korea and much higher than during sub-prime bubble in US [1]

Devaluation of the yuan threatens a wave of forced selling and increasing problems for those with $US debts. There is a fire sale of Hong Kong real estate by those desperate to raise cash in the face of liquidity squeeze in mainland China. The losses on structured products as yuan devalues could force further devaluation and losses [1]. Alternately devaluation of the yuan can be viewed as part of deliberate Chinese strategy to stem hot money flows into China which had over-heated property markets [1]

China seems to be headed for a 'hard landing'. It has had 30 years of strong growth. Until 2007 this was driven by exports and investment. Imbalances both external (current account surplus) and internal (high investment-GDP ratio and low consumption to GDP) have increased. These are seen as inherent feature of China's growth model related to three price distortions (ie for exchange rates, wages and interest rates). Great Recession of 2008-09 made export reliance harder because of weaker demand growth elsewhere and yuan appreciation / increasing wages which impeded competitiveness. Thus growth depended even more o investment - and external imbalances reduced sharply while internal imbalances worsened. The fall in China's trade surplus reflected commodity imports - usually at high prices - because investment surge was commodity intensive. Though government has committed to rebalancing, this has not yet occurred - perhaps because of insufficient effective reform. Fundamental features of China;'s growth model (eg financial repression) remain uncorrected. That model has reached its limits - as shown by China's steady slowdown since early 2001. This could lead to a Japanese-style 'hard landing'. Reasons for suspecting this are: historical rebalancing precedents (most countries with similar model to China's experienced sharp growth slowdown; China's characteristics are those of other countries that experienced slowdowns); overinvestment (some see 12-20% of GDP being over-investment; capacity utilization fell from 80% before crisis to 60% in 2012); unsustainable debt trends (investment surge was largely financed by debt); and a real estate bubble (situation is like Japan at start of 1990s, and investment option in China are limited to real estate). [1]

Is China different, or must its debt binge end in tears. While China won't have a meltdown, growth will slow. China's net exports fell from 8.8% of GDP in 2007 to 2.6% in 2011. This was offset by sharp rise in investment. The latter was associated with explosion of credit and debt. Social financing rose to 200% of GDP (up from 125% before GFC). Most increase has been outside traditional banking. Private sector credit is now as large (relative to GDP) as in US in 2007. China's growth has slowed to 7% pa. If this data applied to a company a bad outcome would be expected. However it has been argued that: China borrowed to fund investment; companies are the main borrowers; and China does not depend on foreign lenders; and yuan is not freely convertible. However others have had problems with excessive corporate investment, and a substantial amount of investment (eg 12-20% of GDP) may have been squandered. The other points are stronger. Yet credit can't grow faster that GDP in China forever. Debt accumulation is likely to end with a wimper, not a bang. Households and smaller enterprises have subsidised SOEs. These subsidies will have to increase - harming the economy, if growth is to continue. China faces major difficulties in arranging a transition [1]

China has the greatest construction boom / credit bubble in history. China's development since Deng has been based on monetary and credit inflation. In 2000 US had $27tr credit - and this rose to $59tr (ie at 7% pa). In 2000 China had $1tr credit but now it has $25tr. There is no real banking system in China - just bureaux that distribute credit from the top. There has never been any real pricing or honest accounting. There is no financial discipline based on contract law. China's GDP grew $10tr after 2000 - without anyone ever apparently making mistake / loss. China had 1.5 bn tons of steel capacity - but use for only half of that. This is also true for cement, ship-building, solar power, aluminium. It also has 70m empty apartments. Local governments have little income, but large debts supported by inflated land values. Coal mines face collapsing prices / revenues - but double digit interest rates on shadow banking loans collateralised by overvalued coal reserves. Shipyards have no orders, but vast debts collateralized by their idle construction bays. Speculators have collateralised massive copper / iron ore stockpiles at outdated prices. Onece asset values start falling, its pyramids of debt will stand exposed. Zhejiang Xingrun Real Estate may be the catalyst for collapse - though there are thousands of other possibilities.  It borrowed $562m of which $112m was at 30% interest. It proposed a redevelopment project - but was unable to proceed because it was bogged down in a lawsuit with residents. It continued rolling over loans. But private lenders no longer want such risky projects. There are calling in loans. And real estate values are declining . Its default will add to local government debts and thus to provincial debts [1]

Major Chinese banks claim admirably low non-performing loan levels - but no one takes the official figures seriously. A mini bank run in Zheijiang could be a sign of things to come [1]

Many observers now believe that China's property bubble is like Japan's in 1990 and that it is only a matter of time before it bursts [1]

Turnover in China's property market fell 45% year on year to May 2016 and 19% over the previous month. A fall in property turnover has often been an indicator of recession. There are 53m unoccupied properties in China. Property development has accounted for 16-25% of China's GDP [1] - as compared with 6% of the US's GDP prior to the GFC [1]

China has backed away from long term structural reform because of the need to respond to its slowing economy [1]

China has suffered from a debt addicted economic growth. Other countries who have had a rapid rise in credit (eg a 40-50% increase) over 5 years have suffered serious financial crises (eg Japan to 1990, Korea to 1998, US and UK to 2007). China's debt-expansion (at 87% since 2009) has been much greater. Corporate debt in China is now greater than in US. The average Chinese company has been seen to have worse cash flow and more debt that firms anywhere else. Other countries also have accumulated debt problems (eg Japan, US, various European countries). It is only a question of who will hit the wall first  [1].

The state-owned Bank of China has been accused of money laundering and not complying with foreign exchange controls. Clients allegedly were helped to 'launder money' (eg illicit money gained by corrupt officials and businesspeople). There is a dilemma facing China regulators. They are seeking to promote financial liberalization and outward investment. But at the same time there is an unprecedented crackdown on corruption - and many officials are fleeing China. China could be preparing to clamp down on the illegal outflow of capital [1]

Debt plays a major role in recent evolution of China's economy. Investors take debt issues more seriously than economists, Many analysts get China wrong because they fail to understand the distortions driving the economy (especially the creation of debt). Unbalanced growth may make sense initially - but this has to change at some point. Eventually the imbalances must be reversed - and in countries with centrally managed economies like China the imbalances can have become extreme. There are various ways in which China could rebalance away from reliance on rapidly rising debt - but they perhaps require 4-5% of national wealth being transferred from state to household sector annually and growth rates on 3-4% (not 7-8% as at present). Everyone now recognises China's debt as a problem. However some see that this is merely a matter of administrative changes to eliminate the distortions in shadow banking system. But the reality is that escalating debt has been a fundamental part of the way the economy worked. There has to be a massive transfer of wealth from state sector to households to change this. Some believe that China's debt problem can be solved by socializing it - ie transferring it from banks to state - and that as China's total is less than in Japan (where high debt levels have been managed) this should not be a fundamental problem. But Japan's government debt has been sustainable so far only because GDP growth and thus interest rates have been close to zero. Socializing China's debt (or transferring local government debt to central government) would reduce the risk of legal defaults - but do noting to resolve the actual problem of resolving the debt problem which requires assigning the costs. China has been misallocating investment for years (ie generating returns on investments much less than debt service costs) and, because there have been no debt write-off these implicit losses remain on balance sheets of China's banks. GDP has thus been over-estimated (perhaps by 20-30%) by not writing down these losses. Productivity numbers have also been biased upwards. Losses that are rolled over do not disappear - but has an adverse economic effect in some way. GDP growth only increases while increasing amounts of losses are being rolled over, and is reduced when they eventually are written off. The difference can be very significant in terms of reported GDP growth (eg increasing a desired 7% pa growth to a reports 10% pa while losses are rolled over, and reducing it to 4% pa when they are being written off). The problem would be worsened by distress costs during the write-off phase. Debt can only be resolved by assigning the losses. China has hidden losses in its banking system - and China's government has to decide how to assign them. China can't assign losses to households as it did previously by financial repression without suppressing domestic demand, generating social unrest and creating an escalating requirement for increases in debt. If losses are assigned to SMEs then the engine of China's future growth will be affected. Assigning losses to state sector would be difficult as China's elites profit from control of state sector assets - and will thus resist attempts to assign them losses. The losses in the balance sheets of China's institutions can't simply be ignored. They have to have an effect somewhere [1]

Chinese property buyers are not concerned about a property bubble. But prices are falling and some see major problem. The risk that China's banks / shadow banks face is not the same as in the US. Rather the risk is that property is used as collateral for everything else - as applied in Japan before its 1980s' boom collapsed. Property is 15% of China's GDP. Authorities have sought to constrain China's property boom - and the effects are now becoming obvious. Credit drives expansion of China's property market - and when this fades property is directly affected. Since 2008 China's money supply expanded three fold - with most going into property. Constraints on credit to developers requires then to cut prices which discourages buyers. Developers are seen as the weakest link in China's property market. The market could be supported by: easing of government restrictions; relatively low level of household debt; requirements for large deposits mean that loan / valuation ratios are low [1]

China is seen as likely to experience a full blown banking crisis. Authorities are understating the extent of bad loans on their books - and will face difficult choices when bank failures start . 20 years ago authorities responsibility for 30% of bad loans in the system - but now claim this is 1%. A Chinese 'Lehman Brothers effect' could result if small banks are allowed to fail [1]

In China almost all debt is government debt - and bankruptcies / corporate failures are rare. Will Beijing step away from this practice, or might it face a situation where government is unable to prevent a broad unraveling? A $500m investment vehicle recently faced default. China's government its four pillar banks to have a massive borrowing-lending spread. Private borrowers can't usually get funds from them - but must rely on alternative vehicles (the 'shadow banking' system). The investment vehicle had been set up by one of the giant state banks - and a 'white night' rescued it. This was an entity that had been set up as a 'bad bank' to hold the assets of the major bank in 1999. Authors of red Capitalism argue that this is a shell game - where assets move around as Beijing maintains a fiction that NPLs are 1%. Now the AMCs are being listed as the communist party struggles against financial losses of all kinds. Since 201 China's banking assets have grown to double those in US. To postpone NPL time Beijing can print money. This casts a shadow over the prospects of real financial reform. 15 years ago the prospects of reform seemed better. It is now necessary to belatedly build on that start [1]

China risks heading in the direction of Japan - a nation synonymous with decaying first world economies. Urgent action is needed by authorities to prevent economic stagnation. China's problems are more serious than those in Japan. There are strong signs that the housing cycle is tipping over. Japan experienced rapid growth in second half of 20th century to become world's second largest economy - but was derailed in early 1990s - and is now mired in high inflation, low growth and high government debt. China's government debt problem is even worse. China may go the way of Japan as bad debt accumulates rapidly and assets deflate in value. China's problems are similar to Japan's - ie unbalanced growth; government stimulus; over-capacity; and overwrought housing market and an under-capitalized financial system. However there are steps that China to take to improve its position [1

The People's Bank of China will inject liquidity into the five largest banks in what is seen as as a form of quantitative easing [1]

China's attempt to achieve financial reform is running up against the pressing need to maintain growth. Growth has slowed. Beijing has tried to avoid short term stimulus measures at the expense of longer term reform -- as banks, companies and local governments carry huge debts, China's central bank has long sought competition between state owned banks and to get more money into consumers' hands. People's Bank of China offered money to banks at discounted rate - so that it could go to commercial enterprises - but political connections still proved dominant. Unlike US Federal Reserve, China's central bank is not independent and for decades directed banks to provide politically approved activities. With growth stalled China's leaders have made it clear that priority should be given to stimulating growth - and it is hard to also seen financial market reforms. The central bank is concerned that new funds made available could stimulate demand for loans to support real estate. Policy makers are now trying to prevent property market becoming an economy-wide crisis [1]

China's financial sector was reasonably sound prior to GFC - but since then its has become the biggest threat to China and perhaps to the world economy. The cause of the problem was probably the adoption of rigid economic growth targets and incentives that encouraged over-performance [1]

China's industrial production has fallen to lowest level since 2008. Retail, investment and housing all point to a slowdown. Government has given $81bn to 5 major banks - but this will make little difference, Corporates (especially in mining, property and industrials) face grim future. China's corporates took on 5.4 times more leverage in first half of 2014 than they had before - restoring levels like those in 2006. This has largely been unintentional - as debt growth has been decelerating. Situation is unsustainable - and government insists it won't provide rescue with big stimulus. Chinese companies seem to be in terrible position as in 2008 and 2011 - and on both occasions growth decelerated. Defaults, credit events and failure by weak companies should be expected [1]

There is a need for close attention to China's banks, China has to cope with a slowing economy and cooling real estate markets. Government has made it easier for households / business to borrow. This won't address growing pile of bad debts. Debt can still be increased at the moment - but the rate of debt increase since GFC is alarming. Since GFC over half of China's GDP has been from debt financed investment. This led to historic rise in property values which is now slowing. If this reverses significantly China economy could be badly damaged [1]

Despite this other observers have argued that problems facing China can be ignored because China has demonstrated a superior ability to avoid the effects of potential financial / economic crises in the past.

This might however be invalid. China's society and economy had responded to centralized coordination through a quasi-bureaucratic neo-Confucian hierarchy centered on the so-called 'Communist' Party - just as Japan's had done at least until the 1980s (though in Japan's case it was the actual bureaucracy that had provided that coordination) - see Understanding East Asia's Neo-Confucian Systems of Socio-political Economy

However this was not a sustainable arrangement because centralised coordination through an elite hierarchy that is able to create credit for 'desirable' investments with limited or no regard for return on capital (see Evidence) is a formula for escalating and unserviceable debts. Japan grew rapidly in the second half of 20th century but then became mired in low inflation, low growth and significant government debt. China now has an even bigger debt problem

Moreover for such systems unsustainable debt levels create the risk of political collapse (not just a financial / economic crisis) because it is the governing elites themselves (eg the so-called 'Communist' Party or Japan's bureaucracy) rather than private entities that would lose control if huge quantities of debts have to be written off. When Japan's financial crisis followed the excess credit creation of the 1980s, bad debts were concealed to be written off slowly so that Japan's governing elites would not lose power. The result was decades of economic stagnation.

To minimize the risk of either economic stagnation or political collapse China arguably needs to reduce the role that affiliates of the neo-Confucian bureaucracy - the so-called 'Communist' Party (ie state banks and politically connected individuals) play in allocating / using capital and place greater reliance on independent profit-oriented decisions in a market context. Another justification for doing this would be to reduce the wealth inequalities that have resulted in China as many have exploited their positions in the economic hierarchy. The (possible) extent of the corruption (and its adverse economic effects) can be seen in 2014 suggestions (of unknown validity) that up to $4tr (almost half of China's 2014 $9tr GDP) have been corruptly moved offshore by Chinese officials since 2000.

However, if this were done, the view that China will successfully manage its current challenges because it has done well in the past would be invalid (because the key to moving forward would be to demolish past machinery)

Though not all are convinced (see indications), the possibility that real market reform was intended was supported by:

  • suggestions by Chinese analysts (see above);
  • a perception that China's president (Xi Jinping) has orchestrated an anti-corruption campaign across China. This has consolidated his power and resulted in jail sentences for his former political rival, Bo Xilia and for many other prominent officials [1] [CPDS Comment: another interpretation of these purges is that they have had the effect of eliminating those who might have sought a more truly 'communist' China - in which social elitism and gross wealth inequality is reduced. This certainly seemed to be the basis of Bo Xilia's populist campaigns - which appeared to favour a return to a variant of the Mao era and a primarily state-owned economy]
  •  the reported flight from China by rich Chinese (most of whom presumably gained their wealth from connections with the Chinese state) in order to get their wealth out of the reach of a reformist Chinese state. One third of China's 'super-rich' were reported to have already left, while another 1/3 were said to be considering leaving [1] [CPDS Comment: another interpretation of a large-scale shift offshore by China's economic elite would be that this is intended to provide a means to orchestrating a global, rather than a purely domestic, Chinese economic empire];
  • lending through China's shadow banking system ground to a halt in February 2014 (down from $160bn in January) - at about the same time that China experienced its first corporate default [1] an indication that government would no longer automatically bail out failed ventures;
  • a China Development Forum in March 2014 heard acknowledgement of China's economic challenges (which included demographic constraints on labour force; rising financial risks; pollution; and water-availability constraints on resource-intensive growth) and proposed liberalizing reforms to provide a basis for China's future political and economic success (see details below).  [1] [CPDS Comment: The problem with such proposals is the same as it has always been - ie that 'liberal' arrangements seen incompatible with China's traditional culture - see also China's Credibility Problem ]
  • there is a perception that China's efforts to promote the role of the yuan as a international / reserve currency is a sign of serous intent to establish a free-market financial system [1]. However this is not necessarily so.

Are Yuan Reforms an Alternative to Market Liberalization? - email sent 27/3/14

Geoff Weir and Kathleen Walsh
Australian Centre for International Finance and Regulation

Re: Casey M J., China markets to take off with yuan reforms, The Australian, 27/3/14

There are possible problems with the suggestions ascribed to you in the above article:

“CHINA is poised to accelerate liberalisation of its capital and foreign exchange markets, a move that will turn the yuan into a major reserve currency within 10 years and catapult Chinese stock and bond markets into the ranks of the world’s two biggest, according to researchers from an Australian government-sponsored think tank.

A comprehensive report by Geoff Weir and Kathleen Walsh from Australia’s Centre for International Finance and Regulation argues that if new experiments with free-market finance in the Shanghai Free Trade Zone succeed, Beijing will expedite the opening up of China’s capital account.

Such a move, which would allow more or less unrestricted exchange of yuan for other currencies, has been flagged as a five-year goal by the Chinese Communist Party’s Central Committee.”

While there is little doubt that China would like to see the yuan become a recognised ‘reserve currency’ this would probably be regarded as an alternative to the adoption of a true free-market financial system because there are massive cultural obstacles to the adoption of such a system within China itself (see China's Credibility Problem). Moreover China is arguably facing a financial, economic and political meltdown unless it can convince the world that yuan are worth having irrespective of the true balance sheet of China’s banks and government. Where financial institutions do not take profitability seriously (see Evidence) the need to borrow internationally (which China’s declining current account surpluses suggest is imminent) is a formula for financial crises – unless one can borrow in a ‘reserve currency’ that one manufactures oneself.

The view of an experienced ‘China-watcher’ about one of the issues you reportedly mentioned is referenced in Not Everyone is Convinced that the Shanghai free-trade zone is serious.

I would be interested in your response to my speculations.

John Craig

Observers had both positive and negative perceptions of China's economic reform agenda.

China's premier presented his annual Work Report in March 2014. It referred to maintaining 7.5% pa growth and free trade negotiations with Australia. It also targeted international audiences with references to pollution / corruption reduction - and targeted China's political business elite in warning of break-up of government monopolies and corporatising financial services. In relation to concerns about a 'hard landing', China's government committed to reducing its deficit, spending cuts and a wider trading band for renminbi. Foreign trade would be increased, conditions for foreign investors improved and outbound investment streamlined. There was a wider blueprint for wide-ranging market and fiscal reforms as the foundation of deregulated and liberalised economy. Reforms related to marketisation, entrepreneurship and public finance were outlined at Third Plenum. These were converted to deregulation agenda involving abolition of government monopolies, opening state-controlled industries to private capital and banking sector corporatisation. private entrepreneurship is recognised as contributing to innovation / job creation. Private sector would gain better access to bank finance and protection of intellectual property. Markets for services and other areas would be opened to foreign participants. Most reforms are just on paper - though some are being trialled locally. They would be complemented by social welfare reforms (eg extending the right to live in cities). The problems of reform in China have long been known - but now there is a government plan that permits private entrepreneurship and a market-based fiscal system. This is like deregulation in Australia during Hawke / Keating years. However implementation is likely to be gradual. Chinese government's desire for a better market economy and better system of governance is now indicated. [1]

Everyone wants to hear of 'reform' in China. Those who rejected criticism of China's system now say that its system needs 'reform'. China's premier recently spoke more about maintaining growth than about 'reform'. Reforms mentioned included: closing idle factories; encouraging private investment; cutting red tape; encouraging consumption, rather than investment, driven growth. But these are not real reforms. What is the  'market-based reform' to which Chinese leaders are committed? Real reform requires: (a) encouraging real competition between firms / individuals; and (b) building institutions needed for fair and even transactions between economic entities and for 'creative destruction' of undeserving entities. One requirement to achieve merit-based competition would be winding back the special position of SOEs. However at present all that is being done is apply band-aids to problems created by SOE dominance. Raising the social safety net can not significantly encourage consumption. Rather this requires enabling millions of private firms to seek opportunities by reducing SOE role. However SOEs continue to be subsidies at expense of consumption. Interest rates are kept low to give SOEs cheap finance. Investment options are limited to state-owned banks. Creating private banks won't overcome the bias to financing SOEs which is implicit in their government guarantee. Profit is not the way market-worthiness of firms is judged in China. Many SOEs are profitable because of advantages given them - not because they are more efficient or provide better products. Also the advantages given SOEs mean that they can ignore measures intended to improve environmental situation. Chinese officials claim that institutional support for fair competition is proceeding. And urban residents now have more secure long-term lease rights. Contract law is generally enforced. However in important ways reform has ground to a halt.  When the state or SOEs are involved in disputes, problems arise because the state controls courts and tribunals. Millions of rural residents have had property siezed to allow developers to profit in property market. Land rights would be the best way to remedy rural poverty in China - yet government has to pour in huge subsidies to compensate for lack of land rights. To avoid the 'middle income trap' China needs real reform [1]

Japan was seen to be likely to overtake US economically in 1980s - but asset bubble burst. Plunging share / land prices led to banking crisis (with $US 950bn banking losses from 1992 to 2007). Japanese government spent $500bn on non-performing loans. China could be going the same way with non-performing loans. NPLs of 12 listed Chinese banks are (officially) $A67bn. China's banking regulator has demanded better performance. China seems better prepared than Japan to now avoid a crisis. Corporate debt is likely to fall over coming years, and credit growth has been constrained. Rate of private debt growth / GDP in China is below that in US, UK, Spain.  China's banks have strong balance sheets to withstand losses. In 1980s Japan's banking regulator did not take pre-emptive steps to curb credit expansion. China's homebuyers need to find 30% deposit (or 60% for second homes). Banking reguator has implemented Basel III capital framework. In early 2000s banks had 40% NPL rations - so government injected a lot of capital. This could happen again. Japan's government could not do this in 1980s. China's rapid growth rate is higher than in Japan - and this provides a buffer. None-the-less China's banking system will come under stress. [1]

China skeptics used to be regarded as curiosities even as late as 2010 -but since 2011 this view has been more widely considered. The focus is now less on China's double-digit growth model and more on what level of chronic slowdown it will suffer. Intellectuals can tend to get things wrong because they are 'slaves to fashion'. Hype about the China model has been led by: (a) those who could profit from that hype; (b) those who advocate engagement with China to ensure its peaceful rise; (c) intellectuals / malcontents who were seeking an alternative to Western-style capitalism - and hoped that the Beijing consensus would avoid the chaos, corruption and indecision that can affect developing countries. Those with no experience of China's system fantasized that an all-knowing / all-powerful political party can avoid short-termism, political disputes, factionalism and other democratic features; and (d) the Communist Party - which needed to have a good story to tell to attract foreign capital and resist pressure for property / intellectual property rights and a rule of law [1]

 'New normal' is used to describe China's slower (ie about 7% pa) annual growth. However there are significant structural change. China long pursued a mercantilist model that prized production over consumption. But consumption is now seen to exceed investment. Services now account for 46.7% of GDP growth. Ryan Rutkowski (Peterson institute for International Economics) cast doubt on these nominal Chinese figures. He suggests that rebalancing is occurring but more slowly than claimed.  [1

China's anti-corruption efforts have been seen to be directed against opponents of the ruling regime, and suspicions exist about those in senior roles in the regime (see below)

The way bad debts disappear in China raises troubling questions about China's plan for its financial system [1]

One possibility that occurred to the present writer was that reform could ultimately involve a break-up of SOE's enterprises (ie to bring to an end the Mao-era economic arrangements that Bo Xilia and his supporters seemed to have favoured) and to replace this with a 'market' economy driven by businesses with social links to the state rather than one driven by independent initiative - thus creating a 'non-capitalistic market economy' somewhat like that in Japan..

However if genuinely market-based methods of setting economic directions are required in future (ie those based on independent / private enterprise), China's economy will lack the discipline it has had in responding to the fairly-well-informed consensus developed by the quasi-bureaucratic economic hierarchy. Moreover:

  • massive cultural changes would be required to enable a more liberalised financial system to operate - for reasons suggested (in the context of the 1997 Asia Financial Crisis) in The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems (1998) and in Understanding East Asia's Neo-Confucian Systems of Socio-political Economy (2009+);
  • China's education system does not seem to be geared to creating a population with the cultural characteristics required to operate in a liberalised financial / economic environment (see Financial and Educational Reform in China: Headed in Opposite Directions?, 2013);
  • the creation of a market economy does not necessarily indicate the end of internationally disruptive financial distortions. Japan was said in the 1990s to have a 'non-capitalistic' market economy (ie one in which capital was allocated to a 'market' involving state-linked enterprises with limited regard to financial returns, so that current account surpluses - and trading partners willing to sustain ever rising debts - were vital to avoid a financial crisis). Having a 'market economy' has not meant that those distortions have been eliminated in Japan's case (see evidence).

Structural Problems (above) draws attention to underlying obstacles to reforms to ease these outlined difficulties including: dependence on unsustainable international financial imbalances; over-optimistic assumptions about the economic benefits of large scale capital spending; and incompatibility between Chinese people's desire for social equality (which China had in the Mao era) and the neo-Confucian social hierarchy (centred on the so-called 'Communist' Party) that has been the basis of its centrally orchestrated economic 'miracle' since the late 1970s (and incompatibility that could even lead to another civil war).

An aside on QE: It can also be noted that quantitative easing (QE) to compensate for any decline in the availability of credit as financial institutions suffer the effects of widespread bad debts could be quite risky for China.  Under some circumstances 'printing money' to support state spending can generate hyper-inflation. One factor in containing this risk is presumably ensuring that QE merely compensates for declining credit from other sources. However another factor that has limited the potential for an inflationary outcome from QE in the US / Europe / Japan is that the pricing power of producers (and thus the potential for wage / price spirals like those that resulted from oil price shocks in the 1970s) has been contained by competition from cheap imports (especially from China). This obstacle to an inflationary outcome from QE would not apply to China. It can also be noted that QE does not provide a solution to structural problems in the financial system (eg the effect of international financial imbalances on the requirements for some countries to be willing and able to perpetually increase their debt levels in order to prevent global economic growth from stalling in the face of 'savings gluts' elsewhere). It merely allows debt levels to rise for longer without an immediate crisis, but is likely to lead to severe problems when interest rates subsequently rise to market levels.

Uncertainty  (2014) > >>  >>>

In mid 2014 it was argued that observers expecting China to liberalize economically or politically were misguided as what seemed to have been put in place by president Xi Jinping was a reversion to an ancient Chinese elite-guided style of regime (see The Resurgence of Ancient Authoritarianism in China).

In the latter the present writer argued that introducing this reform reflects the very weak position in which China and its leadership found themselves. China's economy was messy (property bubble, shadow banking) and highly dependent on nothing going wrong with a highly-uncertain global economy. The (so-called) 'Communist' Party confirmed its status as the top level coordinators in a (neo-Confucian) bureaucratic state - and sought to promote virtue to overcome problems associated with a past lack of ethical behaviour by 'Communist' Party elites. Anything that goes wrong is now clearly their fault. Many of the people who orchestrated the economy in the past (and who have vital knowledge) have been marginalized by anti-corruption push. The Bo Xilai challenge was the face of a growing reaction against the currently-dominant factions – who presumably have their power-base in the commercial south (Shanghai) and amongst the Chinese Diaspora. Opposition to this is significant (as much of China puts communal before commercial values – and a desire for social equality is strong). Regime is tolerated so long as economy advances. Opposition is underground / invisible – but could have unexpected manifestation at any time. China’s history is littered with civil wars – which have often seen the predecessors of current dominant factions thrown out of China. Maintaining domestic security is a major challenge.

In August 2014 it was argued (on the basis of research by US Conference Board) that China's recent reform agenda had not put it on a sustainable growth path and that it seemed to be headed for the 'middle income trap' that had affected economies such as Brazil and Malaysia. Productivity growth had gone into reverse for the first time since the end of the Cultural Revolution - a classic sign of the 'middle income trap'. Over-building / over-capacity / the advance of less efficient SOEs into private sector markets have been a drag on China's economy. Growth has relied increasingly on state-directed investment - which the incremental approach to reform had failed to achieve the necessary changes [1].

CPDS Comment: This conclusion is possible (eg because efforts to eliminate corruption from China's government have probably also eliminated many who with the best understanding of China's economy). However it also needs to be recognized that the criteria for economic 'success' that the US Conference Board perceives may not be the same as China's criteria

In September 2014 there were indications that China's administrators might have recognized the true difficulties China faced and intended to confront them - even though this would involve immediate pain. The actual implications of that 'solution' were not immediately obvious. Panic might be imminent.

China's leaders have ignored warnings of an incipient credit crunch - and seem determined to purge excesses from the financial system despite falling house prices and a deep industrial slowdown. Industrial production fell in August. Fixed asset investment fell to record lows. Despite a sharp deceleration Beijing seems calm. New credit has fallen 40% - and there has been a shadow banking system clampdown, A 'credit crunch' is being engineered by regulators. Nominal GDP now grows faster than credit. The property market suffers. Washing machine production has fallen 7.5% over the past year. China's central bank may have to step in to prevent over-kill. Premier Li Keqiang seems determined to implement deep reforms and wean economy off very high debt levels. The money supply was said to be being restructured rather than expanded. Reform will continue so long as growth is strong and unemployment low. China's workforce is shrinking and rural-urban migration is slowing rapidly. Catch-up growth options may be exhausted. Until recently each slowdown was met with fresh blast of new loans - creating increasing problems. Credit / GDP ratio has doubled over 5 years to 200-250%. The economic benefit of new credit has collapsed - and creating new credit was becoming dangerous. Communist Party's decision to constrain credit has global implications - as its $25tr banking system was already as big as US / Japanese banking systems combined. China's industrial slowdown explains why iron ore prices have crashed - and oil demand is below expectations. China's new discipline may not last. The problems in the construction industry are disguised by advance payments that are treated as cash flow. China may find it as hard to deflate a housing bubble as Japan and US did [1].

In late 2014 there were increased reasons for concern about China's economic sustainability (eg see Assessing China's Prospects).

  • In October 2014 an attempt was made to solve the problems associated with China's local government debts - a move that would both:(a) improve future financial transparency; and (b) pass losses associated with poor investments by financial institutions, which had been seen as implicitly subject to some sort of government support, on to those who deposited funds with, or loaned money to, the financial institutions).

China's State Council issued directives to improve transparency, clarify debtors' responsibilities and reduce overall debt. China's local governments have direct debts, debt guarantees and partial responsibility for other liabilities that are about 1/3 of China's GDP - though some are concerned that these figures are understated. Reforms include: (a) allowing local governments to raise their own debt - rather than turning to local financing vehicles - and limiting this to funding infrastructure; (b) reducing moral hazard by making it clear that central government would not bail out local governments; and (c) clarification of who is responsible for debts (to clarify the blurred lines between government debt and corporate loans). Local governments will be unable to raise debt through corporate platforms - and companies can't shift debts to local government. Local governments must withdraw from all commercial real estate projects - and liquidate assets through market mechanisms [1]

CPDS Comment: What has been announced seems to involve the ultimate 'bail in' (ie passing losses associated with poor investments by financial institutions on to those who deposited funds with, or loaned money to, the financial institutions). It seems very likely that these measures will: (a) inflict substantial losses mainly on Chinese savers and companies (given the likely massive level of bad debts that will be written off and the refusal of China's government to accept any responsibility for what local authorities were encouraged to do to sustain China's post-GFC growth); (b) be possible only because of the repressive control that the Chinese state exerts over its people; (c) have the perhaps-serious impact on China's financial system / economy that has long seemed imminent; and (d) provide China's regime with an ability to blame  the adoption of liberal Western style financial reforms for triggering that outcome.

  • it was suggested that China's risks of a financial crisis seemed to exceed that in the US that led to the GFC, and argued that, though Chinese leaders were smarter, China still faced a major challenge.
CPDS Comment: China's prospects can't realistically be understood without consideration of what is different about ways of thinking and doing things in East Asia - see Assessing China's Prospects.
  • China's transition from its past growth drivers is likely to be very difficult, and that indicators of its actual economic growth suggested that this has fallen far more than official GDP data would indicated.

Germany and China are at the center of regional trade blocs. They both trade globally but also depend on their regions. German exports are 50% of GDP, compared with 24% for China (14% for US and 20% for Australia). Germany's primary market is Europe - and it has problems because European economies are struggling to grow. China has much more regional demand - but much of it is from people who lack the purchasing power to buy the goods China produces for export markets. China's reliance on low-cost exports and state-led infrastructure / housing investment are no longer viable. Domestic consumption / high value-added manufacturing / services are not yet of sufficient scale to offset risks of social and economic dislocation (as political legitimacy depends on creating jobs and rising material prosperity). Both Germany and China depend on sustaining strong exports. The Communist Party was shaped by rising unemployment in Shanghai in 1927. The GFC decimated China's low-end export sector - which had been maintained for too long by low wages and subsidies. Exports fell suddenly from 38% of GDP to 24% - and reliance had to be placed on state-led housing / infrastructure investment. The housing boom is now ending. China hopes to expand exports of higher value goods. China's real growth has slowed - and there are deflationary risks in housing / shadow banking system and overcapacity. China's official GDP figures are unreliable. An alternative (China Momentum Indicator) suggests that China's growth is now well below what GDP data suggests. [1]

  • China seemed to be unable to escape from its dependence on a extraordinarily high rate of credit creation despite the declining economic impact of that credit.

China seems to have abandoned its policy of monetary tightening. It has cut interest rates to head off corporate crunch and increasing dangers of deflation. This seems like a return to old ways of credit-driven growth - a tactic that has passed its sell-by date. Falling inflation has caused the real cost of borrowing to rise from zero to 5.5% since 2011 (while non-financial companies face interest costs of 15% of GDP - up from 7.5%). Cutting rates is significant change from recent piecemeal injections of liquidity. It is being forced - but China won't be safe until its dependence on credit creation is constrained. Cuts were needed because of $250bn tightening associated with clampdown on shadow banking system over past 2 months. China is close to deflation - made worse by fall in Japanese Yen and quasi-peg to $US. It is importing contractionary forces when its housing boom is wilting. China requires 20% loan growth to keep economy going - but it has fallen to 15% and this is strangling economy. There is less GDP growth out of increasing credit - which says that loss-making assets are being rolled over. Bad loans are rising 50% p. The biggest problem lies with SOEs whose debts are about 100% of GDP - as compared with 50% of GDP for private corporate borrowing. Central bank has been trying to wean China off credit, but it may have been overruled by state council. China's debts are 250% of GDP which is unprecedented for a large developing economy. Some observers see the problems as manageable with no signs yet of real distress. The cuts to interest rates may not be as significant as some have suggested. China's labour force is declining by 3m pa (due to one-child policy) and this automatically tightens the labour market [1]

  • China's economic dream is at an end

Economists suggest that China will become the world's largest economy. China's president has launched a 60 point plan to remake China's economy - and campaigned to cleanse the Communist Party of corruption. However in 2009 China's economy was growing 10% pa- but is now 7%. GDP statistics are only accurate in terms of direction - and this is now clearly down. China's economic miracle is ending. Success has depended on debt-powered housing bubble and corruption-laced spending. Many Chinese cities are surrounded by vast, empty apartment complexes. Real estate has been the main driver of China's growth for 20 years. Debt paid for the boom - with borrowings by governments, developers and many industries. The IMF has pointed out that only four countries have had as rapid a debt build-up as China (Brazil, Ireland, Spain and Sweden) - and all had debt crises in 3 years. China followed Japan and Korea in using exports to pull its people out of poverty - but China's immense scale is now its problem. It is the world's largest exporter - but can't get much more growth from this. Shifting to innovation will be hard - as its competitor nations encourage free thought and idiosyncratic beliefs.  Few engineering students in China seek to become entrepreneurs - about 1/7 the percentage in Stanford. Xi's reform agenda is standard fr China. But it is hard to make it happen. The government wants to reduce steel production in the province surrounding Beijing (where twice the steel production in US is located). It was decided to destroy blast furnaces - and this was publicly done. But those facilities has had long been out of production. China's steel production is on track for record this year [1]

  • it was noted that debt guarantees between companies had been very useful in allowing small firms with limited collateral to borrow and fuel China's rapid debt expansion in recent years. But as China's economy slows this is now leading to cascading problems and potential regional crises - because some firms are failing and their guarantors are actually having to pay up at the same time that they themselves come under financial strain. China's reserve bank reduced interest rates to take pressure off SMEs [1]
  • it appeared that China had wasted $US6.8tr over past four years (invested this amount ineffectively according the China's National Development and Reform Commission). This amounts to about half of all 2010-1013 investment. Low interest rates and government stimulus measures are seen to be the problem. China's deserted ghost-cities are a major manifestation of this. The problem is likely to continue as the PBoC has slashed interest rates. It is exacerbated by corruption amongst the countries autocratic elite [1]
  • China is experiencing a stock market boom despite having excess capacity in 'everything'. Authorities are striving to contain it, but China's excess savings have nowhere else to go [1];
  • China is likely to experience recession in the next year or so

China is struggling to maintain growth - given shadow banking, ghost cities, slumping property prices, a manufacturing slowdown and debt defaults. Home prices have fallen 7 months in a row. China's property market is the biggest domestic economic threat (and perhaps a global threat). A growing middle class is nice, but China needs strong export growth which is hard with a now expensive currency. China buys most of the world's iron ore - but now has huge stockpiles. China's efforts to rebalance its economy towards domestic consumption seems like a 'hard landing' from Australia's viewpoint. Jobs growth is the main driver of consumption - and this has been weak. Shadow banking has been a necessary part of China's growth (because the banking system is not working well) - but is weakening. In China, companies, individuals and government continue to leverage up to an extent never seen before - creating a massive credit bubble. A recession seems likely over the next year or two. China's housing bubble is unsustainable [1]

At the same time:

  • it seemed possible (though not certain) that protests in Hong Kong about the erosion of political liberty associated with truly becoming just another part of China might be a 'canary on the coal mine' in relation to political stresses in China more widely - see China: No Turning Back Now???? .
  • China was seen to be seeking to undermine G20 proposals for international cooperation in reducing corruption despite supporting such a proposal of it own, because the latter is part of a process of purging political opponents in China, while the global initiative would also make those associated with China's current regime exposed. It has been claimed (with unknown validity) that up to $4tr (ie almost half China's $9tr annual GDP in 2014) has been moved offshore by corrupt Chinese officials since 2000.

Global anti-corruption efforts have been dealt a blow as a hoped-for agreement through G20 is likely to be torpedoed by China. Proposal involved establishing a public ownership register to prevent people hiding their financial affairs. China's likely disruption of this is peculiar as it proposed the issue at the recent APEC summit. China's corruption busters have been applying pressure on countries such as US, Canada and Australia to help repatriate corrupt officials and their loot. China argues that 19,000 officials have made off with $123bn since mid 1990s. Global Financial Integrity (US-based) argues that $2.8tr was siphoned out between 2005 and 2011. AT APEC China got member states to agree to ACT-NET initiative to facilitate information sharing on corruption. This network would be headquartered in CCDI - the discipline watchdog of Communist Party (whose methods are notorious for involving torture and abuse). However the most favoured destination for corrupt officials (US, Canada and Australia) have no extradition treaties with China because its legal system is not trusted. While Australia should cooperate in anti-corruption measures, in China there is very fine line between anti-graft campaigns and political purges. China's anti-corruption campaign since late 2012 has been as much about preserving single-party rule as about eliminating corruption. All of the 48 most senior 'tigers' who have been caught in the anti-corruption process have humble backgrounds - none are 'princelings' (sons of senior party officials). Thus Xi Jinping's own faction has been spared, while rivals have been vanquished. The G20 proposals would help China's program. But it is believed that relatives of China's political elite have been stashing huge quantities of cash offshore. As much as $4tr may have left China since 2000 - mainly through opaque corporate methods. A corporate transparency regime would put China's top leaders at risk. [1]

  • China was seen to face significant limitations on its ambition to become the dominant power in Asia. [CPDS Comment: China seemed to have ambitions that went well beyond becoming Asia's dominant power - see China as a Dominant Power]  

China may be Asia's economic powerhouse but a report by Paul Dibb and John Lee suggest that it won't become the region's dominant power. The factors that contribute to China's national power would be unlikely to provide it with an ability to become a region-dominating superpower. Problems arise from the nature of China's economy; a lack of close bilateral relationships; and weak military capacity. China has the economic hardware in place (and is an economic / military power).  China's economic growth rate is 7% pa - but declining productivity suggests that this rate of growth can't be maintained. In 2012 $5.50 of capital input produced only $1 of output. Experience shows that such low levels reflect massive inefficiency and are unsustainable. Also China can't shift from middle-income to high-income status (which a dominant state requires) unless it improves citizens' living standards. This would require much more government spending on social security / unemployment benefits / health care. Defense receives a large share of government spending (15% in 2014) but China can't be a super-power until it can take global-scale action. As a result of territorial disputes China has few friends in Asia. This limits its ability to wield influence / power in the region. China does not have the charismatic soft power that Asia dominant power would need [1]

  • despite China's anti-corruption programs, China was assessed to be more corrupt in 2014 than in 2013 - under criteria used by Transparency International [1] [CPDS Comment: Transparency International's criteria seem to include a 'rule of law' which is not the way China is governed]

Ongoing Uncertainty 2015+  [>> ]

In 2015, China's started referring to its situation using the slogan: the 'New Normal'.

After the China Dream of a new dynasty, the Fox Hunt for corrupt cadres, the New Silk Road to connect China to the world comes the New Normal. This refers to persistence of leader Xi and his economic team. Slumping commodity prices are a major boost for China. The New Normal is also seen to apply to: refraining from criticizing the Communist Party; a new basis for university education - which involves more emphasis on ideological guidance; and China's shift towards consumption and services [1]

And the Chinese government increasingly sought 'religious' authority to ensure desired behavior by Chinese people. This was significant because: (a) the traditional role of Confucian bureaucracies in governing China on behalf of emperors included promoting appropriate behaviour in accordance with Confucian virtues; and (b) the authority of the state traditionally depended on the perception of the emperor's 'mantle of heaven' (ie that emperors had divine authority and the state would act virtuously). And the latter had been anything but China's recent experience (see The Dali Lam's Search for Moral Wisdom).  Examples of China's leaders' search for a moral / religious basis for authority include:

  •  it was reported that China's education minister has vowed that 'western values' would never be allowed into that country's classrooms;
China's education minister has vowed that 'western values' will not be allowed into classrooms - as Communist Party seeks to consolidate its autocratic rule and resist demands for democracy and human rights. Anything that defames leaders or smears socialism should not be in universities. China has clamped down since President Xi took over in 2012. Many people have been detained / imprisoned for expressing views contrary to Party.  Teachers and professors in Beijing have been order to toe the Party line on history / geography / etc and not discuss democracy / human rights. Academic discussion of press freedom, civil society; elected government and constitutionalism is forbidden. President XI has sought more ideological guidance in schools / universities, and study of Marxism. Nationalism has been emphasised as a way for academics to keep themselves safe.  Even before this China's education system was highly ideological. The 'patriot education' curricular adopted after 1989 Tiananmen Square student uprising is still the basis of curricula. Paramilitary troops have been garrisoned on campuses since then. Internet censorship is now being tightened [1]
  • China seemed to be seeking to establish a religious / moral basis for state authority.
  • The Dali Lama suggested that his soul may not be reborn (as has been the Dali Lama tradition for hundreds of years) - while the Chinese Communist Party leaderships insists that it will. In 2011 the Dali Lama had ended the era in which Dali Lama's were both political and spiritual leaders in Tibet. He had also expressed fears that vested political interests could misuse the reincarnation system [1];

This tends to create a clash between the so-called 'Communist Party' and Christianity which: (a) can be seen as the ultimate Western 'value'; and (b) is now a significant influence and growing so rapidly (ie at 7% pa) that (if continued) 2/3 of Chinese people would be Christian by 2050.

China has historically tended to follow religions such as Buddhism and Taoism. But a recent study suggests that monotheistic religions (eg Islam and Christianity) are becoming significant. Buddhism dominates in south and SW regions. Protestants and Catholics have begun to occupy China's eastern regions while some western regions are mainly Muslim. Protestant Christianity has been the fastest growing religion - with around 100m Christian in China potentially rising to 160m by 2025 (with an ongoing 7%pa growth rate which could lead to 66.7% of China's population being Christian by 2050). This is leading to tension between Christians and the Communist Party. There are also tensions between China's authorities and its indigenous Muslim population - involving violence and restrictions [1]

In mid 2015 it was reported that China had substantially increased persecution of Christians and other believers as part of a broader war against dissent [1]. The emphasis on the welfare and capability of individuals that is by-product of Christianity is incompatible with the state-centered authoritarianism that China's regime seemed to be seeking to create (see Christian Persecution in China).

During 2015 and 2016 concerns about China's economic sustainability continued to mount (eg see in particular Context to China's Share Market Boom and Bust;  and China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism'). >>


  • US analysts suggested that China was at risk of a financial crisis.

Bank of America warns that China faces the risk of a financial crisis associated with slowing growth and deflationary pressure to to defaults. A credit crunch is seen to be probable. Highly-leveraged companies are at risk form President Xi's attempt to eliminate moral hazard and reduce dependence on credit growth. Slow growth and excess debt could damage financial system. Few countries escape financial crises after after such rapid credit growth. Likely scenario involves: bad debt surge as growth slows; credit crunch in shadow banking system; and major bank recapitalization. Rescuing lenders cost China 15% of GDP in late 1990s. The problem is harder now. Loans have increased 100% of GDP over 5 years - which is twice the rate before Nikkei bubble burst in 1990. Total credit exceeds 250% of GDP (once shadow banking and offshore lending are included) - which is high for emerging economy without mature markets or layers of accumulated wealth. Explosive growth on Shanghai markets (up 350% in 3 months) is unrealistic. China has seen factory gate deflation for 33 months, and this is deepening. When producer price deflation last occurred, it took 6 years to reverse. And now there is nothing like China's access to WTO in 2001 to boost demand. Falling inflation reduces the real cost of borrowing. There has been a rapid increase since 2011. Hot money outflows raised the risk of devaluation - and will drain money from stock market and increase problems for those with $US debts. China's firms have borrowed $.12tr in external currencies. Rising $US has pulled yuan higher (because of soft peg) and it has revalued 60% against yen over two years. This reduces China's competitiveness. Hot money is now likely to leave China - perhaps leading to something like Asian financial crisis of 1997. China's capital account has been in deficit for last two quarters. China has a great deal of economic depth and is likely to muddle through [1

  • options were suggested to deal with China's financial system problems by reform of its fiscal systems. In the past expenditure that should have been by government were funded inappropriately through bank lending to provincial and local government.

Banks are not the source of China's economic problems. The real problem is fiscal system. Local governments have 45% of tax revenues, but 85% of state spending. They have had to obtain funding (for social / infrastructure spending) through off-balance sheet sources (eg land sales / shadow banking). This results in bank lending that does not generate commercial returns. Such spending should have been funded by state budgets. Such debt piles up and is written off with other non-performing loans. China has plenty of productive capacity to grow over 7% pa, but there is inadequate demand to sustain this (eg because of Europe's weakness and the US's import-weak recovery). China's rate of investment will fall because of low returns and the need to deleverage. Household consumption won't increase much because its growth will be hampered by slowing wage rises. China needs to fix its fiscal system - and a plan to do this exists. This involves expanding tax revenues, and restructuring local government debts into long term bonds and eliminating loans related to land. Incentives for seeking off-budget revenue will fall.  State budget expenditures (which have been very low) will rise. This will allow government to be more transparent. Few outside China have recognized its ambitious fiscal agenda. Success is not assured [1]

  • it was suggested (based on a parallel with what had happened in Switzerland) that China might be forced to abandon its currency's peg against the $US - and that the results could be disruptive

Currency pegs cause problems when they are out of kilter with economic reality. China announced that it would restrict margin lending to stop market speculation. The stock market fell significantly. China has problems because it linked its currency to $US since 1994. This accounts for China's trade surplus and $tr foreign exchange reserves. However to maintain pegged currency China needs to print yuan to swap for $USs. If this was not done, exporters would lose competitiveness. Thus there has been a huge amount of liquidity flowing into economy which can be inflationary. China sought to stifle this by issuing notes and bonds of varying maturities and increased bank's lending margins to restrict credit growth. But the 2008 crisis forced China to get banks to lend aggressively - thus creating a credit bubble.  China's new leadership in 2012 started trying to curb this - including purging many corrupt officials who had been profiting. The main effect of credit bubble as land boom - which is deflating. The stock market was an alternative - but now government is trying to stifle this. China might need to end currency peg to solve this problem. It is uncertain then whether yuan would go up and down. Because China has long sought to keep yuan down, revaluation seemed likely. But the damage done by the credit bubble could have the reverse effect [1]

  • China was seen to be finding (as others had previously found) that it is impossible to deflate a credit bubble safely.

Money has been tightened for a year and there has been a shadow banking crackdown. China is headed for a debt-deflation crisis. It will be hard to overcome the effects of its $26tr credit boom. Factory gate inflation is -3.3%. China debt rose from 10% of GDP to $250% in 8 years - as compared with 50% of GDP debt growth in Japan prior to its lost decade. The unemployment situation is increasingly unhealthy. Home prices fell 4.3% in December. New committed construction is down 30% over 3 months. Property investment in China rose from 4% to 15% of GDP - the same as in Spain at the peak. Inventory overhang is 18 months. Property slump is turning into fiscal squeeze as land sales are 25% of local government revenue. Fiscal deficit would be 10% of GDP without land sales revenue. China is not alone in facing such problems as 15 central banks have eased money policy in 2015. China's link to $US is eroding thin profits of Chinese companies. A significant yuan devaluation would have big deflationary impact worldwide. China has been trying for two years to wean itself off credit. Yet this is proving hard to achieve [1]

  • China's goal of boosting domestic consumption is limited by the lack of a large middle class that is capable of high levels of consumer spending [1]
  • China was facing a major fiscal contraction

China's Politbureau is attacking the country's credit-driven growth. Real interest rates have increased. The Yuan has appreciated. Fiscal policy is tightening as big-spending local governments are constrained. This is leading to sliding global prices for commodities. China is seen to be facing a fiscal cliff. Budget deficits exceeded 10% of GDP. A budget squeeze has emerged as property slump continues - as revenues relate to property cycle. Property bubbles in China (and elsewhere in Asia) exceed those in US before 2008. There is a reliance on government bail-outs. Local governments have been prevented from raising money off balance sheet - potentially tightening fiscal policy 5.5% of GDP (similar to fiscal contraction imposed on Greece). Monetary policy can't be used to compensate for fiscal expansion - as its economic impact has collapsed. New lending now only rolls over existing debt. Total credit rose from 100% to 250% of GDP over 8 years. China is close to a deflationary trap.  Apparent monetary stimulus is merely offsetting the effect of tightening as central bank dips into foreign exchange reserves to strengthen currency. China's capital deficit in fourth quarter was $91bn. It is now a net seller of US Treasury securities. The PBOC is now in the reverse of its boom years position. Then it bought foreign assets and caused liquidity in China to surge. Now liquidity is draining away. China's shift from buying to selling bonds has been $40bn per month - outweighing the $15bn per month that Japan is buying. Asia is tapering $25bn per month - offsetting the effect of prospective QE in Europe. China needs devaluation - yet yuan is tied to soaring $US. China real growth rate is now less than 2% pa. Boosting growth requires devaluation. If half the big central banks resort to currency combat the world's deflationary impetus will escalate at a time when there is no monetary ammunition left to counter it [1]

  • a new source of financial instability was seen to have been introduced through the development of asset-based securities [1]
  • China sought advice from Japan about avoiding the sort of economic stagnation which Japan had suffered from 1990 because their economic systems were very similar

Chinese regulators are turning to Japan for lessons - to avoid taking the same path of recession / deflation that blighted Japan for the past 20 years. Tokyo's handling of the liberalization of capital flows over part 30 years is seen by China as leading to the bust of Japan's asset bubble in the early 1990s. Japan's and China's economies share similarities - so lessons should be valuable. Communication about this continued despite the chill in diplomatic ties from 2012. China is undertaking three reforms that Japan did (ie liberalizing interest rates / internationalizing currency / opening capital account). China sees Plaza Accord which approved a stronger yen and opened capital account in leading the Japan's lost decades. The stronger yen hit exports and prompter BoJ to ease monetary policy. However money from this and foreign capital flowed into stocks / property and other assets. China is applying these lessons. China is not taking measures that could heighten imbalances even when growth is slowing. Japan was said to have been unable to tighten monetary policy when bubbles were forming because of the effect this would have on US. Domestic policy considerations should dominate over international considerations. China has other problems that mirror Japan's (cooling property market / rising bad debts). China is like Japan in corporate reliance on bank loans / heavy banking regulation. China may copy Japan in bank consolidation. Exchanges between Japan and China on this are often informal. [1]

  • China sought to make the yuan a global reserve currency - as one of the foundations of the IMF's SDRs [1] [ See CPDS comments in China Does not have a Normal 'Currency' ];
  • Japan had grown at 10% pa for two decades in the 1980s - but since then has stagnated. China faces a similar risk. Economic growth is only possible by adding more labour, capital, productivity. Russia and Japan suffered malaise because growth had been driven because of expansion of inputs, rather than lifting productivity . China grew 162% from 2004 to 2014 - but 136% of this was due to more capital inputs. National corporate debt has risen from 147% of GDP to 250%. China's building programs have been wasteful. China doubled-down on Japan's strategy - and lacks means to escape middle-income trap. Dismantling China's state-dominated political economy is needed but difficult. China now has more people leaving than entering workforce - because of demographic issues. China's concealed bad debts are estimated as 70-140% of GDP. Unfunded pension liabilities could be 40% of GDP. [1]
  • About 25% of China's economic growth of past 3 decades was due to its demographic structure - with a young workforce lifting output by gaining new jobs. The proportion of children and older people was low. However since 2010 China's working-age population peaked and its dependency ratio has been rising. The government's package of economic reforms have achieved little - because of entrenched interests. China must now raise productivity with a shrinking workforce. Ways to overcome this problem have been suggested to involve: ending one child policy; and strengthening market mechanisms [1]
  • China has introduced a moderate form of QE to provide funding for debt-strapped local governments [1]
  • In April 2014 it was suggested that China's economy is worse than admitted. Demand has fallen for first time.  Officially growth was 7%pa in first three months - yet power output was flat and imports were plunging. One estimate was that real domestic demand was falling 10% pa in first quarter [1]
  • It was suggested that China's potential real estate crash might not happen [1];
  • China's finance minister drew attention to China's 'middle income trap' risk. He referred to: wage rises outpacing productivity gains because of new labour laws; China's aging population; and high debt levels [1]
  • China's economic reform policies were seen to have been successful in developing a large cluster of high tech and software firms in Hangzhou - a city on the east coast [1]
  •  IMF has warned of danger to emerging economies from tightening by US Federal Reserve - and this has particular implications for China (see The New Big Short).
  • China's financial support for Venezuela's regime in return for oil supplies is putting it at risk of significant losses [1];
  • China appeared to provide net economic benefits to Australia through the terms of a Free Trade Agreement (see CPDS Comment)
  • China has averted a deep economic slump by again expanding credit. Consumer confidence, output and home prices are improving. This has positive implications for world's commodity producers. To achieve this the debt swap plan (to clean up local government finances) has been expanded. This frees up borrowing for other purposes. Attempts at a controlled slowdown were abandoned - as this led to 'fiscal cliff'. Investment crashed - and the shock spread world-wide. China still faces severe deflationary pressures and industrial over-capacity. China seems to be in much the same position now as Japan was in the early 1990s. It was too late to escape the effect of a credit bubble - and necessary to turn on the fiscal taps to prevent a collapse in GDP [1]
  • Shanghai share-market is either undergoing a correction or indicating major problems. Some believe that China has mastered the art of managing its economy and markets - through command and control tactics. And there is no doubt that governments can boost growth in various ways. However Japan's system was once seen to be superior to Western methods (given central bank discipline, interlocking corporate ownership, and a superior mercantile manufacturing economy). This ended on the last day of 1989. China now looks the same. Its manufacturing prowess is overstated. Its ability to manipulate / stimulate its economy is exhausted. Labour-cost advantages have eroded. Government is less friendly to those wishing to establish on-shore facilities.  China's debt-GDP burden (282%) is double that in US and even higher than in Japan [1]
  • China's plan to resolve problems associated with excessive local government debt amounts to a bailout [1]
  • It was being suggested that China's necessary transition to a new growth model was yet to be achieved

China's economic growth is expected to slow gradually. This implies that its government is seeking (with structural adjustments) to overcome financial vulnerabilities. Growth model is shifting from manufacturing to services, from investment to consumption and from exports to domestic spending. Credit growth has been slowed, shadow banking contained and local government borrowing limited - thus slowing real estate investment. China also seeks to avoid growth slowing too much. Large scale stimulus measures would conflict with efforts to make economy sustainable in long term. There is massive over-capacity in heavy industries. Slowing export growth and softening real estate prices are dampening economy. Thus One Belt, One Road scheme seeks to boost external demand for China's investment goods. Growth of services is also important - and this includes big financial sector. Many countries have failed to graduate to high income status - and many see China facing this risk. China is changing Current account surplus is falling. Consumption is rising. Income distribution is improving. This is mainly due to labour market changes. Liberalization of financial markets / land system / energy policy are also needed - as well as technological innovation and industrial upgrading. Garnaut argues that China's slowing growth masks weaknesses in its economic transformation - related to income distribution and the environment. Macroeconomic changes required for ongoing success remain to be achieved. Slowing growth reflects problems in the old growth model - rather than transition to new model. Since 2011 China has depended heavily on growth of capital stock while productivity growth has been slow. Future growth drivers have to involve innovation and productivity lifting change - and this remains to be achieved  [1

  • Many have expressed concerns about China's economy. However China's stock market has achieved a 130% gain over past year despite lower growth, corporate profitability being squeezed and large increases in non-performing loans. Shanghai market posted 14.3% fall in July. But the turbulence in China may merely be growing pains in an economy that could turn around surprisingly [1]
  • Shanghai stock index fell 7% - and PBOC cut interest rates. GDP growth in China is well below target. Despite nominal easing - real rates have been rising because yuan is tied to $US so inflation has fallen. Stock-market and real estate are obvious bubbles. The main effect of market crash would be on confidence.  Household balance sheets are theoretically strong - but country as a whole is bloated by debt - after years of economic stimulation. Property prices have increased 40% pa in major cities and over 50% of debt increase has been for real estate. China's monetary policy doesn't work because banks are over-exposed to property and won't invest elsewhere. Key question is whether China's banks can remain solvent given both property and share market crash [1]
  • There was extensive debate about the implications of China's share market crash and the extreme measures that China's government took to respond to this.

Outline of Observer's Views

China's desperation to prevent a stock market crash has led it to go beyond increased central bank liquidity and regulatory inducements to allowing homes to be used as collateral for stock purchases. This could create another financial 'time bomb' in home ownership to complement those associated with its debt and stock bubbles. China needs stronger demand, not more market froth [1]

China is going to extremes to stop stocks crashing. Homes can now be used as collateral to buy stocks - even though they are hard to sell when assets crash. China is sowing the seeds of a third financial time bomb to match its debt / stock bubble. Stocks have fallen for 9 days. Iron ore prices have fallen - suggesting that growth is slowing more than government is letting on. China is making its financial system more fragile - the reverse of what is needed. [1]

China is not the first country to prop up a falling sharemarket - but its methods are extreme. The reasons are unclear. The market is down 30% - but still 80% higher than last year. The economic slowdown is stabilizing. Other assets are doing well. Property downturn is moderating. However China's intervention screamed panic. Short selling was banned. Pension funds pledged to buy more stocks. IPOs were blocked. Brokers used central bank cash to buy stock. The state media played cheer-leader. Some see government action reflecting fear of economic crash - but that is unlikely . Stockmarket has limited role in China. However many stocks were bought with debt - which was why it was hard to stop the fall. But this was only 1.5% of banking system assets. Most likely issue is politics - as government has indicated that it wants stocks to provide more corporate financing. And market fall dented leaderships' standing. Biggest concern about panicked policy response is what it says about government's economic agenda. Market forces had been expected to play a major role in allocating resources - but recent events show that China's government wants a decisive role in markets. Share market downturn shows that government can't indefinitely bend markets to its will [1]

When China's economy became larger than Japan's in 2010, it was presumed that China would become economically dominant in Asia. But it is now struggling to deal with over-valued sharemarket and property bubble. Many thus ask if China will suffer what Japan did in 1980s and 1990s. However China's problem is probably more severe.  China is near the end of reliance on exports and fixed investment - and is seeking to promote domestic consumption. In achieving this its authoritarian government supposedly does not have to sacrifice long term needs to political expediency. However the reality is different. The property bubble emerged because of too much Party intervention in response to GFC's impact on export markets.  Fixed investment had been 25% of GDP growth in the 1990s but became 90% in 2009. New credit increased $20tr from 2008 to 2013. And capital controls mean that firms and households can't easily take money out of China. They can't take advantage of best economic opportunities - as these are reserved for SOEs. The stock market became the main way to get a decent return. Government's problem with declining share values is that most listed companies are SOEs. So intervention is mainly about protecting value of SOEs. In Japan, when its economic malaise began, the country had already built solid institutions (ie rule of law, property rights, independent courts, a political system that did not depend on growth for stability).  [1

The key aspect of bursting of China's sharemarket bubble is that its elites have encountered 'creative destruction'. The Communist Party decided that it wanted to stop this. But capitalism doesn't work that way. China had wanted to maintain employment while shifting / reforming economy but increasing liquidity / credit. This seldom works. Local governments had been told to borrow to spend on infrastructure. Interest rates were below GDP growth for years. This is a formula for bubbles. China's sharemarket bubble burst on 12 June - just when markets success was being celebrated [1] [CPDS Comment: China's economy does not seem to include 'capitalism' (see Does Asia have Capitalism?). Markets are orchestrated by social elites, not the drivers of economic change]

China's stock market turmoil is seen by China's leaders as a threat to regime - and this explains measure used to counter market downturn. A multi $bn funds was set up by China's brokerages at government request to buy shares, and 'financial risk' was included in new national security laws. The latter discourages foreign investors (as it involves mandate for political manipulation of share market). 30% fall in Shanghai index was not a major threat to China's financial system. Share ownership is limited - and only late investors have yet lost money. The panisked response indicates a desire to shield Communist Party from criticism / social unrest by maintaining stability. Social stability has become main focus of bureaucracy - through coercion and concession. New national security law is a further expansion of already-massive security enterprise under Xi Jinping. If Shanghai index sells off despite government measures. Party's image could suffer more. Seeking security for the Party may however have undermined it.  [1

China became world's largest economy in PPP terms in 2014. It is Australia's largest export destination. China's slowdown is reducing Australia's terms of trade China's stock market rose 144% over a year and then fell 30% in 10 days. It is hard to tell the effect this will have on China's real economy. China only recently established financial markets. China's authorities have more capacity to intervene in those markets than others do (eg by directing SOEs; banning directors / large shareholders from selling; providing credit to brokers to buy shares). China avoided both the Asian financial crisis of 1999 and responded skillfully to 2008 GFC. China may be more cautious in pursuing market liberalism. The relationship between financial sector and real economy is different in China to that in advanced liberal economies [1]

China's sharemarket jumped after government banned big shareholders from selling; directly bought stocks through China's state margin lender (with central bank support); limited short selling). Adverse effects of crash will eventually be felt (eg corporate earnings / distortion of capital flows / market can't work normally). Potential losses will be transferred from investors to government [1

Market turmoil is testing China's commitment to opening financial markets as part of its economic transition. Turmoil may not affect China's real economy. No country has ever liberalised markets without adverse effects during transition [1]

Market crash will have little real economy effect - equity finance provides only 4% of investment capital. The biggest effect will be in terms of consumption and finance. This would compound problems related to declining exports and investment [1

China has tried to stop stockmarket slide - but the harder they try to more it looks like they are losing control. China's bond and currency markets have been hit by worries of contagion of slowing economy. China's investors are anxious - and their leaders face a crisis of confidence . Government has driven decades of strong growth - and kept economy strong during GFC. China has suffered rising debt levels and needs to reform economy away from government driven infrastructure investment. As economy and property market slowed, government focused on stock market. Recent decline has worried investors who are used to seeing government in control. The more authorities try to calm the market, the more the panic spreads. Also investors could be forced to reduce spending. 80% of all share investments had been made with borrowed money - and margin loans doubled to over $US 2 tr in the six months to June 2015. When investors started selling in mid-June, margin debt created a spiral down [1

China's stockmarket rout compounds global economic uncertainties. That market is unimportant in itself - but the crash and China's reaction is symptomatic of broader problems. The market has clearly been in speculative bubble for months. Until last November stocks had been weak while real estate boomed - then property prices flagged and (to boost confidence) authorities cut interest rates and increased access to margin loan (ie loans secured against shares). This attracted inexperienced investors - and their funds swamped the market. Valuations were unrealistic. China's authorities did nothing - perhaps hoping that heavily-indebted state enterprises might be able to refinance themselves by issuing new equity. However authorities also believed that had the means to easily cope with any problems.  Modest changes had cooled property markets. This assumption proved false - and authorities panicked.  This was not to prevent an economic problem - but to avoid political damage by imposing losses on 90m investors - for many of whom market speculation was their only way to accumulate wealth. The big problem with this is that government has signaled that it will transfer market losses to financial institutions. This will leave them with large losses. What was done shows that Xi's commitment to market forces is very limited. The fact that China is in transition adds to difficulties.  There are important precedents from other Asian precedents. All countries that grow over 7%pa suffer problems (political as well as economic) as growth slows when per capital incomes reach 10,000-15,000 pa. The effects on influential interests makes it hard to actually make the necessary transition. South Korea suffered repeated crises before changes were made. Japan suffered long period of stagnation. The main question is how China will handle this transition - ie away from housing / infrastructure investment. It must double its productivity growth (to 4% pa) but this would happen in economy based on command and control. Market liberalization is needed - but encounters strong opposing forces.  [1]

There has been a perceptible dampening of economic activity in China as a result of stock market downturn [1]

China's sharemarket problems reflect the fact that its growth drivers (high investment, exports, migration to the cities) are generating diminishing returns. China's economy is not only slowing but being profoundly transformed - and the parts that benefit Australia are being reduced (a fact that resource companies have not taken into account). China has 6m fewer migrant workers in cities than a year ago (as the rural population itself starts to decline). Migration had been one of the main drivers of China's economy - and as this slowed productivity growth fell to zero. The old growth model was based on large investments support by the shift of hundreds of millions from rural areas to cites. Slowing urbanization has reduced demand for housing and infrastructure - and for significant elements of old economic growth model. As labour became scare, wages started rising - and profits slipped. The migration change required an absolute reduction in investment - not just slower growth - and much faster growth in consumption spending. But this has not happened. This has been compounded by government's response to GFC - which was similar to, but larger than, its response to Asian financial crisis. China moved to arrest slide in property prices. The property slide was one reason for sharemarket bubble -as investors then had no real other choice. The government tried to intervene in that market. Until recently authorities said that market had a bright future. It is uncertain whether government efforts to stop slide will work, and what the effect could be on shadow banking system that holds much of the margin debt   [1

The amount of leverage in China's share market has halved over the past 2 weeks [1]

China's authorities panicked over stock market fall. Most analysts assume that the real economy impact will be slight. However there was a feeling of confidence in US when sharemarket peaked in 2007 - though recession had already started. There are indications of problems. Car sales fell 3% in June. Property transactions increased - but only in larger cities. Producer prices have fallen for 3 years. Consumer sentiment is weaker than implied by 7% pa growth - though many believe growth is only 4%. The unwinding of margin debt that built up over past year will have adverse effect. And government will lack credibility with elites who were encouraged to go down a ruinous path [1

China and Greece share a common problem in that no one trusts their economic data. Greece has long had a reputation for lying about its economic data. China recently claimed that growth was 7% yoy - even though imports were down 15%; gas sales were down 3.4% in June, excavator demand fell 34%; rail freight fell 12% and power consumption grew just 1.8% [1]

The most important consequence of stock market crash was a loss of credibility by China's leaders. The stockmarket boom had been encouraged to help shift China from an economy based on investment to one based on consumption - and the market crash highlighted their inability to do so [1]

China's rescue of its stock market cost $US800bn (about 10% of China's GDP) and has produced quite limited effects [1]

China's heavy stockmarket intervention will be difficult to unwind and will take a long time. However the way the Hong Kong government used foreign exchange reserves to do something similar at time of GFC and unwound this slowly is precedent to study [1]

China's stockmarket crash can be likened to that in US in 1929 - ie it went on for a long time. And China does not really have a 'market' (given the extent of government manipulation. Stock bubble grew out of China's ongoing credit crisis. It has a massive debt pyramid that was crashing. There was a huge amount of concealed bad debt - which China tried to deal with by selling shares to suckers. China's elites are getting money out of China as fast as possible - eg buying off-shore real estate. [1]

There has been concern about whether China's sharemarket fall could lead to something like failure of Lehman Bros in US. China kept growing after 2008 when global economy slowed through a massive investment program. Such debt-driven expansion seems to end up badly. But China is more likely to suffer stagnation like Japan than a Lehman style collapse - though the consequences for China's people will be worst than in Japan. China's stock exchange had become a major casino. After GFC devastated China's export potential, Communist Party initiated largest stimulus policy in history - with $US 15tr new capital first through state banks and then through unregulated shadow banks. China debt rose from 150% of GDP to 300% over past six years - a rate of growth faster than that in US before GFC. About 1/3 of new capital in first six years of stimulus went into new real estate - much of which remains unoccupied (and able to accommodate the next 20 years increases in urban populations). When China blocked property speculation because of fears about property bubble speculators shifted to stock market. By March 2015 4.5m new investor accounts were being established each week. The median PE ratio of China's stocks rose from 9 at the start of 2014 to 80.  However China won't suffer problems like US did because China's banking system is state controlled - and will be forced to lend even though credit risks are poor. But debt levels in China's economy are already so high that 1/3 of new borrowing is merely to pay of interest / principal on existing loans. Doing this was what led Japan into a moribund economy in 1990s. And China's situation is worse because it has an aging population, a fragile authoritarian political system and a failing economic growth model [1]

A 5% rise increase in China's sharemarket in the last trading hour strongly suggests that the government has resumed buying shares [1]

China has abandoned large scale share buying - and instead is focusing on punishing those who destabilized the market. For two months the 'national team' had spent $200bn trying to prop up the market. This was seen to have failed because too much information was allowed to become public. China now wants to punish those who took advantage of state bailout to make profits or obstructed government efforts to support market [1]

China's market rescue operation failed because: (a) those who were required to participate in China's 'national team' (ie prop up market) were torn between that goal and remaining profitable; (b) what they were doing became obvious and others 'gamed' the system - or became involved in insider trading; and (c) the lack of any coherent investment strategy [1]

China tried 40 different things to try to prevent stock market fall - and directly buying shares was the only one that worked [1]

Since stock market started melting in June 2015, China has tried increasingly desperate measures to halt the slide. The latest involves attempts to shift the blame onto perceived market manipulators. China's government has both promised to loosen its grip on the economy - and sought to maintain stability and thus confidence in government. The conflict this involves has made China the biggest threat to global economy. It is now widely accepted that China does not know how to handle markets [1]

China's approach to stock market woes has been to charge 200 people with spreading false rumours. China wants to embrace market reform - yet is only willing to tolerate this when market does what government wants. China's old growth model is broken - yet to achieve the desired new model, China's authorities have to give up the power that sustains their position [1]

CPDS Comment:  Context to China's Sharemarket Boom and Bust presents a scenario which would explain why China spent over 10% of its GDP to prevent the crash of a stockmarket which has very little economic importance. It involves taking account of not-well-known features of China's history and culture which imply that a major threat to China's whole system of government could exist. There are simpler scenarios - but these do not really explain why such huge resources were devoted to an apparently economically-marginal problem.
  • Trade has been key to China's rapid growth over the past two decades. Now imports are down heavily and exports are only achieving marginal growth. This is being repeated elsewhere in Asia. Global trade is the life-blood of Asia and it is not growing fast. Some of the most open manufacturers are in trouble. Normally when US recovers its trade deficit increases. But this hasn't happened this time. Imports to US have been flat for a decade. This weak growth means that the Asian region will be very exposed when the US started raising interest rates in late 2015 [1]
  • China seems to be headed for a financial crisis which will render vain its efforts to promote international China-centered economic projects and arrangements

China's 7% growth in June quarter of 2015 was a surprise as domestic demand had been stalling and the property boom had bust. Rates had been cut and credit made readily available. The stockmarket collapse was too late to affect June data. The collapse highlights potential overstatement of China's economy based on its reliance on debt. Stockmarket expansion was seen as demonstrating authorities money creation to build economy on debt - even as real spending / production / productivity / quality of life declines. $3.8tr expansion of share values was based on companies whose earnings are declining. Money from PBOC and MOF was channeled to brokers and smaller / weaker banks. Government's panic over share market crash reflects fear of major financial crisis - not collapsing share values. Sharp rise and fall of sharemarket could affect real economy - because a debt-fuelled binge blew up equity bubble. Security companies had $3.7tr in margin loans - about 5 times that at start of year. A chain reaction is possible. Forced selling could escalate. There are also hidden risks in structured products. Government support for shares could turn them into dead assets (ie having value but no liquidity) as property has become. Suspended shares could block China's effort to portray itself as shifting to market-driven economy.  The average PE ratio of suspended shares in 187. A loss of confidence will lead to capital flight and loss of confidence in government. PBOC may need to adopt a 'whatever it takes' approach (as US Fed did in 2008 and ECB did in 2012). Chinese will be less willing to invest in what government recommends. Asset bubbles have been needed to main appearance of growth - and to attract external capital. Once bubbles can't be maintained, the question of how large China's economy actually is will become apparent. Plans such as One Belt One Road, New Silk Road, AIIB, Megacities and China-sponsored pipelines / railroads across all continents are likely to be seen as less like attempts to gain geo-political power and more like the wild dreams of a face-saving leadership with empty pockets [1]

  • China's effort to create a stock market boom failed. It has now reverted to credit expansion. This delays, but does not avoid, its coming crisis

 China is again seeking to engineer another mini-boom by expanding credit. The government outlawed falling equity prices. However China's situation is deteriorating. Capital outflows exceeded $244bn in second quarter - which is unprecedented. PBOC is being forced to run down foreign reserves to defend the yuan. $488bn may have been sold in second quarter. These bond sales amount to monetary tightening - just as bond purchases in the past had the effect of monetary loosening (by adding to domestic money supply). China is struggling to emerge from recession. Shipping volumes are contracting - and this adversely affects Russia, Brazil and the commodity exporters. China's industry had stagnated in early 2015 - as efforts to reign in excess credit became uncontrollable. Talking up a stock market boom was intended to counteract this slowdown - and this proved a disaster. After $4tr losses emerged, police state tactics were used to engineer a recovery. President Xi's emphasis on the use of market forces play a decisive role in economy has ended. There was always a contradiction between this and tight control on Internet, academia and political opposition. The need to shift to a more market oriented economy was documented 3 years ago. Its past growth model is obsolete. To end dependence on export-led growth and imported know-how (which must lead to 'middle income trap') China needs to end political control of economy - so that private sector can innovate. Various observers believe that China's current growth rate is about 4%pa  [1

  • China's banks are likely to have to face significant losses from the stockmarket crash because of the significant use of margin debt in buying stocks - and this may merely be the start of broader problems with global impacts

China's equities have suffered 8.5% fall in one day - which has repercussions for commodity markets and currencies in East Asia, Latin America and Africa. There is a view that China's Communist Party may be losing control. Government had tested what would happen if they stopped intervening in the share market. Many investors are trapped as they used margin debt to buy stocks and can't cover this without selling. BoA estimates that $1.2tr of stock are based on margin debt (ie about 34% of market). When market eventually settles, the financial system could suffer contagion - because brokers and trusts have only $260bn to absorb losses and this may be inadequate. This further raises risk of run on the shadow banking system - because of concern that funds in this $2.1tr industry may no longer have implicit guarantee.  Chinese government may need to absorb losses. Government could reduce reserve requirement ration - allowing banks to provide huge amount of extra credit and thus defer the day of reckoning. Government does not want to do this - because it wants to shift economy from reliance on debt to equity. This got out of hand because of growth of margin accounts. China's debt / GDP ratio doubled to 260% after 2007 and is now $26tr. Credit is over-extended and losing its economic benefits. While stock crash is a minor matter in itself its effect is combined with bursting of property bubble; a tidal wave of debt restructuring; and soaring exchange rate (due to $US peg). Not all a negative about China's situation. But as China is a major commodity consumer, Brazil, Russia, South Africa and many commodity exporters are facing a freeze in imports just as US Fed starts raising interest rates [1

  • Migrant workers were a key driver of China's economic miracle. However their numbers have been declining - and turned negative in February 2015. Also migrant workers are rapidly aging. Declining migrant worker numbers will lead to rapid rise in wages and declining international competitiveness. This is affecting China's status as world's factor. Productivity will have to be raised rapidly to compensate. Population aging will also impose pressure on China's fragile social security system. It will come to have the world's largest pensioner population. China needs to urgently review its demographic crisis - perhaps by changing one child policy [1]
  • China's exports fell 8.3% yoy in July 2015 (and imports also fell sharply) where only a 1% fall had been expected - after a slight increase in June. This reflected depressed demand from Europe and a slight drop in exports to US [1]
  • China is seen to face a difficult choice between devaluing the yuan to boost export competitiveness (which would also increase the risk of capital flight) or maintain the yuan and see exports continue to decline. China needs to shift to domestic demand - yet conditions are not yet available to allow this to occur [1]
  • China devalued yuan by record amount (1.8%) in August 2015 resulting in a flight to safety in $US [1]. The next day it devalued again by 1.6%, and this was equally disruptive of bond yields, Asian equity markets and $A [1]

PBOC had been propping up yuan value until recently. There is likely to have been net outflow of capital from China because of monetary policy uncertainty. PBOC has been easing in the face of economic slowdown. FED is likely to tighten policy soon. China has large FX reserves but would not want to use them to defend currency value. China's economy / exports have been weak, China wants its currency to be included in IMF's SDRs - and this would require it to be freely convertible - and China seems to be moving in that direction. It is possible that China's devaluation will be disruptive - but unlikely given the small percentage change involved [1].

China devalued for a second day. However it did this by changing the mechanism by which its currency value was determined - which was what international community had wanted it to do (ie adopt a more market-oriented exchange rate). It is too early to say that this is the start of a long term process of devaluation that would amount to a 'currency war' [1]

China's currency devaluations are seen as triggering currency wars in Asia. The ten most widely traded currencies are already set to decline for a third year - and China's move is likely to trigger a vicious cycle [1]

Despite past problems China maintained its currency value - even when others cut the value of their currencies. With renminbi's biggest fall in decades, there is concern that China's weakening economy is worse than reported and that government is panicking. Credibility of China's government and president in managing a slowdown is suspect. Growth is said to be 7% - but construction is very weak as real estate struggles. Consumer spending is weak. And financial services (a major growth driver while stock market was strong) is slipping. Some provinces / regions could be in outright recession. The data is not reliable enough to tell [1]

China's recent devaluation has been presented as a way to boost a floundering economy - but there are two reasons for concern: (a) doubts about the proficiency of Chinese officials; (b) concerns that all that is being attempted is to make a case for acceptance of the yuan as a reserve currency by the IMF - even though what was done does not help meet IMF criteria. Others suggest that concerns about this are overblown [1]

It is possible to see parallels between recent Chinese devaluation and the currency collapses and instabilities associated with the Asian Financial Crisis of 1997. While there is no certainty of any such deterioration (and Chinese authorities have many options to stabilize their situation), in the event of a crisis the US should be little affected - because of limited US export / investment exposure to China [1]

Other Asia countries have been caught up in effect of yuan devaluation - raising fears of another Asian financial crisis. The PBOC claims this is part of market liberalization push, others see it as a competitive devaluation that risks a global 'currency war'. Where economies are closely linked to China their currencies have been sold off [1

China's steelmakers will be able to flood the world with cheap steel because of yuan devaluation - and their competitors in Europe and US are protesting. Similar concerns affect other sectors [1]

Recent PBOC actions have raised the possibility of both ongoing yuan devaluation and government stabilization of a managed float. After three days of yuan falls, PBOC asked state banks to stop this by buying yuan. PBOC is not allowing a free float - but rather calculated intervention [1]

Emerging markets will suffer from yuan devaluation. If China wants to devalue to boost competitiveness, then a great deal of devaluation can be expected. However if it wants to set up more flexible financial system without a deluge of flight capital then tight control will be maintained on currency movements. Both create problems. Emerging economies already favoured devaltaion - and yuan devaluation will add to this trend. Emerging markets had faced slowing China growth(dampening resource demand). And trade surplus was strong indicating export competitiveness. At the same time US interest rates are likely to rise - and hurt emerging economies dependent on foreign capital. Emerging market currencies are thus at 15 year low. Lower yuan will hurt all these emerging economies. And if more yuan devaluation is intended - this will increase. If China keeps yuan where it is, this will be no use unless capital no longer seeks to get out of China. Devaluation partly reflected a year of strong capital flows out of China (because of domestic economic weakness and fear of confiscation). Capital outflow will explode if China creates the impression it will devalue strongly. If China wants to hold the line on yuan, it will need to draw on its foreign exchange reserves. Any resulting flow of $US out of China would be achieved by selling US Treasuries - and this is likely to force world interest rates up (and further damage emerging economies) [1]

PBOC says that yuan will move both ways and that more 'adjustments' are unlikely [1]

  • China's huge economic advantage over the rest of the world (ie a rapid increase in the number of workers each year) has now disappeared with a reduction in the workforce now occurring for the first time in decades [1]
  • There was increasing doubt about the adequacy of China's financial system and the people who run it.

Allowing market forces to influence exchange rate (as PBOC recently did) is only one obstacle to capital flows across China's borders. China's stockmarket meltdown shows holes in its financial regulations - and this makes political leaders nervous about allowing investors to move money in and out of China. At the same time China is experiencing economic weakness. Financial supervision might be inadequate in dealing with disruptive capital movements. Yet PBOC continues to emphasize market liberalization - though it needs to prevent currency free-fall. Stockmarket fall happened after epic rally associated with the creation of lending tools that had escaped regulators notice until debt build up caused investors to run for exists. Officials are now worried about increasing risk. China's saving's glut (deposits stand at $21tr - 50% of GDP) could pour out of country if capital controls are loosened before financial system is strengthened. PBOC is pushing for liberalization - yet many are concerned that China's state-controlled financial system is not robust enough [1]

  • China's financial and economic difficulties have the potential to bring on a global recession [See also CPDS speculations about this in Debt Denial: Stage 3 of the GFC... or Worse? 2009)
  • It is possible to develop a 'doomsday' scenario in relation to China's current situation - given contagion from the effects of stock market falls and devaluation (to other markets, capital outflow and accelerated problems associated with financial sector weakness and corporate indebtedness [1];
  • China may have long term problems but in the short term it is not facing the sort of financial crisis that affected US and Europe in 1931 and 2008 - because it has tight exchange controls and a state banking system. China's recession is over because stimulus has revived its property market, so the day of reckoning has been put off again. China has a $600bn pa trade surplus and is thus rapidly accumulating foreign exchange reserves so its reserve losses will not get out of control (as happened to many countries in Asia at the time of the Asian Financial Crisis). China's credit growth has been 20%pa over past 3 months. China had been affected by severe monetary / fiscal shock as declining inflation had forced real interest rates up in an attempt to deflate China's property bubble and wean economy off its $26tr debt dependency. But the policy overshot at the same time that budget spending contracted. Banks had apparently refused to roll over short term loans to local authorities - because these were no longer covered by government guarantees. Local governments were expected to issue bonds instead - but bond market was slow to develop. This is why China crashed into recession in first half of 2015. China's government has now reverted to strong credit stimulus. The property market has strengthened. China's devaluation is probably not significant. China would face serious risks of capital flight if it engaged in ongoing devaluation  [1]
  • The PBOC is preparing to flood banking system with liquidity to boost lending - as its recent currency moves are squeezing yuan funds out of market and renewing concerns about capital flight. Cutting deposit ratios are a sign that China's exchange-rate maneuvering backfired - but merely involves doing again what China has done before which failed to stimulate economic activity [1]. The PBOC ordered an emergency interest rate cut after the stockmarket experienced 2 days of large falls. This was seen to counteract downward pressure on China's economy [1]
  • China's recent economic troubles make it seem a threat to (rather than rescuer of) global economy.

During GFC China launched massive stimulus which acted as shock absorber. Now it is the source of shocks. Growth starved world has come to depend on China. With 15% of global GDP, China has contributed half of global growth. China's economy is a 'black box'. Government economic statistics are suspect. And policy manouvers are suspect. A desire to micro-manage yuan value undercuts its ability to pursue independent monetary policy - due to spill-over effects on domestic liquidity. Risk averse banks continue to favour SOEs - thus requiring private firms to rely on high interest rate financing. SOEs face overcapacity. The stream of bleak news reached critical mass recently - generating near panic. It still has positive features - but its growth is slowest in 25 years and government is losing control. It had hoped that stock-market would help fund indebted companies. Then market fell. There is now doubt about China's economic management. Past methods used to support growth are losing effectiveness - because of structural inefficiencies and larger economy. Fiscal expansion has limited potential. China's senior officials are reportedly divided on what to do. Reliance on state investment / exports is losing effectiveness faster than expected. Exports were down 8.3% yoy in July. Construction starts fell16.8% yoy during first months of 2015. Advanced technology and entrepreneurship are slow to fill the gap. Many firms are succeeding - but this is not enough to replace the old economy which is contracting quickly. The flow of migrant workers to cities is reversing - because of weakening demand / conditions. Worker protests and strikes are more than double a year ago. PBOC is flooding the market with liquidity to counter these problems - but would prefer not to do so. Buying / selling the yuan to affect exchange rates influences domestic liquidity - and thus requires changes to monetary policy also. Beijing is having trouble getting people / institutions to follow its instructions. Some suggest that concerns are overdone - as there are bright spots and for many it is business as usual [1]

  • China is experiencing serious economic problems - partly because promised and necessary reforms have not been made

There are abandoned / unfinished apartment blocks all over China - as a result of rash judgments made during the world's most extreme speculative investment bubble. These are not 'ghost cities' - merely empty unfinished buildings. This has implications for Australia because it was assumed that China's demand for coal / iron ore was insatiable. But imports of these have fallen / collapsed. And motorways have been built everywhere that are almost unused. China's excess steel / aluminum capacity has caused a global glut. Investment has comprised 50% of China's GDP - and this has to fall. At the height of the boom China was using half the world's steel / cement to build (often) empty buildings. There are no statistics on abandoned buildings but there must be tens of thousands of them. China claims that its housing sector is still expanding - but more slowly. However there is doubt about such claims. Exports are flat. Manufacturing is contracting. Electricity use is falling. Cranes are thinning out. Millions of workers are moving back to villages. China's sharemarket problems are not really significant. The problem analysts see is that Xi Jinping promised structural reforms in 2012 / 2013 which have not been made (eg of household registration system; financial reforms to fund credit-worthy borrowers not those with political influence; creating land market; rural education; intellectual property rights; reform of SOEs). Migrant workers in cities have declined (due to growth slowdown and aging population). This matters because migrant workers drove productivity gains. Many expect China's growth to fall to 5% pa - but bursting of housing bubble and flat global demand could lead to uncontrollable recession. China's ghost concrete towers are a symptom of a financial system that supports groups that obtain finance on the basis of connections without objective credit analysis. Some expect excess property to be absorbed gradually - but there is now over 2 years stock on hand. China is facing vested interests who are blocking necessary reforms. China's earlier reforms forced the Party to change - but it did not require that it lose control. This is now what is needed and it is being resisted. [1]

  • China has warned its people and the world that much slower growth is now likely as it moves from smokestack industries, huge exports, vast infrastructure spending - all underpinned to trillions of state-backed debts. Debt is now twice GDP and some industries (construction / steel) are in trouble. China's leaders are having trouble managing the transition. There are areas of improvement - but consumer spending is not rising fast enough to compensate for declining areas. China had seemed to be a dependable source of growth - and now it is exporting volatility [1]
  • China was seen to be headed for recession (defined as growth below 4%pa) unless large scale fiscal expansion monetised by PBC was put in place - and authorities were seen as yet unwilling to do this [1];
  • China's deepening problems were seen as adversely affecting global economy [1];
  • China's proposals for the development of a new economy (which probably included reliance on a share-market to provide capital for industrial investment) have not been going well - and this will have adverse international effects [1]
  • While China is experiencing difficulties, it was seen as likely to weather the storm

Financial crises in 1987 and 1998 did not lead to recession - though crisis of 2008 was different. Crash of 1929 did not cause Great Depression - as the real problem was tight policy by Federal Reserve from 1930 on that caused banking system collapse. The 1987 crash followed two Fed rate tightenings - and then prevented this having any effect by increasing liquidity.  And in 1998 the Fed tightened because of domestic inflation fears - and countries with too much $ debt suffered. Then Fed reversed policy and US economy continued growing - a step that some see as a mistake. Question is whether ructions in China matter. US economy is accelerating, Consumer confidence is up. Housing sales rose 21% in July. Job openings ratio is high. Germany is solid. Eurozone is doing well. There is no monetary implosion now like that in 2008. QE is still strong. US loans are rising. China is main unknown. Some never believed in China miracle. Its post-2009 credit blitz is unprecedented. China's premier agrees that China faces middle income trap unless it ditches catch-up model and weans off investment led growth and Party grip on China's society. While trouble was likely, crumbling credibility of China's leaders is painful. One year borrowing costs rose to 5%. Local government reforms were botched - leading to fiscal crunch (19.9% spending fall in January). Stock market mania was stoked. Capital flight reached $200bn in July (or more). PBOC is burning foreign exchange reserves to defend currency - and this squeezes domestic liquidity. It can't cut rates to support economy without encouraging further outflow. China will probably weather current storm. Fiscal spending is growing at 13%. Housing market is recovering. Service grow at 10% pa. [1]

  • China (the world's largest holder of US Treasurys) has been selling (over $100bn) since currency devaluation - in order to protect value of yuan. Many see this as bearish for US bond prices - though this may not be correct as there are complex factors involved [1];
  • China's economy was seen by Citigroup as likely to crumble with huge increase in money supply by central bank. China would take the world into recession with it. Another observer suggested that stagnation is the best outcome that China can expect over the next decade. Another drew a parallel with Japan's lost decade [1]
  • China's debt (not changes in share market) are its real problem. Local government debt increased dramatically over past two years - and this is major facto in China's financial instability. Government is seeking to bring problem under control.  [1].
  • While China has consistently hit growth targets, it has a major problem because its debt levels have been rising 2-3 times faster [1]
  • Significant falls in factory activity in China and a cooling services sector suggest that China could be headed to a hard landing [1]
  • Capital outflow from China will have a self-reinforcing adverse effect on its economy;

China's dumping of US Treasuries is big issue. Usually share market volatility causes investors to buy Treasuries - but recently their prices went down. China has pegged yuan to $US since 1994 - and moved to managed peg in 2005. This allowed $4tr foreign exchange reserves to be accumulated. To maintain peg (and China's competitiveness) China needs to 'print' yuan to exchange for $US. These can be sterilized to reduce inflation risk by issuing notes / bonds / increasing banks reserve requirements. Or surpluses can be invested in US Treasury bonds (or Fannie Mae / Freddie Mac) which had implicit US government guarantee. This pushed US interest rates down - which lead to consumption / house price boom and to 2008 bust. This adversely affected China - because its economic structure was oriented to manufacturing for Western consumption. China launched a stimulus / credit boom that (in conjunction with West's reflationary efforts) encouraged continuance of pre-2008 speculative flows. China's foreign exchange reserves grew again and speculative capital flowed into China - expecting China to revalue yuan higher. QE and zero US interest rates encouraged borrowing $US to buy yuan to take advantage of higher Chinese interest rates and lack of currency risk. However a country can't maintain a fixed exchange rate, have free capital flows and set interest rates independently. China long had a closed capital account - which allowed them to control exchange rate and set monetary policy. But as capital flows were allowed. When China's economy slowed in 2012/13 and US moved towards capital tightening, speculative capital started flowing out of China. Thus China must now sell (rather than buy US Treasuries). The unwinding of speculative inflows is self-reinforcing - because running down foreign exchange reserves reduced liquidity in China - which is not what it needs when economy is already slowing [1]

  • the rapid growth of local government debt in China (ie 30% over 18 months) - combined with falling revenues compounds other concerns about China's economy [1]
  • China's economic reform agenda has been slow to be implemented. It was seen as legitimizing and reinforcing Communist Party rule. It also included: raising incomes; promoting markets to allocate resources; and become more consumption based. While some progress has been made (eg on market liberalization) little has been achieved on most of the reform agenda [1]
  • China is spending increasing amounts of its foreign exchange reserves to defend the yuan ($US94bn in August 2015 - double the amount in July). This signals that the currency has further to fall - and that the currency has to be propped up (ie demand is artificial) [1]
  • China is experiencing significant and increasing capital outflow.

China's problem is no longer what to do with capital inflow. Not long ago the world was awash with cheap $US - due to US Federal reserve monetary policies and the re-export of China's offshore trade earnings. Then China started investing in expensive off-shore initiatives (eg AIIB and New Development Bank, Silk Roads projects) while also recapitalising its policy banks. China's problem has shifted from excess reserves to questions about whether its reserves will be sufficient. What the PBOC is doing has the effect of 'quantitative tightening'. The more market-determined approach to exchange rates could lead to a dramatic fall as capital outflows increase. China's foreign exchange liabilities probably account for 40% of its foreign exchange holdings. The IMF estimates that it needs a minimum of $2.6tr in reserves. There are about $2tr in various financial arrangements that could be a source of outflows [1]

  • a long term China 'bear' suggests that China is running out of room to borrow - because its debt grows 2-3 times faster than its GDP. China could lose control of its currency - and this may have been the cause of August 2015 market instabilities [1]
  • China's leaders expressed deep concern about the economy at G20 meeting - despite official claims that growth at 7% pa will continue

 Reference was made to stock market bubble bursting. However more significant was a statement by officials that China would suffer 10 years of tough economic conditions - with a lot of pain for 5. China is trying to move its economy to one based on domestic consumption. To generate cash for this China encouraged investment is the stock market. Until mid-2015 this market had seen a major rally. Then this method for corporate capitalization failed. Also China's economy has started slowing faster than expected. Export and manufacturing data were well down yoy - and services / property sectors are not growing as fast as expected. China is walking a tightrope with its currency. It allowed yuan to fall a little - but risks capital flight if it falls too far and has to spend a lot on money ($95bn in one month) to stabilize yuan. The PBOC can't do this indefinitely . There are also rumblings that some officials want China to end its 'new normal' shift. Serious infighting is possible [1]

  • China's declining imports suggest that its transition to a consumer driven economy is slow [1]
  • China's real problem is in its banks - not its stock-market.  China's entire foreign exchange reserves might be needed for a bail-out - see details;
  • China has again stimulated its slowing economy with infrastructure spending - a step which sets back efforts to get its debt load under control [1]
  • There have been suggestions that China could experience problems like Japan did in 1980s and 1990s - but this is not so. China's problem is much harder to deal with - eg because of higher levels of government intervention [1]
  • China has announced plans to reform its debt-laden, mostly state-backed corporate sector. It desperately needs foreign investment - but now does not seem to be a good time to invest.
China has announced plans to reform its debt-laden, mostly-state-back corporate sector. This has been inevitable as China shifts from reliance on foreign investment to domestic consumption. The plan involves selling off bad assets, reducing government's role, privatizing and allowing markets to have a fee hand. But this is happening while China's economy is in trouble. Government wants to both maintain control and get cash. President Xi announced China's desire for foreign investment - and also that it would not change its heavy-handed policy on foreign investment . The reform process China envisaged has fallen apart. Everything would have been fine if reform had been financed domestically (ie by encouraging China's people to get into stock market). This initially led to a boom - but then to a bust. China's $529bn in offshore (euro and dollar denominated) debt rose $10 with a 1.9% devaluation. China promises now to defend yuan but doing so cost it $110bn in August 2015. China's corporate sector was already struggling with PPI deflation - so debt was becoming harder to repay.  China wants foreign investment - but it does not seem to be a good time to do so [1].
  • Property sales are increasing rapidly in China and stimulus / credit is unleashed. There is a shift to hard assets after confidence was lost in stock markets. Interpreting China's economy is hard, as data are unreliable. Fed held off rising interest rates because of fear that China may be in real trouble. Efforts to rein in China's credit bubble seem to have been abandoned. It is unsure whether what is happening will translate into new property development because of the large over-supply of properties. Land sales attract no buyers. Also flow of migrants to cities has slowed and China's workforce is now falling 3m pa. China has a housing shortage for poor people and an over-supply of glitzy apartments. [1]
  • China's falling foreign exchange reserves are forcing PBOC to increase monetary easing to keep liquidity flowing. This used to be automatic and a consequence of China's increasing foreign exchange reserves [1]
  • after the collapse of China's sharemarket bubble, funds were widely shifted into Chinese bonds - where the problems may be even greater [1]
  • informed observers suggested, in relation to what is going on in China is that: (a) there is great uncertainty about the competence of China's administration - but no uncertainty about who is in charge; (b) the collapse of Shanghai share market was the result of deliberate creation of a stock bubble by government - as values reached could never have been justified. China's people were made to think that government could dominate market forces; (c) China is in for a bumpy landing - and faces great uncertainty. Official FX reserves are falling; (d) the end for China is not near - progress continues to be made; (e) China's equity market bears no relation to real economy - growth will be maintained by fiscal expansion; (f) China is trying to shift to service / consumption driven economy at a time when the advantages it had in manufacturing no longer exist ; (g) China is seeking to deleverage from past excesses - and this is becoming harder ; (h) China's growth is slowing because of high labour costs, unsustainable debt levels and enormous supply capacity related to politically-motivated investment. There is a risk to Communist party from slower growth, stagnant wages; rising unemployment - and widespread corruption. Despite talk of reform the government seems to be increasing its economic control; (i0 government seems to be fighting the corporate deleveraging that is needed because they don't understand the problem. Hare brained efforts at government-sponsored stock market rally smacks of desperation; (j) China is in difficulties - but it would be unwise to ignore its remaining strengths [1]
  • The UK rolled out red carpet for China's president. Britain's pivot to China is based on its economic strength. However there are reasons to expect to expect China's future economic performance to be poor
  • China's economy has been slowing for years. According to authorities its September 2015 growth was 6.9% - though the true figure may be lower. There are many reasons to expect problems: (a) China's huge demographic challenge; (b) China's real estate investment has been massive (10% of GDP) - and this is incompatible with its demographic challenge; (c)  there is large industrial sector over-capacity; (d) everything now depends on consumption - and though there are signs of improvement, in many areas growth is weak or negative; (e) China has very high debt levels [1]
  • China's official interest rates have been cut - but this will make little differences because liberalization of China's financial system (to gain IMF recognition for the yuan as a reserve currency) will mean that banks will increase rates. In any even China's most pressing need is to reduce the dependence that economic growth has had on increasing credit [1];
  • The profits of China's SOEs are falling because they have taken on too much debt. Their response is to increase debt levels - and this makes the situation worse.  However without that increase in debt they would be unable to function. To move from investment-led economy to one based on consumption China needs to restructure SOE debt - but to maintain its economy China needs to keep giving SOEs access to credit [1]
  • China has decided to end its one-child policy. However its workforce is already declining rapidly and this change can not increase working age populations for another 20 years. It will do nothing to alleviate China's expected 140m workforce deficiency in the early 2030 - when dependency ratios will be very high [1]
  • Weak exports (related to China's reduced competitiveness as a result of wage rises) and weak domestic demand are both contributing to a growth slowdown in China [1]
  • China now seems to be applying the same methods to stimulate its economy as it has done in the past and getting less economic impact from doing so. Stimulus measures were introduced following problems in mainland stock-market and precipitous fall in exports are having little impact. Easing money policy started in 2014 - and usually has an impact in a few months. Data now suggests a slower response.  China is moving from reliance on investment to consumption - while trying to avoid a credit event. This requires continuing to provide high levels support for property sector and SOEs that carry huge debts and a proving sluggish. Most credit has gone to SOEs. China needs to shift its emphasis from rescue to reform. [1]
  • Chinese borrowers are taking on record amounts of debt merely to repay interest on existing loans. 45% of new debt is for this purpose. This is a classical Ponzi scheme - which is a formula for a financial crisis [1]
  • The steady stream of capital outflow from / fleeing China which has disturbed global financial markets is likely reach a record ($113bn) in November 2015 [1]
  • Rises in / normalization of US interest rates could be economically disruptive - but this has to be done sometime to avoid simply creating greater future risks. However the biggest risk world faces is large Chinese devaluation. This could set off further declines in commodity prices and a currency war across Asia (and elsewhere) that replicates 1998 - but is more dangerous. China's fixed capital investment is $5tr pa (equal to North America and Europe combined). There is massive excess capacity. Capital outflows are over $100bn per month. $57bn in foreign exchange reserves are being used monthly to defend the $US peg. RBA estimated capital outflows at $300bn in third quarter - and that $200bn of foreign exchange reserves had to be liquidated). Such reserve depletion entails monetary tightening - and thus makes a 'soft landing' much harder. Chinese exporters want to keep foreign earnings in $USs - and foreign suppliers have reduced willingness to accept yuan. China held vast quantities of $US bond in Belgium - and these have now been halved. China's exports stalled in November 2015 - and fell 6.8% yoy. China is exporting excess output into saturated global market. There is debate about whether China's currency is overvalued. It has $800bn current account surplus. Yuan is linked to strengthening $US while Japan devalues yen and currencies in Russia and East Asia have crumbled. Chinas effecive exchange rate rose 30% since mid 2012 - at the same time that it runs out of cheap labour.' This has squeezed corporate profits. There are major problems in ship-building and steel industries. Devaluation has been resisted to avoid falling into Japanese-style outcome - and would be hard to square with China's ambition to be a stabilizing pillar of world economy. China has a ''new economy' that is doing well. Yet there are domestic political tensions associated with this transition. China's president is mainly concerned with using 'reforms' to ensure hegemony of the Party - and this is incompatible with a market economy. Those promoting economic change could be pushed aside [1]
  • China's debts are rising significantly relative to GDP. This is however not likely to lead to a financial crisis because most debts are by state-linked companies / agencies to state-linked banks - and the government controls the whole financial system. However there is a cause for concern because those rising debts indicate poorly-directed investment and this will harm China's ongoing growth prospects [1]
  • China is seeking to prevent a spread in the value of the yuan between the somewhat higher exchange rate it achieves in China, and the lower value attributed elsewhere [1]
  • China is facing increasing difficulties in managing its economy. There were problems in 2015 - and policy induced turbulence is possible in 2016. A sharp yuan depreciation is a risk - which could trigger competitive devaluations elsewhere. It is also hard to know how markets would react to significant corporate default. Debt has been increasing significantly - and government efforts to constrain this could lead to problems. other challenges relate to pollution, to possible policy paralysis as a result of anti-corruption campaigns. However positive gains are also possible - and whatever happens will make a big global difference [1]


  • China is tightening rules related to foreign currency trading in order to stem the flow of yuan out of the country - because China's economy is weak and outflows increase pressure on yuan value - which is already being devalued [1]
  • A Chinese player in stock investment believes that Communist Party will save stock market and make people rich. Many Chinese now make highly-leveraged stock bets. they could run into problems because of China's debts. China's debts are rising as its economy slows. Overall debts ($28tr) are half the world total. Since GFC China's debts escalated, while US's were reduced as % of GDP. In Singapore / HK, non-financial private debt is 200% of GDP. This would not matter if growth wasn't slowing. China's real growth has slowed by 1% - because inflation is low. But in nominal terms growth slowed 7%.  China's loan growth has slowed - but not as much as nominal GDP growth. China's debts are now 282% of GDP - up from 121% in 2007.  China's corporate debt / GDP has grown twice as much as next highest country.  In 2007 few Chinese companies had debt service costs over profits - now over half of them do. Debts in emerging markets have boomed. The $US has appreciated against other currencies. China used to rely on foreign currency inflows to its financial system - but this year as US raised rates China started losing foreign exchange reserves. AS China's debt increases it is less able to pay it off.  Much of China's increased debt has been taken by local governments - and is also hidden in SOEs. Some argue that the world is in last stage of debt super-cycle when it suppresses growth everywhere. This may already be happening in Asia - ie people have so many debts that banks can't lend more. China won't have a credit crisis in 2016 - but several companies have defaulted on their debts [1];
  • China has injected $100bn of liquidity into financial system and cut interest rates to stimulate economy - but this may be insufficient because of capital flight. This was necessary to stop liquidity drying up and reverse passive tightening associated with capital outflows. The PBOC is also drawing down foreign reserves - and this has unintended consequence of tightening monetary policy (which is why countries can't use foreign reserves in a recessionary downturn). It is uncertain how much cash has gone offshore - but the PBOC might have burned through $200bn since August. China's strategy is unworkable. Trying to defend exchange rate requires bleeding reserves and loosening monetary policy at the same time. China probably has about $900bn in reserves that could be used - a sizeable but not unlimited stock. Running these down would also be constrained by high levels of short-term external debt. China's reserves are in fact low by emerging market standards. Analysts are uncertain whether China's problems are over. There are signs of improvement (eg in house prices, transport, demand for aluminium, services (growth at 10% pa). There are also positive international economic signs. [1]
  • China is struggling to get its debts under control. It seems to have appropriate policies - but is having trouble putting them into effect [1]
  • China started 2016 in hopeless position - noting stock market crashes and investors' alarm about currency depreciation.  Comparisons are being drawn between China now and US on the eve of GFC. However what happened in 1998 is more relevant. The AFC caused China's growth to fall. Foreign demand for exports crashed, and it was impossible to rely on domestic demand. This is like China's current problem. SOEs were in serious difficulties - profits were weak and there was excess capacity. And real-economy problems affected the banking system - creating huge bad debts. Solutions were similar to those now being proposed - loose money policy, and adoption of more market-centric reforms. Tough policies were introduced - loose lending practices and infrastructure duplication were avoided. Efficiencies were sought in state sector - which was significantly reduced allowing more scope for private operations. The bureaucracy was also tightened. The short term effect was severe - but the long term effect (combined with joining the WTO) was China's rapid subsequent growth. 1998 reforms show that China's problems are not insurmountable - but current regime seems more concerned with consolidating its political power, fighting endemic corruption and flexing its muscles abroad. Without decisive action current government will end China's economic miracle  [1]
  • China's shift to a service economy is being driven mainly by a decline in export and domestic demand for manufactures. In most cases of sustained economic growth in modern economic development, industrialization is the key. Countries fall into the middle income trap due to the inability of manufacturing to move up the value chain and compete in global markets when wages reach a certain level. The increase in China's services share is a symptom of the hollowing out of its manufactures. China still needs substantial improvements in manufacturing - and this requires investment  [1]
  • China is trapped. The more it uses foreign reserves to defend the currency, the more it tightens domestic credit. Bad debts in China's banking system are 4-5 times greater than officially admitted. Massive malinvestment has occurred during China's $26tr credit bubble. China's credit may still be growing faster than economy. Foreign reserves have fallen $700bn to $3.3tr as capital flight overwhelmes the trade surplus. This would normally lead to a 25% devaluation - which would have a huge deflationary impact worldwide. China's government is trying to maintain currency stability. China believes it is different because it funded growth from domestic savings and capital - and thus can deal with financial market risks. However investors are not sure that China can defend the yuan. The more it burns through reserves to defend the yuan the more it tightens internal monetary policy. This worsens credit crunch and causes more bad debts. Opinions are divided. Some see property crisis claims as exaggerated as 'new economy' companies are buying real estate to rent. Others see that there is excessive pessimism about China - which will probably muddle through [1]
  • China suffered much larger capital outflows in 2015 ($1tr) than anyone had expected. China's foreign exchange reserves are thus declining faster than expected - and could soon be below the recommended safety level. Those reserves are needed to allow China to stimulate its desired economic structural adjustment [1]
  • while most observers have been concerned about China's stock market and currency values, China's biggest problem probably lies in local government debts. These had become unsustainable (because of borrowing huge amounts at high interest rates on short terms from shadow banking system). In 2015 maturing debts were refinanced through long term bonds at much lower interest rates. This process needs to continue - but it is not certain that issuing such bonds will still be easy [1]
  • China may fall into the 'middle income trap' rather than continuing to grow at a rapid pace and become the world's richest and strongest nation. China's income gap with US is only now reaching the level that Brazil and Turkey achieved in 1970s - and they have never succeeded in further closing the gap. The middle income trap could be due to: rising wage costs which reduce competitiveness; too much physical investment and too little spending on education and skills; or political failure. [1]
  • Markets have gone from excessive admiration of China to excessive pessimism. However China's growth is not slowing - but rather accelerating after recession in 2015 that was due to bad policy actions.  Growth is however based on stimulus measures that are unsustainable and will perhaps only be able to be continued for another year or two. Capital outflows are a major source of concern - even though much of this is sensible reductions in $US debts - given rising US interest rates and $US value [1]
  • China is experiencing the greatest capital flight in history. Cash reserves fell $700bn last year. This complicates China's economic transition and also raises risks for other emerging economies that are also experiencing cash outflows. China's huge foreign exchange reserves mean that this poses no immediate risks. A devaluation by China would be a major worry - this would make other emerging economies less competitive and increase their risk of capital flight. Capital flight usually reflects economic turmoil, political instability of external crisis. China is affected by several inter-related factors. Large amounts were invested in China on (false) assumption that strong growth would continue. Anti-corruption campaign is encouraging people to get money out. Also Chinese companies that had borrowed offshore and reducing external debts. Flight is also encouraged by the view that getting money out will become harder.  The issue is complicated by possible difficulties for heavily indebted companies and local governments to refinance their debts. Russia's problem with capital flight was much worse than China's. China's challenge is not to stop the phenomenon but to contain it [1]
  • The fact that stockmarket problems don't tell anything about China's economy does not mean that everything is OK. China's main vulnerability is inexorable rise in debt - and unless this is addressed any solutions are worth nothing. Important reforms of China's real economy havs stalled. China can continue producing 7% growth rates for a couple more years - but this is not a solution if it requires increasing overall debt levels much faster [1];
  • Institute for International Finance suggested that China had not been convincing in dealing with capital flight risk - and that significant renminbi devaluation was possible. Authorities have not yet expressed a coherent strategy. Capital outflows could accelerate and get beyond China's control. Foreign exchange reserves have been falling - perhaps by $140bn in December 2015. Big renbinbi devaluation would have deflationary shock worldwide. The bulk of outflows are probably to pay off liabilities - and thus benign (and not 'capital flight'). But the component that is not just repaying debt seems to be increasing - and even when all external debt is repaid Chinese companies may continue outflow if China seems to be losing control. China needs to restore confidence by pushing reforms through. [1]
  • China's large debts are unlikely to be a major problem because government has necessary controls. Capital outflows are a bigger risk of triggering a hard landing. China's foreign reserves fell $100bn in January. China has been forced to expend reserves to prop up currency. However doing so is a bit like trying to prevent a run on bank - as it encourages others to also try to get out. Wealthiest Chinese have deep distrust of China's policy-makers. Anti-corruption reforms have been too narrow and have not addressed inequality which is becoming socially destabilizing   [1]
  • A credit crisis in China could see banks incur losses 5x those of US banks during sub-prime crisis according to Kyle Bass (Hayman Capital). China’s banks (like those of US before GFC) have pursued excessive leverage. Regulatory arbitrage and irresponsible risk taking. China’s banking system has $34.5tr in assets – up from $3tr 10 years ago. This funded huge / inefficient infrastructure investment that propped up China’s growth. Loans are not made on the basis of borrower’s ability to repay but on their political connections. This is compounded by problems in China’s shadow banking system. Losses in China’s banking system from 1998-2001 were 30% of GDP. Losses in current cycle are likely to be as bad – and this now equals $3,6tr. China could be forced to recapitalize banks by printing $10tr yuan. Doing so would result in 30% yuan devaluation. China’s foreign exchange reserves may be only $2.1-2.2tr – after allowing for $700bn in China’s sovereign wealth fund – compared with $2.7bn minimum required for banking sector bailout. A collapse in China has been long predicted. And Bass has been predicting a collapse in Japanese government bonds for 5 years – which has not yet happened. In fact bonds surged recently because they move inversely to interest rates [1]
  • Concerns about China were seen to be overblown by Deutsche Bank - who sees only a 20% hard-landing risk. Buffers against NPLs include those already written off, excess provisions and $1.1tr in pre-provisional profits. Also only $20tr of China's banks' $34tr assets were credit-type. The rest were reserves at PBOC, interbank deposits / lending and treasury bonds. There is also potential for 20% recovery of collateral - with 43% of loans collateralized. The PBOC has also strengthened oversight of shadow credit while banks have improved risk controls [1]
  • Kyle Bass (Hayman Capital) argues that wealth management products have been used by China's banking system to contribute to China's rapid growth of credit. They offer investors guaranteed interest and principal payments but are not on the banks balance sheet (where there is a limit of obligations relative to bank capital). However in the event that there was a repayment problem they would need to be brought back onto balance sheets. A particular variation of this involve Trust Beneficiary Rights which (Bass says) are being used to hide loan losses away from regulators' view. When loans approach a non-payment status they are pushed into TBRs (ie to Trust Companies for whom the bank is guarantor). Then bank records TBR as an asset. TBRs require much less bank capital to support (2.5%) than than on-balance-sheet loans do (11%).  Some banks now have more TBRs than they do loans  [1]
  • China's economy seems to be facing problems when one looks at its stock market (which is not a significant source of finance for industry) and GDP - which largely measures what is happening in China's 'old' economy. However rapid growth in services and consumer-oriented industries is occurring - which suggests that China will not have a 'hard' landing [1];
  • Pessimism about China (because of growth slowdown / high debts / policy bungles) has been seen to be excessive. reasons to suggest that a wave of bad debts would not sweep through China's banking system were that: (a) the yuan is only modesty over-valued; (b) banking sector losses would only come from bad banking credit not from total system assets. Also banks have ample liquidity and don't need to recognise bad debt immediately; (c) China does not need to use FX reserves to recapitalize banks - as the state could do this directly; and (d) China's $3.2tr FX reserves do not include China's sovereign wealth fund. The IMF believes that China needs $2.7tr in reserves as a minimum - but China has capital controls that it can implement [1]
  • There has been concern about China's FX reserves and the stability of its exchange reserves. China's central bank has now argued that China does not need to devalue the yuan. China has a large current account surplus. Capital outflow is seen as mainly associated with repaying foreign currency debts - not with 'capital flight'. Despite this China still faces a currency risk [1]
  • China's private debt / GDP ratio (290%) is the highest in the world and is growing at 28% pa. This is an indicator of a likely recession - which occurs when debt ratios cease rising [1]
  • China's debt levels are of concern but are unlikely to lead to a hard landing because credit is primarily provided by domestic savers through state owned banks to state-owned companies [1]
  • China's attempt to  to end its massive over-capacity in steel and coal industries could have serious adverse effects domestically (leading to politically destabilizing levels of unemployment) and internationally (through have to export the products of its excess capacity - and thus undermining similar industries elsewhere and potentially triggering trade wars) [1]
  • China's attempt to defend its currency will end badly because doing so by running down foreign exchange reserves because doing so has the effect of tightening money supplies and thus creating a deflationary environment. A once off devaluation is needed. Authorities are worried this could lead to an unstoppable currency slide - but this would be unlikely to happen [1]
  • Panic about China has abated - as the yuan has strengthened and money outflow eased. Growth is expected to increase. Yet there is a problem because this has been achieved by stimulus through more rapid credit growth - which increases the risk of future problems. Without needed structural reforms China is headed for middle income trap. China's 'credit overhang' [ie the deviation of the credit-to-GDP ratio from trend] has risen to 25% - leading to falling factory gate prices / profits and putting China at risk of 'debt-deflation' trap. Many firms have declining ability to service their debt obligations. Gross debt to earnings has doubled since 2010. Median days to pay suppliers have risen to 70 - as compared with 35-45 elsewhere. Potential loans at risk are 15.5% of GDP ($1.3tr - with potential losses of $756bn).  The IMF warned of an abrupt re-pricing of risk - even though banking system is an arm of Chinese state. Total credit is rising rapidly - much of which is used to repay old debts. The GDP growth for extra debt has collapsed 2/3 since lending spree started in 2009. The structural (market liberalization) reforms that President Xi promised in Third plenum in 2013 never happened. Instead the government deliberately inflated a stock market bubble with margin debt - which collapsed. SOEs are still getting most credit. It was never possible to deliver a 'free market with Chinese characteristics' while tight political control was maintained. Despite headlines indicating that China has recovered - this can only last a few months. When this ends rapid capital outflows from China could resume and swamp its reserves / force a massive devaluation / disrupt global trading system. This could happen just as inflation risks rise in US [1]
  • reports of improvement in China’s economy in early 2016 seem inconsistent with reports concerning Chinese enterprises and China’s trading partners [1].
  • Turmoil in likely to resume on China’s financial markets and spill over into the world’s fragile financial system. Concerns about China’s financial system emerged in late 2015 when currency devaluation was botched. This continued with stock-market sell-off that rippled globally. China’s connections to global financial system is likely to increase. Assuming that China is still a growth engine and a place where profits can be earned is dangerous. China recently opened its huge bond market to international investors – but its domestic economic reform program has lagged. And Chinese companies are investing offshore. This has involved Chinese firms with non-transparent financial positions buying insurance firms – which could cause a lot of problems if things go wrong.  Closure of China’s stock, bond and currency markets to foreign investors in the past has protected the world from China’s ups and downs. This is ending – as China opens its bond market to spread the risks associated with its credit binge.  The problem is that in China, stability and political goals have always overshadowed financial goals. China wants to spread its market risks to the rest of the world – though its markets are not markets as others understand them but a government political tool.  Even without this the world is heavily exposed to China – via bank lending. Turmoil in China could lead to large losses to banks elsewhere. China needs to keep its economy growing – but so far it has only been able to achieve this by borrowing more. This poses risks in bond market and to companies / banks that have invested in China. Devaluation of the yuan would be a way to boost growth [1]. 
  •  Everyone used to believe that China's growth was going to continue to be strong. Now many doubt this. Some see parallels with Japan's problems in the late 1980s as a result of build up of bad loans. China could experience a situation it can't control (ie a banking crisis). China total debt levels are estimated as 308% of GDP (ie $30tr). Debt growth has been enormous in 2016 - and much of this has found its way into property market which the government seems to have chose as growth engine despite the existence of 2-5 years glut of unsold properties in smaller cities. This is just more of the old' China - where the post 2009 stimulus package led to inflation, asset bubbles and excess capacity [1]
  • China debt-fuelled growth has been suggested to face a risk like US experienced in 2008. Both involved unsustainable expansion of credit heavily linked to real estate [1]
  • China's elite have wanted to have everything - stimulus by money printing, reducing support for companies that lose money, boosting role of markets and private sector, and supporting SOEs. This leaves everyone unsure of ultimate direction. PBoC is injecting large amounts into financial system increasing risk of housing bubble. Government usually intervenes to stop dangerously fast property price growth. If this does not happen soon a boom / bust cycle is likely. China's housing sales rose 1/3 in first quarter after 2% previously. However corporate profits in China fell in 2015 - for first time since 2000. However China's debt rose to 237% of GDP - double that of 8 years ago. Monetary policy needs to be reducing overcapacity / stockpiles / leverage / overcapacity - but it has actually been doing the reverse [1]
  • Global banks expect China's latest credit-driven boom to lose momentum by late summer 2016. Curbs have already been placed on lending for property in eastern cities to prevent a speculative bubble [1];
  • the amount of debt now carried in the Chinese economy (mainly by zombie SOE) is now so high that a financial crisis is seen to be  likely [1]
  • China's government now seems less likely to be willing to bail out its huge corporate bond market - a perceived willingness that allowed Chinese companies to borrow heavily in recent years [1]
  • Research by CLSA shows why China had to apply economic stimulus at end of 2015 (ie falling job creation, rising wages, reduced competitiveness, effect of trying to slow property boom) - though the benefits might be unsustainable. China's problem is that property sector is its economy (ie drives 43% of economic growth). This driver was falling at end of 2015. This had to be reversed - though the sector is unproductive, there are 5 years of housing inventory, and there is overcapacity in all industries that contribute to property. Unproductive growth means that economy / banking sector is susceptible to problems. IMF says that 14% of debt of Chinese listed companies is 'bad' - though adopting less conservative criteria suggested that this could be 28%. [1]
  • rampant speculation in China's commodity markets could adversely affect global markets and the global economy. Trading volumes and volatility have been so extreme that they make stock market swings seem mild. Prices have fallen after reaching a massive price spike - which could have seriously damaged China's already fragile market system [1]
  • Authorities in China are increasingly discouraging negative reports about its economy from being published - as its problems become more severe [1];
  • China is officially talking about reducing its economic dependence on rapidly increasing debt - but seems to actually be continuing that dependence [1]
  • In June 2016, the yuan seemed to be depreciating rapidly again (as early in 2016 - when this led to international instability) and again encouraging Chinese to try to get money out - and generating aggressive official reactions  [1]
  • China has been involved in a huge rate of offshore deal-making - to buy foreign companies. However such deals are increasingly failing (in an environment in which attempts have been made to get money out of China and its government has attempted to block this). Information about the deal-makers and government agencies that block them is not available. The situation is further complicated by links between deal-making companies and government. Government wants China to have same international influence in deal making as it does in economy - but external partners don't take proposals on simple trust [1]
  • CLSA suggested that China's banks' bad debts are reaching crisis levels. Non-performing loans are seen to be 19% of bank assets - not the official 1.6% and global average of 4.5%. Despite this government is injecting massive new stimulus into economy as unemployment rises, manufacturing contracts, bonds default; GDP growth slows; and DFI falls in key sectors [1]
  • Most of what China reports about its economy is meaningless - as its leaders prefer propaganda to facts and never publish anything that might cause alarm [1]
  • China's debt problem can be seen to be a symptom of 'state capitalism' which does not present any immediate risk of a financial crisis - but will lead China into an economic trap unless policies are changed. However this view seems overly simplistic. [See outline of that suggestion and CPDS comments in China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism']
  • China needs to address its soaring debt levels and accelerate reforms to its financial system to avoid serious problems - according to IMF. Its outlook was uncertain because of rapidly rising credit, structural over-capacity an opaque / interconnected financial sector [1]
  • China's banks have $1.7tr in losses (according to Societe General). 60% of capital of China's banks is at risk. And debt is expanding rapidly - rather than shrinking. China's non-financial debt rose 15.2% to $35tr (250% of GDP) in 2016. Problem is mainly confined to China's SOEs. SOE inefficiency is dragging down China's economic performance - but recognising even small part of SOE non-performing debt would overwhelm financial system. And SOEs still have preferred access to bank finance.  Technically-bankrupt companies still accessing finance is dragging down economic performance. There has been talk of reform - but abundant credit continues to be provided.  SOE debt restructuring would jeopardize 50% of banks capital. Attempts to restructure SOEs in 1990s pushed banks' NPLs to 30-50% of GDP. Government was slow to respond. They can't do this again - as recognition of banks' credit risk could overwhelm the system. Unlike 1990s restructure, doing so now won't be supported by very strong economic growth. A fast restructure could lead to economic hard landing - which threatened social stability. Government favour a gradual approach to restructure - which risks loss decade and policy uncertainty [1]
  • China's looming debt crisis (which, as for Brexit, companies don't want to consider what they will do about it) is big issue. Companies are taking on new loans to cover overhead and operating costs. Debt-equity swaps and securitization of NPLs would be an option (as China did 15-20 years ago) - but would now be much harder. SOEs have liabilities of 115% of GDP. Government said that it had not used a 'strong stimulus' to maintain growth - but it had been 2/3 of GDP in year to April 2016. Warnings about China's debt from 'authoritative person' was believed to indicate a willingness to tolerate growth below 6.5% - but this may not be so, in which case even more stimulus would be needed - resulting in wastage / corruption. Indications of trouble emerged with rapid growth in capital needs for a 'bad bank' that had taken on some of China's debt mountain. [1]
  • The numbers of loss-making enterprises in commodity sector is rising rapidly in China. Local governments want to keep them going because of potential adverse effects on employment. To overcome the problem structural reforms are needed in China as a matter of urgency. The recent rebound in commodity prices has been due to Chinese policy-makers again turning on the stimulus taps (to increase infrastructure / residential construction in the face of overcapacity) is likely to reverse in late 2016 [1]
  • China not only has a very high debt / GDP ratio but this is now being increased by $1tr / quarter (ie about 25% of GDP) for speculative investment rather than for investment in real (ie not always used) infrastructure and property - see here
  • Increasingly Chinese companies are taking on new debt to pay old debt - which ultimately could mean that debt is not being repaid - creating a Ponzi-like situation. The percentage to repay old debt was 8% in 2014, 44% in 2015 and 42% in 2016 [1]
  • China may have attempted too early to shift from an  economic model based on investment in manufacturing to one based on domestic consumption. The shift lowered China's productivity growth. China's debt / GDP ratio is 280% - mostly due to manufacturing / industrial functions which now suffer overcapacity [1].
  • Leading economists agree that China faces a debt crisis, there are no signs of policy renewal and recession (either sharp / calamitous or drawn out like Japan's) is almost inevitable by 2020 though not immediately. Debt has grown faster than GDP for years. And government has had to provide huge stimulus to maintain desired growth. Outstanding loans are now about 200% of GDP (double the 2008 figure). Total debt is about $35tr. The debt bubble (unproductive loans) is now past US 2007 subprime level. At current rates of expansion banks will find themselves unable to fund their assets safely. There is now widespread agreement about the dangers posed by China's corporate debt (which is still increasing rapidly). Until recently there had been disagreement about this because some presumed that China's regime would prove competent no matter what. President Xi seems to be driving policy - yet seeking to be able to shift the blame if problems arise. Mismanagement of stock market bubble and of exchange rate caused concern. Rating agencies are now downgrading China. CLSA suggests that China's debts have reached crisis levels - with NPLs now 19% of bank assets (not the 1.6% official figure and global 4.5% average). Most NPLs come from loss-making companies - yet these continue to receive funding at the same time that unemployment rises, manufacturing employment falls, there are bond defaults, foreign investment falls and property experiences declines. China's (mainly state-owned) banks would need to raise 15% more capital to cover bad debts. Shadow financing (off balance sheet lending by banks) has reached 59% of GDP. Some economists argue that Communist Party is incompatible with China's future. Despite talk of reform to give market grater role, little has changed and state sector is still favoured.  Government announced an intention to shift from exports / investment to consumption / services. But little has been achieved. Investment remains main growth driver (46% of GDP). There is a need to close / privatise worst SOEs - but Communist Party doesn't want to do so as this would reduce its ability to direct economic change. Change is needed to avoid 'Japan trap'. IMF warns that countries that experienced rapid debt growth like China had financial crisis. Xi is seen to be running a gigantic monetary bubble that has corrupted every aspect of economy. A massive proportion of the credit that has been given to companies can't be accounted for - and is believed to have been stolen. One industry leader has confessed to taking $20bn. many others are believed to have done likewise. Despite this, stimulus can't be turned off - as this would cause growth to collapse.  Unwinding is likely to start with banks becoming unable to get sufficient capital despite government funds' flow  [1]
  • China's president (Xi) and Premier Li) have conflicting views on China's economy - specifically on reform of SOEs.  Xi called for stronger, better, bigger SOEs while Li emphasized slimming them down. This disunity is adding to uncertainties about proposed economic restructuring - which has been stuck for months [1
  • China has major demographic problem - despite abolishing one child policy. There is a 24m surplus of men over women - because of preference for male children and abortion of females. History suggests that excess males can lead to rebellions to vent frustration. In relation to this it can also be noted that China's people are becoming more disillusioned with what is happening (noting increased strikes). They are also becoming more nationalistic - - and in this regard excess males could increase the risk of external aggression. China also faces problems in taking care of large numbers of seniors - eg because of poorly developed pension system. [1]
  • China has been making progress towards cleaning up the bad debts in its financial system [1]
  • China is pouring huge amounts of cash into buying Silicon Valley assets - just as Japan did in the 1980s. And like Japan at that time, China's corporate debts are very high [1]
  • China's manufacturing industry that has been based on low cost labour will be under threat as robotics comes to dominate manufacturing [1]
  • China is at risk of Japan-like 'liquidity trap' as monetary policy loses effect and economy approaches credit exhaustion - thus forcing a shift to Keynesian fiscal stimulus. PBOC officials have started calling for a fundamental change in strategy. They can't stop companies hoarding cash or halt slide in private investment. Growth of private investment has fallen to 2% pa - the lowest since GFC. Central bank is 'pushing on a string' - as funds are not flowing into real economy. A surge in public spending and a property boom is only masking the problem  [1
  • China is at increased risk of falling into 'middle income trap'. Its government is trying to arrange an economic 'pivot' but is not committed to a real free market. China's economy has probably grown less than 5% this year as debt-fuelled, state investment led growth model ran out of steam and became counter-productive, China needs to change foundations of its economy - to reduce state role - to avoid what most other countries that have reached middle income status have experienced. Policy makers understand the problem - but the losses that resulted from loosening their grip on resources and capital created political difficulties.  Fiscal reform by local governments and attempts to create local capital markets have been poor.  SOE reform has not yet materialised. Instead of mixed ownership current reforms are creating stronger / better / bigger SOEs. Restructuring SOEs would require higher unemployment and more welfare spending. Financial system reform would leave government less direct financial control over credit growth, resource allocation and exchange rate - and a lower current growth rate [1]
  •  Bad debts in China's banking system at 10 times greater than officially admitted - and rescue costs could be 1/3 of GDP in two years. NPLs are between 15-21% and are rising fast as China delays serious reforms. It would cost $2.1tr to fix this now - and government would carry most of loss. Banks have been taking losses off balance sheet into wealth management vehicles - with government collusion. The more debt grows the greater the risk to asset quality and liquidity shocks.  Defaults in China could lead other firms into distress because of mutual credit guarantees. The total damage would be much greater than 8% of GDP that was the cost of GFC bank rescues in US / UK - and would be like the failures in Ireland, Greece and Cyprus - but on  a much greater scale. Chinese state already has debts that are 55% of GDP following local government bail outs. China allowed a fresh bout of stimulus spending in early 2015 to counter risk of serious recession - and abandoned any pretense of serious reform. Credit reached 243% of GDP at the end of 2015 - double the 2008 levels. Curbs on property lending and much of the new credit flows into housing speculation - driving up prices 30-40% pa. As credit has grown faster it economic efficiency has fallen - and GDP growth has halved making it much harder for China to work off its debt load. China would be unable to repeat what was done to deal with financial crisis in 1990s - when roaring global boom reduced the burden and financial repression was used to reduce deposits at cost to savers. Interest rates have now been liberalised and China faces strains from shrinking workforce. The fact that major banks are instruments of Communist Party reduces the risk of a western-style banking crisis. What is more likely is something like Japan's lost decade of muddling through [1]
  • China could have $2tr in bad debt - 10 times the official level [1]
  • China has been seen as the biggest threat to global economy. Its economy is slowing more than official figures show. It is going through major political transition (eg related to anti-corruption campaigns and shift to consumer-driven economy). China has a debt problem - because of credit-fuelled growth - and such problems go on forever.  Its situation is like US before financial crash of 2008. [1]
  • China has started allowing some badly indebted SOEs to fail [1]
  • Markets believe that China's economy has stabilized - because of headline data. However close examination of other data suggests that it has gotten worse. Corporate borrowing has risen across the board while profits and cash flow fell. All that is still growing are old (investment driven) drivers of economy that government has been trying to wind down in favour of domestic consumption. Deteriorating corporate finances and a reversal of rebalancing are a high price to pay for maintaining growth. The government seems to be preparing for things to get worse - by allowing credit default swaps and allowing a SOE to prepare for bankruptcy  [1]
  • many Chinese believe that China will 'rule the world' given its comeback from centuries of relative weakness and 'national humiliation'. And many non-Chinese seem to agree with them and expect a China-centric order will supplant a crumbling West. Martin Jacques suggested that China's economic transformation will provide a platform for unrivaled influence and an alternative path to modernity and a very different world order. In Australia there has been debate about whether Australia can accommodate China's rise without losing independent / sovereignty and the values of a liberal democracy. Former UK PM (David Cameron) seemed to accept the need to accept China as the world's new emperor from the East. Independently minded SE Asians seem powerless to resist China's military clout and economic / financial blandishments. The Philippines' president announced the end of joint naval patrols with US - because he believed that China now has the power and military superiority in the region. Should Australia get onto the Chinese train. This requires examining the assumption that China is on track to being dominant global power in 2030. People believe that assumption because everything in China is big (geography, reach, population, building, ambition) and China has been able to harmonise its hard and soft power assets. China's surge from under-developed backwater to emerging superpower has been impressive - and China aspires to lead now in everything without much concern for whether it plays by established rules in doing so. China supports Robert Mugabe (the Zambabwean dictaror) and puts cash into many other areas of Africa. It has thus become Africa's biggest trading partner. The Chinese military now operates everywhere. A supposedly civilian space facility was established recently with Argentina - which could have military implications. Soft power strategies have also been used effectively to reinforce China's image as a nation of standing and influence in world affairs - and heir apparent of declining US. The Dastyaria affair illustrated this in Australia. President Xi Jinping's new silk road (OBOR) project would position China as the centre of economic and geopolitical influence. Australia's federal government sees Australia as part of this - and links it to its plan for northern development. Given about $3UStr at China's disposal, the OBOR project might succeed and allow China to rule the world - but there are reasons to believe that this won't happen. China has economic problems - eg may be unable to maintain 6-7% growth rate / transition from export dependent to domestic demand driven economy. Debt is rising twice as fast as GDP growth. China's exposed banking sector might have to write off debts 4 times larger that US banks did in 2008. Many experts expect a China debt crisis. China's OBOR goals could be adversely affected by negative reactions to its South China Sea activities. China's international expansion (with about 5m Chinese national working internationally) could require funding to expand / protect that exceeds China's ability to support.  China also faces risks of imperial overstretch and hubris - given the rapid expansion of its influence. China also faces: (a) demographic challenges - given its aging population and the consequent end of its inexhaustible supply of cheap labour; and (b) potential domestic political instability. Xi has been seen to have broken post 1978 practices by a revival of ethno-nationalism and Mao's practice of rule by fear. Xi may thus only succeed in undermining China's political system - in much the same way that Mao did.  It is not unreasonable to assume that China has already peaked - and will continue as a leading developing nation for a couple of decades on the basis of its momentum but won't bypass the US or rule the world. There is a need to recognise that China's party state will use soft power to exaggerate its achievements, influence and power. This should not stop Australia having a constructive relationship with China - providing: (a) this does not conflict with core Australian values; (b) is accompanied by trade diversification to prevent over-reliance on China; (c) good relationships are emphasized with other countries in Asia. Until China's regime changes, there will be growing resistance to the notion of a China-centric world  [1]
  • The shift of speculative investment in China from shares to property suggests that it is facing a bubble. However China was not included amongst the locations that face a property bubble in recent UBS report - because of the lack of reliable data. However the existence of a problem is demonstrated by the fact that the case for buying land in 10 major Chinese cities disappears unless property prices continue to increase - which is a classic sign of a bubble (ie buying on the basis of a 'greater fool' theory) [1]
  • Recent data suggests that China is continuing to favour near term economic growth while ignoring concerns about mounting debts [1]  
  • Those who believe that China is experiencing a bubble according to two major Chinese companies. Suggested problems are real - but are being addressed by Chinese authorities. The transparency of economic and fiscal information in China was said to equal that in the West. China's economy is highly dependent on the big four banks and the government seeks to ensure that they are safe. And rather than not being free, China's economy was seen to be highly competitive while the government encourages entrepreneurship  [1]
  • Leyland Miller (China Beige Book founder) as asked about China's future. Latest data suggests that China is not rebalancing as growth was confined to old economy functions while services and retail weakened. It is thus wrong to believe that China is stable.  China has a property bubble - and belief that China will strengthen commodities demand could be wrong. Some official data is unreliable but there are data that indicate what is going on. However data quality is getting worse and government attempts to control it. Kylie Bass predicted a banking crisis in 2017. However the banking system is insolvent - so there is a 'crisis' already. However government control means that China is not vulnerable to the sort of crisis that can occur in US / Europe. China has a non-commercial banking system - and government can move money around the system at will and also draw on Forex reserves to deal with the most pressing problems. This is a formula for economic stagnation - but not for an immediate crisis [1]
  • China has a debt problems - but it is not due to industrial sector or SOE but to the booming private property market. GFC showed that debt problems in one part of the world could have global effects. Since 2008 China has been responsible for 50% of borrowing globally. 2/3 of China's debts are accounted for by corporates.  Many commentators blame inefficient SOEs for China's problem. And though construction and excess industrial production are part of China's problem, the main problem arises from real estate and private developers. China's overall debt trajectory is unsustainable. To solve its problem China needs to reduce property speculation [1]
  • China's government has introduced new measures (M&As, bankruptcies, debt / equity swaps; and debt securitisation)  to try to deal with its corporate debt mountain - but observers are not convinced this will work. The goal is to reduce corporate debt level soon - from current 169% of GDP. China's debt mountain, like the subprime problem that led to GFC, was a result of political miscalculation that economic analysts have trouble taking into account. Encouraging local governments to use venture capital to fund projects looks promising. S&Ps believes China's debts are unsustainably - and increasingly risky. Its banks should be strong enough over the next year or two - but any major problem that derailed a bank could have huge effect. China's extremely high level of state-driven investment is likely to continue - as China's regime needs to maintain credibility. The credit ratings of China's top 100 companies are deteriorating. Maintaining China's growth requires increasing stimulus. growth is being prioritized while reforms are ignored and there are growing problems in banks and state enterprises [1]
  • most people are familiar with made in China products - but China intends to become a developed nation by mid century - and a focus on innovation is central to this. Progress is being made through a three stage process: (a) moving from copying to 'fit for purpose'; (b) moving from being world followers to world standard; and (c) from seeking new resources to new knowledge [1]
  • China has many asset bubbles due to torrents of speculative money flowing to stocks / bonds / commodities. The most obvious bubble is housing - but prices for niche assets (eg caligraphy, antiques and art) as well as pig feed and a pipe making material have also surged. A lack of real economy investment options has caused investment in virtual economy (shares / bonds / commodities). There is concern that China's credit expansion has gone too far and is producing hazardous side effects. Senior officials have warned excessive credit could lead to systemic financial crises, recession and destruction of savings. The risks have global implications - eg in relation to iron ore.  Risks have grown because banks, companies and investment funds participate in speculation. Consumers have sunk savings into high return investment products - some of which have collapsed. Increases in apartment prices have been faster than anywhere else in the world.. China's total debt will rise to 260% of GDP - up from 154% in 2008. The debt binge started with a crisis related stimulus package. A stockmarket bubble burst in 2015 - and money then moved to bonds. Many investors repeatedly bought bonds by borrowing against those they already held. Deflating China's asset bubbles poses risks for China [1]
  • China's GDP remains dominated by fixed investment - but growth is being experienced in the GDP's 'other' category. During the recent G20 meeting, China's president promised emphasis on supply side reform - and urged global leaders to join him in 'real action .. not talk'. China is using pledges made at the G20 to turn the 'China dream' into a 'China program' - as a step towards a 'China solution' to the world's problems.  The Communist Party flew global leaders to an October meeting - and participants praised China's efforts to promote international cooperation and global economic governance. They praised public goods provided by China to the global economy and global governance - eg through OBOR project to generate new demand by increasing effective supply. Despite this China is having trouble rebalancing its economy. It wants to shut down excess capacity in SOEs while using OBOR badged credit from state banks to export excess capacity to others. Central planning and the Party's determination to remain in control (which are at the heart of Xi's program) are incompatible with supply side reform. Fixed asset investment remains over 50% of GDP - but it used to be 70%. The 'other' category of China's GDP used to be 3-5% and is now 19% (including education, logistics, tourism, e-commerce, software. R&D, healthcare). Most growth is driven by the private sector. China's private-dominated sectors are providing investment options for brands from the rest of Asia to become more competitive with Western brands. The biggest concern is the rapid build up of debt - which has been staggering. However it is internally owned and concentrated in SOEs  [1]
  • There is concern about a possible repeat of 2015's panic associated with questions about China's currency reserves - given simultaneous concerns about US elections and Fed rate tightening. Reserves fell by $100bn in October 2016 - 5 times greater than in September.   [1]
  • 2017 will be decisive for China. Low cost exports have declined as a share of its economy. To maintain growth China's leaders have embraced monetary and fiscal stimulus which escalated outstanding debt to 250% of GDP. Corporate debt (the largest component) rose 60% to 16% of GDP. A nationwide debt crisis looms - given business defaults / bankruptcies / low industrial profits / poor return on investment / another likely real estate slowdown. China always depended heavily on fixed investment - and this has increased over past decade as low-cost exports and household consumption decline. Funding has been obtained from many sources - but mainly by increasing debt - and mainly from state owned banks financing SOEs. The latter account for 55% of debt though they only contribute 20% to GDP. After GFC China's supposedly temporary stimulus became start of long period of investment-led growth. By 2013 Beijing started cracking down on wasteful local spending.  This increased reliance on corporate debt - most of which is dependent on real-estate-linked construction. In 2014-15 the latter appeared to be headed for downturn - before being re-invigorated though still with a slow rate of actual construction. China's authorities recognise the risk - but the problems are huge and suggestions of 45% tariffs on exports to US will compound these problems  [1]
  • Chinese demand for global property has become the world's biggest real estate frenzy. One estimate was that the amount spent in the first 6 months of 2016 was the same as in 2015. Money is getting out despite the Chinese government's efforts to stop it. Middle class Chinese buyers are following the lead of China's elite. [1]
  • China is planning tighter restrictions on Chinese companies who want to invest offshore [1]
  •  China wants to convert its store of $US reserves into foreign assets but is concerned that outflows could turn into a tsunami unless tightly controlled. Companies are investing offshore in search of better opportunities - because of tight competition from SOEs at home. Families are doing so because of concern about yuan devaluation. Families could get around restrictions on investment in foreign real estate - but those routes are now being blocked off [1]
  • China's debt levels are the and of England's greatest concern about global stability. Debt / GDP ratio has risen 100% since 2008. bear record capital outflows in September 2016 quarter add to concerns [1]
  • China's banks are disguising bad debts by turning them into securitized packages writing them down according to IMF. This parallels what was done in the US prior to sub-prime crisis [1]
  • China's central bank has increased its efforts to drain cash from that county's financial system - to reduce excess borrowing and frothy markets. At the same time PBOC has been guiding state-owned banks to restrict short-term ;ending to other financial institutions. This has contributed to sell-off in domestic bond markets. This is all part of government's deleveraging campaign - designed to bring China's debt under control. The days of easy money are over. This is totally unexpected - and occurs at a time when banks need lots of cash which the PBOC would normally provide [1]
  • When Marco Polo went to China he found that China was creating money out of paper. He did not know how risky that policy would be for the country that invented it. Many Chinese rulers have paid off spiraling debts by printing money - and encountered inflationary scourges. The Mongols and Mao's Communists seized power after after China had destroyed the value of its paper currency. China is now struggling with its latest bout of monetary excess. China's problem is not inflation - yet. But it has created the biggest pool of domestic liquidity in history to help stimulate its economy and finance a crushing debt burden. Between 2007 and 2015 China created 63% ($16tr) of world's money supply. China's problem is that debts are increasing almost as fast as money is generated to service them. China will have a problem when it ceases creating money fast enough to service debts that are now 250% of GDP. Officials fear that Chinese people believe that they would be better off getting their money out of China - as capital flight would sap the liquidity needed to keep China's bubble from bursting. China is seeking to control outbound capital flows.  China's stock of foreign reserves fell from $4tr in early 2014 to $3.1tr in October 2016 [1]
  • China has made itself liable to bubbles (currently in commodity markets) because it has created a great pile of money that has to go somewhere [1]
  • China's debt problem is likely to be worse than most statistics indicate - but this may not matter because the primary goal of its financial system is not to make money but to follow political instructions [1]
  • China's trade (especially imports) have fallen significantly in March and April 2016 - indicating the government efforts to stimulate the economy are not working [1]
  •  China's debt is extreme. Its credit-to-GDP gap (a BIS measure) is 30% -  the highest of any country back to 1995and three times the level BIS regards as unsustainable. The government plans debt-for-equity swaps but this is only a temporary measure (eg because banks would not want equity stake in problem companies). China needs real market reform. Companies need to be restructures, hard budget constraints imposed and losses revealed. SOEs are kept afloat for political reasons. Equity swaps would need to come with control to reform the problem companies. China's debt is now about 300% of GDP and 25% of companies don't earn enough to pay interest on their debt. The IMF has suggested a reform strategy - though it would be difficult politically and constrain growth.  [1]
  • After 25 years of growth Australia's bank balance sheets are good. There are however issues related to household debt (187% of GDP) and heavy investment in apartments. While Australia is likely to see reduced asset quality - rather than a disaster this may not be true for China. It has 75% of Asian NPLs. This implies pressure on earnings / volatility - or at worst a financial crisis - if there were a liquidity event such as Lehman Bros in US. China under-reports NPLs - and the real figure could be 15-20% of gross loans (ie about the same level as the Asian Financial crisis in late 1970s). ANZ noted that this had happened before and ,ost NPLs are to SOEs - so it is basically just government money going round and round. Growth is what is needed to solve this problem. UBS suggests that most NPLs come from private sector in manufacturing / wholesale / retail and SMEs. The most overcapacity sectors (mining / construction / real estate) are yet to contribute much to NPLs. Considerable progress has been made in dealing with the problem - as major banks are well capitalized to deal with a large number of NPLs. However if credit continues to rise 2-3 times faster than GDP, the problem will grow faster than the ability to deal with it. [1]
  • China's growth could rise in 2017 - given a large fiscal / monetary stimulus. This could open up capital markets, prompt service sector growth and achieve transition to consumption-led economy. China's future consumer spending will be more than that in Europe. It has become much easier to operate foreign banks in China over the past two years [1]
  • Someone powerful in China has declared war on debt and the fantasy of perpetual stimulus - and commanded an end to reliance on credit. China needs to take its punishment (with bankruptcies) before matters spiral out of control. China's debt is $30tr - and has increased since 2007 by more than total liabilities of US, Japanese, German and Indian commercial banks combined. SOE debts alone are 115% of GDP - and 20% may require restructuring. Leverage rose by 50% of GDP in Japan before bubble burst in 1990, in Korea before 1998 Asian crisis and in US before subprime crisis. In China debt has risen by 120-140%. Given China's role in commodity markets any problem will have global implications. Proposals now for reform of China's SOEs have parallels with reform proposals under Qing Dynasty and Kuomintang - where the reforms failed and stagnation resulted. China's credit cycle has now accelerated into epic blow off - and is reminiscent of 2015 stockmarket boom and bust. Those who expected a China bust in 2015 may see this in 2016. 100 firms have cancelled or delayed bond issues in April 2016 due to widening credit spreads. 10 companies defaulted in 2016 - and expected government support was missing. [1]
  • Chinese banks are classifying loans as investments in order to be able to continue providing credit to maintain economic growth. This makes it easier to put off hving to acknowledge bad debts [1]
  •  PBOC foreign reserves fell $69bn (to $3.1tr) in November 2016 - a total fall of $500bn in 2016. Government has sought to reduce this by clamping down on foreign investment and gold purchases. This has deep roots and could affect China's ability of China to buy Australian products. The story started with devaluation of yuan in August 2015 - to boost exports and growth. This triggered a huge capital outflow. During boom years investing in China had offered good returns - and China's shadow banking system grew and flourished. It made sense to borrow at near zero rates in US to invest in China - until China devalued. Now yuan denominated assets are being sold to repay old loans before it is too late. This further devalues yuan and creates feedback loop. Before 2015 PBoC bought $US from Chinese companies earned from exports and printed yuan to do so - thus providing credit for huge expansion in China.  Now it is selling its reserves to prop up yuan - which increases the cost of capital and puts further pressure on foreign exchange reserves. At the same time government encouraged Chinese firms to 'go global' - and foreign investment in China fell as labour and other costs rose. This is part of overall strategy of internationalisation - while moving away from export dependence to dependence on services / domestic consumption.  This domestic consumption has not occurred to the extent expected.  A crackdown on luxury consumption (seen as corruption by Communist Party officials) has further detracted from domestic consumption. It is hard to prevent movement of yuan out of China through offshore yuan market -especially as China pushes for yuan to be used as international currency. All this means that Australia will need to engage more with China's economy - not just sell 'stuff' to China.  Australia should also be more willing to transfer technologies to China while China arranges better protection of intellectual property [1]
  • A slowdown in China's property market could overwhelm lenders. China's banks are masking $2tr of loans as investments (ie about 20% of their existing loan portfolio).  Attention is increasingly given to the levels of China's debts. Two years ago shadow banking was studied - now it emerges in a different form. Off-balance sheet vehicles are a risk for China if liquidity dries up - eg if there is a property slowdown. Classifying loans as investments (especially to property developers) means that banks are not holding capital against potential losses. China's officials are aware of the problem. But lending by any means necessary is mandated by top level directives that China must maintain 6% pa growth - which requires state-owned banks to support growth by providing credit to struggling businesses despite the risks. China's official debt levels (250% of GDP) are only part of the story [1]
  • Middle class Chinese investors are providing funds for property development in the US - as technology (smartphone apps and online lending platforms) makes this easier while bypassing banks and other traditional funding sources. This adds to money pouring in and boosting property prices thus raising local concerns about affordability. This digital flow of wealth reflects Chinese people's desire to diversify in times of worries about a slowing economy and China political / social challenges. Though China restricts the flow of money, these new technologies make it harder to do so. New financial platforms have really good lawyers. Money can be invested in yuan and repaid in $US - thus effectively moving money offshore which is otherwise difficult. These new technologies have lept ahead of regulators. China cracked down on money flowing abroad after investors started shifting funds out at an alarming rate contributing to a sharp fall in foreign exchange reserves. New steps were taken requiring scrutiny of transfers over $US5m. Investing channels have not yet been affected. Mobile apps (eg Niuniu, Jimbox and Tioger Stocks) allow offshore purchases / sales of foreign stocks from smart phone. Online portals allow money to be pooled to buy real estate.  Chinese investors want wealth preservation and peace of mind the same as others. China limits individual transfers of $50,000 - but online portals make transactions on behalf of individual investors to bypass those limits [1]   
  •  Chinese yuan has been in steady controlled decline since start of 2014 - which has drawn criticism from Donald Trump. However China's currency is still over-valued in trade weighted terms. As $US strengthens because of rising Fed interest rates, the yuan will weaken as money pours out of China. Capital outflows are increasing and the yuan is viewed bearishly. They may have risen from $70bn in September 2016 to $80bn in November.  China's foreign reserves are $3.3tr - and its net reserves are $1.8tr [1]
  • Chinese bond yields soared (and prices fell) and authorities halted trading as the global bond market sell-off worsened after Fed signaled faster increases in interest rates [1]
  • While US sharemarkets have risen, China's has been falling despite the close US/ China linkage. China is being forced to tighten. Its $9tr bond market is seizing up. 40 companies have cancelled bond issuance this month while 24 large companies are in default negotiations. China had a 4% of GDP fiscal deficit - which stoked a housing bubble. It was like China's post-Lehman blitz - but much less effective because the efficiency of credit has collapsed. Despite severe capital controls, net currency outflow from China has accelerated - eg to perhaps $15bn in November 3 times the level in October. Foreign investment by Chinese companies is on hold. others are having trouble getting money out of China. Higher bond yields in US while yuan faces devaluation have attracted Chinese money. China's central bank slowed the yuan slide by burning through $US1tr of foreign reserves. It's reserves are $3tr just above the $$2.8tr needed by a country with a managed exchange rate. China's system is more deformed tahn it was under Mao or Japan was at end of Nikkei bubble in late 1980s. PBOC is in a bind. It can't raise interest rates to slow capital outflows because of stresses in banking system. Its recent tap on brakes led to  liquidity crunch and shockwaves in bond market. Global markets are too complacent about the risks of financial turmoil in China in 2017. Continuing to defend yuan value which drove reserves down to $US2tr could cause market panic. Letting yuan float to find its own level is seen to be needed. Corporate debt in China is larger than that in US - and a lot of bad loans are just being rolled over. Bad debts may be 10x official figures and result on losses 30% of GDP [1]
  • There has been a massive (ie up to 43% pa) rise in house prices in major Chinese cities - because of urbanization and rising incomes. 8 out of the top 10 cities worldwide in terms of house price growth are in China [1]
  •  China's debt-fuelled property boom and potential bust will be main issue facing China's government in 2017. Rapid rises in land sales / auction prices / debts need attention [1]
  • China's regulators need to wean the economy off cheap borrowing and rising credit levels - which will be anything but easy because of the complexities involved. China also needs keep its currency stable to prevent capital flight [1]
  • China's capital outflow will be a major 2017 issue as it will contract domestic liquidity. China boosted domestic liquidity in early 2016 - but capital leaked out at an accelerating rate. FX reserves are falling at an accelerating rate. Authorities are trying to stop this. This is important as wealth in China is in few hands so decisions by a few people can have big effects. China's credit / GDP ratio has been rising very fast (ie well above long term trend) and it is not clear how long this can continue [1]

Continued below for 2017 when the risks associated with China's rapidly rising debt and falling foreign exchange reserves seemed to be being officially recognised

Throughout  2016 the viability of the Chinese 'system' itself (which had long seemed to be at risk as suggested in 2004 and 2009) continued to be questioned (eg see Understanding China's Current Regime (2015) and Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures, 2016). [^ >]


  • the rule of China's Communist Party was seen to be at risk because the crackdown that President Xi had put in place had made all Chinese people fearful [1];
  • China's autocratic political system was seen to be in danger of collapse in the much same way that this happened in the USSR

China's National People's Congress can be seen as either sign of strength or a theatrical veneer. China's political system is badly broken. President Xi's crackdown on corruption is supposed to end this problem. But his despotism is severely stressing China. It is hard to predict the end of authoritarian regimes. The endgame has however started. This is indicated by: (a) China's economic elites are poised to flee; (b) political repression has been severely increased in recent years; (c) loyalists are only going through the motions in defending the system - without conviction; (d) the corruption that pervades China's society / military also pervades the whole society. The problem is rooted in China's system - and can't be eliminated by an anti-corruption campaign; and (e) China's economy is stuck in a series of traps - because necessary reforms challenge entrenched interests [1].

  • There has long been debate about the relevance of Singapore's model of authoritarian capitalism for China [1]
  • Though the 'Umbrella Revolution' by students against Chinese authoritarianism had failed in Hong Kong, organized protest action continues and is highly disruptive of the relationship between mainland China and Hong Kong [1]
  • The 'rule of law' that China's leaders had espoused as a critical to the country's future was seen as not necessarily consistent with the way China was actually ruled.

The campaign to entrench the rule of law in China is now recognised, but many have trouble understanding its implications. Before Xi's appointment, his predecessors had lost control of political power (noting Bo Xilai' efforts to create his own kingdom in Chongqing). Xi's reform commitment (and power) has given China more certainty - but it is not clear where it is headed. Problems had included: power of SOEs; business / government collusion - which exacerbated corruption; and inflated real estate prices. Xi's reform proposals included a rule of law. These attempts are real. However in China 'rule of law' is seen as subservient to rule of one-party state. The Party is seen to be leading the rejuvenation of Chinese system. Its mandate is to do whatever is needed to transform economy / society and the drive progress. The Party alone is seen to have the correct intellectual approach and the ability to make 'rational' decisions. The 'rule of law' seeks to strengthen control over party-state apparatus. Some support this, yet others note its inconsistencies. [1]

The arrest of Crown Resort employees shows the problems that foreign businesses can have in China where the rule of law down not apply. It is impossible to rely on law because in China the government has the final say [1]

18 staff of Crown Casino's were arrested in China. China has a lot of laws - one of which stipulates that one can't advertise gambling in China - and Crown staff advertised gambling in Australia for 'whales' / high rollers as an alternative to Macao. This would have upset China's 'mafia'. The Chinese government enforces law arbitrarily - and those charged will not receive a fair trial  [1

  • it was argued that the position of China's leadership was too weak for them to risk conflict with the US (a view which in the present writer's opinion is probably simplistic and strategically-dangerous if taken at face value - see Understanding China's Current Regime below). 

Outline: Bao Tong was director of political reform in Communist Party's central committee. He was policy secretary under Zhao Ziyang.  The Communist Party once had a liberal wing. Young Chinese believed in reform slogans and opening up. Bao paid for his beliefs. He was arrested in 1989. Zhao was purged. Days later Deng Xiaoping sent tanks to Tiananmen Square. Now while dictatorial princelings rule China, Bao helps us understand what happened. China and US have become rivals as China seeks to expand power beyond territorial waters. China is on US's policy agenda in a way that it has not been for a generation. US's problem is: What is it dealing with (eg Germany in 1900). Or is China an era-of-globalization power whose rise won't bring war. Policy-makers should read Bao's words to understand. China's Communist Revolution and Mao Zedong's victory broke an old civilization, killed its gentry and overthrew the social order. China had been the greatest trade market. Mao abolished capitalism. Bao argues that Mao turned private property into state property. Deng Xiaoping transferred national assets to party elites. China's 'princelings' now control much of China's wealth. The biggest princeling is President Xi Jinping - who no one knows much about. From 2012 he became the most powerful leader since Mao. He unleashed a campaign against corruption - which sidelined rivals and frightened the bureaucracy. Bao says that graft is built into the system. When Deng began reforms he said some would become rich first. This was taken as a sign of free enterprise. But it really meant that party members / families / cronies would become rich.  The US faces a regime that aims to keep power in the hands of its leading clans and reform the economy while retaining state supremacy. Such regimes would not want war and their tyranny is an instrument of self-preservation. Throughout China's history factions divided. Nationalism is a tiger that China rides at its peril. The Party's endgame may be near. Bao has written about this for the US administration [1

  • Intelligence agencies have believed that China needs 7%pa growth for social stability. While yuan devaluation and economic slowing is not necessarily a crisis for China - but China must adjust because of non-performing loans, overcapacity, exhaustion of old model. Since Tiananmen Square massacre China has had to create a new political dispensation. The problem was grass-roots resentment of insider privilege. China's leaders responded by emphasizing nationalism over communism (and also emphasizing ongoing growth). But (as Bo Xilia case showed) concerns about social / regional inequality remain. [1];
  • China seemed to face the risk of another anti-Confucian cultural revolution because the neo-Confucian methods that has been adopted to achieve its economic miracle were based on the social inequality that Mao's cultural revolution had sought to eliminate;
  • China's authoritarian political system was seen to have disrupted its economic reform agenda - concerning which CPDS comments are in Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures 

An authority on China's long-term reform efforts (Barry Naughton) suggests that the 'train wreck' of the Shanghai Stock Exchange shows how long term reform plans have been derailed by domineering style of China's president. Policy moves have been incompetent to serve his political agendas. Failure occurred in local government reform, SOE reform and the fiasco of cheer-leading an over-heated share-market and then injecting huge amounts to compensate for crash. This shows problems in how China's economic 'engine' works. Professor Naughton supported the Third Plenum reform program in 2013. But this was set aside as propaganda fuelled share-market's huge rise. The China Dream was seen as being achieved instantly. Then in July 2015 extreme measures needed to be taken to arrest the crash. Image of reform-oriented president has been replaced by an authoritarian leader who seeks to control the entire policy agenda - which is impossible. China's current economic dynamism and policy-making dysfunction is the opposite of what existed in early 1990s. China's 'miracle growth' phase is over. Healthy growth is unlikely for 5 years [1

  • While the decline of China's share-market is unimportant, what is important is that China's leaders face massive challenges in shifting to a consumption driven economy and found it hard to deal with the mere bursting of a stock-market bubble.
China's share-market is a mere 'casino'. It is thus surprising that the government devoted huge resources to unsuccessfully trying to stop a bubble collapsing. It must have been driven to do so by concern about economy. China's actions in relation to devaluation are also strange - as it could imply a desire to return to export-based growth - which is unlikely. The real concern is whether China's authorities can achieve the shift from investment-led economy to consumption driven one while sustaining aggregate demand. Without the latter growth would fall and economic / political stability be lost. China is investing something like 44% of GDP yet achieving only about 5% growth - which suggests very low / negative investment returns. If wasteful investment were cut demand would collapse - and this seems to be what is most worrying China's authorities. There is nothing new about demand deficiency - as this started when GFC devastated demand for China's exports - and required China to embark on its own credit-fuelled investment boom. This occurred just as the potential return from that investment declined.  China thus faces three major problems - cleaning up debts, transitioning from investment-led to consumption-led growth and maintaining demand while doing so. Recent events suggest that China's authorities have not yet worked out how to do this - while their experiments over the past 7 years have probably made the situation worse [1]]
  • China's president is facing fierce opposition to his policies - according the Communist Party's flagship newspaper. This arose at annual meeting of Party grandees. The useful statements about agreement were replaced by silence this year. Journalists believe that something went wrong for Xi Jinping - related to growing unease about China's economic management. The People's Daily criticised retired cadres for seeking to exert behind the scenes influence (eg former presidents, Communist Youth League and China's Prime Minister). Xi's reforms have met immense difficulties (eg bureaucratic inertia, greed, resistance by vested interests in SOE). There seems to be fear and loathing of Xi and concern that he is turning into another Mao who might never give up power. [1]
  • China's government is losing control (according to German economic adviser) - and this poses risks for Germany and Europe. 40% of German economy is exported - with 10% of this going to China [1]
  • Many analysts have expected a soft landing by China after 35 years of rapid growth - yet there is no sign of this. China has to shift from an economy based on investment to one based on consumption. In trying to do this it is clear that Communist Party wants to remain in control of economy. Instead of liberalization, the government is trying to fix the economy with a stick rather than a carrot [1]
  • the dominance of the state sector in China has been seen as a major source of its current economic predicament

China's politics had been seen as economic virtue - ie the idea that authoritarian leaders could easily identify / fix problems. However it is now obvious that this is not so and the country has problems - both a growth rate much below official numbers and concern about the viability of its authoritarian model. In the 1980s and 1990s China advanced because policies increased domestic private sector's ability to thrive - but since then state sector has become increasingly dominant. A property bubble emerged as a government-driven response to GFC which had devastated China's advanced economy exports. State-owned banks were forced to lend mainly to SOEs to build more things to get headline growth - thus creating ghost cities. From 2008 to 2014 there was a $20tr increase in credit to economy. With excess capital around, it flooded into stock market. These fixes are being applied to enhance the dominant state sector at the expense of households and individuals - and this has just been making things worse. The repayment of $trs of local government debt wastefully incurred by their SOEs has been delayed - because state-owned financial institutions and other SOEs have been forced to buy it.  While liberal-democratic economies have their problems, China problems are worse. A radical transfer of wealth away from SOEs to the rest of the economy is needed [1]

  • the risk of political instability seems to be a 'black swan' event that could disrupt global oil markets. Most observers associate China's risks with its economy - but the biggest risk could be its politics. The political environment has been deteriorating rapidly. Many see China in terms of Deng's market-liberalization reforms. This is being replaced by restless / unhappy country. Earning money has been replaced by a desire to make others bow down to China's superiority. Power, not money, is the currency of the realm. Foreign businesses are being pressured. NGOs are being directly supervised. Christian churches are being demolished. China's president does not see economics as a priority. China's main emphasis has been on militarization of South China sea - which only makes sense in terms of power politics. Continuing this will result in reduced incentive to invest in / trade with China. If China's President Xi wants to be the new Mao, then China's economy will perform as under Mao [1].
  • there is now little / no confidence in China's ability to manage its debt crisis. This has been highlighted by dispute between China's top leaders (its President and Premier) over who is to blame for fruitless spending of 260% of GDP. State Council (and thus Premier) was criticized by an 'authoritative figure' (Xi) for keeping bank loans high and propping up share prices. The tension does not only reflect problems with policies - but also the structures that Xi has set up to increase his control [1]
  • China has economic problems that could lead to political instability - because there is no political outlet for dissatisfaction. For 40 years the US has sought improved relationships with China - despite some frictions. This could now be different because China has become much more repressive. There has long been support for China's economic emergence - on the basis that a richer China is better than a poor one. The assumption was that China would change as it became richer. Until 2010 China became freerer as it became richer - but this is no longer so. This is illustrated by: (a) censorship of communications; (b) repression of civil society; (c) extension of China territorial borders; (d) the need to suppress corruption - which has been indistinguishable from a political purge; (e) warnings about foreigners and foreign companies; and (f) military tensions with neighbours. These trends started before Xi Jinping became president. - as the GFC was seen as a sign of a change in global power so China's moment would come. The more uncertain Xi feels the stronger he tries to act. China is challanging the US in many ways - and this could get worse. And the limits that are being placed on academic / scientific / commercial / cultural achievements by cutting itself off from the world are adversely affecting China's people. There is concern that there will have to be conflict between US and China as both will play on worst fears of the other. US leaders should not choose confrontation with China - but would emphasise collaboration. Many observers have suggested options if China goes 'bad' [1]
  • A significant populist movement has developed in China that rejects official 'economy first' priorities and supports Mao's egalitarian ideas

UK and US have empowered populists. China could be exposed to similar backlash which will test national leadership. President Xi's ability to manage rising socio-economic pressure is uncertain. Cynicism about China's 'economy first' policies have given rise to New-Left / neo-Maoism that supports Mao's egalitarian ideas. Its emphasis is on using state power to redress injustice and negative effects of privatization / marketisation and globalization. China is seen to benefit from globalization - but there is widening socio-economic inequality and skepticism about free trade and open markets. Some expect China to overtake the US as world's largest economy - yet many still live in poverty or on very low incomes. Similar problems have led to reactions at the ballot box. China's New Left dates back to early 2000s when intellectuals became concerned about economic inequalities and social polarisation. It remains underground but is very popular with students, peasants and workers.  Many are questioning the government's pro-growth programs of last decade - and Xi administration seems to be listening [1]

  • China's leaders will test the promise of rapid economic growth that has held the country together because it has been recognised to be dangerous to do so through rapid increases in national debts (see below)


However, despite the problems China was experiencing as a consequence of the neo-Confucian methods that the Chinese state had put in place in the late 1970s to accelerate China's economic advancement, Confucianism was increasingly promoted as a national religion - presumably in order to promote national unity in the face of expected social and political stresses. See further comments in Promoting Confucianism in China

In early 2016 it was argued that China was positioning itself as the centre of an international economic system that could dominate the world. Very large Chinese investments were being directed along the One Belt One Road route. The world economy was seen to be being driven by China's urbanisation, population growth and consumerism [1]

China's president (Xi Jinping) was seen to be seeking to have himself installed as leader-for-life in China so that he could remake the political landscape in China - which contrasted with the Communist Party's collective leadership in the post-Mao era [1]

[CPDS Comment:  To continue with state organized economy China probably needs to adapt to be more like Japan - ie  a virtual 'whole of society bureaucracy' under a great leader / (divine?) Emperor. China's presidents have been accorded the 'mantle of heaven' that was the authority base of China's emperors.  Perhaps President Xi Jinping would like that role for life. He has certainly been advocating Confucianism as the moral foundation of his regime and China]

In late 2016 Xi Jinping's status was upgraded to that of 'core leader' by China's Communist Party [1]

Attention was drawn to the extent and character of corruption in China, and the political motives that can be behind accusations of corruption (see CPDS Comment in Global Implications of Corruption in China).

There has been significant suspicion about the wealth of business people, investors and companies from China (eg in terms of tax evasion, corruption, stolen money, illegitimate / illegal businesses). However from a Chinese viewpoint, corruption looks different. The government's anti-corruption program is just as notorious. Diversion of state resources to private hands is of concern in China. There is no developed rule of law in China. Those (often officials) who have taken available state resources to generate wealth for themselves and China have been encouraged to do so. Many of the new wealthy have become so by exploiting housing allocations.  Taking state resources to generate economic activity was viewed positively - and doing so was not seen as corruption or tax-avoidance. Tight definitions of legitimacy have had little to do with China's past / current reality. A large part of China's economic transformation has been achieved by those who violated restrictive laws. Accusations of corruption can be part of a politically-motivated campaign. China's approach to this creates problems for other countries that wish to attract Chinese capital and are concerned if it is not legitimate  [1]

Attempts to suppress corruption have arguably also suppressed the initiative required for the development of China's economy - given the dominant role that local officials have played in stimulating / organising economic initiative while simultaneously profiting personally.

In China economic development and corruption go hand in hand. Local leaders seek out opportunities, exercise power and profit themselves in the process. President Xi has an impossible tasks in keeping economy humming under state domination while trying to eliminate corruption. Anti-corruption program dampened demand for luxury goods. It also forced officials to become highly risk-averse. The current environment does not tolerate mavericks. All policy innovations require risk - which can be unpopular and generate reactions including allegations of corruption. Now China's local officials sit on their hands - and China is becoming increasingly centralized.  In democratic countries bureaucrats are portrayed as lazy and risk averse - this is now becoming true in China also. IN US the market economy continues to buzz on its own - because private citizens are the main actors. In China, while there is a sizeable private sector state officials have usually played lead role in the economy. When bureaucratic initiative is suppressed development is adversely affected. President Xi wants to have both state control over economy and strict adherence to rules. China needs to place more realistic demands on its bureaucracy  [1

In late 2016 it was argued that President Xi's rise to 'core' leader status in China would allow him to succeed in purging the corrupting influence of the political faction established by a former leader of the CCP (Jiang Zemin). This would both increase stability in China and aid its economic development - because corrupt officials had both harmed the state and public welfare by stealing from the people. [1]

China's economy is facing a severe crisis - due to falling growth, rising unemployment, real estate bubbles, troubles in manufacturing and capital flight.  This was seen to have multiple causes. After the Cultural Revolution the CCP had forced through economic reforms to survive - and liberalizing reforms allowed Chinese people to create a 'miracle economy'.  However after 30 years that model was no longer viable - while continued economic growth is vital to maintaining CCP's legitimacy. Most of the problems relate to the influence of Jiang Zemin faction - which Xi has been purging (eg the financial system meltdown associated with sharemarket crashes). When Jiang Zemin took control there was no ideology or limit to its conduct. Corruption and a conspiracy of power and profit resulted. Clean officials were purged (eg Huang Jinguo). Corruption spread to the military, judiciary, health care, education, sports, media, SOE's, etc. China's economy was in the hands of interest groups that coalesced around Jiang's rule. In recent years corrupt officials have sought to escape from China with their families and stolen assets. The system of official theft and corruption Jiang created came as China was going though a process of privatization and economic transformation. Economic reform allowed theft to be concealed. This prevented China becoming something like a normal country via its reforms - and the economic and social foundations that enable order were undermined. As the moral turpitude of China's ruling class became clear any notion of fairness became remote for most Chinese people. Economics and morality are interlinked - and where morality is broken embezzlement, corruption, plunder and everyone for themselves results.  The Communist Party was digging its own grave. Purging corruption will enable: (a) stolen wealth to be returned to the people; (b) restoring proper economic order and trust; (c) allowing a workable system of government. One of Jiang's goals had been to persecute Falun Gong - and history shows that persecuting religions results in punishment. History also says that a change of dynasty is likely when many officials are corrupt. President Xi is distancing himself from CCP's historical crimes and from persecution of Falun Gong. Xi will abandon the CCP and allow China to make a peaceful transition to a non-communist future

[CPDS Comment: This has the 'feel' of propaganda - perhaps from a Falun Gong perspective. Other views of Jiang Zemin say nothing of suspected corruption [1, 2]. The above account acknowledges China's massive problems in late 2016 and blames them on a former regime rather than on features that that regime share with Xi Jinping's regime. On the other hand it is suggesting a process of cooption / theft of economic assets as the latter were privatized somewhat like Russia experienced on the collapse of Communism. This seems to be what happened in China - but what is not certain is who, if anyone, was at the core of the process]

In early 2017,it was suggested that:

  •   China's move towards liberalization and 'opening up' to the world might be being reversed.

Under Clinton administration US policy towards China shifted to supporting rather than containing China in early 1990s because it was believed that it could be a stablizing force. But now there is tremendous tension in Hong Kong because of end of one China two-systems policy. Western observers tend to believe that China's system is likely to open up and be more like Hong Kong. Many assume that China will join the world and become the leading economy. China's anti-corruption program was needed. In early 21st century an influential Chinese academic concluded that democracy would be chaotic. China now wants to join global economy but not be democratic. Capital flight is another issue.  Wealth inequality in China is also giving rise to widespread discontent. Human rights are being increasingly violated. Darker view of China has gotten attention over last year. Question is whether China is going 'bad' (increasing crackdown / closing up). Previous Chinese presidents had supported constructive engagement / opening up. The West might now confront a weakening / closing China [1]

 Increasing nationalism, especially amongst the young, has been presumed to be driving China's assertive foreign policies. Asia Pacific countries are being advised to either accommodate or Challenge Asia's rise on this basis. But surveys show declining nationalism since 2009 - especially amongst the young. Alastair Johnston (Harvard) says that China's coercive diplomacy in the South China Sea is being seen to reflect rising nationalism as a reaction to US-dominated liberal international order. Survey responses to question about whether China was the best country ever peaked in 2009 - and expressions of enmity towards Japan and US slowed down or started falling in 2009. China's 1990s' generation was more skeptical of China's government than their predecessors. Beijing's population has become better educated and been most exposed to economic and cultural effects of globalization. Some suggest that the effect of hard-core nationalists amongst political elites could be what is most influencing foreign policy [1]

  •  China is now embroiled in an internal political struggle around the efforts of President Xi to make himself the most powerful leader since Mao Zedong

After excesses of Mao era, China developed a new model of collective leadership under Deng Xiaoping in early 1980s. It is now embroiled in internal political struggle around President XI's efforts to make himself as powerful as Mao. Deng was never president - but he created presidential system under which president was seen as paramount leader and to have 'mandate of heaven' - a quasi religious concept that bestowed legitimacy on China's emperors for 3000 years. The new system had a single leader chosen by consensus amongst Central Committee of Communist Party. Each leader was elected (in rigged process) to 5 year term and was allowed to serve a second term. At start of second term he would nominate two potential successors who would jockey for position during the second 5 year term. President Xi is certain to be elected for second 5 year term in March 2018 - but has not nominated potential successors. Some fear he wants to get a third term. XI ran an 'anti-corruption' campaign that resulted in the arrest of two of his most powerful rivals (Bo Xilai and Zhou Yongkang). XI could lose 'mandate of heaven' if he seeks a third term - or at the very least make policy responses hard to determine. China suffers internal contradictions to its global economic ambitions (internet censorships stifles exchange of ideas; one-child policy in the early 1980s - has resulted in large pool of unattached men ripe for anti-social behaviours). There is a risk of a breakdown in China's social order [1]

  • China's economy and everything else is now subordinate to politics under China's President (Xi Jinping). It is wrong to see China as still a communist state. Reference to boosting the role of the market actually meant creating a structure in which private companies, NGOs and other organisations carry out the functions of government while being controlled by party committees.

 Main message from latest work report by China's premier (Li Keqiang) is that communist party is intensifying its control over the economy and all other spheres of life - and that President Xi Jinping is at the core of everything. Instead of speaking about the work of the government he heads, Li spoke of the role of the party in setting national directions. Xi could remain in power for another decade. Economic management is now subordinate to politics. China would continue to use the 'China dream' (Xi's first great motto) and core socialist values to build consensus. James Packer recently suggested that corporate leaders, public servants and MPs are wrong in still viewing China as a communist state. Xi's dream is starting to come into focus. Li spoke of enabling the market to play the decisive role in resource allocation. Three years ago this was viewed positively as indicating rapid reform - related to privatizing and pricing. But what Xi has in mind is a structure where private companies, NGOs and other organisations carry out functions previously performed by state bodies. These 'market' bodies would be guided by the party committees that they now have to have at their heart - and would be the chief agencies of party policies allowing the government to be stripped back. New credit in China now generates under 20% of what it did a decade ago. Credit in financial sector now represents 25% of banks total assets - double that a decade ago - prompting fears of financial bubble. Moody's was concerned that Li's report said nothing about implementable economic policies. 70% of the profits Chinese listed companies come from their investments (mainly in real estate) - not from main businesses. This highlights the challenge of reforming China's economy [1]

  • China's foreign exchange reserves rose marginally ($7bn) in February 2017 - where a significant fall ($30bn) had been expected. This seems to reflect the fact that the PBOC ceased selling reserves to defend yuan value and instead started buying them. This could make China vulnerable to Trump administration charge that it is manipulating its currency to boost competitiveness [1]. At the same time the PBOC stated that China's gold reserves rose from $71bn to $74bn. China's import of gold from Switzerland had reportedly been 158 tonnes in December 2016 up from 38 tonnes in November. China started increasing its gold reserves in 2014. Official figures suggested that it held 1678 tonnes - though the World Gold Council believed that the official figure was 1843 tonnes [1]
  •  China is emphasizing financial reform (re regulatory system, corruption, securities / insurance industries, local government and business debts, managing past debts). This will not lead to liberalization of the financial system and time soon - but rather will restructure / improve heavily state-influences financial / economic systems. China has long had financial reform as a priority - but little was achieved as post-2009 investment boom led to alarming rise in debt. NPLs are claimed to be low but could be 10-20%. Little has been done in the past to reform incentive structure that generated China's explosive debt growth in the first place. Leaders are no calling for better regulations and control of corruption. Reform has three dimensions: rooting out corruption, addressing local government debt and regulatory reform.  [1]
  • A very well China-connected Chinese billionaire living in the US has claimed (with unknown reliability) that China's 'anti-corruption' drive is being driven by corrupt elements at the top of Communist Party [1]

Recognising the Financial Problem 2017+

In early 2017 there was a marked change in the tone of observers' comments after China's regime had apparently recognized that its rapidly rising debt and declining foreign exchange reserves were dangerous [>] - see CPDS Comments in China's Likely 2017 Financial Crisis: .

  • China's leaders are about to test the promise that has held their country together (ie rapid growth). Until now China's leaders have done everything to deliver fast growth - but decided in December 2016 that it was too dangerous to continue doing so as this has required lifting national debts to 280% of GDP. A flexible growth target is likely until 2020. They had little choice. Capital is flooding out of the country - and this is pushing yuan value down. However China may have trouble cutting its debt dependence - and has been promising to do this since 2014. Maintaining political stability will be difficult without increasing the debt load - especially because of its highly centralized power (eg its president has cracked down on all forms of dissent).  A slowdown combined with political centralization could cause Chinese people to feel they are not getting the 'dream' they are paying for [1]
  •  China promised to contain company debts and cut coal / steel overcapacity - while seeking to maintain solid / balanced growth and avoiding asset bubbles. China might accept modest growth in 2017 to avoid risks from debt-fuelled stimulus. Debts of non-financial firms will not be allowed to rise further - and debt restructuring will be encouraged  [1]
  • Data show China's economy is buoyant. Its central bank is supporting yuan to deter capital outflows. However there is also concern about debt crisis, property bubble, financial market turmoil; slow economic reform; depreciating yuan and little prospect of recovery by export businesses that drive China's past rapid growth. Central Economic Work Conference was held in December, 2016 - which considered cutting excess industrial capacity, a more open economy and increasing foreign investment. There was a lot of discussion of managing risk. Martin Wolf argues that China has a problem because its president is too focused on purifying the party-state. A new politbureau is to be appointed. Stability is needed while debt soars. China is trying something different which no one knows about - because it believes that Western methods don't work. There will not be a crash because the state controls everything. Maintaining growth requires a massive amount of debt. [1]
  • 'Stability' is the new official watchword for China's economy - though what this means is undefined. The Chinese Academy of Social Sciences referred to a decline in China's growth rate from 6.5% pa to 6.4% pa [1]
  •  China's top leaders decided (off the record) in December that the cost of debt-fuelled growth was too high. Stability is now the main priority. A US analyst suggested that  small decline in growth (eg half a percent) would be less damaging that instability in bond / currency markets [1] [CPDS Comment: The latter estimate of what would be needed seems unrealistic]
  • Strong $US is forcing China to slow the 'money machine' that has driven economy since 2008. This will adversely affect economies worldwide - as slow / weaker Chinese economy and weak yuan create competition in developing markets. There has long been concern as China's debts rose to 280% of GDP through actions of state-run banks. Now party leaders have said that it is no longer necessary to keep hitting growth targets - because of concern about mounting debt. At the end of 2016 a strengthening $US encouraged people to get money out of China to avoid losing value. Charlene Chu (Autonomous Research) suggests China is in unchartered territory. China took its own approach to GFC - it instructed banks to lend rather than having central banks buy bonds. This added 30% or more credit each year to economy. There is now $24tr more in circulation than 8 years ago and yuan value has remained almost unchanged. China's people have had a large increase in purchasing power. There is an imbalance between increasing yuan in circulation and steady currency value - and this will worsen if yuan does not weaken and financial sector continues expanding rapidly. Total bank assets would increase by 30tr yuan (to 228tr) in 2016 and by another 100 tr if banking sector grows only 10% pa - the lowest rate on record. Last month $82tr left China. Now China's main concern is keeping capital in the country rather than maintaining growth. It has been using foreign exchange reserves to support yuan - but can probably only do this for another two quarters. China needs to think about attracting money - so its money-making machine are winding down. It could do this by raising interest rates - which would hurt borrowers with high debt levels. Reduced liquidity would harm property market. Liquidity and market risk in the financial sector would become more obvious.   This is why China is preparing its people and the world for a slowdown. As the economy slows the yuan will weaken. The problem would be reduced if $US weakens. However it is clear that the largest source of monetary easing since 2008 won't continue as it has - whether by blocking outflows, a fall in Chinese companies / individuals  power or weakening exchange rate. Change will happen very slowly because the Chinese government has so much control over financial levers (eg controlling interest rates / money supply). Economists increasingly expect China to become like a poorer Japan [1]
  • China has indicated an intent to curb investment in foreign assets. Chinese companies are expected to spend $US160bn in 2016 on new non-financial assets up from $US104bn in 2015. At the same time inward foreign investment has remained roughly stable ($US110). The widening gap has led to concern about capital flight. China's commerce minister referred to reducing the problem by constraining firms' capital spending and reducing obstacles to investment in China - though no details were given    [1]
  • China's exports fell 6% yoy in December 2016 while imports rose 3% because of weaknesses elsewhere [1]
  • Predictions for 2017 by Charlene Chu (Autonomous) include: China's inability to combat capital outflows with capital controls; and China's future depends on US and $US.  China's outflow problem has been resisted more strongly - but this can't be maintained indefinitely by world's largest trading nation. Growth will slow in late 2017 as a result of a weaker credit impulse - but this is of secondary importance relative to outflows and currency.  China has $82bn outflows in December 2016. Capital controls have been put in place to stem this - but can't be mintained indefinitely without hurting economy. FDI has weakened - with less inbound investment and more outbound. Chu estimates that China burned through $800bn in foreign exchange reserves in 2016 - and that China could lose half its reserves over the next few years.  nd foreign exchange controls are making households more nervous. if China lost $800bn in 2016 with limited contribution from households then the problem in 2017 should be bigger. China's authorities must either stop controlling yuan and interest rates or end free flow of capital in an out. Interest rates ill be be raised to keep money in the country and attract inflows - but this will hurt banks and heavily indebted corporates. A trade war with US under Trump could increase nerves and capital outflows.  [1]
  • Trump sees protectionist policies as the key to increasing US jobs - while Nariman Behravesh (chief global economist, IHS Markit) regard this as the biggest threat to global economy in 2017 [1]
  • Data shows that China's growth has stabilized after falling from 2010 to 2014. A breakdown of underlying demand-side components is not available - but it seems that 'secondary' industries (including construction / industry) have stabilised while 'tertiary' sector strengthened. There has been a slowdown in investment spending and in housing starts. While China's economy won't crash a growth slowdown below 6% pa is likely. China's external accounts are of more interest. Sizeable current account surpluses are achieved - at the same time that net capital outflows rose sharply. As net capital outflows have exceeded China's current account surpluses, its FX reserves have been falling since 2015 (ie from $4tr in mid-2014 to about $3tr now) after authorities spent $1tr to support value of Chinese yuan.  China's FX reserves have fallen $1tr because of rising net capital outflows. Gross inflows collapsed from record $563bn in 2013 and became negative in 2015 - though they improved somewhat in 2016. FDI inflows to China fell about 50% from 2013 to 2016. Foreign banks have resisted making loans to Chinese entities because of the high debt levels of Chinese businesses. Foreign bank exposure to China has fallen from over $800bn in early 2014 to $650bn in Q2-2016. Foreign deposits in Chinese banks have fallen from $500bn in 2014 to less that $350bn. Gross outflows were $200bn in 2013 before rising to about $400bn in 2014 and 2015 - and were likely to be about $600bn in 2016. Direct investment by Chinese companies had risen from $70bn in 2013 to $200bn (projected) in 2016. Portfolio investment from China rose from $5bn in 2003 to an estimated $90bn. China's government had sought to financially integrate Chinese economy with rest of the world - and that policy was working.  There have been increasing discrepancies in China's capital account and unrecorded capital outflows probably account for an extra $200bn outflows.  China's government has spent $1tr to slow the decline in yuan value. Despite stable growth, money is flowing out of China. This has been encouraged by economic liberalization - but concerns about underlying state of economy, expected yuan devaluations, rising rates elsewhere will contribute to outflow. China has acted to offset downward pressure on currency for 3 years and still has ample FX reserves. It could tighten capital controls further if necessary. China's government prizes stability and will prevent sharp falls in yuan value. [1]
  • China's president spoke to the chief citadel of capitalism at Davos about the wonders of free trade, globalization and innovation. Many observers saw this as indicating a new era for China. However Mao's picture still adorns Tiananmen gate and China's constitution endorses Marxist-Leninism. However there was a problem with China's president's speech - related to capital outflow. The flow of cash out of the paradise of socialism with Chinese characteristics is its uncomfortable secret and one that Trump may exploit. Net foreign payments recently by Chinese banks for clients has risen sharply to now $24bn per month. Chinese people / companies are getting cash out as fast as they can. The yuan has been devaluing despite government efforts to support it. Despite speaking about free markets at Davos, China has strong capital controls in place - and outflow would have been much greater otherwise. If Trump's trade policies or FED interest rate rises strengthen $US, the rush for China's exist will increase. Trump wants to devalue $US but his proposals for border tax adjustments would have the reverse effect. China should not have too much trouble with any trade war Trump starts - because it still have huge foreign exchange reserves.. And its government is quite happy to subsidize exporters. Exports to US account for 3.7% of China's GDP - so if this were to fall 60-70% 2.5% would come off slowing growth rate. Also the fall in capital inflows to US-bonds would result in a sharp rise in interest rates and probably a recession. [1]
  • China might be preparing for a yuan devaluation in response to President trump's anti-China rhetoric. China is struggling with too much debt, poor demographics and competition from low-priced suppliers. It needs economic relief. Fiscal stimulus just adds to non-sustainable debt. The easiest way to boost its economy would be devaluation. When yuan devalues it encourages capital flight. [1]
  •  China has created credit twice as fast as underlying growth - and relies on hazardous bubbles to keep growth running - according the Fitch Ratings. Short term stimulus is papering over deep cracks in economy storing up serious trouble for the future. State control of the banking system will prevent a sudden collapse but China catch-up boom from early 1980s will splutter out as banks struggle with bad debts and chronic mal-investment. This may resemble Japan's problems in the late 1980s - with much slower growth by end of decade rather than by an outright financial crisis (according to Andrew Fennell, Fitch Ratings). All forms of credit grew 16% in 2016 while while nominal GDP grew only 8%. Non-financial debt is 270% of GDP (according to Wei Yao of Society Generale). There is no longer any point in sticking to foolish growth targets as China faces a demographic crunch - as it is running out of cheap labour. Fitch said capital outflows would continue to drain foreign exchange reserves (already down $US1tr) but were not fast enough to be systemically threatening - and even more draconian curbs could be used. Recent lending had led to asset bubbles in home prices which led Beijing to slam on the brakes and led to price falls in 20 of 70 cities. China regretted its 2015 effort to slow down a share-market boom. Local governments are more interested in maintaining prices at high levels rather than allowing market forces to work. China went into unacknowledged recession in early 2015 and let rip with a fiscal stimulus like that after 2009. Growth in infrastructure investment fell to 5.7% pa in December 2016 from 14.7% the month before. Yang Zhao (Noumura) said boom will peter out in 2017 - and the drag on growth more evident. December 2016 data were weaker than expected. The question is whether China will continue to seek perpetual 'uber growth' [1]
  • A major risk to markets is emerging because of China's economy. China could submerge under the burden of its enormously high debt. The BIS's Credit-to-GDP ratio is a key measure and China's is now 28.8% - compared with the US's 12.4% prior to the GFC. The 19th gathering of the National Congress of the Communist Party will determine China's future leadership - and this will then decide whether or not structural reforms will be made [1]
  •  China has been told (by MSCI - a company that makes stock indexes) it needs to either keep money from flowing out of the country or join the ranks of the world's modern, transparent economies. The former would be an act of desperation while the latter would unleash massive pain on China. China has wanted to be included in MSCI's Emerging Markets Index ETF - as this could encourage huge inflows to China's stockmarket. China has been trying to that its economy is open, transparent safe - but MSCI has said that it is not there yet. The yuan has declined at a record pace recently as economy is slowing because people are taking money out of country. China has tried to stop this - because it wants consumer-driven economy. Also China needs to attract money - but foreign investment has been falling. Charlene Chu said that China would be only be able to prop up the yuan for a few more quarters before something happens. Capital controls can't be maintained without hurting trade. At the WEF China's president urged the world to be open to free trade. But the yuan will continue to weaken as long as China's growth is fuelled by debt. Changing that requires deleveraging massive companies - and this would be a massive process taking years. But China does not have much time [1]
  • The rate of major Chinese overseas takeovers is slowing as rules related to capital outflows are tightened. Many of the $225 bn overseas acquisitions announced in 2016 are stalled. While the value of acquisitions had doubled in 2016, the rate of Chinese acquirers backing out of deals is up by a factor of 7 to $38bn.    [1]
  • Chinese overseas deals worth $75bn were cancelled in 2016 - due to regulatory clampdown. This was 7 fold increase over the 2015 figure of $10bn. European and US sellers of assets are becoming wary of Chinese buyers [1]
  •  China's economic miracle has been built on rapid credit expansion. Busts that followed from credit booms occurred in Japan, Asian emerging economies and US - and is now due in China. Global debt grew $57tr since 2007. Over that period China's debt rose from $7tr to $28tr. It accounted for about 40% of total increase in global debt over that period. Despite this China's growth has been slowing since 2007 - as credit become ever less effective in boosting growth. China's growth might fall to less than half current levels by end of decade. China contained the collapse in its share market in 2016-16 - but the market remains 40% below its peak. China has been seen to be seeking short term growth at the expense of long term gains  [1]
  • China's central bank is running out of ways to stem capital flight - and faces near impossible task of managing effect of extreme credit growth. Defence of currency by PBOC is no longer viable according to Standard Chartered. Powerful forces are driving capital out. IIF estimates outflow as $725bn in 2016 - and this is not slowing despite capital controls. Intervention in currency markets to slow yuan fall (eg selling $US reserves to buy yuan) drains liquidity and tightens financial conditions - which could do a lot of damage to domestic banking system. Nomoura issued parallel warning that East Asia faces financial storm - with region-wide credit crunch. Fund managers could pull money out en-masse. PBOC still has $3tr in foreign reserves - these can't be used are hard to use domestically without making things worse. Reserves are not as large as they look given scale of financial pressures and China's economic structure. M2 money supply has collapsed to 15 year low. If reserves fall much below $3tr people will worry about reserves' adequacy. PBOC is tapping on brakes gently so far - with increased interest rates. Stealth tightening has been underway since November 2016. Credit growth will become a drag on economy rather than a boost as it was in 2016. Imposing 'border adjustment tax' in US could boost $US value and create problems for $10tr offshore $US debts with no lender of last resort behind it. Much of East Asia is in final stage of exhausted credit cycle which has led to endemic mal-investment. Debt service ratio has rising 5 times over decade to 15% of GDP - just as at time of GFC in 1997. Property and debt overhangs and keeping zombie companies afloat is bearing down on China's growth. Monetary and fiscal stimulus are not the answer - as they are losing efficiency / fuelling bubbles / misallocating resources [1]
  • China is trying to drain liquidity from its economy - but may be unable to raise rates too quickly because of fear of being labeled a currency manipulator by President Trump. China was not yet seen to be seriously trying to stem loan growth (according to Rabobank strategist, Jane Foley). China's FOREX reserves fell below $3tr - suggesting that China might devalue to stem currency outflow.   [1]
  • it is clear that there is a desperate problem with China's economy because authorities have made it illegal to use bitcoin to get money out of China [1]
  • China hopes to get growth from domestic consumption - but many contacts in Beijing seem to be hoping to get money out of China. China's Belt and Road Initiative (BRI) was presented to WEF as evidence of China's commitment to globalization while US withdrew.  However exposure to this could create new set of asset quality problems for China's banking system. In trying to move away from investment-led growth China invested heavily in infrastructure - which boosted SOEs and commodity prices and China's national debt. BRI was seen as a way to export China's industrial overcapacity and surplus domestic savings. It involved extremely expensive projects which do not have to demonstrate normal levels of return. There are problems with proposed Silk Road because many of the rail networks involved can't be connected because of different rail gauges. There is concern because Chinese banks do not have a track record of allocating resources efficiently at home. The BRI would be funded by loans - and create a new set of lending quality problem because many loans would be secured against volatile commodity prices. Obstacles are becoming more obvious [1]
  • Investors need to seriously consider China - as government has established controls that will have a dramatic effect on capital outflow.. This needs to be recognized by: (a) property investors; and (b) equity investors into China. China's forex reserves are used to stem depreciation of yuan - and have been falling quickly. While $1tr of foreign exchange had flowed out of China over previous 18 month, this fell to nil in December 2016. Major developers are likely to see increased settlement risk. China's government will eventually need to devalue yuan. China's credit system is coming to a halt. Credit excesses in China have built up more than in other countries prior to crises. Recent growth has been driven by unsustainable state-led infrastructure spending - thus driving up iron ore prices. Credit in China's banking system rose from $3tr in 2006 to $34tr in 2015 - and many of these loans will turn bad. Rising bond defaults and cancellation of bond issues are signs of rising pressure on banks. PBOC has injected liquidity and cut reserve requirements for banks. A recapitalization is inevitable. The real test will be the large number of junk bond maturities in 2017 and 2018. Over the past 18 months debt rose $6.5tr while deposits grew $3tr [1]
  • Chinese companies are stepping in as lenders as banks reduce their funding to struggling industries and China's huge bond market comes under strain. This rose 20% in 2016 to $2.5tr - and is now fastest growing segment of China's shadow banking system. Arrangements are made through banks as middlemen. Interest of up to 20% is being sought with limited checks on creditworthiness [1]
  • Since GFC the viability of the economy China used to have has declined. To maintain growth monetary and fiscal stimulus measures have expanded debt to 250% of GDP. Corporate debt has risen by 60% of GDP to 165%. Now it faces a nationwide debt crisis amid business defaults and bankruptcies, low industrial profits and prospects of another real-estate slowdown. China's economy has always depended on fixed asset investment - but over past decade as cheap exports' share of economy collapsed and household consumption slid, this investment has been one of main drivers of economic growth and employment. Much of this comes from biggest state-owned banks which answer to Beijing. China funded investment by cutting interest rates, reducing bank reserve requirements, boosting domestic equity markets and direct spending. But most came from debt. Whereas countries like US and Japan use government money for stimulatory spending, China used its control over banking system. Most money went to huge SOEs. SOEs hold 55% of China's debt but contribute only 20% to GDP. Beijing's government debt is low - 22% of GDP in 2015. After 2008-09 crisis, stimulus measures became permanent rather than temporary. The biggest systemic risk emerged in local government debt - as most was borrowed by pseudo-corporations which had no assets or functional management structures. Beijing started cracking down on this in 2013. China's corporations have become its major source of financial risk. Big borrowers account for 60% of corporate debt - and have debt / equity ratios up to 85%. This is a problem because most of the big companies are involved in real estate construction. Construction has been limited, and after rapid price growth local governments have been pressured to curb speculation. Credit has become less effective in driving China's growth. A protracted property downturn would be catastrophic for major Chinese companies - given rising debt / equity ratios and shorter maturity periods on debt. Loans have been taken to repay existing debts.  Many companies in construction-related industries will default on debts or declare bankruptcy in 2017. China has set up measures to mitigate these risks (eg debt / equity swaps and special bankruptcy 'tribunals') - but these measures have achieved little to date and face structural obstacles. China is facing a difficult year. China's plans to tighten credit will be constrained by dire financial straits of many companies and depend on construction. At the same time external pressure from President Trump is likely. [1]
  • In 2017 China's economy remains overleveraged with credit outpacing economic growth. Yet turmoil in financial markets has abated. Economic expansion has steadied - allowing central bank to mount a modest tightening. $US pull-back is also favourable. Selecting next generation of China's top officials will be significant this year.  [1]
  • China's stockmarket is experiencing rapid growth - yet many foreign investors are staying away: concerned about capital flight, mounting debt and slowing economic growth. Economic growth has been 6.7% the slowest in 26 years - and US President has threatened to label China a currency manipulator. Sharmin Mossavar-Rahmani (Goldman Sachs) sees China as most likely source of global economic shock over next 2-3 years. The main concern is about rapid build-up of debt. Total social financing surged to a record of $545bn in January 2017 - double the previous month despite government efforts to rein in lending. A financial crisis is seen to be likely in next 3 years. Western investors continued to pull back from China in 2016 as outflows persisted. And outflows have continued (more slowly) since China's authorities sought to stem them in late 2016. [1]
  • China has suffered continuous outflows for two years - but reforming its bond market could reverse this according to Goldman Sachs. FOREX reserves fell $12.3bn in January 2017 to just under $US3tr after a $41bn fall the previous month -for a total 2016 fall of $320bn after a $513bn drop in 2015, China could stem the outflow through its bond market. It is the world's third largest with $US1.7 tr outstanding but is not included in any major global index because of the country's capital controls. China could induce natural inflows (eg of $US250bn) by further liberalizing its onshore bond market and be eligible for inclusion in global bond indices. This could take 3-5 year with major concerns involving market access, hedging, liquidity and concerns over repatriation  [1] - see CPDS comment here
  •  The biggest financial story in the world is that there is a $US shortage. This makes it impossible for China to control its currency, emerging markets to roll over their debts and prevents FED tightening monetary policy without making things worse. The Fed printed $4tr to bail out financial system in 2008 but since then global debt has risen $US100tr. When debt holders want money back there won't be enough unless new debt finances old. China is an example of the problem. It faces the risk of insolvency. China has $3tr in hard currency foreign exchange reserves, of which $2tr are illiquid or needed to bail out its banking system. $1tr is left over to defend the currency. It needs to defend currency because China wants to satisfy both US and IMF that its currency is reliable store of value. US has long complained that yuan is under-valued to promote exports. Recent support for yuan is seen to be intended to satisfy US. Yuan was kept artificially low from 2007 to 2010 - but $US weakened from 2011 and yuan strengthened. This phase is now over. Yuan has weakened due to government intervention in August and December 2015 and since then due to capital flight. China has used reserves to prop up yuan. China also needs to satisfy IMF that yuan can be global reserve currency (which requires stability). But China can't afford to support yuan. It does so by buying yuan with its $US reserves. Yuan would go into freefall when reserves run out. China still needs to use $US reserves to buy oil as yuan is not widely accepted in oil trade. And China's oil fields are drying up. China won't actually go broke - its options will be: (a) raises interest rates (which will bankrupt even more heavily-indebted SOEs; (b) impose capital controls - which are of limited effectiveness because businesses can disguise capital flight as normal business dealings. More draconian measures would anger the IMF; and (c) currency devaluation - which is its only real option. China's people have seen this risk and sought to get money out. A large overnight devaluation is likely after Trump confronts China over trade / currency wars. This will stop bleeding in capital account and also weaken demand for $US  [1]
  • China's president suggested that China's economy will be transformed - by the death of highly-indebted SOEs to make room for new more privately owned service industry companies. The process of change would be painful because of the extensive job losses and need to retrain workers  [1]
  • China's president has promised to speed up reforms. This involves a determination to get rid of SOEs that stay alive by sucking public funds. Previous concerns about social unrest associated with job losses will be accepted.   [1]
  • China's premier (Li Keqiang) has suggested a cautious economic course - with a slight downshift in growth to rein in swelling financial risks and ensure smooth political changeover in late 2017. China is being made because binge of credit and infrastructure spending propped up economic growth while causing property prices and debt to balloon. The growth target would be 6.5% down from 6.7% - associated with tighter money supply, lower investment and lower military spending. Maintaining political control seems to be the main consideration as there is little sign of economic reform. Concerns about financial risks are leading to tighter monetary policies - and this will undercut growth. Li indicated a desire to cut excessive industrial capacity. In 2016 Li's program had backed 2 stimulus measures - which resulted 'authoritative' criticism of debt-fuelled growth policies  [1]
  • China's premier indicated that China would continue to walk economic tightrope (ie avoiding strong stimulus measures while giving priority to creating jobs).  Global growth was seen to be weak because of de-globalization and protectionism. China would support multilateral trading regime. More industries would be open to foreign investment (eg services, manufacturing, mining) - and also to private investment from within China. Consumption was confirmed as main driver of China's growth (51.6% of GDP)  The high leverage of Chinese companies (especially SOEs) was criticised - and government would tighten constraints on credit. Steel production will be squeezed [1]
  • China's corporate debts are too high but it will take time to reduce them - according to PBOC. Government has pledged to contain debt and housing risks in 2017 after years of credit-fuelled expansion. Analysts are doubtful about following through on reforms if growth falters. Efforts will be made to contain debt levels - including restructuring firms with heavy burdens and reducing industrial over-capacity. Banks won't support financially-unviable firms. But this will take time to be effective because of large stock of existing debt. Attempts to contain house prices will be made, but housing loans will continue to rise rapidly. China needs to stabilize its overall debts before gradually reducing them. China's debt growth has been fast by global standards and without a comprehensive strategy to deal with this it will have a banking crisis. PBOC has moved to a modest tightening stance - to discourage explosive growth of debt and speculative activity.  Yuan value has stabilized as authorities took steps to restrict capital outflow. China burned through $320bn reserves in 2016 to shore up yuan. Reserves had fallen below $3tr - but then rebounded due to fund outflow curbs and steadying yuan. China has opened its bond markets to foreigners - but won't seek to have them included in global bond indices  [1]
  • Several senior officials have spoken out against China's debt spiral - suggesting a determination by government to deal with this. But asset management companies tasked with controlling NPLs continue to borrow to keep highly leveraged entities afloat. Bank lending in January and February 2017 was at record highs.  Local governments (main stimulus spenders) will be licensed to issue special bonds to cover $160bn in 2017 - almost entire deficit central government expects them to accumulate. They are being encouraged to spend to maintain 6.5% growth. Irregularities in the way local governments obtain loans are being investigated however. While government advocates shift from investment / manufactures to services / consumption, profits in heavy machinery rose because of local government stimulus program. Zhou Xiaochuan (PBOC) highlighted debt issue. Yin Zhongqing (National Peoples' Congress) suggested that attempt to deal with local government debt ($1.6tr in bonds) were merely cosmetic - and that it was hard to eliminate such borrowing. PPPs established by local governments to raise funds (where 'private' component is mainly minority stake in state-owned entity) is just disguised local government borrowing. There are already fiscal crises in some regions. Local governments never worry about repaying debts. Upper level government will pay the bill.  [1]
  • China invested $225bn to acquire foreign companies in 2016. Now this is being discouraged. Some Chinese deals have come apart - either because of government constraints or companies own decisions. Chinese families and companies have been rushing to et money out for over a year - because of slowing economy, weakening currency etc, China has recently increased efforts to prevent this. Banks were told in November 2016 that movement of over $5m required government approval. They have also been told not to move more money out of country than they move in (after a past 6:1 ratio). This could interfere with global companies' ability to move profits out of China and thus with China's commitments to IMF. China is still likely to be active in international acquisitions in 2017 - where technical know-how is involved. Official portray efforts to constrain outflows as a desire to promote more responsible investment, rather than to protect China's financial system. However they have incentives not to emphasize administrative limits on capital outflow, as this would discourage foreign investment inwards. Many Chinese companies already have money overseas (eg $500bn was taken out after stock market plunged in 2015 - and another $50bn leaves each month). Many deals involving Chinese companies don't require getting money out of China. [1]
  • China's PPI has swung from deflation to relatively high inflation over 6 months to March 2017. Wholesale prices and import prices are rising due to lagged effect of weaker yuan. CPI has risen also. If China exports inflation, US yields will rise worsening China's capital flight - reducing domestic liquidity and growth. There is some monetary tightening in China - and this may prevent inflation getting out of control. Rising inflation and lower liquidly is squeezing excess liquidity lower - which will remove support for China's equity / property prices [1]
  •  China credit growth slowed indicating concerns about risks with rising debt - especially corporate debt. The risk has been acknowledged but the pain of aggressive deleveraging has led to reluctance to act. Latest figure show that the need to control debt is being recognised. Growth in new loans in January 2017 were at 10 year low. Non-bank lending was strong. Bank loand grew 13%. Non-bank lending grew 16%. .  [1]
  • Former US Treasury Secretary (Larry Summers) has expressed concern about China's capital outflows and real estate. China has built strains in terms of debt accumulation - leading to those problem areas. It will be difficult to sustain growth - and growth over the next 2 years will be that borrowed from the future. State investment to maintain real estate prices can't continue. In the first two months of 2017 real estate loans rose at a rate of 8.9% pa.  China's capital outflow was huge by historical standards. China is delaying necessary reform - and this is a cause of concern [1]
  • China is introducing new regulations to cover outbound investment to stem capital outflow and speculative investments.  Capital outflow by SOEs and private companies rose to $US170bn in 2016 - up 44% pa. This put downward pressure on yuan and led to concern that investment in China was being cut back. New regulations would define what types of investment would be limited. Emphasis would be given to strategic investment (especially Belt and Road initiative), Chinese companies announced $220bn in outward foreign investment in 2016 - but $40-$75bn were cancelled - a practice that has led to concern about Chinese buyers in some countries. [1]
  • Alibaba and Huawei have become well known internationally after being major players in China's domestic economy. There are now hundreds of similar companies ready to take on the world. China now is not what it was 3, 5, 20 years  ago. These companies have innovative products perhaps better than those in the West.  [1]
  • IMF and OECD have upgraded growth estimates for China. But concern about China's financial stability are still growing. Chinese authorities won't allow growth to flag before next national congress of Communist Party. Alvaro Peteira (EOCS) said China needs to do more to tackle spiraling debt. Corporate debt has risen from 100% of GDP before GFC to 190% - one of world's highest (compared with 50% in Australia).75% is owed by SOEs - which have excess capacity and poor profitability. China's big 4 banks have been disguising their exposure - and though regulators have tried to prevent this they have been circumvented. China's central bank has to deal with contrary objectives (ie support demand and contain risk). Michael Pettis (Peking University) argues that China's debt burden is worse than usually recognised - but that a financial crisis is less likely than a prolonged period of economic slowdown. Diana Choyleva (Endo Economics) argues that crisis is both possible and imminent - with interbank market being chief vulnerability. Non-bank share 0f this has risen from 14% to 54% over past 3 years - and they invest in illiquid assets with longer maturities. Deteriorating asset quality will eventually prompt lenders to reduce risk and lend for shorter periods - thus leading to mismatch in maturities.  China's central bank will have to lift interest rates because of rising inflation. [1]
  • China is beating the US at innovation because it has significantly increased spending on the latter stages of R&D where discoveries turn into commercial products. By 2018 it will spend twice as much on this as US. The US does the hard work of inventing new technologies 9ie via R&D) while China (and other countries) emphasize turning them into commercial products. This is costing US huge amounts in manufacturing output and large numbers of jobs [1]
  • While companies worldwide seek to access China's growing market, start-ups with HQs in China are seeking not only to conquer domestic market but also to come out on top worldwide. This is a continuation of 'going out' policy initiated at start of century by Alibaba and Tencent. This differs from earlier attempts to expand sales by offshore mergers and acquisitions   [1]
  • Leading China-focused economists believe that it is vulnerable. Its problems are not like those of Soviet Union when it failed - but rather involves 'soft budget constraint'. China has a tottering and still accumulating debt mountain. Though a huge fiscal stimulus can keep going for years it will eventually make economy vulnerable (eg to external disasters or domestic bank runs). PBOC is concerned about capital flight. What seems to be closed circuits of lending and spending create moral hazards. China's SOEs have only soft (easily ignored) constraints on borrowing / spending. It controls less than half of economy - but those parts are critical to economy. 10 years ago privatisation of SOEs was being considered - but this idea is now taboo.  State sector has been expanding. China's economic thrust worked well when it had a single-minded aim to increase GDP.. But this has now changed. Issues other that GDP are emphasised. Bankruptcy laws have never been enforced. Local governments borrow from state-owned banks offering land as collateral - which enrages present users. Most of earliest listed 'Shanghi Eight' stocks have run into trouble - but none have been delisted. Privatisation would be a solution but leadership won't consider this. Private profits are being held down because governments and SOEs gouge profits wherever they can. China is exporting its problems through the belt and Road initiative  [1]
  • China's property / infrastructure booms have been locked in by government for another year. This has driven commodity price recovery that benefits Australia - but creates uncertainty because no one knows when destabilizing mountain of debt will topple over. The constant postponement of efforts to rain in debt-driven spending brings reckoning closer. Attempts to constrain property speculation with a property tax have been ineffective. GDP growth has been mainly driven by property investment - and China's economy has again become investment driven. Laying a favorable foundation for 19th 5-yearly communist party congress in November 2017 has been given priority [1].
  • a property boom in China that only benefits city dwellers has widened that country's wealth gap. Those born outside China's cities are unable to buy property in them. House prices have risen very quickly (about 700% over 10 years and the main cities). City dwellers now earn 3.5 times as much as those in the countryside - up from 2 times in 1978.   [1]
  • China has become markets biggest worry. A problem has been recognized for months and is now supported by weak data. A slowdown will affect commodities. If China loses a lot of steam its currency will weaken and commodities will sell off. This would be negative for other markets. Government has slowed infrastructure spending thinking private investment will increase. Rising interest rates, tighter conditions and some new down payment method might make that impossible [1]
  • There has long been speculation about China's corporate debt bubble. China's system can't be propped up forever. China is not manipulating its currency lower. It has propped up yuan to prevent economic destruction. Shadow banks have lent companies huge amounts at low rates which they can't repay. However yuan peg is unsustainable and will eventually trigger a GFC (especially affecting commodity markets). China is seen to be already below critical foreign exchange reserve level ($US2tr). After adjustments official $3.005tr reserves are only $US1.69tr. Government has tried to rein in over-leveraged shadow banking sector - but economy is too over-leveraged for capital controls to work. When China's dam bursts a global financial crisis will result. This will take down commodities as China consumes 50% of commodities globally [1]
  • China's economy is slowing. Copper imports fell 30% month on month in April 2017. Copper inventories are increasing rapidly. Iron ore imports fell 13%. This is due to deliberate tightening of credit. Broad credit growth is now 15% pa down from 25% pa at start of 2016. It is unclear whether this is a standard Chinese slowdown or something more sinister. China can't go on increasing credit / debt forever. Commodity price downturn is not yet sufficient to suggest major problems in China's economy - though such problems could unfold. If China has problems so would Australia - because its economy is driven by: (a) 'dirt' shipped to China; and (b) debt to speculate on house prices. If income from 'dirt' falls, foreign creditors may demand higher interest rates - causing problems in housing markets and potentially major problems for economy [1
  • There is an expectation that China will continue with its high rate of investment but ACAPITAL (which works for China Investment Corporation) argues that the 2016 spike in Chinese investment would end - resulting in investment levels like those in 2015. In a 90 minute address on China's foreign investment Australia was not mentioned. Europe and North America gain 70% of China's offshore investment - which has a total of only 10% of GDP. Politicians fete vising Chinese business leaders - though they are not actually investors. And when they do make announcements they often fail to follow through. The biggest constraint relates to concerns about pressures on yuan, capital flight  and financial stability generally. There have been no major foreign investments in China in 2017 - compared with $225bn in 2016. Large Chinese firms are mainly domestically focused. Foreign investors have found investing in China to be becoming harder [1]
  • China's is cracking down on risky investment and causing problems for investors. Bond yields are rising, stocks are falling and more loans are defaulting [1]
  • World Bank warns that China's local governments remain addicted to off-budget borrowing - despite government efforts to impose discipline. Runaway growth of local government debt is seen as a huge risk to China. There was heavy borrowing to sustain growth after GFC - and practice has continued. Returns on investment are falling. White elephants are common. Many projects don't produce enough cash to repay loans. In 2014 China tried to limit borrowing through special purpose vehicles - which localities had used to circumvent direct borrowing. But LGFV (Local Government Funding Vehicle) debt has accelerated since 2015. This accounts for most public investment. Government no longer monitors LGFV growth as this would imply official acceptance. Some localities are moving to restrain this. Fiscal sustainability requires ending public investment-driven stimulus measures soon [1]
  • Rising bond and money market yield (which are at highest level in a year) concern Western investors. However China is different to 2007. China's debt problem is concentrated in corporate sector is seeing revenues growing at fastest pace since 2011 while real borrowing costs are falling. US economy was different in 2007. Mortgage debt had built but mortgage backed securities did not start causing problems until mid-2007. Employee income growth peaked in 2005 but Fed kept rising rates for a year afterwards. In China central bank started tightening recently. Factory gate inflation is at 6 year high - so real rates had fallen. Producer price-adjusted one year rates were 10% in early 2016 - but are now below zero. Firms earnings rose 10-14% in first quarter of 2017. This can't last forever. Big rises in 'shadow finance' have obscured problems - blunting the effect of tighter corporate bond market, Outstanding corporate bond debt fell 58bn yuan - while shadow finance grew 2tr yuan in first quarter of 2017 - twice as much as in last quarter of 2016. Firms are borrowing heavily and the banks backing them rely on risky interbank funding. Eventually there will be a problem. AS in US problem will arise when borrowers face higher borrowing costs and falling incomes. [1]
  • There is a myth that China has excess savings. The US is seen to consume too much while China saves too much. After 2007/2008 financial crisis it was suggested that trade and current account imbalances had something to do with the underlying problem (ie excessive savings in China). The problem was supposed to disappear when consumer spending rose. But this didn't happen and Chinese government stimulus was the alternative. Now debts are rising rapidly - soaking the whole economy with non-performing loans. The IMF is warning of serious problems. Growth now requires increasing multiples of increased debt. However 'excess savings' may not be the issue. In The New Depression, Richard Duncan argued that it was wrong to believe there were not attractive investments in China so China had to send it surplus to US.  Instead US dollar export earnings have been converted to printed yuan and held in central bank reserve. Some were used to buy US T bills. This a a change in reserve account not in capital account and is a loan to US government not investment in US economy or purchase of US goods and services. The investments made by Chinese government make up the bulk of Chinese savings. The hoped for rise in consumer demand wont happen unless China's investments generate a return. High GDP growth matters as it implies that China is getting wealthier. [1]
  • China's banks extended more credit in April than previous month - though household loans fell in a sign that authorities are walking a tightrope as they try to constrain debt. PBOC increased check on bank's off-balance sheet wealth management products. China is keen to ensure steady growth before Communist Party meeting in late 2017. Authorities have pledging to contain rapid debt-build-up this year. Crackdown is starting to result in weakened off-balance sheet financing (shadow banking) and household loans. Property lending is cooling. Cites have tightened up on real estate. Pick up in loan growth last month was more than offset by decline in bond issuance. Total new credit in economy rose $1.01tr in first quarter.  Crackdown on debt risks will slowly temper growth late in 2017 [1
  • China's central bank made its biggest one-day cash injection into country's fragile financial markets in 4 month - indicating concern about damage to investor confidence from efforts to damp down speculative excesses. Bond issuances had plunged in recent months - making it hard fro struggling businesses with limited access to banking sector that favours inefficient SOEs. Companies raised 674bn yuan via bonds down from 1.8tr yuan in same period in 2016. Secret guidance has been given to large investors to avoid selling stocks ahead of OBOR summit [1]
  • China's efforts to limit foreign investment have contributed to a 60% fall in foreign investment in Australian real estate. Treasury commented on Moody's downgrade of China's credit rating from AA to A - noting that China was maintaining growth by increasing use of credit. This downgrade follows 2 weeks after China agreed to allow big three US credit rating agencies to operate in China as part of a deal with President Donald Trump. Moody's noted conflict between China's desire to stimulate growth and slowing debt growth. China suggested that Moody's over-estimated the problem. Moody's concerns are shared by RBA and Treasury. China's efforts to maintain financial stability led to decline in outward foreign investment - and reduced foreign investment applications for housing from 40,000 in 2015-16 to expected 15,000 in 2016-17. RBA suggests that the longer China's growth is driven by financial distortions, the greater the risk of a financial crisis  [1]
  • Running businesses in China (especially international firms) is getting harder. Companies depend heavily on government getting settings right for debt, currency values and capital controls. Recently policy has been seen as based on 'flexible' / 'anxiety'. China's finance Ministry objects to Moody's downgrade - on the grounds that government can organise structural reforms and expand demand. However there are problems. Reliance on Communist Party is rising. Emphasis on boosting the financial role of the market 14 years ago has been replaced by the view that the Party and its leaders are best placed to price risk for China. As the state sought to re-centralize control inder President Xi, local governments (with limited capacity to raise funds) have had a problem. Central government leveraged ever rising funds to maintain China's growth. Yet it is local government that undertakes vast infrastructure spending. After a government clamp-down on speculative investment it was found necessary to push $30bn into financial system in one day after fear of going too far. A lot f local government debt is off balance sheet. There are potential problems with this and with Belt and Road proposals. Made in China program has been launched to propel high-tech manufacturing. Cyber rules related to this will marginalize / ban dominant Western tech firms. Capital controls were tightened in early 2017 - which exacerbates problems for payment problems for China-based companies offshore activities. Re-pegging yuan at different level against $US is a further step away from market liberalization. Foreign operators in China now require agility and close attention to politics. [1]





Ending the West's Global Predominance?

Ending the West's Global Predominance? (email sent 18/12/10)

Professor Niall Ferguson,
Harvard University

Re: ‘Middle Kingdom re-emerges to claim its place on global stage’, The Australian, 18-19/12/10 (= In China’s Orbit, Wall Street Journal, 18/11/10)

Your article (which has been outlined below) speculated about whether China’s rise presages the end of 500 years of Western global predominance.

For reasons outlined further below, I should like to suggest that the issues are more complex than your article indicated. Specifically:

  • Western societies’ strengths resulted from more fundamental features than you suggested (eg from enabling rationality to be effective in problem solving);
  • the West’s consumer society ‘app’ was not one of those copied in ‘Asia’, and economies without that ‘app’ may have reached their ‘use by’ date;
  • China indeed seems to be trying to re-establish itself as a ‘tributary state’, but this is incompatible with a consumer society – because a key feature was that outsiders who provided symbolic ‘tribute’ to China’s elites received greater benefits in return because ordinary Chinese worked hard but received little reward;
  • economies without reliable profit signals to producers from consumers are likely to experience long term problems in balancing supply and demand;
  • quantitative easing by the US Federal Reserve is likely to be seeking to reduce international imbalances by stimulating external demand (rather than by devaluing the $US), and is only one of the many tactics that could be used to counter mercantilist economic strategies that depend on such imbalances;
  • the potential civilizational crisis, that your article implies, suggests that the humanities’ faculties in Western universities have been ‘asleep at the wheel’.

John Craig

Outline of Article and Detailed Comments

My interpretation of your article: China’s leaders see themselves as masters now – and rejected recent US calls for capping imbalances in global capital accounts and criticising Fed Quantitative easing. Confident Chinese economists explained China’s goal of becoming a leader in green energy and the need for privatisation. Western domination of China and the world for five centuries after Forbidden City was built was discussed with them – as was question of possible end of western dominance. One paper argues that China was not up to West’s GDP until as recently as 1800 – because of stagnation in Ming era (1402-1626). China’s economy remained mainly agricultural with negative savings rate. The ‘great divergence’ between East and West began early. By 1600 GDP / capita in UK was 60% above China. China then stagnated while West surged ahead. In mid-20th century China suffered Japanese invasion, revolution, man-made famine and ‘cultural’ revolution. In 1968 US citizens were 33 times richer than Chinese. West’s advantages came from: competition; scientific revolution; rule of law and representative government; modern medicine; consumer society and work ethic. Others gradually copied the West. Japan did so without understanding what was important – including taking up empire-building just when the cost started exceeding the benefits. From 1950s other Asian countries started copying West’s industrial model – but were more selective (with an emphasis on science, medicine, consumer society and the work ethic rather than competition and representative government. Now China’s income is 19% of US – a figure others achieved earlier and have since gone beyond. China has had biggest and fastest industrial revolution. Asian century has already arrived. China is close to US share of global manufacturing, and Shanghai is the world’s top megacity. Power shift from West to East is demonstrated by US fiscal crisis (with higher debt to revenue than Greece, and a forecast rise in interest costs from 9% of revenue to 20% by 2020). The $US role as global reserve currency provides breathing space, but even this is being undermined. Many see US quantitative easing as currency war between US and China – but China also benefits (because currency is linked to $US) – so other countries are main losers. China’s output is 20% above pre-crisis levels, while US’s is 2% below. China has a plan to reduce $US reserve accumulation and subsidised exports – a strategy not for world domination on model of Western imperialism but for re-establishing China as the Middle Kingdom – the dominant tributary state in Asia-Pacific. China’s new strategy involves ‘four mores’: consuming; importing; investing abroad; and innovating more. Consuming more will please trading partners – especially emerging markets and commodity producers. Concern about vagaries in commodity markets justifies offshore investment (mainly in Asia and Africa). In Africa China’s mode of operation involves exchanging infrastructure investment for long-term mineral / agricultural leases with no questions asked about human rights abuses of corruption. Resource investment reduces the risk of $US devaluation, and also mobilizes financial power through sovereign wealth funds and justifies naval development to protect transport routes. China is also innovating more – and combined patent applications from China, India, Japan and South Korea now exceed those from the West. The dilemma a rising power poses for departing power is agonising – noting problems UK had with Germany’s rise. Coming to terms with end of Cold War was hard (and went to the heads of many in West). But issue now is end of 500 years of Western predominance. This Eastern challenger is real both economically and geo-politically.

In relation to the points made in the above article, it is suggested for your consideration that:

  • The features that led to the rising influence of Western societies in recent centuries were more fundamental than your article suggested (ie than competition; scientific revolution; rule of law / representative government; modern medicine; a consumer society; and work ethic). Rather the likely key was creating simplified social environments in which rationality (by individuals, businesses / political leaders) could be effective in problem solving (see Cultural Foundations of Western Strength in Competing Civilizations, 2001 which referred to Christianity and capitalism (as well as the rule of law) as creating such environments). Rationality fails in dealing with complex problems, and the presumed inadequacy of mere ‘thinking’ seems to be the foundation of quite different traditions for problem solving in societies with an ancient Chinese (rather than the West’s classical Greek) heritage (see East Asia in Competing Civilizations);
  • Your suggestion that a consumer society ‘app’ was a feature that various ‘Asian’ economies copied from the West seems invalid. Quite the reverse. Suppressing domestic consumption was vital to the variations of Japan’s system of socio-political-economy that were adopted elsewhere in ‘Asia’ (including eventually China) – see Understanding East Asia's Economic Models and Resist Protectionism: A Call That is Decades Too Late . Where the economic goal is to maximize production (ie turnover / cash flow) rather than profitability, it is critical to avoid dependence on borrowing in international markets, and essential to have trading partners with deep pockets who can afford to run current account deficits (and continue to increase their debt levels) indefinitely;
  • That economic strategy has clearly reached its ‘use-by’ date, as shown by: (a) the role which it played in the emergence of the global financial crisis (see Impacting the Global Economy and GFC Causes); and (b) the inability of trading partners in the developed world to continue increasing debts to sustain international imbalances, and the risks that emerging economies elsewhere face if they don’t also continue to enjoy current account surpluses (see Who's Got Superman?). Many economies were able to proceed beyond the point that China has now reached on the basis of export-driven growth (and domestic demand deficits), because the US continued to play the role of ‘consumer of last resort’. But China’s growth has now killed that particular golden-egg-laying goose;
  • As your article suggested, China seems to be trying re-establish itself as the dominant ‘tributary state’ in the Asia Pacific region, in a way that parallels its role prior to Western expansion (see Creating a New ‘Confucian’ Economic World?). In an economic region based on ‘Asian values’ highly-educated ethnic elites (such as China’s so-called 'Communist' Party and Japan’s bureaucracy) would be freed from the constraints imposed by: capitalism (ie the need to use resources to meet consumer demands); and democracy (ie the need for elites to be responsive to citizens). A key feature of China’s traditional role as a ‘tributary state’ was that others: deferred to China’s elites; provided ‘tribute’ (largely symbolic gifts); and received significant net material benefits in return, because ordinary Chinese were motivated to work hard for very limited reward. Such a system can’t be the basis of an alternative global order because: (a) only those prepared to defer to ‘Asian’ elites can be included; and (b) it is incompatible with maintaining any influential role for domestic consumption;
  • Non-capitalistic economic models, such as China’s, are likely to suffer problems in the long terms – because, without the feedback from consumers that the profitability of enterprises provides, it is very difficult to balance supply and demand. Also the use of savings with little regard to financial return implies that the liabilities of China’s institutions are likely to exceed their assets, and this would be exposed when / if ‘the economic music stops’. And it could well do so if austerity becomes normal in much of the world due to the debts others incurred partly to sustain growth in the face of the financial imbalances required by ‘East Asian’ systems of socio-political-economy. In retrospect, the huge state-driven boost to China’s economy over the past couple of years (on infrastructure, property and over-capacity in diverse industries) might be seen to be the straw that broke the camel’s back (see Heading for a Crash?);
  • Quantitative easing by the US Federal Reserve is unlikely to be simply to devalue the $US and thereby promote export-driven growth (because history shows that changing exchange rates has little impact on trade imbalances). Rather the goal is presumably to stimulate demand directly in emerging economies (ie to do unto others as others long did to the US) – see Currency War? Moreover the latter tactic might be only the first that could be deployed to counter economic strategies that depend on long term financial imbalances (see China may not have the solution, but it seems to have a problem);
  • The fact that a potential civilizational crisis could remain unrecognised by opinion leaders until the point of crisis for advanced Western societies (and thus for international institutions based on their favoured principles) is a reflection of both: (a) the humanities’ faculties of Western universities being ‘asleep at the wheel’, and thus oblivious to the implications of cultural differences; and (b) the central role of deception in ‘Asian’ Art of War strategies.
Its Serious for China

Its serious for China (email sent 5/8/11)

Ian Verrender

Re: This time its serious, Brisbane Times, 5/8/11

Good article. However the risk that China faces does not primarily come from its holdings of US debt. Rather its main threat arises from its likely inability to continue adding to those holdings (ie to maintain a current account surplus, and thus a capital account deficit reflecting its offshore investment) in a world where its trading partners face economic constraints due to huge debts. And when China can’t maintain current account surpluses, its financial system is likely to experience a crisis. This point is developed further in the attached email – though the latter was based only on constraints arising from the US’s predicament.

It has long seemed to me that:

  • the G20 totally failed to address (or even to understand) the problem of international financial imbalances that were a significant factor in the first stage of the GFC (see Structural Indicators of Ongoing Recession / Depression); and thus
  • the GFC would have second and third stages over several years involving: (a) a government debt crisis; and (b) failure of East Asian economic models which relied on financial imbalances that could no longer be sustained (see Unresolved problems and coming crises)

John Craig

Avoiding a Hard Landing in China

Avoiding a Hard Landing in China - email sent 20/2/12

Jerome Booth,
Ashmore Investments Management

Re: A Chinese hard landing is about as likely as a comet destroying Earth, The Telegraph¸19/2/12

Your article suggests that gradual currency appreciation (to boost domestic demand) could provide a solution to the apparently-severe economic challenges that China currently faces – difficulties that lead some observers to predict a ‘hard landing’.

My interpretation of your article: China has bubbles that can be dealt with easily, and pose no real risks – unlike the systemic risks the West faces. If banks losses on ‘social expenditure’ need to be covered by central government, that is quite affordable. And banks are rolling over loans, so nothing stops – it may only be a cost to central government. After Lehman Bros collapsed China had to boost aggregate demand, and move from export-driven growth to that driven by domestic demand. China launched a massive fiscal stimulus (unlike the West). As monetary policy loses its effectiveness (because of inflation risks), the answer will lie in currency appreciation (which will give companies the incentive to favour domestic demand). Concern that companies might send cash surpluses offshore is the reason for slow Renminbi appreciation. A 30% appreciation is needed because of imbalances dating back to 1944 Bretton Woods agreement. Imbalances built up in 1960, and the system crashed in 1971. Imbalances have re-emerged as emerging markets and commodity exporters generated large current account surpluses after the Asian financial crisis of late 1990s. This can’t go on indefinitely, and currency appreciation will occur when emerging economy central banks decide to act. China is a stabilizing influence, and is likely to move Renminbi up slowly. With large foreign exchange reserves, emerging central banks can move their exchange rates any time at will – which is opposite of the situation in the de-leveraging developed world.

However, while increasing domestic demand in such economies is undoubtedly desirable, the situation seems vastly more complex than your article suggested because:

  • The shift towards export-driven growth and the mercantilist accumulation of foreign exchange reserves started long before (not after) the Asian financial crisis of 1997 (see An Unrecognised Clash of Financial Systems which refers to an apparent contest for control of global financial systems that seems to have been under-way for decades). Both Japan and China had significant surpluses much earlier, and this was the reason that their economies (which also involved financial institutions that favoured state cronies rather than independent enterprises with proposals that focused on profit) escaped most of the effects of the Asian financial crisis. The protection that current account surpluses provided to economies with under-developed financial systems was then recognised by other emerging economies, and adopted widely (see Leadership by Emerging Economies?);
  • The suppression of domestic demand needed to achieve current account surpluses imposed a serious macroeconomic constraint on the world’s economy generally, and those demand deficits had to be compensated for by developed economies if global growth was to be maintained. The excess demand needed to offset demand-deficits was supported by easy money policies that led to ever-increasing debts offset by asset inflation, and ultimately to the global financial crisis (see Structural Incompatibility Puts Global Growth at Risk, 2003 and Impacting the Global Economy 2009);
  • Significantly increasing reliance on domestic demand in China and other emerging economies will lead them to current account deficits in a very few years– and this will in turn lead them to financial crises unless reliable financial systems are first developed (see Emerging Market: What about the longer term and see Eyes Wide Shut at Davos?). Reforms will require a long time, and (as the latter document indicates) arguably faces extremely difficult cultural obstacles in East Asia. There would seem to be a critical need for developed economies to provide support to emerging economies such as China in reform of their financial systems if such risks are to be avoided as a consequence of the transition to significant reliance on domestic demand (see Options Available to liberal Democratic Capitalism);
  • China’s autocratic political institutions also seem to be serious obstacles to: (a) changes that would empower consumers / households economically by significantly increasing their share of national income; and (b) the increased grass roots access to information that would be needed to sustain increasingly high-income economic functions.
  • [added later] reserve banks can not always engineer currency appreciation simply because an economy has large foreign exchange holdings. Strengthening exchange rates are rather likely to reflect: (a) the levels of currency transactions at a particular time - with the demand associated with trade surpluses tending to lead to appreciation; (b) well developed financial markets; and (c) stable / reliable government;
  • increasing income levels in emerging economies will reduce the protection that cheap imports provide against inflation in developed economies - and potentially require a rapid and potentially-disruptive reversal of the quantitative easing that: (a) has provided a boost to asset values and economic activity in the post-GFC environment; and (b) would normally would not be possible because of the inflation risk.

It may be that not everyone in China is convinced that China’s current challenges can be easily resolved by increasing domestic demand. A couple of sources not only suggest why a hard-landing hypothesis is plausible (eg because dramatic political and economic changes seem to be needed almost overnight), but also contain vague indicators of the possibility of capital flight.

John Craig

Confucian Renewal in China?

Confucian Renewal in China? - email sent 27/4/12

Professor Daniel Bell

Re: Real meaning of the rot at the top of China, Financial Times, 23/4/12

I appreciated the logic of your argument about non-democratic Confucian-style legitimacy in China, and what might be required to maintain this in future.

My interpretation of your article: see above

However I should like to submit for your consideration that there are probably two significant complicating factors, related to the economic model that China has adopted.

The systems of socio-political-economy that have been developed in various ways across East Asia appear to be neo-Confucian rather than simply Confucian, with the difference involving a blending of Confucianism with Daoism – because of the latter’s parallels with Shinto and Zen which are significant in Japan from which the East Asia models were derived. This blending has permitted / required learning from others, arguably because of Daoism’s rejection of traditional Confucian certainty about the wisdom that could be gained primarily from a study of history.

While this created an economic system that works (for reasons speculated in a section on East Asia in Competing Civilizations, which was derived from an attempt to ‘reverse engineer’ the intellectual basis of Japan’s pre-1990s economic miracles), it also created two serious difficulties. In particular:

  • The methods used to mobilize resources for economic activities have been based on Confucian-style social status and connections rather than on calculations of expected profitability in the use of capital. This has:
    • required macroeconomic imbalances (ie domestic demand deficits and excess savings) to make it unnecessary to borrow in capitalistic (ie profit focused) international financial markets (see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy);
    • played a significant role in the international financial imbalances that have disrupted global financial systems and economic activity in recent years (see Impacting the Global Economy); and
    • laid the foundations of likely future financial / economic crises when trading partners cease to be willing and / or able to continue increasing their debt levels, and demand has to be domestically driven (eg see Heading for a Crash?);
  • Introduced moral uncertainty, and thus undermined Confucian aspirations of virtuous leadership. Confucian leadership is not traditionally concerned primarily with economic success, but it has had to do so in recent decades, and (because of the way economic functions have been organised) this has created options for acquiring personal wealth at the same time that the traditional basis for acquiring moral certainty has been eroded.

My undoubtedly inadequate speculations about the issues involved in reforming China’s system (which tries to recognise both the East Asian cultural context and the economic context) are in Change and Potential Instability Driven by China's Rising Generation?

I would be interested in your response to my suggestions.

John Craig

China: Sustaining Growth by Neglecting Profitability? +

China: Sustaining Growth by Neglecting Profitability? - email sent 14/7/12

James White and Stephanie Cain
Colonial First State

I should like to comment on your suggestions that China will be able to sustain growth because it is a ‘post capital economy’ (in The Rise of the Ferro Dollar - of which relevant extracts are on my web-site).

As I understand it you are suggesting that:

  • China’s rise has been driven by government infrastructure investment for which limited return is expected, because this makes the economy more productive and government can capture positive side effects through tax revenues;
  • In the developed world, economic progress is viewed in terms of return on capital. However in China capital is seen as just one element in the economy, where the goal is to raise the living standards of households. Capital is treated much differently. Investment comprises 45% of GDP, and this is leading to sustainably higher growth, though return on capital is poor (relative to other BRICs). Strong investment improves labour productivity and allows wages to rise faster than in other BRICs;
  • Capital and intellectual property rights are well protected in Western markets, but not in China – where scale and productivity growth are the only way to sustain profitable businesses. China improves the allocation of capital in its economy, by not using capital returns as a scorecard. A broader view is taken of the role of capital, and there is more protection than global markets seem to understand because: (a) government can fund losses through accumulated financial reserves; (b) government can recoup returns through positive externalities; (c) failure by individual projects does not mean that economy as a whole has not benefited; and (d) government can continue to invest through the business cycle. This has resulted in an economy that produced both rapid growth and low inflation.

It is submitted for your consideration that, while you have presented a reasonable view of China’s economy from one perspective, there is a great deal more to the story. For example:

  • The lack of concern for profitability in the use of capital in major East Asian economies such as Japan and China has been obvious to Asia-literate observers for many years;
  • This arguably has cultural roots in societies that lack the West’s classical Greek heritage, and thus have no tradition of (or institutional) reliance on such abstract concepts as law and profit;
  • International financial imbalances have emerged from these non-capitalistic practices which have put global growth at risk, and played a major role in the world’s ongoing financial crisis;
  • China’s main economic goal is more likely to be mercantilist (ie to boost national power) than to raise the living standards of households;
  • Economic growth driven by massive investment is not necessarily sustainable;
  • The rest of the world will eventually have to get to grips with the threat to growth posed by non-capitalistic practices that require trading partners to be willing and able to indefinitely increase their debt levels;
  • Australia needs to take a more Asia-literate view of the challenges and opportunities posed by Asia’s rising influence.

The above comments are presented in more detail on my web-site.

I would be interested in your response to my speculations.

John Craig

Detailed Comments

It has been increasingly obvious for many years that (as was suggested in relation to China) the financial systems in major East Asian economies are not ‘capitalistic’ in the sense that capitalism involves a profit-focused approach to investment (eg see Profitability in Competing Civilizations). As the latter notes Japan’s economy is similar in this respect (and was said to be a ‘non capitalistic’ market economy in 1993 by Sakikabara, a senior Ministry of Finance official).

Arguably this practice has constituted a generally unrecognised source of industrial protectionism (see Resist Protectionism: A Call That is Decades Too Late , 2010).

Limited regard for ‘abstract’ concepts (such as profitability and intellectual property) and a primary concern for ‘real’ economic variables (eg production / market share / cash flow) is a by-product of cultural traditions in East Asian societies which have an ancient Chinese cultural heritage (rather than the West’s classical Greek heritage, that gave rise to the notion that abstracts / ideas usefully model reality) – see East Asia for an outline of the origins and practical consequences of this fundamental difference.

Capitalism (profit focused investment) is one of the methods that Western societies invented to allow individuals to make decisions ‘rationally’ (ie on the basis of abstract concepts such as profitability) – see Cultural Foundations of Western Strengths). Investment by Japan and China is far more market-directed than would apply under the centrally-planned Communist regime that China used to be, because the influence of social elites (ie operating on variations of traditional Confucian methods) force market reality to be considered by their subordinates in reaching consensus (eg see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy, 2009). It is unrealistic to view China’s rapid development since the 1980s as owing much to its nominal Communism (eg see Communism Versus Confucianism: The Continuing Contest in China, 2011).

The absence of real concern for profit in the use of capital in East Asia has been a growing threat to the global economy (eg see Structural Incompatibility Puts Global Growth at Risk, 2003).

Where (as in Japan and China) national savings are captured through state-linked banking systems and directed to state-linked undertakings with limited regard to profitability even when they are market-oriented, a financial crisis can be expected if there is any need to borrow in capitalistic (ie profit focused) international financial markets. Thus it has been necessary in such economies to suppress domestic demand to ensure that a current account surplus results in an opportunity to export capital (rather than a need to import capital through banking institutions with poor balance sheets). The resulting domestic demand deficits would have made global economic growth unsustainable – unless their trading partners (especially those in North America and Europe) had been willing and able to maintain current account deficits, and increasing debt levels, indefinitely.

The associated financial imbalances were one of the major factors giving rise to the global financial crisis (GFC), because rapidly rising overall debt levels were only tolerable so long as overall asset values were stimulated to rise faster by easy monetary policies – see Financial Imbalances (2007) and Impacting the Global Economy (2009).

The risks to the global economy associated with the financial imbalances needed to protect economies that encourage investment with limited regard to profitability have expanded beyond Japan and China. The Asian Financial Crisis in the late 1990s affected countries with similar crony-ist financial systems but which lacked the protection of current account surpluses that Japan and China had. Though the IMF sought to encourage affected countries to reform their financial systems in terms of Western methods, many apparently chose to reduce their risk in another way because of The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems (1998). Similar options were at times taken by emerging economies elsewhere (see Leadership by Emerging Economies?).

It is most unlikely that China’s economic goal is to improve the living standards of households. The People’s Liberation Army has been proportionately the largest beneficiary of China’s rapid growth, followed by ‘Communist Party’ insiders with households very much is last place (see Coalitions of Interests?). And the China-centred trade / tribute system that existed in Asia prior to Western expansion required China’s people to work very hard for limited reward so that China’s elites could exert their regional influence (see Creating a New International 'Confucian' Political and Economic Order ).

Economic growth driven by massive investment is not necessarily sustainable - because investment may not raise productivity enough to generate increased revenues or other benefits to offset its costs (eg consider the rapid growth achieved by the Soviet Union in the 1950s on the basis of investment in things for which there was no market, and Queensland’s debt-driven investment binge of the past decade which appeared to involve accounting practices as reliable as those in China). And there seem to be fundamental constraints on balancing supply and demand in any economy where return on capital is not considered important (see Balancing Supply and Demand)

The international community has proven unable (so far) to get to grips with the threat to global growth posed by the financial imbalances needed to protect countries such as China that seek to have ‘post capital economies' (eg see G20 in Washington: Waiting for Hell to Freeze Over?). However eventually the rest of the world will probably realize that there is a need to do something about this (eg steps along the lines suggested in China may not have the solution, but it seems to have a problem).

Australia needs to take a more Asia-literate view of the challenges and opportunities posed by Asia’s rising influence (eg as suggested in Babes in the Asian Woods, 2009+ and Autocratic Asian States and Australia's Economic Options, 2012). The systems of socio-political-economy that have been the basis of economic miracles in East Asia, by (for example) enabling investment to be somewhat divorced from considerations of profitability not only result in macroeconomic obstacles to sustainable global growth (eg see Economic Recovery is Constrained by Dead Weight Economies) but are also incompatible with Australia's liberal egalitarian social traditions.

There is no doubt that the profitability of individual undertakings has limitations as a way of driving economic change (eg for reasons suggested in The Advantages and Limitations of Financial Criteria and Restricting the Role of Financial Services). However methods of achieving this that are compatible with liberal egalitarian democratic capitalist societies are available (eg see Lifting Productivity: Considering the Bigger Picture View).

Outline of The Travelling Economist: Rise of the Ferro Dollar, Global First State

China’s rise confounds economic history, but not necessarily economic theory. A focus on capital investment in infrastructure is at the heart of growth (to create more productive lives) funded by a government which may bear losses but captures the still positive side-effects (externalities) from rising tax revenues. The government also promotes a competitive industrial landscape to lower the cost of living for households. These foundations seem brittle to those used to judging an economy by on capital. But China is comfortable with low capital returns if the pay-off is a stronger economy.

The Chinese don’t play chess. They play wei qi a game of strategy played on a larger board with black and white pieces each of equal value2. The Chinese government views the economy as though it’s wei qi. Each piece has its own economic role, but each is no more important than another.

In the developed world, the stronger the outcome for capital the stronger the perception of the entire economy. Low returns on capital show economic weakness reflecting over-investment, which is naturally followed by under-investment. This is the business cycle.

In China, capital is just one factor in raising living standards, and is used differently.  Government’s role is paramount. Despite claims of imbalances (investment spending has made up to 45% of GDP in recent years) investment is driving sustainably higher economic growth.

The higher allocation of capital has led to falling profit growth and lower returns for capital. Compared to its BRIC counterparts the Shanghai Composite has been bad. And there have been stories of large capital losses (eg by local government financing vehicles under the Great Stimulus of 2009, property developers and informal lenders in the coastal cities).

But, strong investment improves labour productivity and allows wages to rise. Chinese wage growth out-strips wage gains in other BRIC markets. Since 2005, Chinese wages have doubled - reflecting  productivity improvements and improving income equality (more than falling competitiveness).

Capital is often very well protected in Western markets. Property rights are important in capitalism. Property rights are evolving in China - but are less protected where this may discourage competition. Competition is seen as a way of raising living standards by lowering the cost of goods and services. This drives innovation through the threat of failure; there is no carrot for innovation. Achieving scale and productivity growth is the only way to sustain a profitable business.

By not using capital returns to assess economic progress, China improves the allocation of capital (ie it takes a broader perspective to the value of capital). This has dangers - but there is more protection than global markets understand.

First government can fund losses from financial reserves (> $3.2 tr). Second, and most important, the government (the ultimate capital allocator) can recoup returns from positive externalities in the form of higher tax revenues created by higher levels of activity. Third, the failure of individual projects does not discourage investment elsewhere if other projects can still add value to the economy as a whole. The government can continue to invest through the business cycle - and this has driven stable economic growth.

Government tax revenues have risen as a share of nominal GDP; 11% in 1992 to 20% in 2011.

China can get returns from individual projects. The Great Stimulus should perhaps have been smaller and  better regulated. But that investment will provide dividends for years and be a foundation for future growth.

China’s economic performance in the last 20 years has been remarkable; with very strong growth and low inflation. This is particularly the case when compared with other developed, BRIC and Asian nations. India has similar opportunities - but India’s government is not capable of undertaking this investment. Instead, capital investment generally falls to the private sector, which focuses on the returns specific to an investment rather than the good of the wider economy. Thus the economy suffers from under-investment and an unstable mix of growth and inflation.

Infrastructure investment creates economy wide positive externalities and a competitive economy improves living standards. These two drivers stand in contrast and so highlight the nuanced role of government. Government must build infrastructure as only it can capture the returns from the investment. Conversely, government removes itself from consumer industries where the private sector is willing to invest. The risk , is property which sits between infrastructure investment and a competitive private industrial economy.

The development of infrastructure promotes growth and price stability by improving productivity. Productivity and supply management (increasing the supply of goods and services), rather than demand management, is at the core of successful emerging markets.

The lack of simple infrastructure comes at a cost - the time people take at unproductive tasks. Building infrastructure brings short-term jobs - but its long-term impact (creating time for more productive activities) is much more important.

Urbanisation is at the pinnacle of this process. By moving to a city, a family immediately increases its productivity and living standards (eg by access to better jobs and providing access to economies of scale in the provision of (say) social, health and education services.

China does not allow the ad hoc urbanisation. Most emerging economy cities have large slums with new migrants from rural areas. China limits migration by a licensing system or hukou (which ensures culturally similar people). The urban hukou provides considerable privileges / allows households to lower their precautionary savings - thus increasing consumption of goods and services that further increase living standards and productivity. The hukou helps manage urbanisation. Cities are being built prior to settlement to limit the extent of incremental urbanisation.

China currently has relatively high costs of transport. Only more infrastructure, including the high speed rail network, can lower these costs.

The second plank in China’s bid to lower the cost of living has been the creation of a super competitive industry structure. The industrial structure of China adds to the economy’s growth - but remains a constraint on capital returns.

China’s industrial structure emerged with manufacturing economy after the Cultural Revolution. Each province established its own factories for the manufacture of a variety of goods *rather than following USSR with national champions). This created inefficiencies with the non-performing loan crisis at the turn of the 21st century. China then denied bank funding to companies that were not cash flow positive - allowing only the strong to survive and creating hyper-competitive companies.

The impact of competition is negative for capital returns. Many manufacturers operate at a loss or only small profit. But what’s negative for capital is not necessarily negative for the economy.

The aggressive use of capital reflects its relative abundance due to a closed capital account and high savings by firms and households. The resulting low interest rates provide an incentive for business investment by lowering the required return. Low interest rates lead to the creation of new capital rather than asset bubbles (with the potential exception of property). Businesses start again, rather than bid up the price of assets. Rates of return are low because of fierce competition.

China has the capacity to grow. Economies with less competitive industrial structures tend to have more limited capacity that allows incumbent firms to earn higher profit margins. More profitable firms come at an economic cost as production is not maximised and growth is contained. China's steel industry operates at a very small profit, but high state ownership allows the government to benefit through positive externalities such as lower infrastructure costs because of abundant cheap steel. Unprofitable steel mills lower the cost for other, valuable activities, such as road-building.

Property is China’s Achilles’ heel. It sits between the government-led infrastructure building and a hyper-competitive consumer economy. Each apartment, office, shopping centre or factory is in its own way unique. Location and design play a role in determining the value of property. China knows it must shift to a system of individual property rights, particularly for residential property. It is difficult for the market to be truly competitive; as excess returns exist and it’s not possible for the government to capture them.

This makes property policy extremely difficult. The value of property closer to the city centre, jobs and other facilities rises. Private ownership of property excludes the government from capturing the appreciation - and leaves some households out. Households bid up house prices. This  creates risks of price bubbles / inequalities / unaffordable housing.

Through the prism of financial markets China is not a welcoming economy for capital. Capital returns are low because of competition, a closed capital account that makes capital abundant and companies that have more than just financial motives in mind when they invest. It takes skill to identify opportunities that can offer a sustainable long- term return above the cost of capital.

But this is positive for the broader economy. The aggressive use of capital is lowering the cost of living by raising the productivity of firms and individuals and cutting the prices households pay for the goods and services they need and want. The government, as the largest capital allocator, can both manage losses from individual projects and capture the benefits of loss-making projects through its tax-collecting authorities.

China's Super-Ponzi-like Financial System

 China's Super-Ponzi-like Financial System (2012)

Western ratings agencies work in terms of balance sheets, whereas China's claims to financial strength are based on the mercantilist accumulation of a stock of 'treasure' (eg foreign exchange reserves and domestic capital assets) through organising production capabilities and building up savings by suppressing consumption. A large stock of 'treasure' can be accumulated by a high rate of savings, even if those savings are used wastefully so that the balance sheets of China's banks and state enterprises may be weak because the neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  uses national savings to create economic activity / jobs / capital assets or mandate desired policy changes without taking profitability seriously (see more general comments in Understanding East Asia's Systems of Socio-political-economy). Indicators of the emergence of problems and the increasing potential in 2012 for China's financial system to implode are outlined above and in Profitability?

China's economic growth has largely been based on investment funded by transfers from households (via low interest rates on savings, repressed wages and a depressed exchange rate) [1]

As a result of those transfers China's state enterprises generate huge cash flows and save a great deal of this. This saving increases the size of their balance sheets and provides funds for further investment, but does not necessarily prove that operations have been 'profitable' (ie increased the amount of capital made available to enterprises both: (a) in establishing them; and (b) through retained earnings).

China's credit rating claims (see above) seem to be based on something that could over-simplistically be said to be like a 'super' Ponzi scheme.

In brief: A Ponzi scheme involves attracting investment by paying high interest rates, and defrauding investors because the scheme does not actually earn enough to cover the interest it promises but pays investors by continually attracting new capital. Providing the promoter of a Ponzi scheme can maintain investor confidence, and thus a strong flow of new cash, the scheme can potentially remain in operation for a long time.  However, once confidence is lost, the Ponzi scheme quickly runs out of cash and investors realize that their capital has been frittered away.

China, and other countries that have adopted variations on the neo-Confucian  system of socio-political-economy that Japan pioneered, arrange capital inflow into what seems to be a Ponzi-like financial system through organising production that generates huge cash flows, substantial amounts of which are saved and then invested with little regard to profitability. It arguably constitutes a super-Ponzi' scheme, because new cash flows are required not only to fund new investment and pay (tiny) interest rates on capital, but also to continue topping up capital which is being eroded by losses on investments that are perceived to be be in China's national interests by social elites and their subordinates.

In November 2011, Standard and Poors produced an assessment of the risks associated with banking systems in various countries worldwide [1]. This assessment (written from the perspective of Western approaches to economics) tended to support the view that  there were significant  risks associated with China's banking system, and that access to a very high rate of domestic savings was the reason that crises could be avoided. There was not, however, any comment on what would be likely to happen when the international financial imbalances that permit a high rate of domestic savings were reversed, as they must be because trading partners simply can't maintain strong demand if this required continually increasing their debt levels.

"  Although in terms of economic risk, Vietnam is in the "highest risk" category, we believe China represents the most significant future risk in Asia-Pacific. This is owing to the combination of China's "high risk" of "economic imbalances" and "high risk" of "credit risk in the economy", given its sizable economy and connections within the region and the globe.

The distribution of industry risk scores in Asia-Pacific is broadly similar to that for economic risk. Our assessment  of "institutional framework" reflects a regional dichotomy. On the one hand, systems like Australia, Hong Kong, nd Singapore are among a handful of systems to be classified as "very low risk". ....  On the other hand, half of the systems in the region have classifications of "high risk" or worse for "institutional framework", reflecting our assessment of insufficiently robust regulatory frameworks, weak regulatory track records, or limited governance and transparency standards.

Our assessment of "competitive dynamics" in Asia-Pacific shows a concentration toward the higher risk categories.

Eight of the 16 systems reviewed show "very high risk" or "extremely high risk", taking into account important government ownership, significant directed lending, or administrative controls in countries such as China, India, Indonesia, Thailand, and Vietnam. Although we observe a minimal amount of targeted high-risk lending, we believe periods of rapid credit expansion could cause moderate to aggressive risk appetites. ....

We believe "system-wide funding" is an area of relative strength for the region, and we assess 10 of the 16 systems as "very low risk" or "low risk". One reason for this is the region's high domestic savings rate, which exceeds 30% of GDP in a number of countries. This is an important contributor to the relatively stable deposit bases that reduce the need for external funding."  " (p13)

Ponzi-like financial systems can presumably be continuing indefinitely so long as the flow of new cash is maintained, and enterprises that are directly or indirectly state controlled generate most of the savings that are unprofitably invested, so that no one questions what is happening to the enterprises' balance sheet.  However in the event of a serious global slowdown, cash flows to feed into this system would be reduced and the balance sheets of China's institutions would be called into question - because they would require external capital if growth were not to fall below the levels at which political instability would be a serious risk.

China's financial situation may usefully also be likened to that of the 'entrepreneurs' who built large business empires in Australia following financial deregulation in the 1980s. Money moved around so fast that it was impossible for anyone to realistically assess their balance sheets. But when the economy stagnated, and the financial shuffling stopped, they were found to have serious balance sheet problems.

China's only prospect of avoiding crisis might be to try to create an environment in which its institutions / economy would not be evaluated against prevailing international financial criteria.

China's Political Tensions

China's political tensions - email sent 17/9/12

Ambrose Evans-Prichard

Re: The End of China's Easy Growth, Telegraph, 16/9/12

Your article drew attention to the contrast between the bullish certainties of outsiders about China’s economic prospects, and the despondency of insiders.

“I missed the World Economic Forum in Tianjin last week but Jamil Anderlini from the Financial Times reported a pervasive tone of "despondency and cynicism" from Chinese officials and economists, in marked contrast to the bullish certainties -- or naïveté? -- of foreigners at the event.”

This internal uncertainty about China’s economic future seems to be paralleled by political indecision – according to a couple of articles reproduced below.

The latter are one observers’ attempt to explain what is going on in China’s political system from his socialist perspective. In brief it seems to view:

  • the removal of Bo Xilai as pointing to political infighting in the top CCP leadership between two major factions—the Young Communist League led by President Hu and Premier Wen Jiabao, and the “Shanghai gang” headed by former President Jiang Zemin and Zhou Yongkang, the state security chief on the Politburo Standing Committee;
  • the recent disappearance of Xi Jinping (China’s vice President and expected next President) as possibly indicative of similar tensions – as he was a compromise candidate who (being acceptable to both factions) was endorsed for this role in 2007 but may have recently increasingly favoured political liberalization [which, for reasons suggested below, would disrupt China’s current economic methods].

My suspicion is that there is also a need to take account of the incompatibility between the social equality aspirations of China’s nominal ‘communism’ and the social hierarchy required by the neo-Confucian methods that have been one key to China’s rapid economic transformation in recent years (as suggested in Communism Versus Confucianism: The Continuing Contest in China). The (so-called) ‘Shanghai gang’ are likely to reflect those who (probably with Japan’s help) introduced and control neo-Confucian methods of state-orchestrated economic change. However the state can only orchestrate economic change if it focuses on market demand rather than on community needs and aspirations (for reasons suggested in Economic solutions appear to be beyond politics, 1995). However:

  • a state focus on what the community needs, rather than what markets want, appears to be high on the agenda of the New Left / Young Communist League in China; and
  • this would require parallel market liberalization (ie towards a profit-driven / capitalistic approach to economic change) and the latter would probably result in financial crises like those experienced elsewhere in Asia in 1997 – for reasons suggested in The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems (1998).

Once again bullish / naive outsiders (who hope that China will be the solution to their local economic problems) seem to ignore such questions.

John Craig

Chan J. ‘The strange absence of China’s vice president’, World Socialist Web Site, 15/9/12 [text omitted]

Chan J. ‘Open letter demands Chinese premier’s removal’, World Socialist Web Site, 8/9/12 [text omitted]

Debating China's State

Debating the Chinese State (2012)

On 4/11/12 an article was received from a member of a China-focused forum which had suggested that China's system of government was more legitimate that that of the west - but that the reasons for this are outside Western experience (ie because it was regarded as being like the head of a family comprising the whole of Chinese civilization). This led to an interchange which illustrated differences concerning the role of Confucianism and the Chinese state.

Outline of: Is China more legitimate than the West? (Jacques M. BBC News Magazine, 2/11/12)

US / Chinese political styles in selecting leaders are radically different. Chinese state enjoys greater legitimacy than any in the west - for reasons that are quite outside western experience. China is a civilization-state rather than a nation-state (ie for Chinese what matters is the civilization - ie its integrity / unity) . The state is the embodiment and guardian of Chinese civilisation. Its most important responsibility is maintaining the unity of the country. The legitimacy of the state lies, above all, in its relationship with Chinese civilisation. However Chinese people also say they are happy with the state - though there are still some conflicts. Chinese governments display paranoia (controls on the press and the internet, the periodic arrest of dissidents) to guard against unexpected instabilities. In the West it is believed that the role of the state should be codified in law, there should be clear limits to its powers, and there are many areas in which the state should not be involved. The Chinese idea is quite different. The state is seen as an intimate / member of the family (the head of the family). The family is a template for the state, and the state is an extension / representation of themselves. This lends the Chinese state authority, ubiquity and competence. The competence of the state has now become a serious issue - which China's rapid rise resulting from a competent state, and massive problems associated with incompetence in the West. No Western state could be like China's - as it is the product of a different history and a different relationship between state and society. None-the-less the West could learn from China, just as China has learned from the West. The new Chinese paradigm combines a highly competitive market, with a ubiquitous and competent state.

In response CPDS circulated the following comments to members of that forum.

From John Craig (4/11/12).

I doubt that Martin Jacques’ suggestions in this article are valid. Questions about China’s legitimacy are not likely to be relevant for long for reasons that are suggested in Heading for a Crash or a Meltdown?

While the issues involved are complex, because the neo-Confucian cultural foundations of China’s rapid economic advancement cannot be easily understood from a Western viewpoint (see Understanding is difficult), China faces structural difficulties that could easily precipitate financial, economic and political crises such as :

  • The dependence of East Asia’s non-capitalistic financial systems on the willingness and ability of developed economies (most notably the US) to continue tolerating current account deficits and ever-increasing debts. If such countries decided that they wanted to resist the mercantilism implicit in the East Asian systems, the latter would be in real trouble (see China may not have the solution, but it seems to have a problem);
  • The potential for a domestic revolution based on recognition of the neo-Confucian character of China’s economic miracle, noting that: (a) China’s real communists favour social equality, whereas the is not a feature of the current system; (b) a Confucian approach was apparently favoured by the Nationalists that Mao’s Communist Party drove out of China in 1949 – but was secretly reintroduced in the late 1970s as a neo-Confucian component of the market-opening agenda introduced under Deng; and (c) China’s people have been (but may no longer be) willing to sacrifice themselves to support the authoritarian state because of a belief that this would enable China to gain vengeance against those who in the past oppressed China (ie Western societies and Japan). It now seems possible that it was Japan that sponsored the introduction into China of a variation of the neo-Confucian methods that had been the basis of its post-WWII economic miracles (see Fingleton’s comments). Even more potentially significant (if it is valid) is Fingleton’s suggestion that those methods were developed by the Japanese military in Manchuria during Japan’s invasion of China in the 1930s. The current friction between China and Japan probably needs to be considered in that context (see Friction between China and Japan: The End of the Asian 'Century'?).

In response one forum participant (XXX) suggested (5/11/12) ...

... I am not sure you all have been to China lately. ......

My parents fled China in 1949 ..... I have been back to China several times a year since ...... From what I have witnessed, China has been self-correcting, swiftly moving up, while the United States two party "democratic" system is zig-zaging down: This democracy is dysfunctional, election every 4 year wastes a lot of energy and resources, reducing productivity of many talents, which can be better utilized otherwise.

Again, we need input from political scientists like ........

Below is the comments from my UK colleague who has been to China frequently (YYY).

"Thanks ...., very interesting and I would support much of this. I often say to people that as a visitor, I feel much more free in China than I do in the US…. It’s a fascinating blend of capitalism, individual empowerment and carefully managed state strategy and control."

From John Craig  (4/11/12)

I can’t claim any useful on-the-ground expertise. I was in China for only the second time last year, and only as a very sick tourist.

However, I do suggest that China (like Japan) does not have a ‘capitalistic’ economy (ie one that is driven by the profit motives of independent enterprises) – so YYY (who XXX quoted) is not quite right in that respect (eg see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy). However a ‘non-capitalistic’ market economy has a highly disruptive impact on the international economic environment, because it requires a domestic demand deficit that is macroeconomically unsustainable unless its trading partners are willing to make the financial sacrifices needed to support it (see Impacting the Global Economy).

This situation is a product of the adoption of neo-Confucian methods which have simply not been understood in Europe or the US, and certainly not by economists or political scientists who view the world in terms of Western analogies (eg see Babes in the Asian Woods). There is a need to recognise the implications of radically different ways of thinking (eg see Epistemology: The Core Issue and Competing Thought Cultures). This would normally be the domain of those in the humanities faculties of Western universities. However the latter have been off in a post-modern dream world (in which there are no real consequences of cultural differences).

Moreover it seems very likely that Japan has treated the US to a dose of traditional East Asian Art of War methods since its defeat in WWII (see Coalitions of Interests?). Those methods include an emphasis on deception and ‘winning without fighting’. While the US Federal Reserve (through what some have described as its ‘currency war’) has arguably sought to ‘do unto others as others have been doing to the US’, the US’s political establishment has not yet publicly caught onto what has possibly / probably been happening and the issues involved. However, when / if it does it is likely that the US will not be amused (no matter who is in power).

A strategic approach to Asia literacy is arguably possible, and this would seem likely to: (a) deprive the neo-Confucian systems of their main current competitive advantage; (b) generate unity of purpose; and (c) reduce the risk that Western responses would be diverted by poorly informed economists or defence analysts. And there is a lot that could be done (eg as suggested in Getting out of the Economic Quicksand and Suggested Strategic Response). And while there is no public political mention of such issues it is noted that: Obama has beaten the drum about whether China ‘plays by the rules’ and has written about the need for nation building in the US; while Romney has backed away from a militaristic approach to US foreign policy.

The implications of a real Asian Century attack the heart of the individual liberty that drove Western resistance to authoritarians during the 20th century. YYY suggested that ‘individual empowerment’ exists together with ‘carefully managed state strategy and control’ in China. The character of that empowerment needs to be considered (eg see ‘Chinese individualism’) as does the constraint on states in centrally coordinated efforts to define / control strategy. Very large complex organisms do not exist in nature because the coordination / control systems can’t be effective.

Certainly (as XXX  suggests) ‘China has been self-correcting, swiftly moving up”. But it has been encountering very real domestic political obstacles at a time when its external difficulties are likely to escalate. China appears to be responding to its domestic political difficulties by seeking to make consultation within the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) a less unreliable guide to the broader community (consider parallels with what is being done to China’s state controlled media – see Reading China's Mind?). However there are limits to which complexity can be encompassed within a unified / centralised control system.

From XXX: (9/11/12)

Thank you for your thoughtful input. Sorry that I didn't get to respond sooner. We had a superstorm Sandy last week which paralysed the East Coast  .........

I hope you will be healthy on your next trip to China so you can gain more on-the-ground experience to better appreciate the traditional values of an old civilization, beyond the modern history during which the Western Powers with Japan tried unrelentingly to divide and conquer China. I include a chart of "China's Re-emergence as a Power" based on the data from Angus Maddleson in 2001, which showed China was the world leading economy in the first 18th centuries.

I believe that unlike the USA, China does not consider it is a priority to be #1 in the world, as it is to feed all the people in the nation. (Confucius). Thus, historically, the leaders assume the responsibility as the parents in a family.


Here is also China's 18th National Congress of CPC

From John Craig  (8/11/12)

Thanks for your feedback.

Glad that recovery from Sandy seems to be getting underway – though I gather that other weather problems are arising.

My impression is that China is facing a different sort of ‘bad weather’ that could well impede its re-emergence.

From XXX (9/11/12)


China has never been as good as it is now in the modern history. The obstacles are lessoned now than before. Martin Jacques is only half right.

It is not my priority to teach the ignorant, but you should travel to China to learn from the ground up, instead of only from readings. There is a saying, "Garbage in, garbage out!"

From XXX (10/11/12)

Just after the 6 Bullion USD spent on the US election, you all might find this of interest. Knowledge is power.

Hu calls for building China into maritime power 2012-11-08 10:40
Hu calls for efforts to enhance social ethics 2012-11-08 10:11
Hu stresses improving socialist market economy 2012-11-08 10:03
Hu vows to boost domestic demand 2012-11-08 09:55
Hu outlines 'overall approach' for modernization drive 2012-11-08 09:43
China firmly follows socialism with Chinese characteristics: Hu 2012-11-08 09:26

Key quotes from Hu's report to CPC congress Updated: 2012-11-08 12:53 (Xinhua)

BEIJING - Chinese leader Hu Jintao delivered a report on Thursday at the opening of the 18th National Congress of the Communist Party of China (CPC). The following are key quotes from his report:

On Scientific Outlook on Development

-- The most important achievement in our endeavors in the past ten years is that we have formed the Scientific Outlook on Development and put it into practice.

-- This theory provides new scientific answers to the major questions of what kind of development China should achieve in a new environment and how the country should achieve it.

-- Together with Marxism-Leninism, Mao Zedong Thought, Deng Xiaoping Theory and the important thought of Three Represents, the Scientific Outlook on Development is the theoretical guidance the Party must adhere to for a long time.

On socialism with Chinese characteristics

-- We must unswervingly follow the path of socialism with Chinese characteristics.

-- Our overall approach is to promote economic, political, cultural, social, and ecological progress, and our general task is to achieve socialist modernization and the great renewal of the Chinese nation.

On building moderately prosperous society

-- We need to have a correct understanding of the changing nature and conditions of this period, seize all opportunities, respond with cool-headedness to challenges, and gain initiative and advantages to win the future and attain the goal of completing the building of a moderately prosperous society in all respects by 2020.

-- An examination of both the current international and domestic environments shows that China remains in an important period of strategic opportunities for its development, a period in which much can be achieved.

-- On the basis of making China's development much more balanced, coordinated and sustainable, we should double its 2010 GDP and per capita income for both urban and rural residents.

-- To complete the building of a moderately prosperous society in all respects, we must, with greater political courage and vision, lose no time in deepening reform in key sectors and resolutely discard all notions and systems that hinder efforts to pursue development in a scientific way.

On economy

-- Taking economic development as the central task is vital to national renewal, and development still holds the key to addressing all the problems we have in China.

-- The underlying issue we face in economic structural reform is how to strike a balance between the role of the government and that of the market, and we should follow more closely the rules of the market and better play the role of the government.

-- We should firmly maintain the strategic focus of boosting domestic demand, speed up the establishment of a long-term mechanism for increasing consumer demand, unleash the potential of individual consumption, increase investment at a proper pace, and expand the domestic market.

-- We should give high priority to rural areas in developing infrastructure and social programs in the country.

On political structure reform

-- We must continue to make both active and prudent efforts to carry out the reform of the political structure, and make people's democracy more extensive, fuller in scope and sounder in practice.

-- We should place high importance on systemic building, give full play to the strength of the socialist political system and draw on the political achievements of other societies. However, we will never copy a Western political system.

On improving people's wellbeing

-- We should keep making progress in ensuring that all the people enjoy their rights to education, employment, medical and old-age care, and housing so that they will lead a better life.

On ecological progress

-- We must give high priority to making ecological progress and incorporate it into all aspects and the whole process of advancing economic, political, cultural, and social progress, work hard to build a beautiful country, and achieve lasting and sustainable development of the Chinese nation.

On military modernization

-- Building strong national defense and powerful armed forces that are commensurate with China's international standing and meet the needs of its security and development interests is a strategic task of China's modernization drive.

-- We should attach great importance to maritime, space and cyberspace security. We should make active planning for the use of military forces in peacetime, expand and intensify military preparedness, and enhance the capability to accomplish a wide range of military tasks, the most important of which is to win local war in an information age.

On Taiwan

-- We are ready to conduct exchanges, dialogue and cooperation with any political party in Taiwan as long as it does not seek Taiwan independence and recognizes the one-China principle.

-- We hope that the two sides will jointly explore cross-Straits political relations and make reasonable arrangements for them under the special condition that the country is yet to be reunified.

-- We hope the two sides will discuss the establishment of a cross-Straits military security confidence-building mechanism to maintain stability in their relations and reach a peace agreement through consultation so as to open a new horizon in advancing the peaceful growth of these relations.

On foreign affairs

-- China will unswervingly follow the path of peaceful development and firmly pursue an independent foreign policy of peace.

-- We are firm in our resolve to uphold China's sovereignty, security and development interests and will never yield to any outside pressure.

-- We will decide our position and policy on an issue on its own merits and work to uphold fairness and justice.

-- China is committed to peaceful settlement of international disputes and hotspot issues, opposes the wanton use of force or threat to use it, opposes any foreign attempt to subvert the legitimate government of any other countries, and opposes terrorism in all its manifestations.

-- China opposes hegemonism and power politics in all their forms and will never seek hegemony or engage in expansion.

On Party building

-- Combating corruption and promoting political integrity, which is a major political issue of great concern to the people, is a clear-cut and long-term political commitment of the Party. If we fail to handle this issue well, it could prove fatal to the Party, and even cause the collapse of the Party and the fall of the state.

-- Leading officials at all levels, especially high-ranking officials, must readily observe the code of conduct on clean governance and report all important matters. They should both exercise strict self-discipline and strengthen education and supervision over their families and their staff; and they should never seek any privilege.

From John Craig (9/11/12)

You suggested that my concerns about China’s prospects were unfounded.

However I don’t believe that my ability to understand China would be aided by going there again to learn from the ground up (see Why?). My interest is in understanding the way of thinking, and how this translates into methods of political and economic organisation (amongst many other things). On the ground I suspect that I would be more likely to be exposed to ‘garbage’ than if I rely on diverse other sources.

Hu’s address to the Party Congress (that you mentioned subsequently) spoke of boosting China’s maritime power, social ethics, socialist market economy and domestic demand while continuing to rely on ‘socialism with Chinese characteristics’.

While the neo-Confucianism that is called ‘socialism with Chinese characteristics’ can be presented idealistically (as you suggested) as involving leaders who “assume the responsibility as the parents in a family”, the reality is that this involves:

  • social inequality which: (a) has translated into the world’s most extreme imbalances in wealth; and (b) is so incompatible with the original aspirations of China’s socialist revolution that it has led to political instabilities (the Bo Xilai affair) and even warnings about the risk of another Cultural Revolution;
  • opportunities for corruption – in the absence of any clear foundation for social ethics;
  • a growing gap between the ever increasing knowledge of China’s population and the ability of internal Communist Party consultations to take account of what the community knows / fears and to ensure community support;
  • economic and financial systems that are critically dependent on the [now exhausted] willingness and ability of trading partners to continue increasing their debt levels indefinitely – and which are thus (like Japan’s) clearly past their use-by date;
  • incompatibility between the specialised knowledge / skill requirements of China’s future economic environment and an education system that is still shifting towards educating future generations in a Confucian framework (ie to encourages unthinking responsiveness to leaders rather than creativity / initiative);
  • a fairly poor basis for international relationships – as harmony can only be promoted amongst those who are insider to the hierarchical ‘family’ – while those on the outside are confronted with a lack of information and at times deliberate deception in the perceived interests of the ‘family’

China’s premier (Wen Jiabao) acknowledged in 2007 that China faces severe economic challenges (ie he described the economy as unstable, unbalanced, uncoordinated and unsustainable) and Hu Jintao has often spoken of the need for political reforms.

But there have been obstacles to change, and these problems remain. The speech that Hu (who won’t be president much longer) gave at the Party Congress in 2012 was virtually identical to that he gave in 2007 [1]. And it is not at all clear that the incoming leadership in the Politburo has any clear idea of what to do now, or any way to get such ideas.

Response from a Chinese American (ZZZ), who prefers to remain anonymous (10/11/12)

Well said about the problems and issues exist in China's culture & political system in which a few of the top leaders always “assume the responsibility as the parents in a family” in their effort to manage and lead the nation and their people. Unfortunately, being an American of Chinese origin I have enough "down-to-the-ground knowledge" about culture, people and political systems of both China and the US, and I have to say that your observations on China are pretty accurate and right on the mark. In fact, my observation and view points on China's system are much the same as yours. Especially I share very much your views about the effect of a social foundation of China that is built on the "Confucian framework" which encourages unthinking responsiveness to leaders rather than creativity / initiative of the individuals. I would also add that this has been the key culture elements or heritage which prevented (for thousands of years) China from becoming a strong nation even though China was the richest nation on the planet for more than 10 centuries in human history.... I often argued with many of my American or Chinese friends that, despite of becoming world's No. 1 economy in the near future (I have zero doubt on this one), it is unlikely for China to become a military power (or a strong country in technology innovation, creation of industrial revolution etc.) simply due to the culture heritage that is deeply rooted in the extremely conservative of Confucius ideology. So, my theory is that China needs another truly culture revolution (of course, not the violent style of Mao's revolution) for seriously confess and revitalize on the weaknesses of a Confucius ruled culture & society for China to become a truly democratic, strong and vibrant nation....

Another aspect of observation on China I want to add is that the huge risks and instability that the system carries on behalf of the nation and its people. In other words, Chinese society as a whole can be many times more efficient and doing well in terms of leadership capacity for reaching out and fulfilling some goals setup by the top leadership, however the system and its economy can be extremely vulnerable and could collapse within a very short period of time if the people at the very top happen to be corrupted or lack of wisdom. There have been many historical lessons throughout the long history of China that one dynasty was wealthy and prosperous yet, the next dynasty could collapse in very short period of time....

Nevertheless, it is impossible for China to adopt the western system or wise versa due to the culture heritages which dominates how people think and behave. One of the most sad culture phenomenon in the "parent ruling" style social & political system of China is extreme lack of trust between people and between people and their leaders.

I am not surprised at all to see that Hu's current report at this CPS Congress is almost identical as that of his 2005 version; an excellent observation of you John!

Of course, the western system has its own problems & serious issues but we can discuss one at a time....

An exchange continued amongst members of the online forum about the role of Confucianism in Chinese society and the character of the Chinese state.


China's financial challenges are not limited to its banks

China's financial challenges are not limited to its banks - email sent 31/1/13

Yukon Huang
Carnegie Endowment for International Peace

Re: China’s banks are too big to manage’, Business Spectator, 30/1/13

Your article suggested various problems with China’s banks that might be remedied by break-up and competition. However I would like to suggest that there seems to be a more fundamental problem, namely the limited concern for profitability by business enterprises under the neo-Confucian systems of socio-political-economy that have been the basis of ‘economic miracles’ in Japan and elsewhere in East Asia (including China).

My interpretation of your article: China's big four state banks make large profits. Though many see them as the source of problems in China's economy, they merely reflect problems elsewhere. China's banks are too secure – and their performance could be improved by break-up. Critics cite: inflexible / low interest rates; government interventions such as encouraging property bubble; and huge deposits which raise the risk of misuse (given lax governance). But China's interest rates are relatively high in real terms. Capital markets lack the depth needed for flexible interest rates. The property bubble is more due to capital controls that discourage investors moving funds offshore (thus encouraging domestic property speculation). And the huge deposits are the consequence of economy with limited investment options. The emergence of wealth management products / a shadow banking system allow higher returns, but at the cost of introducing risky financial instruments. But this diversification is useful. Though there will be problems, this is the cost of learning in a regimented system. There is no basis for a banking crisis in China. The big four banks pay high dividends; non-performing loan ratios are low (though flawed); their volume of deposits is immense; mortgage lending is not highly leveraged; and most lending goes to state entities - so the ultimate risk is of state creditworthiness. The main problem in China's banks is a lack of incentive for prudent risk-taking and commercial objectives in state-dominated activity. The main need is to introduce more competition into a system that will continue to be dominated by the state and vested interests. Increased entry of foreign banks could help. Breaking up the big four into regional banks would also help - as HQs away from Beijing would reduce the pressure to respond to political goals.

Your article suggests that China’s banks make large profits and that China’s financial problems lie elsewhere. In relation to this I should like to point to indicators that profit has not been a serious consideration in the use of national savings in either China or Japan (who allegedly had a role in the 1970s in introducing the economic methods that were the basis of China’s subsequent rapid development).

Those neo-Confucian methods appear to involve state-led orchestration of economic activity financed by state-owned banks, rather than profit-focused decisions by independent enterprises. And while this is effective in creating production capabilities, it is not geared towards getting a return on national savings. And this system is likely to have very serious domestic and international consequences namely:

  • consuming the community’s savings, and in the process providing an undisclosed subsidy for producers;
  • requiring that enterprises, state-owned banks and regulatory regimes tolerate poor and / or misrepresented balance sheets;
  • creating a risk of financial crises, which require suppressing domestic demand to achieve sufficient savings to avoid the need to borrow in profit-focused international capital markets; and thus
  • making global growth dependent on the willingness and ability of trading partners (especially the US) to continue tolerating large current account deficits and escalating public and private debts – a fact which appears to have played a significant role in the international financial crisis.

Your article suggests that there is no sign of an imminent banking crisis in China.

However the situation in Japan (whose economic / financial methods are similar despite its apparently different political arrangements) is becoming serious – noting that:

  • important trading partners increasingly appear to be unable to continue tolerating large current account deficits , and are forced to rely on risky monetary policy options to promote economic recovery;
  • government debt amounts to some 200% of GDP – which suggests that a limit to government borrowing is possible;
  • the Bank of Japan is being pressured to boost money supplies, which will presumably ease government borrowing constraints while encouraging a resumption of the carry-trades that had a role in creating asset bubbles elsewhere prior to start of the international financial crisis;
  • substantial current account deficits are now being incurred (eg Obe M. Japan post deep current account deficit, Wall Street Journal, 11/1/13), and this implies a need to either: (a) draw down foreign exchange reserves thereby increasing the current account deficit constraints facing trading partners; or (b) risk borrowing in international markets with still-suspect financial practices.

And if Japan experiences another financial crisis, it is very likely that this time there might be significant and Asia-literate international attention to the nature of its problem – which could also lead to recognition that competition and break-ups may not be sufficient to strengthen China’s banking system if its major enterprises (like Japan’s) remain state-orchestrated with limited regard to return on capital. My speculations about the possibility of a financial crisis facing China eventually are in A 'Super-Ponzi' Financial System.

I would be interested in your response to my speculations.

John Craig

Resulting Interchange with Yukon Huang Regarding China's Financial Challenges

Initial Response from Yukon Huang - 31 /1/13

China's banking system is different because the big four are state owned.  With interest margins controlled they are guaranteed profits.  As long as the public debt levels are low - which they are - any financial risks are sovereign risks and not banking risk.  As an added measure, China's huge reserves are used to protect the system against NPLs being much higher than they are officially state.  Thus the issue is more about getting the banks to serve the real needs of the private sector rather than just rely on easy lending and implicit government guarantees.

Reply to Yukon Huang - 31/1/13

Thanks for your response. I would appreciate your permission to include it with the copy of China's financial challenges are not limited to its banks on my web-site.

An aside: A subsequent brief discussion about reproducing this interchange has been omitted from this record. Conditional permission was granted

You again pointed out various reasons to believe that China’s banking system is not at risk. However you did not comment on concerns expressed in my email, ie that China’s state-funded public and supposedly-private major enterprises (like Japan’s) do not seem to be required to take profitability seriously, and that this practice has serious domestic and international repercussions.

Poor balance sheets can be disguised as your email suggested (ie by ensuring that China’s major banks are (artificially) profitable; considering the financial risk of investing / NPLs to be sovereign risks; and pointing to the protection apparently provided to China’s sovereign credit rating by large foreign exchange reserves). However the fact that this arrangement is non-transparent (both in relation to the lack of serious emphasis on profitability in the use of national savings, and to the actual state of corporate and national balance sheets) is: (a) incompatible with prevailing international financial practices and systems; and (b) likely to increase the risk of domestic and / or international financial / economic crises.

Three Responses from Yulon Huang - 1/2/13

China’s banks do not take profitability as seriously as others because at state-owned banks a large portion of their lending are actually quasi-fiscal expenditures – typical of socialist systems. There is less expectation that these loans will be profitable. Nevertheless they are relatively profitable as evidence by the dividend stream and the huge capital gains that outside investors such as Goldman and Temasek have made on their investment shares purchases years ago.

China’s government expenditures to GDP ratio is unusually low – around 28% compared with 40% in OECD countries. They fund what would be normally included in government budgets through bank loans. Thus trying to think of them in normal banking terms does not make sense. Thus China’s banking problems stem actually from a failure to use the budget properly. It is a fiscal rather than banking problem.

Japan’s banks are completely different – they are not state owned.

Attaching another article of mine on China’s banks

Outline of attached article: There is increased scrutiny of China's banking system - and concern about negative interest rates, repressed consumption and excessive investment. Premier Wen Jiabao said the big four have monopoly position, earn excessive profits was catering for large state enterprises and neglecting small private companies. However there are myths involved. Negative interest rates are a global phenomenon - and more of an issue in US than in China. China's financial repression does not result from negative interest rates, but from capital controls - which lead to restricted investment choices so that government can capture savings easily for its own spending. Decline in consumption relative to GDP results from shift from agriculture to industrialized economy - and also arose in Japan, South Korea and Taiwan. Consumption spending has grown 8% pa over 2 decades. Big 4 banks have only 45% of bank assets now compared with 75% 2 decades ago. And while they have large profits they will face big write-offs from 2008 stimulus program. The real problem is limited role of other financial intermediaries and rudimentary bond / equity markets. Excessive investment is not the result of low interest rates. Given savings of 50% of GDP, rates might fall if financial system was liberalised - without government driving investment. Build up of heavy industry reflected an overly ambitious effort to rebuild capital stock after Mao era. And despite this China's capital stock remains low relative to others, and to its needs to support rapid urbanisation. Reform would not allow the banking sector to play a bigger role in economy, as its existing role has been huge because government has used credit expansion to drive demand and households have limited investment options. Suggestions that reform of banking system requires improved governance / regulatory framework misses the point that banking weaknesses are less important than inadequacies of fiscal system - where expenditures account for only 27% of GDP compared with 35% in other middle income countries, and 40% in OECD. When reforms started decades ago government revenue and state enterprise profits had collapsed - and the only way to mobilize resources for investment was to tap household savings. Now China needs to move away from having banks as the main instrument for funding public spending. Thus fiscal system needs to take on its normal responsibilities. This would be more accountable and transparent. (Tall Tales about China's Banks hide Economy's Problems, Bloomberg, 5/6/12)

One last point. Yes China’s banks do not fit the mode other global banks but this is not a systemic risk for the global financial system for many reasons.

Working Draft Reply to Yukon Huang RE: China's financial challenges are not limited to its banks -

As I understand it your conclusion, is that China’s major financial problems are largely outside its banking system – related to the way banks have been used by the state - and that the goal should be to: (a) normalize China’s fiscal arrangements; and (b) find ways to mobilize funds for private business;

While this is reasonable, I submit that:

  • there is a need to consider cultural features as these impact on both current arrangements of which China’s banking system is part, and on realistic options for reform. What has been called ‘Socialism with Chinese characteristics’ appears to involve the same sort of neo-Confucian (ie bureaucratically –orchestrated ) approach to economic development that Japan used, and to involve a similar approach to the use of national savings (ie limited regard for profit in the use of capital and a consequent need to rely on the accumulation of foreign exchange reserves to protect against the resulting ‘sovereign risks’);
  • while China’s major banks (like Japan’s) do not in themselves constitute a risk to the global financial system because they are artificially made to seem profitable, the neo-Confucian system of socio-political-economy of which China’s banks are part is the source of very severe risks to the global financial system and to countries such as China in particular.

My reasons for these suggestions are developed further on my web-site.


The responses to my earlier email and the other article that was referenced (Tall Tales about China's Banks hide Economy's Problems which is outlined above) suggests that:

Socialism with 'Chinese Characteristics'

It was suggested above that China uses banks to fund what should be state fiscal expenditure – and that this is typical of socialist countries. However ‘socialist’ countries usually can’t invest to meet market demand – because collectivist politics over-ride market considerations.

China is not ‘socialist’ in anything like a traditional form. There is frequent reference to ‘socialism with Chinese characteristics’. And those ‘Chinese’ characteristics seem to involve neo-Confucian methods for accelerating economic development (ie stimulation of market-oriented learning by their connections / subordinates within enterprises and whole industry clusters by social elites within the neo-Confucian bureaucracy - ie the so-called 'Communist' Party) rather than the central ‘planning’ that is typical of socialist economies.

My speculations about the methods being used are in Understanding East Asia's Neo-Confucian Systems of Socio-political-economy. This suggests that those economic methods: (a) are similar to those that were the basis of earlier ‘economic miracles’ in Japan and elsewhere in East Asia; (b) are effective in orchestrating the development of potentially-market-oriented production capacity by the use of the ‘real-world-education’ methods like those that Confucian bureaucracies traditionally used in governing countries such as China and Japan; and (c) don’t involve making investments on the basis of the expected profitability of independent / truly-private enterprises. And, as noted above, those methods have generated serious political tensions within China because they required the reintroduction of a social hierarchy, whose elimination had been the primary goal of Mao's cultural revolution, and also into gross inequalities in the distribution of wealth.

However as far as China's financial system is the concerned the result is that investment has been funded by state-controlled banks to which national savings are channelled by various methods of 'financial repression' and which make these available to state-linked (sometimes-nominally-private) organisations with limited regard to the profitability and balance sheets of borrowing organisations.

'Socialism' with Japanese Characteristics?

The suggestion that "Japan’s banks are completely different – they are not state owned" appears suspect.

While Japan's banks are nominally 'private' they were controlled by Japan's Ministry of Finance (MOF) during Japan's period of rapid industrialization (eg noting the 'descent from heaven' system whereby former MOF officials gained the senior roles in those banks). Moreover Japan's system was like China's also in that it involved:

  • 'financial repression' to direct national savings to state-linked investments; limited regard for profitability in the use of national savings; and government-driven investment to build up the capital stock (see Why Japan's Can't Deregulate its Financial System). Thus in Japan also there was a need to accumulate foreign exchange reserves in order to provide protection against 'sovereign risk'.
  • apparent state endorsement (via the LDP and the so-called 'Communist' Party respectively) of  a neo-Confucian catalytic role in controlling the government / economy / society (by the bureaucracy in Japan and by the s-called 'Communist' Party itself in China) on the assumption that this would both build economic capacity - and benefit the connections of those in the political system. 

A prominent 'Asia watcher' has also argued (with unknown validity) that a variation on Japan's system was transmitted from Japan to China in the late 1970s.


While China’s major banks (like Japan's) do not in themselves appear to create a risk to the global financial system, the neo-Confucian systems of socio-political-economy of which those banks are components does pose such a risk – and also poses a particular risk to countries in East Asia such as China.

In relation to the global risk it is noted that:

  • neo-Confucian systems of socio-political-economy have required that the countries involved accumulate large foreign exchange reserves to protect the state against ‘sovereign risk’. The ‘financial repression’ needed to achieve this has created demand deficits that would make global growth unsustainable unless their trading partners had been willing and able to tolerate large and persistent current account deficits and increasing debts so as to provide the demand in excess of their national incomes that was needed to prevent global economic stagnation (see Structural Incompatibility Puts Global Growth at Risk, 2003). And trading partners' current account deficits require that they have domestic demand that exceeds domestic production, which (a) was stimulated by excessively easy monetary policies that contributed to the asset bubbles that ultimately led to a global financial crisis; and (b) affected the US in particular because of its post-WWII ‘mission’ of encouraging the global spread of democratic capitalism by acting as a 'consumer of last resort' (see Impacting the Global Economy);
  • accumulating foreign exchange reserves to protect poorly developed financial systems is incompatible with international financial practices. Moreover this arrangement :
    • is not the basis of an alternative global system, because not all countries can adopt this practice;
    • has not been transparent. For example, the 1985 Plaza Accord, which involved attempts to reduce the US’s persistent current account deficits by devaluing the $US against the Japanese Yen, did not reduce US trade deficits with Japan because controls on capital flows in Japan (which were not apparently disclosed) directed national income to increasing production. Thus trade imbalances could not be corrected no matter what was done to exchange rates (see Inadequacy of Currency Re-alignment);
    • has spread to many other Asian countries who had suffered from ‘crony capitalism’ at the time of the Asian Financial Crisis, and to emerging economies elsewhere who had reason to fear financial crises (see Leadership by Emerging Economies?);
  • the creation by reserve banks of huge quantities of credit at very low interest rates in a last-ditch attempt to maintain global economic growth in the face of the large public and private debts in countries that don’t practice ‘financial repression’:
    • has resulted in a so-called ‘currency war’ involving quantitative easing by reserve banks mainly through monetising government debts (which generated ultra-low interest rates). This can be viewed variously as: (a) a means to stimulate domestic economies; (b) a tactic to devalue national currencies to boost competitiveness; or (c) a way to encourage carry trades from current-account-deficit economies in order to boost asset values / economic demand in 'surplus' economies;
    • is very likely to merely stimulate asset bubbles like those that preceded the global financial crisis, if the international financial balances liked to ‘financial repression’ have not been corrected. And this is not likely to happen until reasons for such repression are disclosed and adequately understood so that the problem can be addressed. Another global financial crisis that will leave that of 2008 in the shade seems quite likely (see Debt Denial: Stage 3 of the GFC).

In relation to the risk that this poses to countries such as China, it is noted that:

  • national savings have been eroded and the balance sheet of the whole community is weak even though this does not show up in the accounts of major banks because their 'profitability' has been artificially boosted at the expense of the community. Thus the community has notional financial assets / savings that are not actually available, and there is a need for an ongoing process to continue attracting savings. This has the character of a 'Ponzi scheme' (ie if anything goes wrong, and it proves impossible to continue attracting enough new savings, the problem could become apparent);
  • foreign exchange reserves are not necessarily a reliable means for guarding against 'sovereign risk'. If significant current account deficits start to be experienced (because trading partners face austerity), drawing on those reserves will exacerbate the debt constraints on trading partners' demand. It will also require converting those reserves back to yuan - thus causing the currency to appreciate and undermining industrial competitiveness [1];
  • the need to create a sustainable global economic system must eventually force trading partners, either unilaterally of through international institutions to recognise that counter-cyclical or stimulatory policies can not be effective in the face of structural financial imbalances and thus force change (eg as suggested in China may not have the solution, but it seems to have a problem, 2010). The G20 has been chronically unable to deal with the problem of financial imbalances - even though some observers are clearly aware of its implications;
  • a 'capitalistic' (ie profit focused) economic structure that is able to effectively balance domestic supply and demand has historically proved superior to the mercantilist acquisition of a 'stock of treasure' (equivalent to the accumulation of foreign exchange reserves) - see Balancing Supply and Demand;
  • frictions between Japan and China that have their origin in history make China's apparent reliance on the adoption of a Japan-facilitated system of socio-political-economy very difficult for China's people to accept - and this compounds the many domestic challenges that China faces
  • the creation of ways to provide finance for truly-private enterprise requires radical changes to the methods that have been the basis of early-stage industrialization and: (a) the necessary changes involve significant cultural obstacles; and (b) external help in making those changes can't be provided unless outsiders are assisted to understand those obstacles. Japan was exposed to a need to adjust its methods in about 1990, yet found the adjustment to be immensely difficult (impossible?). There has been no such thing as truly ‘private’ enterprise (see In East Asia Deals always Involves ‘politics’) - a constraint that seems to apply even in Singapore which might otherwise be seen as a model for China to emulate.

The biggest ultimate losers from the imbalances build into East Asia's neo-Confucian systems of socio-political-economy are likely to be in East Asia.

Japan's position already appears to be extremely difficult - even to those who do not take account of the lack of serious attention to profitability in the use of national savings and thus can't see how desperately Japan probably needs to avoid current account deficits and the ultimate need to borrow in international financial markets (see Japan's Predicament).  The latter also points to the effect that rapid population aging (which Japan currently experiences and China will experience after 2020) has on increasing dependence on exports in an environment in which the aging populations of developed economies reduce their import demands and also increase their dependence on exports to sustain growth.

Creating a New International Order on China's Terms

Creating a New International Order on China's Terms (March 2013)

 In March 2013 a 'Chinese' view of future international relations based on peaceful development was expressed by China's ambassador to Australia

China's foreign policy is characterised by three wants, and three don't wants. 18th Congress of Communist Party of China pointed out that humanity only has one world to share, and the arbitrary exercise of force can't make the world better. China wants peace not conflict, development not poverty cooperation not confrontation - and advocates building a harmonious world of enduring peace and common prosperity. Thus China wants new international relations system featuring equality, mutual trust, inclusiveness, mutual learning and win-win cooperation and is committed to upholding peace and development of all countries. China will never waver from peaceful development. China won't seek dominance when it becomes strong. It seeks amicable ties with other nations, and won't seek development at cost to others. However China expects others to do the same, and won't sacrifice its national interests. China will follow a win-win strategy in opening up. Robust, balanced and sustainable growth of the global economy will be sought through cooperation (eg in macroeconomic policy with other major economies) and seeking consultation to resolve friction. A prosperous / stable world means opportunities for China, and visa versa. Domestic development and opening up will be coordinated. China's development will be aligned with the world - and a more active role will be played in international affairs. The Dioyou Islands belong to China. Cyber attack is a global problem, and China is one of the main victims - with most attacks originating in countries that accuse China of hacking. China has carried out bilateral law enforcement with many countries recently, and tabled a draft International Code of Conduct for Information Security. China calls on the international community to work together to build a safe, open and cooperative cyber-space. (Chen Yuming., 'China wants a new international order but won't sacrifice national interests', The Australian, 9-10/3/13)

The aspirations expressed in the above article are attractive. However there are many uncertainties because:

  • Information is traditionally used in East Asia (which lacks the West's classical Greek heritage) to generate favourable responses from others (ie like propaganda), rather than to provide understanding of enduring 'truth' (see Why Understanding is Difficult);
  • traditional 'Art of War' strategies feature deception and 'winning beforehand' - ie by undermining others in times of peace before conflict. Thus 'peace' is very compatible with an ongoing non-military 'war' to advance the position of particular ethnic communities. None-the-less the use of 'soft power' techniques appears decidedly better than traditional 'hard power' - providing all parties recognise what is going on (see also Comments on Australia's Strategic Edge in 2030);
  • When equality is advocated, this is likely to refer to equality of cultures rather than equality of individuals. The latter is a Western aspiration based on a 'rule of law', but is incompatible with East Asia's traditional authoritarian social hierarchies;
  • the notion of an 'open' cyber-space is incompatible with manipulating access to information that appears to be central to the way in which China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  exerts power / control in China (see China's Bigger Secret); 
  • While opening China 'in alignment with the world' (ie 'playing by the rules' in terms of President Obama's call to China) was endorsed:
  • there is no guarantee that China will achieve the 'power' to be a major global economic and political influence because of: (a) its very severe domestic challenges (see Heading for a Crash or a Meltdown?); and (b) the incompatibility between East Asian systems of socio-political economy and the current international order which put the latter (and the East Asian systems which in the past have had a 'parasitic' dependence on the international system) at risk (eg see Structural Incompatibility Puts Global Growth at Risk and Debt Denial: Stage 3 of the GFC?)
Financial and Educational Reform in China: Headed in Opposite Directions?

Financial and Educational Reform in China: Headed in Opposite Directions? - email sent 4/6/13

Peter Drysdale
Australian National University

Re: China’s Next Big Round of Economic Reform, EconoMonitor, 3/6/13

While there can be no certainty about how China hopes to overcome the serious imbalances in its economy, I should like to point to changes that seem to be occurring in another arena (education) that point in a direction that is incompatible with the suggestion in your article (ie that China’s financial system should be aligned with the liberal international financial system).

My interpretation of your article: China may attempt a major round of economic reforms - like that on entering WTO. As China's markets were opened traders became more confident in exchanging commodities with China. It also affected the way China's economy / markets / institutions operated. Prices had previously differed from international prices. Now China's economy is integrated into international economy. China's commitment to liberal international trading system was a major triumph. The focus is now on structural imbalances in Chinese and global economies - especially in financial and capital markets. There is no certainty about what is now intended, but financial and capital market reform must be central - to integrate these with international capital and financial markets. This basically requires liberalization of China's international capital account - so firms / individuals can buy international assets with minimal controls. Liberalization of China's capital account is now a focus for China's leadership. This is needed if RMB is to become an international currency. Progress requires liberalization of interest rates / government bonds / entry of foreign financial institutions, and reducing inward / outward capital flow controls. A pilot program has been set up for open financial zone between Qianhai and Hong Kong

As has been the case in Japan it seems that China’s financial system has been incompatible with the global financial system – in the sense that investment has not been based on calculations of expected return on capital (eg see Evidence, Why Japan can't deregulate its financial system and Comments by a Former World Bank China Expert). Rather it seems likely that the neo-Confucian systems in countries such as Japan and China have directed national savings through state-linked financial institutions into state-linked (even when nominally ‘privately’ owned) enterprises on the basis of consensus about maximizing market share. And the imbalances that those systems have required, have adversely affected the international financial system (see Impacting the Global Economy).

In considering China’s options for financial system reform it is necessary to recognise that the neo-Confucian systems are not based on Western-style systems of rational / abstract thought – see Competing Thought Cultures. The latter includes comments on observations about the differences between Confucian and Western thought by Reg Little (a former China specialist with Australia’s Department of Foreign Affairs and Trade, who in 1976 was arguably the first Western analyst to predict China’s subsequent rapid economic advancement). The difference is significant because the use of profit-focused accounting principles is one of the ways in which Western societies have facilitated independent economic decision making by individuals and enterprises. Those methods have not been used in Japan and China because the emphasis under Confucian traditions is on boosting the position of the ethnic nation as a whole, rather than the position of individuals or independent enterprises.

Competing Thought Cultures also highlights an apparently significant change in the direction of education in China – towards starting education with the rote learning of Chinese classics. The point is that this would condition students to: (a) distrust the use of abstract concepts (including profit-focused accounting principles); and (b) be willing to act as compliant / just-do-it ciphers in a ‘family state’ (which would be a shift somewhat in the direction of North Korea). It can also be noted that the willingness of China’s people to accept brain-washing and compliance within a ‘family state’ dominated by a Confucian elite was critical to the China-centred international economic order that existed in Asia prior to Western expansion (see Creating a New International 'Confucian' Political and Economic Order).

It may be that China intends to try to align its financial system with the liberal international financial system. However this would run into massive cultural obstacles (eg see The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems). And the direction apparently being taken by China’s education system suggests that a return to a pre-Western international economic order might be what China actually hopes to engineer.

I would be interested in your response to my speculations.

John Craig

Why China had to Buy US Debt

Why China had to Buy US Debt - email sent 11/10/13

Eunice Yoon

Re: China wonders: Why do we own so much U.S. debt?, CNBC, 10/10/13

It is interesting that people in China are starting to wonder about why China owns so much US debt. This could lead to real reform of China’s financial system – and thus help reduce one of the fundamental constraints on global economic growth.      

China’s economic ‘miracle’ (ie rapid economic development), like that of Japan, depended partly on using national savings with little regard to profitability. China’s savings were made available by state-linked banks to state-linked enterprises with little regard to return on national savings. Because the Chinese people’s savings were being run down by the (so called) ‘Communist’ Party, the poor balance sheets of China’s banks required that the people’s incomes and consumption be suppressed to the point that it was not necessary to borrow in international (profit-oriented) financial markets. The result (as for Japan) was a large current account surplus which had to be balanced by exporting capital (eg through buying US Treasury Bonds) - see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy (2009).

The resulting demand deficits in countries such as Japan and China involved a macroeconomic imbalance that had the potential to stall global growth altogether (see Structural Incompatibility Puts Global Growth at Risk, 2003). However the US (primarily) provided the excess demand needed to compensate for the demand deficits in East Asia – presumably because its post WWII efforts to promote economic globalization within a liberal market framework had required it to accept the role of ‘consumer of last resort’. However compensating for East Asian demand deficits with consumer consumption built on a shaky foundation of ever-rising household debt was risky – and eventually this led to a financial crisis (see Impacting the Global Economy). Following the 2008 crisis, the US’s ability to provide the excess demand to sustain growth in countries with poorly developed financial systems (such as Japan and China) came to depend increasingly on rapidly rising US government debts – a process that is clearly nearly at an end.  

  If China’s people’s interest in why China has so much US debt leads to domestic pressure for genuine reform of China’s financial system – so that China can build domestic demand and borrow safely in international markets through solvent financial institutions – then one of the major obstacles to sustainable global economic growth of the last few decades will have been eliminated.

John Craig

China's Credibility Problem

China's Credibility Problem - email sent 26/3/14

Martin Wolf
Financial Times

Re: ‘China’s struggle for a new economy’, Financial Times, 25/3/14

Your article provided a useful account of the profound implications of the reforms that China has announced to respond to its currently unsustainable economy.

An extract: “The ‘Decision on Major Issues Concerning Comprehensively Deepening Reforms’ agreed last November is the response. It is the blueprint for the next round of reforms. It proposes, notably, substantial institutional and political reform, including a transformation of “imperative and administrative governance” to “governance by law”. The market is to play a “decisive” role in resource allocation. The government is, in turn, to be responsible for “macroeconomic regulation, market regulation, public service, social administration and environmental protection”. Westerners would recognise all that.

This implies changes in the role of state-owned enterprises. It also implies a shift from positive to negative lists of what new entrants are allowed to do: instead of needing approvals, businesses should be able to do whatever is not prohibited. This might prove revolutionary. Also important are proposed changes to the system of residence permits, which should allow 100m migrants to become permanent urban residents."

However China has a credibility problem in putting forward such proposals at its reform agenda because:

  • Such liberal market options are incompatible with China’s cultural traditions (eg see The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems, 1998). The latter referred, for example, to: fundamental differences in the way information is used; the need to change economic goals from economic 'power' to financial returns; the inseparability of economic issues from questions of social / political power; and the lack of appropriate legal systems. Thus the announced reforms would require a complete change in the cultural practices that have been the basis of its rapid economic modernisation in recent decades. Such profound change would require decades and have many unforeseeable consequences;
  • China’s education system seems to be being changed to create an increasingly compliant population rather than one that could succeed in a more liberal economic environment (see Financial and Educational Reform in China: Headed in Opposite Directions?, 2013). [Note added later: A 'liberal' environment (ie one involving a rule of law and profit-focused resource allocation) requires 'responsible individualism' amongst the general community - because the individual rationality that 'liberal' institutions require can't work where individual decisions are constrained by communal pressures). Building 'education' on rote learning of the Chinese classics (as seems to be intended) will create a sense of communal obligation and a distrust of individual rationality. Christianity is being increasingly accepted by Chinese people (and would provide a foundation for 'responsible individualism'). But it would take several decades for its impact to be sufficient for 'liberal' institutions to work]; and
  • While Westerners would indeed recognise, and generally endorse, such reform proposals, it should be noted that East Asian cultural traditions do not involve leaders making rational decisions which become the basis of a ‘blueprint’ for change. Rather their role is: (a) to provide a framework within which their subordinates can decide on and make changes; and (b) to present a face to the external world that is expected to induce others to do things that would advantage that community (see Why Understanding is Difficult). 

Looking closely at what is actually happening – rather than what is being said – is necessary for real understanding.

John Craig

The Resurgence of Ancient Authoritarianism in China

The Resurgence of Ancient Authoritarianism in China - email sent 5/6/14

Rowan Callick,
The Australian

Re: Beijing Smashes Through Red Tape, The Australian, 5/6/14

The changes in China that your article describes are hardly surprising. However rather than merely seeking to find a way to participate in a new China-centred tributary regime like that which existed before Western societies’ social, economic and political liberalism disrupted Asia’s ancient order, it would be worth considering: (a) what the re-emergence of a variety of traditional Asian authoritarianism actually means; and (b) whether it is likely to work.

My interpretation of your article: Xi Jinping is not just another Chinese leader. He is very different. China’s emerging governance demands close attention. Relationships are important in Asia – but there is a sharper-brisker tone in the way things are now being done in China. Relating well with China’s top leaders is becoming essential to building economic partnerships. In China everyone looks over their shoulder to the person behind and above them – straining to see the summit. Australia’s foreign minister had a meeting with Xi for an exclusive / constructive session in March. Australia’s prime minister did the same in April. A free trade agreement could result. Respectful personal connections are crucial. Anne Stevenson-Yang (J Capital Research) and Ken DeWoskin (Conference Board) have written for Wall Street Journal on emerging governance structure in China. Those who view China in terms of step-by-step liberalization are missing the point. There is a new museum of National History near Tiananmen Square which replaced the Marxist economic evolutionary approach to history. Xi took the new Politburo Standing Committee on a high-profile tour 19 months ago. His anti-corruption and anti-pollution campaigns are seeking to strengthen and purify the Chinese Communist Party. This is not the vanguard of the international proletariat. The Party is being recast as inheritors of ancient Chinese tradition of infallibility and rectitude. This well befits the first core of elites who have ascended to top ruling positions based on hereditary rights since the fall of the Qing Dynasty. ‘Princeling’ children of venerated party leaders (led by Xi) are in the vanguard. This has eluded analysts seeking economic measures involving liberalization. Observers wanted to see economic reforms emerging from Third Plenum. However the agenda was in plain sight – it was just not what was expected. There has been a major restructuring of power – with two new super-ministerial committees (one for security and one for economic reforms) that over-ride government machinery. Both are led by Xi. Many in Beijing complain about bureaucratic interference. The new structure will cut through this. Now ‘reform’ means sidelining institutional bureaucracy and injecting personal power into a sclerotic system. It involves cutting through the red tape that invites bribery. Reform in Australia might mean new government agencies, regulations and legislation. Xi’s reforms are headed in the opposite direction – bulldozing institutional frameworks out of the way. Australia needs to find a way to fit into this fascinating and dynamic new framework.

The need to seriously consider ‘what’ Australia is dealing with in East Asia (which I had expected to be something like your article indicated) was recently suggested in Aussies Outsiders to What? .

The latter included reference to Creating a New International 'Confucian' Financial and Political Order, which speculated about the sort of elitist international structure which political and business leaders might be expected to have to deal with in Asia if something like the international tributary system through which China had ruled Asia were to be promoted (as your article implies is the case).

Aspects of the new ‘ancient’ regime in China that your article outlined need attention. For example:

  • China’s so-called ‘Communist’ Party is putting this arrangement in place out of desperation – because of the financial, economic and political difficulties that it faces (see China: Heading for a Crash or a Meltdown). China’s rapid economic advancement was achieved through a variation of the neo-Confucian non-capitalist market economy that Japan pioneered as the basis for Japan’s pre-1980s economic ‘miracles’ (and post-1990 stagnation). The non-capitalistic financial systems that this involved put China at the same risk of a financial crisis that Japan faces if its institutions were subject to international scrutiny (ie it is forced to borrow to fund current account deficits because growth is being driven primarily by internal demand). And the use of neo-Confucian methods (with the so-called ‘Communist’ Party taking the catalytic role that the bureaucracy had taken in Japan) raised massive problems because: (a) Mao’s ‘cultural revolution’ had sought to purge Confucian social elitism from China and many Chinese still aspire to social equality; and (b) those with ‘Communist’ Party connections had exploited their positions to enrich themselves and their families / friends – thereby creating the world’s most extreme imbalance of wealth;
  • It is presumably intended that power be exerted through the traditional methods used by Confucian bureaucratic elites (ie on the basis of having top-down elite status, being highly educated, having social subordinates who make decisions on their behalf and providing a sense of direction through introducing strategic information to influence others’ consensual decisions). The methods of exerting power parallel the traditional methods used in ‘education’ in East Asia (in the sense that this involves inculcating desired behaviours in students (or subordinates in the elite bureaucracies’ case) rather than enabling them to understand). The new top-level security and economic groups that over-ride existing machinery of government will co-opt bureaucratic machinery rather than pushing it out of the way. Those arrangements are in fact merely admissions of what had existed in China since the late 1970s - ie the so-called 'Communist' Party had taken on the role of a traditional Confucian bureaucratic elite. Providing ‘tribute’ to social elites (which would be viewed as bribery in a Western context) is a traditional part of such systems. It is not a simply feature of existing Chinese bureaucracies that would disappear;
  • China’s educational system has apparently already been in a process of change to be compatible with neo-Confucian bureaucratic rule. It seems to be geared to creating a compliant population rather than one that would be able to operate in a liberal economic environment (Financial and Educational Reform in China: Headed in Opposite Directions?, 2013);
  • It is not currently clear who this system of government is expected to account to? China’s traditional Confucian bureaucratic elites ruled on behalf of the Emperor, who was the recognised centre and symbol of China’s society. Does Xi see himself as the new Emperor, or does he have another candidate?
    • Or maybe there is an existing Emperor in East Asia under whose mantel of authority Xi and the other 'princeling children of venerated party leaders' have been entrusted with the quasi-Confucian bureaucratic government of China. If China is to have such a government, it is very likely that there is an 'Emperor' somewhere.
    • In mid 2016 it was suggested that President Xi himself seemed to be seeking the role of emperor [1];
    • in early 2017 it was noted that, since the 1980s, China's Presidents had been accorded the 'mantle of heaven' status traditionally basis of Emperor's status, and that President Xi seemed to be seeking to extend his term beyond the 10 year maximum expected under China's system;
  • A ‘free trade’ agreement within a China-centred tributary environment would not involve anything like ‘free’ trade (for reasons suggested in 'Free' Trade with China: Not Likely under a Neo-Confucian Regime);
  • Parallels can be drawn between a government by ‘princeling children of venerated party elites’ who carry forward a ‘Chinese tradition of infallibility and rectitude’ and the fascist regimes that emerged in various places in the 1930s – and were initially frequently admired for their ability to smash through red tape. Closer to home parallels can also be seen with the Bjelke Peterson Government in Queensland in the 1980s which the present writer observed from the inside. It decided (presumably with encouragement by Japanese investors connected with Ryochi Sasakawa) to facilitate projects favoured by those with top level connections – and thereby created a situation in which the fairly effective machinery of government that was being created in Queensland in the 1970s was broken down and corruption flourished because no one was ‘minding the store’.

Finally (as noted in Aussies Outsiders to What?) it is by no means certain that the financial, economic and political systems that have been developing in East Asia are even viable or sustainable. This needs to be evaluated on the basis of Asia-literate advice, rather than assumed.

John Craig

It isn't just networking in China

It isn't just networking in China - email sent 3/7/14

Kerry Brown
University of Sydney

Re: China’ networked leadership, Inside Story, 2/7/14

Your useful article suggested that:

“This new elite – those who finally emerged at about noon on 15 November 2012 in the Great Hall of the People – is the first building block in a system of interlinked patronage, tribal, factional and institutional links that reaches out from Beijing into the five-level governmental structure of China, through the eighty-four million members of the CPC itself, and into Chinese society as a whole. The seven members of the new Politburo Standing Committee are the final clue to how power is evolving, developing and renegotiating its parameters in modern China”

Another view of what has been happening is in The Resurgence of Ancient Authoritarianism in China . However I should also like to suggest that what is going on should not be viewed in simply a domestic Chinese context – for reasons outlined in Creating a New International 'Confucian' Financial and Political Order.

I would be interested in your response to my speculations.

John Craig

More on: It isn't just networking in China (email sent 3/7/14)

Kerry Brown

A couple of further comments on issues raised in your article follow.

Bo Xilia fall needs to be viewed in terms of the apparently immense support that exists in China at grass-roots level for social equality like that which existed under Mao – which is incompatible with the hierarchical networks that you article described. Bo Xilia had sought popularity on the basis of restoring this (and perhaps other) features of the Mao era – which was incompatible with the way China had come to work later.

China’s history needs to be viewed in terms of the attempts (under Mao) to purge China’s traditional Confucian power structures (because they had oppressed China’s people) and their discrete resurrection in a different form apparently with Japanese encouragement in the post-Mao era when China opened its economy and adopted a variation of the neo-Confucian economic model that Japan had pioneered as the basis for its pre-1990 economic ‘miracle’. The CPC is ‘communist’ in name only – and has operated increasingly on neo-Confucian lines since the late 1970s.

It is unlikely that there was no strong man behind the scenes to endorse to recent rise to senior administrative positions of China’s current leadership. Given the apparently almost-openly neo-Confucian system that has been put into place, it is likely that the ‘strong man’ will be viewed as some sort of emperor (or perhaps be an actual emperor).

There is not considered to be any need to ‘explain’ anything. The intellectual foundations of East Asian societies with an ancient Chinese cultural heritage are radically different to those of Western societies. Explaining would imply that there is something to be gained by understanding – and that notion is not part of the region’s traditional epistemology (see East Asia in Competing Civilizations and Why Understanding is Difficult). In East Asia ‘education’ (and neo-Confucian government) is about inculcating favoured behaviours rather than about enabling others to ‘understand’. Likewise the absence of an ideology is crucial to the way power is exerted (by facilitating-without-judging whatever powerful individuals / organisations who are prepared to accept a subordinate status want) – see Acquiring 'Soft' Power.

What is going on simply can’t be understood in terms of Western concepts – and attempt s by (say) Chinese academics to explain what is happening in such terms are either naïve or intended to be deceptive.

The background to the present writer’s involvement in dealing with issues such as those outlined is available.

John Craig

China: No Turning Back Now????

China: No Turning Back Now???? - email sent 7/10/14

Ken Wangdong
Emerging Markets Analyst, New Frontier Investor

Re: Hong Kong, No Turning Back Now, Morning Money, 7/10/14

Your article highlights the fact that protests in Hong Kong are a reflection of the massive difference between what Hong Kong has been (which protestors seek to perpetuate) and what it is likely to become as simply part of China.

It also suggested that ‘nationalism’ in China (which the protestors are now being required to sign up to) is like ‘nationalism’ everywhere. However this is anything but the case. Nationalism in liberal societies involves a commitment to nations who value individuals. Nationalism under China’s current authoritarian neo-Confucian regime involves individuals submitting to a regime that seeks to boost the power of the nation that has little concern for their individual welfare or capabilities – and this has many parallels with the fascist regimes that emerged around the world in the 1930s (eg see explanation in Creating a New International 'Confucian' Financial and Political Order).

As I understand it the protestors in Hong Kong are not without supporters in mainland China itself who look with regret at China’s loss of social equality (eg see Communism Versus Confucianism: The Continuing Contest in China). For this and many other reasons (eg see Heading for a Crash or a Meltdown) it may well be that China’s autocratic regime might not ultimately win in the long-term ‘struggle’ that your article suggested that the protestors in Hong Kong now recognise that they will face.

John Craig

Assessing China's Prospects

Assessing China's Prospects - email sent 11/11/14

Steve Keen
University of Western Sydney

Re: Sizing Up the Threat of China’s Debt Pile, China Spectator, 10/11/14

You article provided useful comments on the current situation. However I should like to suggest that China can’t be properly understood in terms of Western analogies.

My Interpretation of your article: Data on China’s debts may be unreliable, but China’s leadership seems trustworthy. China’s data have improved from the days when it was a centrally planned economy. But the Communist Party remains the only power structure and data is produced that tends to tell leaders what they want to hear. But China’s leadership is better than that elsewhere – at least in terms of education. Thus, while China might face a bigger crisis than those in the West its reaction to it will be better. China faces a bigger crisis than the US did in 2007. BIS and OECD data (which understate the problem because they exclude the shadow banking system) show that there is a big problem. China’s debts are now 176% of GDP – the peak that the US reached (or perhaps more based on revised Federal reserve figures). China’s debt has risen much faster than in US (ie up 80% over 6 years as compared with rising 60% over 10 years). China’s bubble has been bigger and faster growing. China’s bubble was engineered by Chinese authorities in response to the US crisis. In US banks tell governments what to do. The reverse applies in China. After 2009 China’s banks lent like crazy (eg increasing China’s debt by 35% of GDP in one year). The US private sector has now returned to leveraging – and this might help boost China’s exports. But a huge increase in exports would be needed to compensate for stabilization of China’s debt / GDP ratio (as the latter is still growing over 25% pa – while nominal GDP growth is less than 10%). Stabilizing the debt / GDP ration could leave a 15% of GDP hole in demand. Economic activity must slow as unemployment rises. But China has a unique difference related to businesses started by local governments which sell land to developers (whose output rather than sales are included in GDP). Slowing of credit growth in China will put an end to the financing of these local government businesses. China’s credit growth is decelerating – so China may be approaching its first home-grown financial crisis. A prior example of a financial crisis in an ex-command economy was that in Russia in 1998 – though there the state was not so strong. In the US the ‘politico-financial complex’ distorted the response to its crisis – with an emphasis on rescuing the financial sector rather than the real economy. In China the government may be stronger and: put failed institutions into receivership; sack managers and bolster the real economy with government money injections. China’s leaders coped with the 2007-08 crisis but at a cost of making China’s economy as ‘financialised’ as the US had been then. The credit slowdown had a massive impact in the US. That in China will be greater.

China’s economic data are unreliable (as your article noted) because they are not the basis on which decisions are made. Major economic decisions (like those in Japan) tend to be made through a power-focused quasi-bureaucratic network of state-linked financial institutions and businesses rather than by independent profit-focused enterprises (see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy, and Meeting the Challenge of China's Rise). Another reason that Western parallels are not enough is that claims about debt levels are no more likely to be reliable than are economic statistics generally. Calculations of profit and loss are not the foundations of decision making by banks / businesses – so accounting standards are weak (see Evidence). My suspicion is that an independent audit would show that China’s financial institutions are in much worse condition that is officially acknowledged (eg see China's Predicament).

And, while the people who try to run these systems have to be incredibly smart / well educated, there is considerable doubt about the viability of centralized orchestration of what could ultimately become an incredibly complex system. Western governments are not so ‘smart’ but they don’t try to control everything. There are many different independent (eg economic) responses to any given situation - some of which will be right while others are wrong. The East Asian systems do spectacularly well when the ‘system’ get it right, but experience disaster when they get it wrong (eg as Japan did in the 1980s). Sir William Slim concluded that his forces in Burma in WWII could defeat Japanese forces because they could take diverse independent initiatives quickly in the field, whereas the Japanese forces would hold regular consultations and produce a superior understanding of the situation but much too late for this to be of any use in the field. Fuzzy logic (involving highly simplified variables) is now recognised to be superior in control systems to reliance on more precise calculations – because the latter respond too slowly due to the time taken to get the ‘superior’ answer. Having ‘very smart’ governments is not always the best option.

You suggested that China might now clean up its financial system in ways that were not done in the US because of the influence of a ‘politico-financial complex’. However the social-political-financial-economic-military-criminal complex that exists in countries like China (and Japan) would put anything in the US to shame. Japan’s ‘system’ ran off the rails in the 1980s with debt-driven over-investment. But in the 1990s after its financial crisis, Japan did not clean up its financial system – because doing so would have eliminated the cronies who helped run the social-political-financial-economic-military-criminal complex. China’s problem now seems similar in that respect – though even more difficult in other ways.

The US went a long way in cleaning up its financial system (by getting GFC losses written off) – much further than Europe did. As your article noted the US took actions that had the effect of minimizing failures in the financial system. One thing this required was expanding the money supply to compensate for the loss of the (about 50% of) credit-creation that had been taking place through CDOs prior to the GFC. In assessing post 2008 responses it needs to be recognized that:

  • the US Federal Reserve had found at the time of the stock market crash in 1987 that it could limited booms and busts in the real economy by providing liquidity to financial institutions – and this became the basis of a system of counter-cyclical economic management for the next 20 years (though it was one that led to all sort of unforeseen and ultimately dangerous side-effects – see Impacting the Global Economy – and has thus now probably reached its ‘use-by’ date);
  • what was done after the GFC arguably has to be viewed in a terms of a geo-political context rather than simply in terms of its effectiveness in economic management (see The 'game is rigged' for geo-political rather than 'commercial' reasons).

The fact that China’s leadership seems trustworthy arguably reflects the fact that it has to seem that way if it is to succeed (as it seems to be doing) in enticing others into something like the trade / tribute system by which Asia was administered from China prior to Western expansion (see Creating a New International 'Confucian' Financial and Political Order). However in relation to trustworthiness it is worth noting that China’s regime seems to have decided quite recently that it should not take responsibility for China’s local government / shadow-banking losses (ie for the consequences of the bad debts that others were encouraged to incur to sustain growth from 2008). It is apparently transferring these likely-massive losses to households and independent businesses. I have some sympathy for those in Hong Kong who are concerned about the implications of becoming totally subject to China’s so-called Communist Party (see China: No Turning Back Now????). The system that now rules China has been likened to that which ruled China under the last emperor in 1911. And eliminating those influences on the grounds that they oppressed China’s people was apparently the goal of Mao’s ‘cultural revolution’ (see Communism Versus Confucianism: The Continuing Contest in China).

I would be interested in your response to my speculations

John Craig

Merging Political Power and Religion Can Create Problems

Merging Political Power and Religion Can Create Problems - email sent 11/2/15

Robert D Kaplan,
Centre for a New American Security.

Re: Asia’s Rise is Rooted in Confucian Values, Business Spectator, Feb 10 2015

Your article outlined some features of Confucian traditions, and suggested that these have been foundational to the development of East Asia in recent decades because the stability they provided allowed the emergence of capitalistic economies and often (except in China) of a form of parliamentary democracy. However it needs to be remembered that for many centuries Confucianism was also the method of autocratic government on behalf of emperors by highly-educated bureaucratic elites. Also those features continue in modern East Asian governments. Current efforts by President Xi to promote Confucian ‘virtue’ in China would involve combining the role of ‘church’ and ‘state’, and this has the potential to result in damaging oppression.

My Interpretation of your article: A feature of a book published by China’s president (‘The Governance of China’) was its emphasis in the ‘brilliant insights’ of Confucius as an explanation of his own political and economic philosophy. While Mr Xi’s sincerity in proclaiming these non-communist ideas is uncertain, there is no doubt that Confucian values have been the foundation of one of the great social, cultural and economic success stories of recent decades. The rise of the Pacific Tigers in the 1970s (and the ability of China and Vietnam to discard communism in all but name in favour of a form of capitalism) would have been impossible without the tolerance, respect for authority, hierarchy and social order embodied in Confucianism. Confucianism is best seen as a philosophy rather than as a religion – and complements Asian religions like Buddhism and Taoism. Asia’s rise has had a great deal to do with the interaction between Confucian social stability and modern capitalism. Dynamic and enlightened authoritarianism has arisen in China, South Korea, Taiwan and Singapore – and all except China evolved into parliamentary systems. China might also be forced to change also. The founders of the most robust modern Asian states were all consciously Confucian. And China’s transition from corruption and inefficiency will require (amongst other things) reinvigoration of Confucian ethos. Confucius is seen to have presented is followers with ‘seminal expressions’ of Chinese civilization (especially in the Analects – which particularly emphasises humanness and virtue). Everyone must be held to a high standard – based on respect for the experience of previous generations. In Confucianism the past is the record of human experience, rather than something primitive. In times of change, the best insurance against chaos is seen to lie in loyalty and filial piety. Postmodern western life can be seen as decadent because of its worship of youth. Confucianism encourages tolerance and discourages insubordination. It seeks to preserve the equilibrium within social and political organisations. A gentleman is seen to have universal sympathies and not be partisan. This seems like Edmund Burke’s conservatism – which focused on gradual improvement and was horrified by the French Revolution. The whole world is in tumultuous transition. Social and political survival in this environment requires preserving time-tested ethical foundations against destructive change. East Asia has been a major success story over the past 4 decades. Even though its rapid growth phase is over, the Confucian influence will remain.

Confucianism is not just a religion / philosophy that provides a basis for traditional virtues and thus for social stability (see A Simple View of Confucianism).

To understand its implications, Confucianism needs to be considered in the broad context of what is different about East Asian traditions relative to Western societies. For example the East Asian notion of ‘education’ traditionally involved inculcating behaviours that historical experience suggested were desirable (rather than as enabling students to understand as a basis for making independent decisions). And, as a means of government, Confucianism involved an extension of that notion of ‘education’ into the inculcation of presumably-desirable social, economic and political ‘behaviours’ within society by elite bureaucrats as agents for Asia’s emperors.

Traditional Confucianism involved elite study of history as the basis for ‘educating’ their social subordinates about how to behave. This failed catastrophically when East Asia was faced with Western expansion because Western traditions were so different and much more effective. It was a modified form of Confucianism (so-called neo-Confucianism) that apparently became the foundation of post-WWII progress in East Asia (see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy, 2009). The feature that was added to Confucianism was probably Daoism (China’s traditional religion). Daoism’s primary implication is that it is impossible to be sure what is good and what is evil. Neo-Confucianism allowed study of Western practices as well as East Asian history as the basis for inculcating desired (eg economic) behaviours in the community. Fairly rapid economic progress was thus able to be orchestrated by neo-Confucian bureaucratic elites (a role which in China’s case was taken from the late 1970s by the so-called ‘Communist Party’). Also, in China’s case, this seemed to undermine tradition notions of ‘virtue’ as many in key official positions took advantage of the opportunities for personal / family gain that this created.

However economic progress was not based on anything like ‘capitalism’ (in the sense that the latter involves independent profit-focused investment) – see Evidence. Rather than capitalism, national savings were mobilized through state-linked banks and provided to state-linked enterprises to achieve nationalistic / mercantilist goals. And this gave rise to: (a) rapid growth of market-oriented production capacity; (b) the international financial imbalances that have proven highly disruptive globally (see Structural Incompatibility Puts Global Growth at Risk, 2003 and Impacting the Global Economy, 2009); and (c) ever-rising risks of financial, economic and political crises in East Asia (eg see Japan's Predicament and China: Heading for a Crash or a Meltdown).

China’s President Xi has been seeking to promote ‘virtue’ / self-discipline quite generally in China through: (a) launching a crackdown on official corruption; (b) endorsing Confucianism as a religion / philosophy as your article noted; (c) requiring ‘self-criticism’ by Party cadres; and (d) supporting investigations / arrests of those perceived to lack ‘discipline’. And this poses risks. Western societies have gained enormously from the separation of ‘church’ (ie the source of religious authority about the nature of ‘virtue’) and state (see Why the separation of Church and State Allowed Government to be More Effective). Efforts by the so-called Islamic State to base government on religious authority would seem very likely to further compound the obstacles to rapid progress that have led Muslim-dominated societies to relative backwardness in recent centuries (see Challenging the Idea of an Islamic State). The crackdown that President Xi launched was recently suggested to be making ‘everyone fearful’ – and thus to be putting government stability in China at risk (see The Twilight of China’s Communist Party, Business Spectator, 3/2/15). And the Confucianism that President Xi is endorsing as the criterion for ‘virtue’ has been a very touchy subject in China because Mao’s Cultural Revolution had specifically sought to purge Confucian influences from China as they were perceived to have oppressed China’s people (see Communism Versus Confucianism: The Continuing Contest in China, 2010). Though neo-Confucianism was officially accepted in the 1970s as necessary to achieve (what nationalists apparently refer to as) China’s Hundred Year Marathon (to achieve a dominant geo-political status), this could not be mentioned in that era. And even now many Chinese still resent the Confucian social hierarchy that re-emerged to control them after the social-equality aspirations of the Communist era. And this remains the source of potential political instability in China.

I would be interested in your response to my suggestions about the apparent complexities involved in Confucianism’s past and current role in East Asia.

John Craig

Understanding China's Regime

Understanding China's Regime (June 2015)

In June 2015 a plausible account of China's current regime suggested that China faces domestic weaknesses that make war unlikely. However that view that might not be correct. It could be very dangerous to the interests of the free world not to examine that question in more depth. The essence of strategy in East Asia is deception. The appropriate response to information is to ask: 'Why am I being told this?'.

Gaining real understanding requires appreciating China's ancient Confucian traditions under which autocratic bureaucrats ruled China (and Asia) on behalf of China's emperors in ways that are quite different to Western traditions and anything but easy to perceive or understand (see Babes in the Asian Woods especially a Simple View of Confucianism). Understanding how Asia was administered in the past is needed because recreating something similar seems to be where Xi Jinping is seeking to take China (see The Resurgence of Ancient Authoritarianism in China, 2014), and failing to take this into account risks major strategic blunders in the event that Xi Jinping's efforts to transform China are successful.

Background: By way of background to these observations it is noted that the present writer had an opportunity some years ago to 'reverse engineer' the intellectual basis of East Asian economic miracles - the result of which impressed some significant Asia experts.  That perspective (eg as outlined in East Asia: The Realm of the Autocratic and Intuitive Ethnic Hierarchy) has provided a more useful way of understanding current events than presuming that Western concepts and methods provide a useful basis for understanding

What is probably being sought would involve rule by an autocratic elite whose power would be based on a 'mantle of heaven' (ie a presumption that they put aside personal interests to act on behalf of the community as a whole) and under whose Confucian-style guidance Chinese people worldwide would work hard for limited reward in order to boost the economic and political power of their ethnic nation as a whole. If this can be achieved (which is not certain) then the 'princelings' position would not be as vulnerable as it would be (and China's unity would be much more solid) if economic gains merely benefited the elite's families and friends (as Bao Tong reportedly suggests). It is worth noting that:

  • Xi Jinping seems to be exploring a religious / ethical foundation for the Chinese state (see Merging Political Power and Religion Can Create Problems). Confucianism was the traditional ethical foundation of the Chinese state. The Dali Lama (who has a key role in Buddhism one of the major religious influences in China) seems concerned that his successor could be coopted to provide a power base for the Chinese state;
  • Mao's Cultural Revolution sought to purge Confucian influences from China as they were believed to have oppressed the people (see Rhetoric of the Chinese Cultural Revolution). Mao's era was characterized by an aspiration to eliminate Confucian social hierarchy and create social equality. Many in modern China retain that aspiration (see Communism versus Confucianism: The Continuing Contest in China);
  • While China had strong commercial traditions, it was never in any sense 'capitalist' in the sense that this implies independent profit-focused economic initiative (see China Opens its Doors to Private Capital - But Not to independent Initiative by Citizens or Investors). Everything that happens is expected to conform with the consensus reached within hierarchical networks coordinated by social elites. There is no Chinese word for 'profit';
  • China's economic 'miracle' after the Mao era ended was based on the re-introduction of modified Confucian methods into China to accelerate economic development probably with the aid of Japan and offshore Chinese groups. Traditional Confucian methods for government (which had arguably been found to be effective in developing economic capabilities by the Japanese military in Manchuria in the 1930s) had become a central feature of Japan's post-WWII bureaucratically-controlled government probably through the combined efforts of Japan's emperor and ultranationalist gangsters (see Establishing Japan's Post-WWII Political and Economic Systems). And those methods were the basis of Japan's post-WWII / pre-1990 economic 'miracles' - just as they were the basis of China's rapid industrial development from the 1970s, and may well have been the basis of the reported rapid development of clusters of knowledge intensive firms since Xi Jinping's reforms were announced (see Hangzhou shows the way to China's new economy);
  • Putting economic resources into the hands of the friends and family of nationalistic elites (which Bao notes was done with so-called Communist Party connections in China) was exactly what had been done in Japan both after the Meiji restoration (giving rise to the zaibatsu which were a major feature of Japan's militarisation in the 1930s) and after WWII (giving rise to bureaucratically dominated banks and companies);
  • Xi Jinping's political reforms (to achieve the 'China Dream') are clearly based on recognition that merely benefiting the elite (ie those at the centre of the so-called Communist party) would be unsustainable. The reforms that have been introduced have been targeted against both corruption and against political opponents (ie those (such as Bo Xilia) who favour a restoration of the Mao-era emphasis on social equality);
  • China's education system seems to be being reformed to create a community that would comply with authoritarian elite guidance rather than encouraging independent initiative (see Competing Thought Cultures, 2012);
  • China's domestic system is being extended into the international domain (see Creating a New International 'Confucian' Financial and Political Order, 2009+). This is taking the form of an embryonic trade-tribute regime similar to that by which Asia was administered from China prior to Western expansion. It would build international political and economic power by coopting external elites into arrangements that the latter believe would be advantageous - but have the long-term effect of cementing the status and power of China's 'princelings' (see Acquiring Soft Power).

The article under review points to growing tension between the US and China because of the US's uncertainty about the implications of China's rising influence. It suggests that Bao's writings are a way of understanding what the US (and the Western world generally) is dealing with. The issues noted above are of potential strategic relevance because:

  • the conclusion drawn from Bao's writings about the domestic weakness of China's 'princelings' is potentially outdated - and being further rendered invalid as time goes on;
  • The primary emphasis of China's efforts to create a new international order as an alternative to liberal Western practices that the US has championed seems to be political and economic. Military exhibitions are not a significant part of this and what China is doing in the South China sea may well just be a diversion (comparable with the base on the coast adjacent to Calais that the allies built in WWII - see Operation Fortitude). The latter was a diversion to keep German forces tied up in dealing with an apparent threat – and away from Normandy. Military dominance of any response to the threat China poses to the 'free world' will probably significantly downgrade the effectiveness of any such response;
  • The strategic methods used by Mao in China and by Ho Chi Minh in Vietnam both emphasized capturing the countryside which was then a base for capturing the cities. Something similar appears to be envisaged by China in its emphasis on emerging economies (eg the BRICS) in creating a new international China-administered  order. A major monetary response by the US Federal Reserve to the financial distortions implicit in neo-Confucian economic is now likely to result in financial crises in China and many other emerging economies (see Sharing the Blame for Global Economic Failure and New International Financial Crisis). This could strengthen China's long term influence amongst emerging economies generally (ie in the 'country-side'). If (as they will probably hope) China's 'princelings' can induce China's people to sacrifice their own interests to help the emerging economies that will be damaged as a by-product of the end of the US Federal Reserve's QE, China's dominance of the global 'country-side' might make the continued operation of liberal Western-style global institutions unsustainable (ie the West could 'fall')
Context to China's Sharemarket Boom and Bust

 Context to China's Sharemarket Boom and Bust (June 2015)

Overview: The following presents a scenario which would explain why China spent over 10% of its GDP to prevent the crash of a stockmarket which has very little economic importance. It involves taking account of not-well-known features of China's history and culture which imply that a major threat to China's whole system of government could exist. There are simpler scenarios - but these do not really explain why such huge resources were devoted to an apparently economically-marginal problem.

The trigger for the stock market crash (various observers' views about which are outlined above) seems to have been that the purchase of stocks which had led to the preceding boom was almost entirely dependent on credit. This meant that once a fall started it could not stop of its own accord - because most investors faced margin calls that required more selling.

This reliance on borrowing to buy shares is a reflection of the emphasis on debt financing of investment in the economic / financial systems that have been used in East Asia.  For significant economic activities national savings have been mobilized through state-linked banks and loaned to state-owned enterprises (or those linked to the state through social networks) with a view to boosting market share / economic power - not earning profits that would be retained by independent / private investors (see evidence).

There have been major cultural obstacles to the adoption of Western-style financial systems that involve profit-oriented investment by independent / private entities - for reasons outlined in The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems (1998); Why Japan Can't Deregulate Its Financial System (2000); and Does Asia have Capitalism?, (2013). The former referred, for example, to: fundamental differences in the way information is used; the need that would exist to change economic goals from economic 'power' to financial returns; the inseparability of economic issues from questions of social / political power; and the lack of appropriate legal systems. Decisions are not traditionally made by independent commercial entities based on their profit opportunities and legal obligations, but rather on relationships, consensus and obligations within social hierarchies.

These systems have been the basis of post-WWII economic 'miracles' in East Asia (initially in Japan) because they have allowed market-oriented economic change to be stimulated within state-linked hierarchical social networks by highly-educated intellectual elites who were not subject to domestic interest group pressures (see Understanding Neo-Confucian Systems of Socio-political-economy). In Japan those methods for stimulating the development of whole industry clusters had been used by Japan's presumably-imperially-mandated Ministry of International Trade and Industry (MITI) and Ministry of Finance (MOF), while in China the methods used for catalyzing the development of industry clusters were far less visible to Western observers (see China’s Economy: What Commentator’s Seldom See, 2012). Such arrangements have their origin in variations of traditional (ie pre-Western) Confucian methods of government and are anything but easy to understand if no consideration is given to the fact that their intellectual foundations are radically different to the ways of thinking Western societies gained from their classical Greek heritage. 

'Private' equity has had very little role in East Asia, and bank credit to those with private wealth was highly constrained. Equity investment would have created a class of 'owners' of enterprises who would have some control at the expense of the managers and employees who are subordinates of the neo-Confucian social elites (ie a bureaucracy in Japan's case that appears to operate largely independent of democratic discipline and the 'Communist' Party in China) that have striven for across-the-board social, economic and political dominance. The fact that equity ownership does not involve any real control over an enterprise (which would obstruct the achievement of nationalistic goals through state-dominated social networks) was illustrated by the arrangements put in place for China's e-commerce giant, Alibaba [1, 2].

The creation of a state-orchestrated stock 'market' (and a market boom) in China had presumably been seen to be desirable because:

  • something had to be done to ease China's world-champion level of social inequality. China had a long history of civil wars which had seen the 'commercial' factions of southern China repeatedly driven out - to become the Chinese Diaspora who became economically dominant and had significant behind the scenes political influence (while being locally-resented) in SE Asia. Because the methods that China subsequently used to achieve rapid economic development had precedents elsewhere, it seems likely that China's 'commercial' factions (whose center in China is Shanghai) gained control of the former 'Communist' Party in the late 1970s after the failure of Mao's methods with the help of China's Diaspora (and perhaps also with Japan's encouragement) . The incoming 'commercially-oriented' factions used a variation of the Confucian methods which Mao's Cultural Revolution had sought to purge from China (because those methods were the basis of pre-Communist rule in China and were perceived to have oppressed the Chinese people). China's variation of traditional Confucian methods was different to those in Japan and Singapore. And in China, the social inequality involved in those methods apparently continues to the present to stir resentment by those 'redder' factions who still favour social equality (see Communism Versus Confucianism: The Continuing Contest in China);
  • China's initial (ie late 1970s) development model based on exports had ceased to be viable when:
    • the international financial imbalances that 'Japan-like' economic models required contributed to a global financial crisis and recession elsewhere then limited export growth;
    • social instability threatened because 'Communist' Party insiders had taken advantage of their positions in the economic hierarchy to enrich themselves and their families - thus creating the world's most extreme wealth imbalance;
  • China's response to the GFC involved high levels of investment in property and infrastructure which again involved the provision of credit through state-linked banks or enterprises with little regard for return on capital - thus laying the foundations for a potential credit crisis that had clearly been approaching. China has an urgent need to find a way to mobilize funds for investment that does not simply involve increasing credit;
  • any shift to growth driven by domestic demand required increasing the incomes of consumers - and doing this through wage rises would have eroded international competitiveness;
  • Increasing incomes through a state-orchestrated share 'market' boom with tens of millions of households involved had the potential to: (a) increase consumer spending; (b) reduce (to some extent) wealth imbalances; and (c) provide a path to funding enterprises without simply relying on credit;
  • the creation of a 'market' also had the potential to attract foreign capital inflows that would be necessary when China's domestic demand driven 'new' economy ceased providing the large capital inflows which, under the 'old' model had protected the poor balance sheets of China's banks from external scrutiny.

However, when China's social-consensus-driven and almost-solely-debt financed investment practices were applied to its share market, the result was necessarily unstable (as had previous been the case with China's property market). Debt-funded investment driven by social consensus rather than independent calculations of expected profit can create 'profits' for a time but also creates the risk of a bust when prices get very high, some decide to sell and many others face margin calls.

The rapid reversal of the state-orchestrated share 'market' boom is likely to have required an emergency response by the Chinese state (which some observers suggest initially cost 10% of China's GDP) because:

  • While a state-orchestrated share 'market' had not yet become a major part of China's economy, it has apparently been intended that 'market' institutions would play a significant future role. Doing this now is increasingly unlikely. It  may be that:
    • China's state will be able to create a 'market' in which investors can be certain of a profit (because the state can be relied upon to organize both financial and supply-side interventions to ensure that outcome). If so investment in China's state-managed share 'market' would be very attractive to both domestic and foreign investors and thus a reliable source of finance for Chinese enterprises (as China's regime presumably hoped); or that:
    • such 'markets' will prove impossible for the Chinese state to manage without ongoing serious instability - which would seem the most likely outcome because: (a) much more than discipline within face-to-face social networks would be required - eg because in the anonymity of share trading individuals can pursue self-interest rather than being constrained by social pressures; and (b) the state would be likely to incur losses in doing so and these would add to levels of credit in China economy that are already becoming perilous as a result the over-capacities that have arisen from a lack of financial discipline; 
  • the credibility of China's social elites (ie the so-called 'Communist' Party and China's president in particular) were at stake - as they had talked up the stock 'market' (perhaps identifying it as as China's best / only means of avoiding the financial crisis that continued expansion of debts to finance investment would inevitably bring). And:
    • the credibility of China's current elite was vitally important to meeting China's economic challenges. Under the neo-Confucian systems of socio-political-economy that have been the basis of economic 'miracles' in East Asia, economic development / change requires the existence and effective influence of social hierarchies (which in China's case all ultimately lead to and up the 'Communist' Party - rather than to the economic bureaucracy as in Japan). These were vital in orchestrating China's rapid export-oriented economic development from the late 1970s. They would be equally vital in orchestrating a rapid transition to China's intended new economy (ie one based more on domestic consumption). Anything that challenged the social hierarchies' ability to orchestrate economic change through their networks of subordinates would put China's whole economy and political system at risk. And foreign investors seem unlikely to take the economic management skills of the Chinese state as a 'given' in future and thus will be unlikely to invest where the state has the total control that is vital for the state-orchestrated development of viable enterprises and industry clusters under Neo-Confucian systems;
    • there has been massive (to-date suppressed) resistance to the very existence of social hierarchy that was both: (a) the key target for elimination by Mao's Cultural Revolution because it was seen to be oppressive; and (b) essential to the post-Mao management of China's economy (see Political Change and Potential Instability: The Continuing Saga above). While changes within China's current regime could be a consequence of internal dis-satisfaction with its economic management, China's history is littered with civil wars that have resulted in the 'commercial' factions of southern China (which have again dominated China since the late 1970s) being expelled from China. The possibility that this could happen again can't be discounted. External evidence of any such potential actions by rival factions would be almost non-existent until they were ready to act. Moreover, while outsiders are not able to tell what is going on, it is noted that unauthorized conclaves of former officials have reportedly been held and difficulties have reportedly been experienced in getting compliance with state directives;
  • the 'market' crash challenged China's ability to control financial market outcomes - and this has potential international implications. China seems to be seeking to create a new 'Confucian' international order similar to the trade-tribute system by which Asia was administered by Chinese bureaucrats prior to Western expansion (and similar to the Asian Co-prosperity Sphere that Japan sought in the 1930s and 1940s). This would be a system under which the international exercise of power by ethnic elites through social hierarchies would not limited by either the democratic or financial constraints that exist under 'liberal' Western traditions. When 'real economy' activities are organised through ethnic social hierarchies and finance is provided through state-linked banks, losses do not really matter provided current account surpluses (which can be achieved by suppressing domestic consumption) make it unnecessary for those banks to borrow in international financial markets (ie the balance sheets of the banks and those they have loaned money to can be anything that the state asks its connections to say they are);
  • the main participants in the share 'market' boom and bust were those Chinese families that already had acquired significant financial assets (ie savings or funds acquired from insider roles in China's state-owned banks and SOEs). These would often be those closely associated with the so-called 'Communist' Party - and the Chinese state would not wish to upset those insiders;
  • China's overall financial position is potentially badly exposed because of China's: heavy reliance on credit / debt to finance growth; limited concern for return on / return of capital; and the creation of industrial and real estate over-capacity which parallels what Japan did in the 1980s. The 'wealth' of China's households is a reflection mainly of their savings balances with banks which might technically be insolvent (or on their way to insolvency) if their financial status was not being manipulated. A share 'market' crash (which was self reinforcing because of the leverage involved) might bring down the whole 'house of cards'; 
  • the international order that China is seeking to create involves China being a source of financing for international investment (eg via infrastructure banks for new 'Silk Roads'). China's ability to do this depends on maintaining current account surpluses and recycling capital into offshore investments - now in (say) regional infrastructure rather than in US Treasury bonds as had been the practice until recently. China's ability to convince others that it is a reliable source of finance for the new international order it has been seeking to establish would be called into question if it was unable to handle the share 'market' boom and bust;
  • Chinese investment in international real estate (eg in parts of Australia and North America) has presumably been backed by the same motivations and methods that led to China's share 'market' boom (ie official encouragement, cheap credit and the margin loans that were needed for a quick result). This practice also would be likely to collapse if confidence is lost - because any decline in values would trigger margin calls that could only be met by selling properties and thus accelerating a downturn - see Are Unfinished Apartments a Risk in Australia Also?.

It can be noted that in May 2016 a massive speculative bubble in China's commodity markets was also seen to be a potential threat to its financial system and economy .

Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures

Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures - email sent 20/8/15

John Garnaut
Asia Pacific Editor
Fairfax Media

Re: China's breakdown reveals the problem with the engine, Business Day, 20/8/15 (outlined here)

In relation to observations by Barry J Naughton that your article cited, I should like to draw you attention to earlier suggestions that there were likely to be serious problems with China’s ‘engine’ (see China's Development: Assessing the Implications, 2003+; and Are East Asian Economic Models Sustainable? 2009+). These (which have been frequently updated since first written) seek to describe events in terms of the present writer’s understanding of significant differences in East Asian cultural traditions to those of Western societies. The background to the present writer’s involvement in this arena is described here, while reasons to believe that such a perspective aids understanding are outlined in Babes in the Asian Woods (2009+). More recent observations from this viewpoint are in Understanding China's Current Regime (2015) and Context to China's Sharemarket Boom and Bust (2015).

In relation to specific observations by Barry Naughton about what is happening, I suggest that consideration needs to be given to the possibility that China is not actually seeking to create the sort of liberal market economy that many observers believed that the Third Plenum had sought (eg see Creating a New International 'Confucian' Financial and Political Order, 2009+; Eyes Wide Shut at Davos?, 2012; and The Resurgence of Ancient Authoritarianism in China, 2014). Rather the intent seems likely to be to create an international order within which economic activities are just one component of the rule by autocratic elites that parallels the ‘trade-tribute’ regime by which Asia was administered from China prior to Western expansion.

Some related observations directed at those seeking to examine China from a security / military viewpoint are in Asian Authoritarians Can’t Be Contained without Understanding How They Exert Power (2015) and Comments on Australia's Strategic Edge in 2030 (2011).

I have little doubt that Barry Naughton’s conclusions are reasonable – but suggest that it is useful to also look at the issues in terms of traditional East Asian cultural perspectives in order to better understand the situation.

John Craig

Promoting Confucianism in China

Promoting Confucianism in China - email sent 22/9/15

Jeremy Page

Re: Why China is Turning Back to Confucius, WSJ, Sept 20, 2015

I should like to suggest for your consideration that China is not turning back to Confucius merely because it provides a moral philosophy that helps legitimize the ‘Communist’ Party.

Rather China is doing so primarily because a modified form of Confucian administration has been the basis of East Asian economic miracles (see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy). It is necessary for China’s government to ‘market’ Confucianism because the primary goal of Mao’s cultural revolution was to purge Confucianism from China (because it was seen to have oppressed China’s people), yet his immediate successors adopted neo-Confucian methods that were similar to those that had been the basis of economic ‘miracles’ in Japan (and elsewhere in East Asia) – and there was no way that this could be admitted to China’s people. The neo-Confucian methods involve a social hierarchy and there was (and remains) massive resistance in China to the social hierarchy that now exists focused on and up the so-called ‘Communist Party’ (see Communism Versus Confucianism: The Continuing Contest in China). The political instability reflected by Bo Xilia’s efforts to promote a return to something like a Maoist system seemed to have had a great deal to do with grass-roots resistance to the social inequalities implicit in neo-Confucian systems (see Political Change and Potential Instability).

Confucianism is being promoted now as a moral philosophy (as well being used as the basis for ‘bureaucratic’ government administration) because so many had abused their positions in the social / administrative to enrich themselves.

It is by no means certain, however, that the neo-Confucian systems are going to prove sustainable (see Context to China's Share Market Boom and Bust and Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures)

John Craig

China's Position Can't Be Properly Assessed Just on the Basis of Western Criteria

China's Position Can't Be Properly Assessed Just on the Basis of Western Criteria - email sent 22/10/15

Professor Geoffrey Hodgson,
University of Hertfordshire

Re: Six reasons why China’s economy is weaker than you think, The Conversation, 21/10/15

I should like to suggest that, while the key conclusion of your article is likely to be valid, there is a need to examine China’s economic and geo-political opportunities and constraints from an ‘Asian’ (as well as a Western) viewpoint.

My Interpretation of your article: The UK rolled out the red carpet for China's president. Britain's pivot to China is based on its economic strength. However there is cause for concern. Growth has slowed and economy looks fragile. China’s exports have fallen. China’s slowdown has depressed global commodity prices adversely affecting exporters such as Brazil and Russia. Some economists forecast unlimited growth for China. But as China shifts to service-oriented economy (involving sectors with slower-growing productivity) its growth must fall. Other reasons to expect China’s growth to stall include: (a) an adverse demographic shift due to effect of one-child policy. The numbers of workers will decline relative to numbers of older people requiring support; (b) China still has a low average GDP / capita (ie 24% of that in US) and few countries in the 20th century grew from there to over 60% of US GDP ; (c) growing to higher levels of GDP / capita requires democracy – which China lacks; (d) there are other vital institutions (eg independent legal systems) that China lacks required for growth to higher GDP / capita levels; (e) China distinguishes urban and rural citizens. The latter’s land rights are often corruptly abused – leading to numerous protests; and (f) there are few large mainland-registered firms – because private property rights were not recognised until 2007. Difficult institutional and demographic obstacles will constrain China’s growth especially because it is a one-party state. Massive and potentially-destabilizing reform of China’s political and economic institutions are needed to avoid slow future growth.

China’s rapid development to date has been based on a variation of the methods for achieving economic ‘miracles’ that were widely deployed in East Asia (initially in Japan). And those methods were, in turn, variations of the imperially-mandated systems of Confucian bureaucratic administration by which Asia was governed prior to Western expansion (see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy, 2009).

Your article pointed to various obstacles that China faces in further developing its economy. However those suggestions reflect experience of what has worked in an international system based on Western practices (see Cultural Foundations of Western Progress: The Realm of the Rational / Responsible Individual, 2001+). There is a need to consider what is different about ways of thinking and doing things in East Asia in order to get a more reliable understanding of what is involved from China’s perspective (eg differences like those suggested in East Asia: The Realm of the Autocratic and Intuitive Ethnic Hierarchy, 2001+ and Babes in the Asian Woods, 2009+). In relation to the obstacles your article nominated, it is noted that:

  • The goals of China’s ‘princelings’ are likely to be mercantilist – ie to involve acquiring power for their ethnic community (and for themselves) rather than boosting the wealth of China’s ordinary people. And that power would largely be exercised both domestically and internationally through social relationships (ie through having others – including social, political and business elites in the UK - accept a ‘tributary’ status because of the ‘princelings’ ability to benefit a new potential subordinate by getting things done through the ‘princelings’ networks of associates ) – eg see Creating a New International 'Confucian' Financial and Political Order, 2009+;
  • As the latter suggests, it is likely that China is seeking to create an international order within which it becomes possible thereby to avoid the political and financial constraints that ‘liberal’ (ie democratic capitalist) systems impose on the exercise of power by ethnic social elites;
  • there is unlikely to be any interest in creating the legal institutions that would be required where economic activities were expected to be driven by independent / private initiative.

It seems very likely that the 'wheels will fall off China’s wagon’, but to see why this is so requires consideration of the issue also in terms of traditional ways of thinking and doing things in societies with an ancient Chinese cultural heritage (eg perhaps along the lines suggested briefly in As Power Shifts from the US to the Soviet Union, to Japan, to China, to .... (2015).

I would be interested in your response to my speculations

John Craig

China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism'

China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism' - email sent 12/6/16

Linette Lopez,
Business Insider

Re: China is walking its economy right into a trap, Business Insider, 11/6/16

I should like to submit for your consideration that the suggestions your article outlined about the solution to China’s financial / economic problems are probably valid, but that that those problems do not have their source in ‘state capitalism’.

My Interpretation of your article: China is frequently seen to have a debt problem - but (according to Larry Hu - Macquarie) this is just a symptom of China's 'state capitalism'. Superficially China's high debt results from high savings and limited equity. But high savings are a result of 'state capitalism' under which the state extracts resources from private sector by financial repression, SOE monopoly, land controls. This suppresses consumption and increases savings - and is the root of China's debt problem. It is futile to simply watch China's debts pile up and expect collapse. 'State capitalism' creates a specific type of bad economy - and puts China's economy in a trap. AS more SOE's show signs of failure - the government bails them out (eg with debt-equity swaps which can worsen state banks position without depositors realizing this). For banks with liquidity problems government issues bonds / prints money to support them. This could raise inflation risk - though in Japan huge amounts of government debt were monetized with inflation / depreciation. China does not want to become Japan. It still needs to lift people out of poverty. But China is already following Japan - eg using non-performing-loan debt to equity swaps - which is likely to increase the rate of bad-debt accumulation. These swaps could create money-sucking monster that kills growth and feeds on more debt. Private sector could help if it were not squashed by the state. State and local governments usually bail out SOEs that are in trouble - though there are now indications (re Dongbei Special Steel) that a harder line might be taken. Hu argues that China’s government could fix the problem - by getting out of its own way; reforming SOEs; letting others drive market; and reform local governments (who have funded China's endless infrastructure investment). But China's government is providing more (not less) support to SOEs and is taking a stake in private tech companies also. The government's policies are China's problem.

China’s does not have the ‘state capitalism’ that Larry Hu nominated as the source of China’s problems. ‘Capitalism’ implies an orientation to profit (ie return on capital) – and this is not true in China any more than it has been in Japan (see evidence and Does Asia have Capitalism?, 2013). Rather, as Sakakibara (‘Mr Yen’) pointed out in relation to Japan in the 1990s, China’s system appears to be distinctly ‘non-capitalist’. Both Japan’s and China’s economies seem to have: (a) achieved economic ‘miracles’ through the undisclosed use of variations of the ‘Confucian’ methods of government on behalf of emperors by elite bureaucrats through hierarchical social networks that were used in East Asia for centuries prior to Western expansion; and (b) had primarily mercantilist goals (ie to build national power by increasing ‘real economy’ production and market share) rather than seeking to generate financial ‘profits’ -see Understanding East Asia's Neo-Confucian Systems of Socio-political-economy (2009).

Under those neo-Confucian systems financial repression (etc) was vital to mobilize tame domestic resources if investment was to be made with limited regard to profitability. Borrowing in international profit-oriented financial markets through banking institutions with poor balance sheets would otherwise have quickly led to financial crises. However mobilizing savings for investment by repressing domestic incomes (and thus consumer spending) created demand deficits that led to significant international financial imbalances - and these in turn created risks to the whole global financial system because those imbalances required their trading partners to cope with ongoing current account deficits and constantly rising, and ultimately hazardous, levels of debts (see Structural Incompatibility Puts Global Growth at Risk, 2003 and Impacting the Global Economy, 2009).

Japan’s late 1980s’ financial crisis showed that (even though savings could be mobilized by state-linked banks by financial repression etc.) a debt crisis could result from industrial, infrastructure and property over-investment by state-linked enterprises. It did not really matter whether or not the enterprises were primarily state or ‘privately’ owned (as was the case in China and Japan respectively). And in China (as in Japan) linkage into, and compliance with, a state-centred social hierarchy seems critical to ‘private’ business success (eg see Lopez L., ‘Richest man in China’s son, ‘Escaping the Chinese system would be suicide’, Business Insider, 29/8/16). China is governed through a 'rule of man' rather than by a 'rule of law' that could provide a framework for 'private' activities. Thus suggestions that there are significant genuinely ‘private’ enterprises in China (or Japan) seems invalid (see also In East Asia Deals Always Involve Politics, 2012).

In 2013 China’s current regime apparently realized that the rising debts associated with economic growth based on industrial, infrastructure and property over-investment put China at risk of a Japan-style financial crisis. However the regime’s decision to try to avoid this by shifting from undisciplined investment to an emphasis on domestic demand to drive growth made it impossible to continue reliance on constraining domestic incomes (by financial repression etc) to provide ‘tame’ capital for ‘non-capitalistic’ investment (see also Importing Risks from China )

China’s challenge is almost certainly to implement something like the policy changes that Larry Hu suggested. However this would not involve moving away from hypothetical ‘state capitalism’. Rather China’s challenge is probably best conceived of as moving away from the modified version of China’s pre-Communist neo-Confucian hierarchical social networks that have been used to maintain political and economic control in the post-Mao era. And, as the machinery that has been used for managing economic change and maintaining social and political order since the late 1970s is what now needs to be changed, it is hardly surprising that China’s progress has been slow.

John Craig

Christian Persecution in China