Is China a Fragile Giant? By James Reed

James Rickards, who has extensive practical experience in China makes a counter the position that China is invincible. On the contrary, it has its own weaknesses and collapse is possible. For one thing, it is highly dependent upon the bicycle economy of exports, and its own militarism could undermine that. It is also facing demographic catastrophe within ten years.

https://dailyreckoning.com/china-fragile-giant/

“I’ve made many visits to China over the past thirty years and have been careful to move beyond Beijing (the political capital) and Shanghai (the financial capital) on these trips.

My visits have included Chongqing, Wuhan (the origin of the coronavirus outbreak), Xian, Nanjing, new construction sites to visit “ghost cities,” and trips to the agrarian countryside.

My trips included meetings with government and Communist Party officials and numerous conversations with everyday Chinese people.

These trips have been supplemented by reading an extensive number of books on the history, culture and politics of China from 3,000 BC to the present. This background gives me a much broader perspective on current developments in China.

In short, my experience with China goes well beyond media outlets and talking heads.

An objective analysis of China must begin with its enormous strengths. China has the third-largest territory in the world, with the world’s largest population (although soon to be overtaken by India).

China also has the fifth-largest nuclear arsenal in the world, with over 280 nuclear warheads. This is about the same as the U.K. and France but well behind Russia (6,490) and the U.S. (6,450). China is the largest gold producer in the world at about 500 metric tonnes per year.

Its economy is the second-largest economy in the world — behind only the U.S. China’s foreign exchange reserves (including gold) are the largest in the world.

By these diverse measures of population, territory, military strength and economic output, China is clearly a global super-power and the dominant presence in East Asia. Yet, these blockbuster statistics hide as much as they reveal.

China’s per capita income is under $12,000 per person compared to per capita income of about $64,000 in the United States. Put differently, the U.S. is only 38% richer than China on a gross basis, but it is 500% richer than China on a per capita basis (of course the massive economic fallout from the coronavirus will have an impact).

China’s military is growing stronger and more sophisticated, but it still falls short against the U.S. military when it comes to aircraft carriers, nuclear warheads, submarines, fighter aircraft and strategic bombers.

Most importantly, at under $12,000 per capita GDP, China is stuck squarely in the “middle income trap” as defined by development economists.

The path from low income (about $5,000 per capita) to middle-income (about $10,000 per capita) is fairly straightforward and mostly involves reduced corruption, direct foreign investment and migration from the countryside to cities to pursue assembly-style jobs.

The path from middle-income to high-income (about $20,000 per capita) is much more difficult and involves creation and deployment of high-technology and manufacture of high-value-added goods.

Among developing economies (excluding oil producers), only Taiwan, Hong Kong, Singapore and South Korea have successfully made this transition since World War II. All other developing economies in Latin America, Africa, South Asia and the Middle East including giants such as Brazil and Turkey remain stuck in the middle-income ranks.

China remains reliant on assembly-style jobs and has shown no promise of breaking into the high-income ranks.

To escape the middle income trap requires more than cheap labor and infrastructure investment. It requires applied technology to produce high-value added products. This explains why China has been so focused on stealing U.S. intellectual property.

China has not shown much capacity for developing high technology on its own, but it has been quite effective at stealing such technology from trading partners and applying it through its own system of state-owned enterprises and “national champions” such as Huawei in the telecommunications sector.

But the U.S. and other countries are cracking down on China’s technology theft and China cannot generate the needed technology through its own R&D.

In short, and despite enormous annual growth in the past twenty years, China remains fundamentally a poor country with limited ability to improve the well-being of its citizens much beyond what has already been achieved. And that has serious implications for China’s leadership…

China’s economy is not just about providing jobs, goods and services. It is about regime survival for a Chinese Communist Party that faces an existential crisis if it fails to deliver.

It’s an illegitimate regime that will remain in power only so long as it provides jobs and a rising living standard for the Chinese people. The overriding imperative of the Chinese leadership is to avoid societal unrest.

If China’s job machine seizes, as parts of it did during the coronavirus outbreak, Beijing fears that popular unrest could emerge on a potentially scale much greater than the 1989 Tiananmen Square protests. This is an existential threat to Communist power.

President Xi Jinping could quickly lose what the Chinese call, “The Mandate of Heaven.”

That’s a term that describes the intangible goodwill and popular support needed by emperors to rule China for the past 3,000 years.

If The Mandate of Heaven is lost, a ruler can fall quickly. Even before the crisis, China has had serious structural economic problems that are finally catching up with it.

China is so heavily indebted that it’s at the point where more debt does not produce growth. Adding additional debt today slows the economy and calls into question China’s ability to service its existing debt.

China also confronts an insolvent banking system and a real estate bubble. Up to half of China’s investment is a complete waste. It does produce jobs and utilize inputs like cement, steel, copper and glass. But the finished product, whether a city, train station or sports arena, is often a white elephant that will remain unused. The Chinese landscape is littered with “ghost cities” that have resulted from China’s wasted investment and flawed development model.

Essentially, China is on the horns of a dilemma with no good way out. China has driven growth with excessive credit, wasted infrastructure investment and Ponzi schemes.

The Chinese leadership knows this, but they had to keep the growth machine in high gear to create jobs for millions of migrants coming from the countryside to the city and to maintain jobs for the millions more already in the cities.

The two ways to get rid of debt are deflation (which results in write-offs, bankruptcies and unemployment) or inflation (which results in theft of purchasing power, similar to a tax increase).

Both alternatives are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either policy would cause social unrest and unleash revolutionary potential.

China also has serious demographic challenges that will limit future growth…

In 1980, China instituted a one-child policy in an effort to control population growth. But the 1980 announcement was really a matter of formalizing an existing policy. The Chinese have a cultural preference for boys over girls. So, when the one-child policy was implemented, the Chinese used pre-natal tests to determine sex and then aborted the girls.

At a more crude level, families kept buckets of water next to birthing beds so that if a girl was born she could be drowned immediately. It is estimated that between 20 million to 30 million baby girls were killed this way, resulting in an equivalent surplus of men over women.

These excess men will never find wives in China. Since women can be selective about husbands, it follows that the 30 million excess men will be the least talented and poorest in Chinese society. This cohort is highly prone to antisocial behavior, including alcohol and drug abuse and violence.

The demographic time bomb is now detonating. The missing children from thirty or forty years ago are the missing prime age workers of today. The Chinese economy grew strongly from 1995 to 2010, mainly because of a rural-to-urban migration and the rise of assembly-style manufacturing jobs.

Now the migration is over, the assembly-style jobs are moving to Vietnam and India, and China’s lack of high-value-added technology has left it stuck in the slow-growth middle-income trap. China might have overcome this through the sheer weight of low-wage workers, but they don’t exist.

China will lose over 100 million workers in the next ten years due to aging, retirement and the absence of working-age replacements. China is now trying to undo the demographic damage with a new “three-child policy.”

But, it’s too late. Demographic disasters take thirty years or more to create and they can take thirty years or more to cure. For the next thirty years, China’s worker shortage will be a drain on growth.”

It seems that the forces for the collapse of China are already at work, let alone geo-politics and World War III.