October 12, 2019:
China is losing its trade war with the United States. In hindsight that should not be surprising. Foreign economists and financial specialists have plenty of verifiable data on the state of the Chinese economy, and for a decade now those independent assessments have accumulated and revealed a different and more accurate picture of the Chinese economy. One finding that has slowly come into focus is the net result of false reporting by provincial and other local governments for decades. It is now believed that, after 2008, GDP growth fell to four percent, or less, not the six percent the government reported. This weakness was more important when China found itself, in early 2018, on the receiving end of American tariffs and other forms of economic retaliation. In the beginning, it was thought the Chinese could outlast the Americans because China was still a Communist police state where the government was not as vulnerable to public anger over government inability to quickly deal with the foreign economic pressure. That view has since changed as China turned out to be more vulnerable, and American voters more resolute, than was originally thought. The trade war triggered an exodus of American and other foreign firms from China. The United States was not the only trading partner angry at the Chinese. Other Chinese trading partners, especially those in Asia, were eager to take a swing at their economic, and sometimes political, oppressor.
American farmers were more willing to endure the Chinese retaliation (halting or reducing purchases of agricultural products) than the Chinese expected. The American president was doing something American farmers and manufacturers had long called for and were told that the Chinese would retaliate but were less capable of enduring the pain. This weakness became obvious when a pork shortage developed in China. This was initially due to the government's inability to deal with a massive outbreak of African swine fever. This eliminated so many live and breeding hogs that supply of pork was cut in half and pork prices skyrocketed. Pork, long a staple of the Chinese diet, and other meat products became much more expensive. Since newly affluent Chinese used their larger incomes to buy a lot more pork and other meat products, the government was forced to lift retaliatory economic measures directed at pork imports and grains used to feed all manner of farm animals in an effort to deal with the pork crises. Chinese leaders learned that even in a police state if you use economic growth to gain more public support, you lose that support quickly when, for example, pork is no longer affordable for a lot of Chinese.
Then there was the problem of oil imports. China is the largest importer of oil in the world and remained an ally of Iran despite American sanctions on Iran. Then Iran attacked Saudi oil facilities in September that interrupted shipments to Asian customers. This also sent oil prices up momentarily. China eventually retaliated by canceling a $5 billion natural gas development deal that Iran was depending on. Iran offended China and had to pay. Some American businesses got the same harsh retribution when they tolerated support for the Hong Kong protestors.
With all these problems and more on the way, China can no longer afford to keep the trade war going until there might be a new American government in 2020. This is especially true when China realized that political opponents of the current American government are not talking about ending the trade war, not while the U.S. was obviously winning and most Americans supported it. Chinese economic problems are getting worse while the American economy improves and Chinese long-term economic prospects are much more in jeopardy and the Americans are taking advantage of that in ways the Chinese did not anticipate.
Even before the United States began its current trade war with China international credit rating firms began, in 2017, downgrading the long-term credit rating of Chinese government debt. This was mainly about too much debt and how much of that debt was uncollectable (“bad” debt). To make matters worse Chinese banks are suspected of using the same deceptive banking methods by trying to repackage bad debt as good debt. This is what brought on the 2008 financial crises in the United States. That economic crisis went worldwide and the Chinese government was forced to use a lot of additional borrowing to keep the economy moving. But if too much of that debt is bad there is an increased risk of an economic crisis that would halt economic growth and take years to fix. The Chinese made this worse by allowing economic data reporting to be “adjusted” to suit the needs of local (provincial) officials. That was bad enough and efforts were made to halt the practice. There was a lot of “correction” required because, during several decades of rapid economic growth this flawed data allowed the state-owned banks, which still dominate the economy, to lend too much money. Thus debt in China keeps rising. It went from 254 percent of GDP (nearly three times what it was before 2008) in 2015 to 277 percent in 2016 and keeps resisting efforts to come up with a solution.
What makes this pile of debt so toxic is that much, if not most of this debt consists of loans that the borrower cannot repay, or not repay in a timely fashion. This is reflected in the rising incidence of bankruptcy over the last few years. The government would prefer to avoid the bankruptcy process because it is embarrassing, turns bad debt into losses and exposes details of how the bad debt mess works. The growing bad debt problem, more than the South China Sea dispute, is what keeps Chinese leaders up at night. GDP growth is slowing, it was down to 6.7 percent in 2016 and that was when a new American government was openly discussing economic retaliation against China. That is scarier than the American military because it can be more safely used by the Americans and the Chinese government refuses to discuss this vulnerability for obvious reasons. It is believed that over $600 billion worth of these loans are uncollectable. Chinese banks are trying to avoid writing off these bad loans because it hurts bank profits and puts some banks out of business. Many banks are repackaging the bad loans in an attempt to sell them off for far more than they are worth. Chinese banks call these new items WMPs (wealth management products) and assure buyers they are legitimate but offer these bond-like securities with much higher interest rates than other corporate or bank bonds. Sound like 2008 all over again.
Chinese foreign trade and investment activities have been growing for decades. China was successful not just because of lower prices but because Chinese firms were encouraged by their government to exploit corruption and opportunities to steal trade secrets and patents, especially in the West. American firms complained of this for decades and the current U.S. government has called China to account for these issues. This began with higher tariffs on Chinese imports and cracking down even more on Chinese economic espionage and patent abuse. While China can and has retaliated that was more for show than effect. China was definitely more vulnerable to this sort of thing. Not only does China have a lot more internal government and commercial corruption, but its economy is far more vulnerable to trade interruption than America. Rising unemployment is far more of a political threat in China, despite being a communist police state, than in the United States. The Chinese financial system is far more sensitive to disruptions caused by a trade war. For example, when the tariffs were first imposed in early 2018 the Chinese stock market fell 20 percent while the Americans markets declined one percent. Facing declining financial markets and rising unemployment magnifies the risk unresolved problems in China pose, like all that bad debt and unreliable economic data.
To make matters worse some massive Chinese overseas investments are going bad and efforts to deal with that could mean more problems for China. In Venezuela, the local socialist government has ruined the economy, despite having the largest crude oil reserves on the planet. Even the Venezuelan oil industry is falling apart and Venezuela has defaulted or in danger of defaulting on more than $50 billion in Chinese loans. Fortunately, China has the option to be repaid with oil. Chinese firms are offering to invest $250 million to revive the Venezuelan oil industry but only if the government allows China to convert some of the bad debt to ownership of some of the Venezuelan oil reserves. Throughout Latin America, that type of foreign ownership of natural resources is generally forbidden. Then there is the American Monroe Doctrine which has, since 1812, protected all Western Hemisphere nations from foreign military intervention to collect bad debts. China is playing a very high-risk game in Venezuela which, if it backfires, will have serious financial and economic repercussions in China.
Venezuela isn’t the only tropical investment that is going bad. In 2008 a consortium of Chinese companies agreed to build nine billion dollars’ worth of infrastructure in Congo in return for access to mineral resources. The 2008 deal specified China would have access to ten million metric tons of copper and around 600,000 metric tons of cobalt. At the time it was believed that China would ultimately make a couple of billion dollars on the deal and possibly more because China was financing the operation. The sheer size of this investment guaranteed China political access to Congo’s corrupt and bribe-friendly leaders. Yet by 2012 the deal began to come apart when Congo could not provide the electricity it promised. To overcome this the Chinese firms had to buy electricity from Zambia. This was an unexpected expense, as was the Chinese decision to build their own hydro-electric dam facility. By 2018 there was another problem; the copper reserves turned out to be about a third less than originally estimated. The price of copper has also dropped by over 20 percent since 2008. This means that the Chinese investments in Congo will, at best, break-even and could easily become unprofitable. What is apparent is that China did not appreciate the problems one could encounter with the mining business and investing in sub-Saharan Africa. One final problem is that the corrupt politicians who helped China get the 2008 deal are being forced from power, putting the Chinese investments at even greater peril.
Not all Chinese foreign investments are in trouble. A case in point is Russia where China has quietly taken control of the local economy in those parts of Russia that border China and North Korea. That explains why China has ignored North Korea using Russia and Chinese cargo ships to illegally export coal. North Korea moves the coal (illegally) into Russia via truck where it is exported on ships owned by Chinese companies. China is tolerating this because Chinese firms have been exploiting corruption in Russia (which is worse than in China) to dominate the economy in the Russian Far East (the area between Mongolia and the Pacific coast). China has a historical claim on this area which China revived after World War II when the communists took over China. Those claims led to border skirmishes during the 1970s that were halted when Russia made it clear it was prepared to risk nuclear war over this issue. That Russian policy still stands, although it is not publicized.
When the Soviet Union collapsed in 1991 and the Russian economy went free market and open to foreign trade and investment, China saw an opportunity to get back its lost lands in the Russian Far East. China will slowly absorb the Russian Far East economically and demographically, with more Chinese settling in the Russian Far East, legally or otherwise. Eventually, Russia will find that the Chinese comprise most of the population in their far eastern provinces and control the economy as well. This approach takes longer but is less likely to trigger a nuclear war with Russia.
Another investment project with neighboring nations is doing less well. This is the BRI (Belt and Road Initiative), a Chinese effort to build roads, pipelines and railroads throughout Eurasia to give China easier access to markets via land routes. A growing number of these neighbors are having second thoughts and calling for the deals to be renegotiated to provide the host country with a better deal. As with Congo, China often gets into trouble with BRI deals when the corrupt government it made the BRI deals is replaced. This happened in Malaysia and Thailand, and BRI deals throughout the region soon found themselves in trouble.