China: We Have Met The Enemy And They Are Us


August 26, 2015: Yesterday the Chinese stock market dropped 8.5 percent, the biggest one day drop since 2007. The stock market was until 2014 largely a government controlled operation mainly used by insiders to raise money for large (inefficient and corrupt) state owned firms. That has been gradually changed to be more like Western stock markets. That has not worked out too well. The government is facing an increasingly angry population who see the government as unable to cope with the problems the government created.

But it is worse than that. The government tolerated too much corruption for too long. This was partly greed and partly an effort to prevent the dwindling number of communist true believers from interfering with the economic liberalization that has brought China unprecedented wealth and power. The “economic miracle” began in the 1980s and in the last decade Communist Party purists have become nearly extinct and public anger against corrupt officials has grown to dangerous levels. This was made quite clear on August 12th when a massive explosion in the warehouse district of a port city (Tianjin) near the capital. This explosion was not supposed to happen. There were laws about storing so much explosive chemicals (and poisonous) in one place and so close to residential areas. The government ordered the arrest of the owners of the warehouse complex and local officials can expect to be prosecuted, and possibly executed, as well. This sort of thing has happened before. It has happened too many times before and is still happening with increasing frequency despite government assurances that it is aware of the problem and is dealing with it. The problem that is not discussed much is that China has never had a strong centralized government. In the past Chinese empires thrived because the imperial government was able to promptly deal with provinces that became too corrupt and unruly. Chinese see their government as unable to identify, arrest and replace corrupt local officials quickly enough. This failure is seen as a danger to every Chinese. It isn’t just the massive explosions in major cities but the growing air pollution, even in the capital, and less obvious but just as harmful water and food pollution. What good is all this new wealth if the government cannot keep people healthy enough to enjoy it?

The government has the power to stabilize the stock market crash, but Chinese are less sure about the government ability to deal with more serious long term problems like corruption and pollution. Even emperors understood the need to maintain the mandate (popular support) of the people. Their communist successors understand that as well, and any who may have forgotten were reminded in 1991 when the mighty Soviet Union quickly dissolved when its ruling communist party lost the mandate of people. The lessons of the communist collapse throughout Europe in 1989-91 still haunts the Chinese leadership.

China’s problems have worldwide impact. In 2014 Chinese economic growth was 38 percent of the world total and the Chinese economy (now the second largest in the world) accounted for 15 percent of global economic activity. While the United States is rather well insulated from Chinese economic problems, most of the world is not. This is particularly true of Asian nations, which depend a lot more on China as a buyer of their goods. For any country China is more important as a customer than as a supplier and economists in and out of China see Chinese economic growth in decline for the rest of the decade and probably longer. While this will not slow down the Chinese military buildup much at all, it will make Chinese leaders more concerned about peace at home than military backed expansion abroad. Chinese leaders are acutely aware of Chinese history and the lessons it provides. Despite being a police state the Chinese leadership knows that in the past censorship and lots of armed men have not prevented massive unrest that brought down seemingly unassailable governments. Even if the uprisings failed, like the 19th century Taiping Rebellion that left 20 million dead did, the aftermath can leave the government too weak to hold the country together. That’s the kind of damage the Taiping Rebellion did which left China weak and subject to a century of civil war, foreign invasion and the destruction of the ancient imperial system. The communists see themselves as the saviors of China for bringing China back to world primacy, a position it previously held for thousands of years. Before the Western industrial revolution the Chinese economy had long been the wealthiest on the planet. Restoring China to its traditional roles as an economic and military power is still very popular with most Chinese and worth taking extreme measures (like replacing the current government) to hold onto.

While generations of Chinese have made enormous sacrifices to get this far, there is less enthusiasm to suffer more simply to allow corrupt officials (most of them members of the ruling Chinese Communist Party) to get rich or to get away with past crimes. The current situation is also something quite new in Chinese history; a large, powerful and assertive middle class that is not willing to tolerate threats to their new economic status. Chinese leaders have looked around for guidance on how to deal with this. There are the examples of Hong Kong, Taiwan and Singapore, all Chinese cultures that went through the development of a large middle-class. Those examples are not very comforting because all largely dispensed with the police state model. China is, in fact, still a communist police state and some leaders are beginning to consider actually changing that. Whatever they do they have to admit that the times they are changing. While the threats of stock market collapse, currency devaluation, pollution, corruption and inadequate banking reforms and personnel shortages grab more media attention, the politicians realize that the new middle class is in the center of all those other problems while also being the solution or the ultimate nightmare for the current rulers of China.

China no longer expects GDP to grow nearly seven percent this year. There has long been reason to doubt the accuracy of that number. For example Producer Prices (what manufacturers sell their goods for) have been falling for 40 months in a row. This is caused by low demand and in response companies have been reducing employees for 21 months in a row. Part of the slowdown is deliberate. China had made it more difficult to borrow in an effort to deal with the real estate bubble and corruption (bad loans) in the banking system. But now the government is loosening credit to make it easier for companies to grow. The problem is that the economy is no longer growing like it did since the 1980s, at over 10 percent a year.  On top of that there is the old problem of corruption within the government when it comes to accurate economic statistics. The unreliable government statistics were long an open secret that did not seem to matter. That has changed.

Bad data is a major reason for the stock market crash in China. Technically this was not a crash but a correction because while the markets lost all its 2015 gains in less than two months the market is still up fifty percent over where it was in 2014. While that is reassuring to investors who bought their shares in 2014, it means little to the millions of small investors who came to market boom late and lost big. The damage was made worse by the ease of borrowing money to buy stocks (“buying on margin”), which was a major factor in the epic American 1929 stock market crash (where the market lost nearly half its value in two months and 90 percent within three years). Unlike in the West, where (especially the U.S.) where most stocks are owned by pension and mutual funds (and a third by families) most Chinese stocks are owned by 90 million individual investors and many of those invested late and got wiped out or suffered heavy losses. Since mid-2014, when the government encouraged “all Chinese” to benefit from the booming (because of changes in government regulation) stock market another 40 million investors bought into the market. So far all the gains for 2015 have been wiped out but many who entered the market eight to ten months ago and have sold (as many have) came away with big profits. Between June 2014 and June 2015, China's main stock market index rose by 150 percent. But since June the market has lost 40 percent of its value, half of that loss was in the last four days. Many new investors now believe that corruption and government control manipulated the market. Many major firms were hiding problems and investors lost faith in companies they had bought stock in and wanted to sell.  While the government can’t hide the damage done here, there is also no hiding those who invested and profited. The problem is that the pain is widespread and felt mainly by the newly affluent Chinese who feel betrayed by their government, which has been encouraging such investing, especially since 2014.

The government has some other problems that make the current situation worse. Because of the Internet, and despite Chinese efforts to “control” (censor and influence) information, it is possible to gather enough economic data to seriously challenge official government numbers. This is forcing the Chinese to reveal ugly truths they would prefer to keep hidden. The government is trying to clean up the corruption in the banking sector and state owned enterprises but does not want the public watching. That’s partly because a lot of senior officials (present and past) were criminally responsible for this mess and partly because if these credit and government budget problems are not fixed there could be a major financial crises and years of economic depression. Most Chinese also know that if a crises is imminent government officials want to get the information first so they can save their own personal wealth before the Chinese currency and stock markets lose most of their value. This is one reason why the government wants to control anti-corruption efforts, lest the public find out too many details of how badly behaved their leaders still are. This is particularly true of cases where corrupt officials with powerful friends use that influence to escape punishment. This is often the case with children and grandchildren of families that were in leadership positions when the communists took over in the 1940s. Nearly as frightening is growing publicity (despite efforts by censors) of corruption in state owned companies. This is no secret to most Chinese but the details create public anger towards the government that seems to tolerate all this misbehavior. Equally embarrassing are the official and unofficial revelations about senior people in charge of anti-corruption efforts who are found to be corrupt.

Publicity of this sort of corruption is particularly dangerous to the government because it makes the ruling (since the 1940s) Chinese Communist Party look incapable of reforming itself. Such reform is no easy task. So far over 100,000 officials have been prosecuted for corruption. This has included a growing number of senior officials and this is causing unrest in the few hundred families that comprise the senior leadership. The government appears to have an unofficial amnesty program that allows senior officials safety if they quietly divest themselves of all their illegal wealth and behave in the future. A lot of senior people are unwilling, or at least very unenthusiastic, about doing this. To encourage compliance the worst offenders among the senior bureaucrats are being prosecuted and jailed. Just to encourage the others.

China is not the only one with major economic problems. There are problems with the Russian economy that have caused Chinese investment (encouraged by both countries) in Russia to decline 20 percent so far this year (versus 2014). China currently has investments in Russia worth about $4 billion. Russian GDP shrank 2.2 percent during the first three months of 2015 and 4.6 percent in the second quarter. This shrinkage shows no signs of slowing down. The Russian government tries to mask the economic damage with positive propaganda but Russians closely involved with the military, the space program and major government projects know better. Budgets are being quietly cut and managers warned that government promises of future funding is subject to “special circumstances” (the sanctions and the price of oil). The sanctions and persistent low oil prices have caused Russian GDP to contract for over a year and this led to a sharp fall in the value of the ruble against foreign currencies. In the past year the dollar has become twice as expensive to buy with rubles. This has had an impact on the value of the ruble against other currencies. At the moment the damage done to China by these Russian problems is minor compared to internal Chinese problems. But eventually the “Russian problem” will grab more attention in China.

Next door the war threat in Korea has abated as North Korea made an unprecedented (by North Korean standards) apology for the recent wounding of two South Korean soldiers by North Korean landmines. In response South Korea shut down its eleven loudspeaker systems that were blasting forbidden news and music into North Korea. China has remained quiet through all this but is known to still have a lot of influence in North Korea. For example it recently became known that China has allowed North Korea to expand the use of North Korea secret police in China as long as these agents speak fluent Chinese and wear Chinese police uniforms and try to act Chinese. There are believed to be nearly a hundred of these agents in China looking for North Koreans illegally in China. When such people are found Chinese police must be called in to make the arrests and then send the escapees back to North Korea for punishment. The North Korean agents are also expected to report anything of interest (to local police or intelligence) to China and to behave themselves. In return these North Korean agents are allowed to go anywhere in China, which allows the agents to pursue North Koreans travelling south to get to an South Korean embassy in Southeast Asia when enables the one to ask for asylum and be moved to South Korea.

China has been putting other foreign adventures on hold. This includes territorial claims on India and in the South China Sea. China still maintains the position that their South China Sea claims are justified and unassailable. Because of that China accuses its angry neighbors of stirring up trouble and demands that the United States halt its military threats against Chinese territory (the South China Sea). The Chinese program of building small islands from sand dredged from reefs and sand bars in the South China Sea appears to have been more extensive than earlier belied. Latest analysis of satellite photos of the area shows that China has built nearly 1,200 hectares (nearly 3,000 acres) of these artificial islands. Many are waiting for construction teams to build, at the very least, light houses and other “navigation and control” facilities which will be run by Chinese government staff. On the larger artificial islands the Chinese are building air strips and military facilities.

China is still a threat to its neighbors because China has paid for its enormous military buildup by increasing their military budget in line with GDP growth. Military spending has stayed at about two percent of GDP for over a decade. So even as this growth rate declines the military spending will not decline. Senior officials recognize that the biggest problem with rebuilding the military is not money but the ancient corruption in the military. Eliminating, or just sharply reducing this waste has proved very difficult.  

August 23, 2015: In the east (Shandong province) an explosion in a chemical plant killed at least one person and injured nine others. In light of the recent Tianjin catastrophe this accident got more play in the media than it normally would. Industrial safety is low in China and more Chinese are demanding some real changes in this area and those demands become louder and more public with each additional industrial disaster that would not have happened if everyone had followed the rules.

August 14, 2015: China has donated more military equipment to Uganda for peacekeeping operations in Somalia. This donation, worth over $5 million, included three 50 ton capacity cranes, a dozen armored personnel carriers, four 10,000 liter (2,600 gallon) water tank trucks and 16 smaller capacity water trailers. Equipment like this is particularly useful because one of the major, yet least publicized, problems with African peacekeepers is logistics. Donations like this make supplying the peacekeepers easier.

August 12, 2015: In the northeast (120 kilometers southeast of Beijing) there were several huge explosions in the port city of Tianjin. Illegally stored explosives went off after a fire, killing over 150 people and injuring over 500. There was billions of dollars of property damage and the eight million residents of Tianjin are worried about pollution to their air, water and land.





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