China: Things That Matter Most

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August 16, 2018: In July the U.S. started a trade war with China, seeking to force China to drop the barriers preventing foreign nations (especially the United States) from exporting to China or operating in China. This trade war is a major threat to China because of existing vulnerabilities. These include continued dependence on essential (to China) export activity. A significant drop in exports will put a lot of Chinese out of work (and companies out of business) and turn public opinion against the government. In general Chinese approve of the trade war because it represents China “opposing foreign threats”. But the Chinese are already beset daily by Chinese threats (air and water pollution, corrupt politicians and businessmen selling dangerous products.) Unemployment tends to change attitudes at the personal level.

In addition to the obvious threats, there is an even more dangerous vulnerability; too much debt and how much of that debt is uncollectible (“bad” debt). To make matters worse Chinese banks are suspected of using the same deceptive banking methods (trying to repackage bad debt as good debt) that 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 debt to keep the economy moving. But if too much of that debt is bad there is increased risk of an economic crisis that would halt economic growth and take years to fix. The government has made this worse by allowing economic data reporting to be “adjusted” to suit the needs of local (provincial) officials. That was bad enough (and is now being admitted and fixed) but 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 unless the government can develop some solutions it will be over 300 percent by the end of the decade. What makes this pile of debt trap 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 (54 percent more in 2016) incidence of bankruptcy. 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 trade war or the South China Sea dispute, is what keeps Chinese leaders up at night. This is especially true not because of the 2008 global financial crises but because of what happened to Japanese banks in the early 1990s. The Japanese had allowed a huge real estate bubble to develop and when economic growth stalled for a bit a lot of the real estate loans became bad debt and that created an economic crises Japan is still dealing with. Japanese were angry and being a democracy they elected new politicians. China is not a democracy and a banking crisis like the Japanese went through in the 1990s will create a lot of angry Chinese who cannot, as the saying goes, “vote the rascals out (of office)”. In China, that degree of public anger means revolution or at least a lot more disorder.

Chinese GDP growth is slowing, it was down to 6.7 percent in 2016 but recovered a bit to 6.9 percent in 2017. Further increases are unlikely because the new American government has gone from discussing economic retaliation against China to actually carrying it out. 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 (which hurts bank profits and puts some of them 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. The government has pitched in by tightening credit. That is risky because continued economic growth depends on access to credit. The problem is corruption and there are still a lot of loans being made to those who are credit risks but have the backing of someone powerful and corrupt.

South China Sea

Chinese claims on Filipino territory are asserted relatively discreetly but relentlessly and many Filipinos are persuaded to submit rather than fight. At the same time, a growing number of prominent Filipinos have become more outspoken in their protests and warnings of the damage Chinese domination could inflict. This now includes the sometimes pro-China Filipino president. This drew a public rebuke from China. At the same time China keeps offering economic deals that seem favorable, but in fact, give China more access to Filipino assets or territory in return for not much. China is slowly asserting its possession over areas where it has built bases on seven artificial islands (by dredging up sand). China offers seemingly attractive joint exploration deals to look for oil, gas and other resources in offshore areas where, by international law, Filipinos should be in charge but where China acts like it is already a partner. China offers small gifts (usually of military equipment) and promises of large investments (that often do not appear) and makes loud protests at anything it objects to; like Filipinos displaying banners saying; "Welcome to the Philippines, Province of China." Displaying such banners is legal in the Philippines but not in China. This is the point for Filipinos that Chinese officials don’t quite comprehend.

For nearly a decade, until 2017, the United States refused to pressure China to back off on its claims, even though a UN-backed tribunal ruled that China had violated international law and a treaty China itself had signed, but seizing Filipino maritime territory. China ignored that ruling (“set it aside”) and continued to build new bases and coerce other nations to recognize these claims. Now the United States is challenging the Chinese claims but so far China is ignoring those challenges (American warships and aircraft passing through waters and airspace China insists is now part of China.) Because of the more forceful attitude of the Americans (and British, Australians and others) Filipinos are unsure which is best; resist or submit. Either way, China is going to hurt the Philippines. If there is resistance China will seek to impose economic damage. If there is submission the Philippines loses valuable territory forever.

The Russian Front

Russia is trying to cope with the fact that the newly (for the first time in history) modernized Chinese forces are a long-term threat to Russia. In China, there is lots of new gear and plenty to go around. China has a more effective economy and lots more money. Worst of all for Russia there are many ways to weaponize wealth. Examples abound in far eastern Russia and that is most unwelcome with most Russians. The threat became very real recently when Russia offered for sale or lease a million hectares (2.5 million acres) of unused (abandoned after the Soviet Union collapse in the 1990s) farmland in the Russian Far East. Foreign nations can participate and China is expected to buy up 500,000 hectares (with South Korea and Japan talking over 200,000 hectares). Local Russians protested and pointed out that this would mean more Chinese allowed in to run the new farms and danger to other farms and water supplies because Chinese farming methods rely on the heavier use of pesticides and fertilizer. The Russian government, eight time zones to the west, paid little attention to the complaints.

Chinese entrepreneurs have 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 Russian 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 (where it 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, claims which China revived after World War II when the communists took over China. Those revived claims led to border skirmishes during the 1970s that were halted when Russia made it clear it was prepared to risk nuclear war over the 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. The plans is for China to slowly absorb the Russian Far East economically and demographically (with more Chinese settling in the Russian Far East, legally or otherwise.) Eventually, Russia finds that 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. Despite that threat, Russia has made itself more vulnerable by becoming more dependent on the Chinese currency (the yuan) as a way to deal with the growing list of Western (especially American) sanctions. By selling off euro and dollar-denominated assets (bonds, government debt) and switching to yuan-denominated equivalents Russia becomes more dependent on (and vulnerable to) China. Yes, all is going according to plan

Meanwhile, the most potent threat to Russia is internal. The corruption has been much more extensive than in China and, in comparison to China, Russia has been a much more difficult place to start and profitably run any kind of enterprise. That is one reason why Russian shipbuilding (both military and commercial) is considered below par while Chinese efforts are world class and a major part of the much larger Chinese economy. Same with most defense firms in China. The greater corruption in Russia not only drives more of the local talent out of the country but also a lot of new wealth. China created all of its new wealth with a rapidly developing and expanding local economy and that persuades many talented Chinese expatriates to return. Chinese who made money and preferred to invest it in China. In contrast, much more of the new wealth in Russia (largely because of oil exports) was stolen and illegally moved outside Russia.

Managing North Korea

The North Korean economy is crumbling after several years of stabilizing and even growing (because of allowing some free market activity). Why this irrational and self-destructive behavior by North Korea? It is most likely that the long-simmering disagreements about economic reforms and relationships with China are at the heart of it. China has long complained about the chaotic and self-destructive North Korean leadership. It’s not just the ruling Kim family (who are quite odd but so are many politicians), but the whole paranoid, dysfunctional, unpredictable atmosphere in the north. China is particularly critical of the unpredictability and has been demanding more discipline and, to put it bluntly, obedience. Lacking that, there will be consequences. More Chinese troops have been moved to the North Korean border, and China is less discreet about its network of spies and agents in North Korea. The rumors of a ruthless "China faction" in the North Korean leadership have been given some official recognition by the Chinese. Thus the Chinese are attempting to use the "offer you can't refuse" gambit. It may work and bring about much-needed reforms. Otherwise, the Chinese threaten to pull the plug on all aid and political support and perhaps order the China Faction to take action, with help from Chinese troops, special operations forces and secret police. This would be an admission of failure by the Chinese although they could put a positive spin on it by referring to past interventions to deal with troublesome Korean rulers. At that point, China would have the primary responsibility for rebuilding North Korea. China could appeal to South Korea, Japan and the United States to join in. China would endeavor to make the North Korea economic recovery effort pay for itself by insisting that Chinese investments be respected along with growing Chinese ownership of North Korean economic assets. That will generate anger in North Korea but as far as the Chinese are concerned that is normal when it comes to China-Korean relationships.

There has always been fear among North Korean leaders when it comes to denuclearization (which China wants) growing fear of what China might do if the nukes ware not eliminated. Historically China was always a threat to Korea but since the Korean War (1950-53) North Korea has increasingly (especially after 1991) depended on China for economic, diplomatic and military support. All that is now at risk because the North Korean leaders would not obey Chinese demands. North Korea sees itself in a situation similar to Vietnam, which has also had a historically hostile relationship with China. But now Vietnam is allied with the United States, South Korea, Japan and many other nations against Chinese aggression. China is aware of this North Korean attitude but China has always believed that it was better to be feared and obeyed than to be loved. Meanwhile, Kim Jong Un has often indicated that he feared China more than South Korea or the Americans. China is still the main conduit for imports and exports. Essentials like food come mainly from China but so do smuggled goods (both the items the North Korean government wants and those it forbids). North Korea exports to China, a major source of foreign currency, are down 90 percent so far in 2018 compared to 2017. This has caused growing shortages of foreign goods, which is crippling a lot of construction projects and factory operations. Russia will buy some North Korean exports, but it has to be kept covert and Russia cannot replace China in this respect. North Korea has been able to smuggle in a lot of items, but not as many as it needs because without the exports to China there is no cash for smugglers (who do not offer credit.) The shutdown of North Korean exports to China and restriction on what can be shipped to North Korea has made the North Korean leaders very responsive to Chinese demands. Apparently, the North Korean denuclearization is going to be more convoluted than South Korea, the United States and Japan expected because China is calling the shots. An example of that is China easing up on economic pressure so that it can gain some leverage in the current trade war with the United States.

Chinese Paramilitary Forces Guard Foreign Investments

Building an overseas economic empire consisting of many outlaw operations, in addition to mostly legitimate ones, puts a lot of Chinese at personal and financial risk. Until recently China had few security companies authorized to work overseas and most of the security firms (about 5,000) in China were doing little beyond providing watchmen (some armed) and bodyguards. Overseas this was inadequate, thus the need for Blackwater-type methods and standards. A firm like Blackwater would not be allowed to operate inside China, as it smacks too much of a private army that could be used against the state. That is something that has happened frequently in Chinese history. But overseas is another matter. If the new generation of Chinese security firms misbehave overseas that is something the Chinese can simply condemn and distance themselves from. In the meantime, there are many Chinese overseas investments that cannot operate without adequate security. This is something the local government is often unable or unwilling to provide and those foreign governments are usually tolerant of Chinese security firms because those, and the Chinese investments they protect, can be ordered to leave. This is often self-destructive but that is a risk Chinese firms accept when they operate in areas like the Middle East or Venezuela.

Among those overseas high-risk zones investments that are in need of Chinese paramilitary protection are Iran and Venezuela. In both countries, China is buying its way into control over local oil resources. Iran is in better shape (in terms of internal security and the economy) but is willing to allow China to bring in their own security forces for some types of security (like inside Iranian run oil business operations) while Iranian security forces take care of everything else.

China is obtaining a larger economic presence in Iran by helping Iran deal with the return of sanctions. The economic problems in Iran are partly the result of the Americans resuming most of the sanctions in November, which includes bans on buying Iranian oil. Already Iran is offering discounts to its customers to entice them to defy the Americans. China will, and pro-American Asian nations will get exemptions The United States announced this decision in March and that set off a financial panic in Iran, which was already suffering from massive government corruption and decades of mismanagement of the economy.

European nations that signed the 2015 treaty are showing their businesses how they can legally try to avoid the American sanctions. That won’t work because the major European firms have already done the math and realized that continuing to do business with the United States is worth far more than any new business they can get with chaotic and corrupt Iran. European politicians also fear that the Americans may be right about Iran (untrustworthy, still developing nuclear weapons). China, with the second largest economy in the world, is willing to replace European firms wherever it can and will continue to buy Iranian oil. China, like Iran, is a dictatorship and a police state. While Chinese and Iranian leaders disagree on religion, they agree on much else.

Venezuela has a similar, but more difficult and dangerous situation. China is the only country willing to put up cash and personnel to fix the problem s Venezuela is having running its oil production operations. Mainly this is because Venezuela owes China $30 billion and most of it is supposed to be repaid in oil. China is not optimistic but apparently believes the inept “socialist” government of Venezuela is desperate enough to give the Chinese a free hand to bring in their own engineers, management and skilled workers. The Venezuelan socialists may not agree with all the Chinese terms (like priority in paying off Chinese debt via increased production and giving China a percentage of Venezuelan oil assets), but the Venezuelans have to realize that no one else is willing to do the job and there are few countries that can. In early July China agreed to invest as much as $5 billion in an effort to repair and restore oil production but has only delivered $250 million so far and more cash is dependent on how cooperative Venezuelans leaders are. Apparently, China is not optimistic but sees the situation as worth a try. China has worked with a lot of dysfunctional governments and rulers worldwide and knows how to measure the odds. Venezuela appears to be a longshot, even though it has the largest oil reserves in the world.

The Real War

The anti-corruption effort continues to get a lot of media attention in China. That includes publishing statistics. Corruption investigations have been increasing every year but who gets investigated is still a corrupted process. The number of investigations continues to grow. There were 172,000 in 2013, 330,000 in 2015, and 527,000 in 2017. So far it appears there will be over 600,000 for 2018. While the number of investigations continues to grow the pattern of who is prosecuted and who is punished had not changed. About 90 percent of those investigated for corruption go on trial and only about five percent were punished. Only about 12 percent of those punished were “tigers” (senior officials) while the rest were “flies” (those with no power or clout to avoid prosecution). The government says (quietly, to foreign observers who know what is really going on) that it is really trying to discourage corruption, not create a lot of enemies in its own senior bureaucracy. Thus the need to get maximum popular goodwill from each corruption prosecution. This means equally, or more urgent areas of corruption (like banking and finance) get less attention. It is obvious from the public records of prosecutions that a tiny percentage (fewer than a thousand “Tigers”) of those convicted account for most of the economic damage (several billion dollars known to be stolen). More difficult to calculate is the other damage done by the corrupt tigers. That includes allowing state-owned banks to make lots of uncollectible loans, often to state-owned companies that are not profitable and never will be while state-owned.

Some tigers accused of corruption use bribes and intimidation to avoid punishment, although few are able to keep their jobs. The government prefers to make deals that avoid a trial or prison if the accused can provide evidence of other senior people who are guilty and not known to prosecutors. Those punished most severely are the ones responsible for something that got a lot of people killed. This often results in execution, especially if the offender is a civilian (usually a senior business executive). Another pattern noticed by foreigners (working from public records) is that “tigers” accused of corruption tend to be disproportionately people who had not supported leader-for-life Xi Jinping before he became head of the government and then permanent leader. Those who did support Xi Jinping for a long time and are caught up in a corruption investigation still tend to get punished but in the form of quietly retiring and often allowed to keep much, if not all, of the wealth, they stole. One area where this “friends of Xi Jinping” angle does not work so well is the military. The senior officers accused of corruption had fewer opportunities to support (or not) Xi Jinping, who came up through the civilian and Communist Party bureaucracy. Corruption in the military has been an ancient tradition and there are a lot more opportunities to steal now. Xi Jinping has made it his personal goal to break that tradition, or at least greatly erode the extent of corruption in the military and that means a lot of the accused “tigers” tend to be generals and admirals. For the senior leaders, corruption in the military is important mainly because of the current Chinese military pledges allegiance to the CCP (Chinese Communist Party), not China.

This is no accident because the government is concentrating on corruption prosecutions in areas that most Chinese are angry about and that impacts them the most. This means medical care, pollution, and anything that resonates with most Chinese is under constant scrutiny. What that means is that the government is using opinion surveys (another essential of economic freedom) to determine what areas should get the most attention from anti-corruption efforts. For example, air and other forms of pollution are a big problem and most Chinese encounter it regularly. The pollution is believed to cause over a million premature deaths a year and the censors have been unable to keep Chinese from knowing this or discussing it. Senior officials can buy expensive air filtration systems for their homes and offices, but they and their families could not completely escape the dirty air. So going after any corruption that is related to pollution is a higher priority and right after that comes medical care (where corruption is currently rampant).

August 15, 2018: The United States imposed sanctions on three shipping companies (in China, Singapore and Russia) for taking part in smuggling oil and other items to North Korea.

August 1, 2018: Indian military planners are growing more concerned about Chinese aggression. China uses its economic power to increase its presence, and influence, in nations bordering India, especially Pakistan, Sri Lanka, Burma and Nepal. This is made possible by the much larger (4.2 times) Chinese GDP ($12.3 trillion compared to $2.9 trillion for India.) China has a lot more cash to invest and trading opportunities to offer. That may account for the relatively lower Chinese spending on defense. China spends $229 billion a year compared to $64 billion for India. More humiliating is that while Chinese spending is 3.6 times what India spends but that China only spends 1.9 percent of GDP on defense while India spends 2.5 percent.

July 31, 2018: China put a new type of photo satellite into orbit. Described as the Gaofen 11 optical remote-sensing satellite, this one has a claimed resolution of 10cm (able to capture objects on the surface that are less than four inches wide). Previously only American photo satellites had that degree of resolution.

Once more a Japanese Navy patrol aircraft photographed a stationary North Korean tanker tied up to a Chinese tanker off the Chinese coast and apparently transferring petroleum. This makes at least three times Japanese aircraft detected (and photographed) North Korean tanker doing these transfers in the East China Sea. The UN has put sanctions on a growing number of cargo ships and tankers but these vessels can still do transfers at sea. This takes longer, is still illegal and is increasingly being witnessed (and photographed) by American, Japanese or South Korean patrol aircraft. China responded with new rules making it more difficult for Chinese companies to get away with the false paperwork, turning off the automatic ship tracking devices and other scams North Korea uses to illegally export items to China. At the same time, China and Russia are blocking UN efforts to investigate this sort of violation.

July 23, 2018: There was another “dangerous food and drugs” scandal as police raided offices of Changsheng Biotechnology, the second largest supplier of vaccines in China. The company was accused of selling unsafe medicines and getting away with it by bribing government inspectors to ignore evidence of poor quality control that results in ineffective vaccines. This is the latest of many such scandals involving dangerous food products or medicines. It is why the government has been so energetic in its anti-corruption campaign but also evidence that the “war on corruption” was not going as well as the government was reporting. This latest incident was so scary that even North Korea refused to buy low-cost medicines from China because of the growing popular belief (in China and North Korea) that too many Chinese made drugs were probably ineffective.

July 22, 2018: In North Korea, satellite photos show that recently (2015-16) built facilities at the west coast (Sohae, near the Chinese border) rocket launching site is being dismantled. This facility was built for launching the longest range, multi-stage ballistic missiles. This dismantling was apparently something Kim Jong Un agreed to do when he met with the American president in June. North Korea has since become less enthusiastic about actually getting rid of its nukes.

July 21, 2018: The Philippines received another gift from China; four 12 meter (38 foot) coastal patrol boats (armed with some 7.62mm machine-guns) and 200 grenade launchers. China provided a week of training for 25 Filipino sailors who will operate the boats.

July 20, 2018: A South Korea bank reported that the North Korean economy shrank 3.5 percent in 2017. This was the second largest annual decline ever. The previous record was 6.5 percent in 1997. The decline is expected to continue in 2018.

 

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