Guest Post: China 2.0 Is in Trouble

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Despite the many differences between China and the U.S., their basic problems are remarkably similiar: an economy that increasingly serves a tiny Elite, and a political/financial system that is incapable of meaningful reform.

 
Setting aside the latest bird flu outbreak and sagging indicators of growth, China 2.0 is in trouble (with 1.0 being the Communist era of 1949 -1977 and 2.0 being the modernization/globalization era of 1978 - 2013), for it remains overly reliant on unsustainable growth dynamics.
 
The following is my summary of the excellent talks given by Jim Chanos and Michael Pettis at Mish's insight-packed Wine Country Conference in Sonoma earlier this month. (Any errors in presenting the speakers' views are of course mine.)
 
Here are Chanos' lecture slides and interviews with Chanos and Pettis:
 
Michael Pettis observed that he'd spent time in Haiti earlier in his career, and pockets of poverty in China today equal those he'd witnessed in Haiti. Experienced China hands know the central government takes pains to limit media exposure of this level of poverty, as it reflects poorly on China's claim to being a superpower.
 
He then described in some detail how the Chinese leadership has created a "no-win" policy by encouraging a dependence on fixed investment to fuel rapid growth of GDP. If it shifts income to households to enable more consumer spending, GDP growth will decline. But if it continues borrowing and spending on increasingly marginal fixed investments, growth will also slow.
 
In effect, China has suppressed wages to fuel GDP growth. Financial repression (low interest rates) has further suppressed household income and encouraged misallocation of capital on a vast scale.
 
Pettis said the Chinese government is pushing a "go west" campaign. While "go west" worked in America's development, it failed miserably in Soviet Russia and Brazil. The difference, he said, is that in America, the private sector moved west and the government simply followed. In China, Russia and Brazil, the government pushed infrastructure west but without private-sector participation. Pettis reported that private sector contractors go west to build the infrastructure and then return east once the work is done.
 
In Pettis' view, the key metrics are debt and the ability to service debt: if debt is rising but the ability to service that debt (disposable income) is stagnant, then the system is unsustainable. He said this is the case in China: debt is rising but the ability to service that debt is not.
 
Given the political power of the state-owned enterprises (SOEs), China's political and financial systems do not have self-correcting mechanisms. Such mechanisms require transparency and feedback that is lacking in China.
 
Pettis flatly stated that the PBoC (China's central bank) is insolvent. Debt levels are high and much of the collateral is impaired.
 
He also noted that pollution is estimated to shave 3.5% off GDP annually, which means that if the 7% reported GDP growth rate is overstated, as many believe, then actual GDP growth after accounting for environmental damage might well be zero.
 
 
Jim Chanos addressed a number of financial and real estate issues. In the last downturn in the late 1990s, he noted, 40% of outstanding loans in China went sour. People in China only have 15 years' experience owning property, and so they have no experience of either a housing crash or long-term maintenance of housing.
 
One of the attendees asked: since China's population is ageing, doesn't the overbuilding of residential real estate make sense? That is, invest in housing now, anticipating that in 10 years more national income will have to be devoted to caring for the elderly?
 
Chanos' response was succinct: "Most of the buildings in China won't be livable in 10 years." His point was that the infrastructure required to maintain buildings is undeveloped in China: most highrise residential buildings do not have a functioning common-area expense/maintenance system in place. If the elevator breaks, there is rarely money set aside to fix it or a person responsible for making it happen.
 
The quality of construction in China, though greatly improved by some accounts, is still sketchy; Chanos said that when a bridge recently collapsed, inspectors found that the reinforcing bars that were supposed to be in the concrete were missing. This might be an extreme example, but the basic point is that much of the money poured into construction over the past decade has not produced a product that will last 50 or 100 years.
 
Wealthy Chinese people often visit him in New York, Chanos reported, and there is one striking blind spot in their grasp of real estate. None of the visitors are aware that uninhabited buildings decay. The average middle class household in China is sinking all their savings into investment flats, assuming real estate will be a durable store of value, without understanding that these vacant units degrade. At some tipping point, entire buildings could become unlivable as elevators break down, leaks feed mold, etc.
 
The store of value is a chimera unless the building is actively maintained, but maintenance is not yet part of the culture.
 
As for the "if we build it, they will come" narrative that underpins the China Bulls' case, Chanos said that there is already 15 square meters of empty space per capita in China, meaning that there is 135 sq. ft. of empty interior area per person in China, and another 10 billion square meters is under construction.
 
Housing is already astronomically high in terms of the average urban annual income-- the annual income/cost of a flat ratio is higher in China, even in 2nd and 3rd tier cities, than in high-cost locales such as London and New York.
 
Most of China's populace cannot possibly afford the tens of millions of flats being built or sitting empty.
 
Chanos also noted that repression is not just financial; China spends more on internal security than it does on its military.
 
An estimated $2.7 trillion in private wealth has left China in the last decade. This is roughly 22% of China's $12 trillion GDP. What does this say about the leadership's faith in their system?
 
As a matter of "face" and policy, China's leadership focuses almost exclusively on GDP growth; GDP is the tail wagging the dog, Chanos noted, and it leads to absurdly unproductive allocation of credit and capital to projects that will never earn the cost of that capital.
 
The easist way to boost GDP is to put a shovel in the ground--build something, anything. That has been China's strategy for 20 years, and it is now yielding diminishing returns.
 
Add all this up and you get a clear picture of a government and economy that is incapable of making the kind of structural reforms that are needed to make growth sustainable. My conclusion is that despite the many differences between China and the U.S., their basic problems are remarkably similiar: an economy that increasingly serves a tiny Elite, and a political/financial system that is incapable of meaningful reform.

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Lohn Jocke's picture

But the U.S. is just fine.

Jam Akin's picture

Always believe the guys who are talking their books.

ParkAveFlasher's picture

My father used to tell me, "eat your food.  People are starving in China."

30 years ago.

Dr. Engali's picture

Now a mother in China is telling her kids" eat your food. People are starving in America".

The Abstraction of Justice's picture

Now a mother in England is telling her kids, 'WTF I don't have any kids'

Richard Chesler's picture

"an economy that increasingly serves a tiny Elite, and a political/financial system that is incapable of meaningful reform."

 

So what's the problem peasants?


Jack Napier's picture

No problem. You are crunchy and taste good with ketchup.

ronaldawg's picture

an economy that increasingly serves a tiny Elite, and a political/financial system that is incapable of meaningful reform

I love it when an author repeats the EXACT same words twice because we are too stupid to get it the first time......

AlaricBalth's picture

The US has become a third world banana republic with a first world appetite.

JustObserving's picture

American workers are now three times more likely than Chinese workers to lack the means of feeding their families, according to a startling new report from the Gallup organization. The polling group found that 19 percent of Americans worried about being able to feed themselves or their families, compared to only 6 percent of Chinese.

http://www.wsws.org/en/articles/2011/10/hung-o17.html

IridiumRebel's picture

The Chinese can grow food whereas Americans have a tough time growing doritos.

ParkAveFlasher's picture

Bro, you ever try rinsing the dirt off a dorito?  NOT EASY.

akak's picture

Plus, there's all those Dorito worms to contend with, and having to frequently fertilize them with crap, and make sure that the soil has the proper ratio of partially-hydrogenated oils, and the need to constantly replenish all the salt after a rain.  I say it's too much work.

ronaldawg's picture

Sure right - there are more Chinese NOT WORKING than the entire population of the US.  I guess if everone ate rice and dirt than everyone would be able to eat like the Chinese in the US.

Tulpa's picture

You seem aware that the US is a massive food exporter.

prains's picture

That's what happens when you let your corporate elite take your jobs to china, but hey you have to be free to do whatever is good for you right? fuck your neighbor

ronaldawg's picture

My neighbors are two Italian sisters: 19 and 20 years old.  Yes I want to fuck my neighbor(s).

akak's picture

Better plan on doing some thatching first.

Tulpa's picture

Keep in mind that the average Chinese worker considers a daily diet of 2000 calories, 90% from rice, to be perfectly acceptable.  Most American workers would disagree.

IridiumRebel's picture

Few are starving in America. SNAP assures us so. Roughly 50 million starved in Mao's "Great Leap Forward". Give it time though. The Left are working hard to mimic Chairman Mao.

Oh regional Indian's picture

Some of us were this pre-scient in 2008 and before. This was me in 2008, note the china/india line please...

 China is staggering under its own curious set of circumstances of a large population set “herded” into rapid “development” mode, much like India.  Most of the “gains” are hype. Credit, cheap and plenty until recently (private equity had moved it into the right hands in preceding years), being the sole driver (flogger?) of growth.

 

v The sub prime mess (and all its attendant tentacles of cause and effect in the world financial systems) is scary with just the lit fuse sparking.  When it really goes off, all bets are off.  Talk of lack of understanding of higher order cause and effect.

v Energy prices are reset in the public mind at dizzying rate (12 dollars a barrel of Brent Sweet Crude is not such old memory), currently 130 dollars a barrel.  Associated inflationary impact is hitting the majority of the world’s population.

 

v On a similar somber note, a discussion on our world’s geo political situation. Every major war in history was a resource war as is every major conflict today. There is a relentlessly hawkish bias in the global dialogue, with too many vested interests in the war – pie.  Oil, minerals, territory / markets and now water. Also, in large theatre wars, multi-generational trauma creates multi-generational conflicts.  Grim but true.

 

v An increasingly nuclear world adds the requisite potential for a runaway reaction!  Our world is ever increasingly polarized with ever greater potential for conflict.

ori

World View on 24th June 2008

 

Seer's picture

"Every major war in history was a resource war as is every major conflict today."

Warms my heart when I spot someone who truly gets it.  It's a linchpin.  When viewed as such it informs us that we actually DO live on a finite planet: and I'd hope that this awareness would help us guard against the "growth hucksters."

BraveSirRobin's picture

The excess housing problem is nothing a good war couldn't fix. Blow it all up, then rebuild it.

ronaldawg's picture

WTF I said that two days ago about Europe and Japan and got down arrowed 10 times.

Seer's picture

People are fickle.  Surprised?

Schmuck Raker's picture

You didn't bother reading the first sentence, at least?

earleflorida's picture

for second there, i thought you were talking about america

kliguy38's picture

Yup China is cooked...but when the smoke clears, we'll just be green glass..........

de3de8's picture

Kinda like here.

Dr. Engali's picture

"This might be an extreme example, but the basic point is that much of the money poured into construction over the past decade has not produced a product that will last 50 or 100 years."

 

Tell me anything we build here that will last 50 or 100 years. Fuck we blow up a 20 year old football stadium to build a bigger and better one to blow up later.  

 

Speaking of blowing up..the twin towers sure didn't make it 50 years.

ParkAveFlasher's picture

Great point.  BTW all, the company I work for is moving into the Empire State Building.  Yeeeeaaa me.  The floors we will occupy have been converted to a minimalist, open workspace with strict restrictions on the allowable mass of polluting and/or flammable material.  No, really.

Do any ZHers have any recommendations regarding OTC products for surviving flames, falls, dirty bombs, JHP volleys, etc?

Jam Akin's picture

Don't move to China though.  

Cthonic's picture

Semtex and abseiling gear.

Seer's picture

You've gotten ahead of yourself.  You need to rewind back to the fundamentals: Food, Shelter and Water.  The path from there is much easier to decipher...

NotApplicable's picture

Those football stadiums don't fall down, though. They are blown to smithereens via the magic of Keynes, financed by the magic of ZIRP.

JOYFUL's picture

Tell me anything we build here that will last 50 or 100 years.

Xactly\;  these kind of chat sessions from guys who think their job is to deliver all the ' real bad news' are just hilarious...ly outta touch. The markers that they are using as yardsticks are imported from a set of cirumstances unique to a period of western*history now over a half century old - and as applicable to china in the following millenium as fur is to fish...

And the comparative spirit, it is interesting to note...always goes one way. Were we to look at ourselves through the lense of the other...several milleniums old cultural continuum, we would be amazed at would could learn about our own oddities, foibles, and serial errors of judgment & intent. But why bother...it's easier to turn the microscope around and look always the other way...at a subject where - conveniently - our target 'audience' knows so little, that one can pose as an informed 'expert'...without really trying...as in going out of one's way to incorporate perspectives more useable, and applicable, to the study at hand. Instead of talking like a C19th anthropologist mongst the Trobriand Islanders!

Are China's current challenges the result of

an economy that increasingly serves a tiny elite, and a political\financial system that is incapable of meaningful reform?

No...that was in fact the story of the so-called China1.0...when a western backed and educated "Communist" elite stole a  country already pillaged by pirates of the pinstripe persuasion...and turned it into a giant experiment in failed economic policies and thought control. The gradual liberation from that failed state...without bloodshed...is a minor modern miracle. And success story so underrated by those who stray into the zone with an urge to see nothing but either the 'failed state' legacy...or a new satrapy of the moneypower empire asto be almost impossible to evaluate objectively in the west.

The putative China 2.0 of this piece is unrecognizable in all this bafflegab done up as an 'analysis' - today's China is not in need of 'proving itself a superpower' lads...rather it is intent upon rolling up the residue of another, rapidly fading one...and supplanting it's hegemony with a regional base of trade and development which can workably provide a basis for a new multi-polar power structure that leaves the sionist hegemonist script out in the cold!

*and "eastern" and 'southern'...had to laugh at the SovietRussia go west reference...was he referring to the Warsaw Pact as a trade organization>|?

 

 

 

  

ronaldawg's picture

LA Coliseum, Hollywood Bowl.  Only know that because there are pictures in the hallways at the office building I work in.

Atticus Finch's picture

Keep in mind that Zhou Xiaochuan, Beijing reports to the Bank of International Settlements just as Bernanke and William C. Dudley. See https://www.bis.org/about/board.htm

Especially read the Code of Conduct to clarify whether any of them are working in the interest of the home nation or the interest of the BIS.

LawsofPhysics's picture

Let's see, what happened the last time a rising mercantilist/socialist country was in a similar situation?  Hhhmmmmm....

China will do anything to protect it's manufacturing power and competitive edge, they are a (forcibly) united people folks.

Tulpa's picture

It's easy to be united when the pie is growing.  Politics in the PRC is mostly done behind closed doors so outsiders like us don't see how many fractures there are in the facade of unity... when the pie stops growing you'll see they're just as disunited as we are, if not more.

LawsofPhysics's picture

Yes, now finish your thought.  Whereas Americans blame each other, due to the "two-party" meme, who might the Chinese people blame? What would the propoganda tell them to do?  The are a of single mind when it come to accepting instructions from the state.  Go ahead, finish your analysis.

Tulpa's picture

The government isn't even united, and that's while the pie is growing.  It's a short trip from up and coming political player in the PRC to being under house arrest facing murder charges.  We've seen that already.

I don't share your faith in the Chinese people continuing to unquestioningly accept instructions when the going gets rough.  They've tasted 21st century living and they aren't going to give it up so easily.  And of course that's assuming the govt itself is united; hard to predict with no charismatic leader really available.

i-dog's picture

 

"The[y] are a of single mind when it come to accepting instructions from the state."

LOL ... project much? A more untrue assessment of the Chinese could not be made! I suspect it could well have been a chinaman who coined the phrase: "You pretend to pay us, and we'll pretend to work".

The Chinese have been successful and peaceful traders - ie. entrepreneurs and free agents - for hundreds of years before western Europeans broke the chains of feudal serfdom ... and they haven't changed their basic nature, notwithstanding their subjugation under Khazarian-instigated communist rule since 1948 (and earlier during the Ching dynasty - another Khazarian-instigated takeover that [coincidentally] began just across the water from Japan and just 5 years after the Jesuits had been expelled from Japan in 1639).

Ruling the Chinese is somewhat akin to herding cats.

Seer's picture

Yup!  It all works as long as there's growth, when there's treasure to split up.

Capitalism, communism, whatever-ism, if it's predicated on pushing perpetual growth on this here finite planet then it is nothing but FAIL!

Seer's picture

"China will do anything to protect it's manufacturing power and competitive edge"

Can there be competition when there are no customers?  Can't push on a string...  That's why they've turned inward to internal consumption (now then, where have we seen this story play out?); and when they're energy poor this is surely going to turn out to be a very short run.

maskone909's picture

been to detroit lately?

Dr. Engali's picture

I don't need to go to Detroit. The degredation around here has been astounding over the last four year. This city used to do a great job maintaining the roads. Now some of them are like driving through a field. There are  houses in nice neighborhoods that have been vacant for years, and the well manicured lawns aren't what they used to be.

NotApplicable's picture

Meanwhile, I see thousands upon thousands of apts. being built to house the stupids coming to town to get in on the student loan lifetime impoverishment program.