By Lawrie Williams
This rather long article was first posted on sharpspixley.com a day ago. I am now posting it in a slightly edited form here on lawrieongold.com as it makes a number of significant, and valuable, observations on how one should look at China’s economic reboot and that China has entered a predictably painful long term restructuring of its economic model which will catapult it into a far stronger global position in the years ahead and probably usurp America’s current position as the top global financial powerhouse. I am hugely indebted to Simon Hunt of UK-based Simon Hunt Strategic Services for much of the content here. His analysis of what is going on in China is something I value most highly and really gets to grips with understanding what the Middle Kingdom is achieving and how it views U.S. financial policy.
Excessive negativity about China is not supported by fact
The following comments are taken directly from Hunt’s analysis of what is really going on in terms of Chinese economic policy to, in part, deal with counter measures put in place by the US Administration which would like to maintain its global economic dominance. Hunt has been one of the most astute of China watchers over the years and visits the country frequently in pursuit of his analytical advice – largely with respect to the country’s huge impacts on the global resource sector.
He deplores the manner in which many analysts and commentators have covered the printing presses with an aura of pessimism with regard to the Chinese economy. He feels that what is going on in China is either misunderstood, ignored or designed to encourage a massive fund outflow that could destabilise the country’s domestic economy. The latter he considers as just another tool in Washington’s geopolitical kit-bag.
Hunt comments that it is easy to forget how important China has become to the global economy and its financial system with so much pessimism being put out by politicians, their tame economists and the media. He feels that integrating China into the world structure would be a win-win option for us all but it would imply the end of the USA’s domination of the world and its continued hegemonic aspirations.
And he sees this as the nub of the problem: America wants to stay King-Pin. China has long since recognised that America does not want to share power with anyone so set up its own institutions with other countries who share similar views by creating the New Development Bank (BRICS), the Asian Infrastructure Development Bank and cementing ties with Russia and other BRICS and SCO members.
Evolving slowly is a network of countries across that great landmass stretching from China and Russia’s east coast across central Asia to Eastern Europe, in the south linking India, Afghanistan, Pakistan and Iran together and in the north across the Arctic Circle into one gigantic grouping that Halford Mackinder called the ‘Heartland’ in 1904. And it is this grouping of countries, Hunt avers, that America fears as the bioggest threat to its current global economic dominance.
The peace dividend after 1991 which resulted from Russia withdrawing from much of Eastern Europe was blown away in an orgy of consumption, leverage and speculation resulting in the financial hangover of 2008/9 – that still lingers on – leaving us with the geopolitical fallout. This includes the rise of the Muslim world with their internal religious wars that could soon climax together with the rise of China as the country begins to rival the existing global emperor (represented by the US Administration). This growing competition between two super-powers need not end in war which is how nearly all empires from the Old Kingdom of Egypt’s empire in 2400BC have so done (the British Empire was a notable exception as it negotiated its way out of it) but the longer that America pursues its hegemonic cause the greater will grow that risk.
China’s growth has been nothing short of miraculous since the economy started to be opened up in 1979, even less than four decades ago. The country’s share of global GDP was then only 1.5% and a mere 0.8% for global exports. But, last year China accounted for 16.479% of global GDP compared with America’s 16.277% and the EU’s 16.939 according to the IMF. In contrast Japan’s share was 4.48% and Germany’s 3.39%.
Hunt sees it as a given fact that China will succeed the EU in having the largest share of the world economy this year. In so doing China’s share of world manufacturing grew from 3% in 1998 to 21% in 2013. In the process it has built up the world’s largest reservoir of engineers and skilled labour, the world’s longest high-speed rail network and the largest network of expressways. The country’s 150 million manufacturing workers compare with 14 million in the USA, 9 million in Japan and 4 million in Vietnam. Her supply chain includes over 140,000 machinery suppliers, 75,000 companies in the communications and equipment industries and 104,000 in the transport equipment sector, all connected by an efficient road, rail and air transport system.
Much of China’s manufacturing success is due to this deep network of suppliers, large skilled labour force and its well-developed logistics infrastructure. The system has allowed Chinese manufacturers to drive process innovation and to benefit from operational scale. The system allows companies to respond rapidly to changing consumer demand and the introduction of new and cheaper components. It is this sophisticated manufacturing and logistical network that will make it very difficult for other countries to compete with China.
Two problems arose from the success that China achieved until recently. First, too much new capacity was created which meant that there was no pricing power and for many if not most companies an inability to achieve real profits.
The new leadership recognised this risk to economic growth and laid out a plan soon after coming into office. Credit would be tightened up; the gung-ho years of easy finance for real estate developers would be stopped. In the ensuing fray the weaker companies would be allowed to fail thus restructuring the entire manufacturing sector in the process forcing China’s manufacturing companies to retain their global competitive edge. At the same time the low value-added goods segment of exports would be encouraged to move offshore.
And this is where China is today – in the midst of a massive transformation of its economy, one that was planned and implemented some two year ago.
What is really interesting is that productivity within the manufacturing sector is set to rise rapidly as companies deploy state-of-the-art automation and robotic systems. In fact manufacturing labour compensation per hour has risen by as much as an average of 11.9% a year in the period 2001-2012 (in local currency terms) according to a detailed study conducted by the EIU. Labour costs will continue to increase at least at historical rates if not higher. The EIU study shows that manufacturing earnings per hour averaged US$2.1 in 2012 in China but US$35.7 in the USA leaving plenty of room for labour in China to negotiate higher wages without losing the country’s competitive edge.
It’s pretty clear then that China will remain a large exporter of goods but focusing on higher value-added products. Its sophisticated supply chain and its deep logistical network remain unsurpassed. It is also one that has allowed China to dominate the global market for consumer goods. For instance, China’s share of the global market for personal computers is 91%, for air conditioners 80%, for toys 75%, for shoes 63% and so on.
The second development was caused by the horrendous surplus capacity that has invaded virtually all sectors of manufacturing. Many manufacturing companies together with those in other sectors such as real estate, base metal smelters etc started to hide negative cash flows from their banks by continuously revolving Letters of Credit, whether 90, 180 or 360 days until the Chinese Central Bank (The PBoC) finally stamped on this trade early this year. The sums involved were simply gigantic, anywhere from 15-25% of GDP according to informed people. Many banks, financial institutions and metal merchants plied this trade feeling it would remain a permanent feature of the global landscape. But success breeds greed and corruption and so the Qingdao scam shook these players resulting in the PBoC finally stamping out this business.
The skeletons both domestically in China and internationally are only just starting to surface. To grow from accounting for only 1.5% of world GDP in 1979 to over 16% now required two important ingredients: imported commodities and credit. To take a few simple raw material examples: China’s share of world consumption of aluminium is 54%, coking coal 59%, copper 48%, iron ore 64%, zinc 46% nickel 50%, cotton 31%, rice 30% and corn 22%. How China’s economy grows in future thus will have a large impact on global commodity prices.
In effect China has a two-pronged economy. The first is the manufacturing sector that made China the great economy it is now but is deliberately being hollowed out to enable pricing power and thus real profits to be achievable. So this sector which accounts for about 43% of the economy is suffering with much of it in recession. The other side is a continually growing consumer society with a huge, and sustainable, growth in its middle class-middle income sector which the country sees a becoming the dominant force in the economy in the years to come.
Manufacturing allowed average household incomes to more than double in the ten years to 2014 averaging $9,290 in 2013 dollars so giving a powerful thrust to consumer spending and the services sector. What’s interesting is that average household income should continue to increase by about 150% to $23,000 by 2024, again in 2013 dollars.
China’s debt is large, last year totalling some $29 trillion compared with the country’s GDP of $10.4 trillion. China’s savings too are large accounting for 49% of its GDP or just over $5 trillion. Its economy is probably actually growing at about 5% a year so savings are probably rising by $0.5 trillion this year.
Debts of this size with such a high savings rate and with an economy growing at 4-5% a year over the coming decade is not a big problem. The bigger issue is the structure of that debt. Much of this debt, especially local government debt, is expensive on a term of around two years. Lower interest rates which need to be reduced closer to international rates as the capital account is opened up together with extending the maturity of these loans, as is being done, will make the debt quite manageable.
On the Chinese currency, the country’s leadership wants its currency to be used far more internationally. They don’t trust the US dollar or the American government to use the dollar’s reserve currency status other than to their own advantage which means weakening it over time. Their own International Payment System will be operational before year-end and next month they will open a trading platform for oil and gold in the Shanghai FTZ with quotes in dollars and Yuan.
As a result, Hunt reckons that quite soon the Petro-dollar will be all but dead. And quite soon as well China will want imports to be paid for in Yuan. Last year the import bill came to $2 trillion. Such a move will have huge implications for global currencies especially since China has a large fortress of gold unlike the USA which, Hunt arguably avers, has squandered most of is gold holdings away. Maybe it has, but maybe it hasn’t
Hunt also picked up recently on a fascinating speech by Chinese General Qiao Liang – the strategist for the Chinese People’s Liberation Army and one who will undoubtedly have the ear of President Xi. This was particularly interesting as it set out some of the Chinese attitudes to, and understandings of, US policy towards China. He likened US diplomacy to boxing – “a direct hit with full strength and the hope of knocking the opponent out. The Chinese are quite the opposite. They prefer ambiguity and using softness to conquer strength. One doesn’t seek to knock his opponent out but he will defuse all of his opponent’s attacks. Chinese like Tai-chi which is a higher level of art than boxing.’’
Perhaps even more interestingly Qiao views view the Ukraine crisis as being stimulated by the US to generate capital flows from a thus-destabilised Europe back to the US, but that the capital flows went to Hong Kong instead and thus the US precipitated the Hong Kong “Occupy Central” disturbances to help stimulate the return of this capital to the US. Now whether this is the case or not, the fact that the Chinese believe it to be so is key here. In Qiao’s opinion “The US needs a large amount of capital flowing back to sustain its daily life and its economy. If any country blocks that capital flow it is the enemy of the US.”
Will China be that enemy? ‘’The fights over the Diaoyu Islands and the Huangyan Island are seen as the US’s latest attempt to suppress its challenger….they pushed the Japanese to create an issue over the Diaoyu Islands and they supported the Philippines to confront China over the Huangyan Island” said Qiao.
These occurred at a time when at the start of 2012 China, Japan and South Korea were close to reaching agreement for a Northeast Asia FTA and in April of that year China and Japan had also reached a preliminary agreement on currency exchange and on holding each other’s national debts. Had the NE Asia FTA been established which would have included China, Japan, South Korea, Hong Kong, Macao and Taiwan it would have been the largest world economy with a GDP of $20 trillion and would then have integrated with the ASEAN FTA so making an economy of $30 trillion, more than one and half times that of the USA. If the NE Asia FTA had been allowed to succeed it would have ended America’s dollar hegemony. ‘’The US has created troubles for China everywhere. It has only one goal in mind: nullify the trend of China’s rise.’’
But China could be a dangerous opponent – not necessarily militarily, but economically - as it appears to have grasped the fact that global financial change is inevitable with the rise of the Chinese economy. A new ‘’big era’’ is coming and that the financial empire that the US has created will soon come to an end. America is too focused on retaining its dollar hegemony to see the changes that are coming.
Apologies for the length of the above article, but there are so many aspects of current ‘Great Game’ politics as viewed by the two current major global superpowers that are so important to the economic future of the entire world and this sets out a viewpoint on China and Chinese thinking not much covered elsewhere.