Gordon G. Chang is the author of The Coming Collapse of China and Nuclear Showdown: North Korea Takes On the World. He is also a contributor at Forbes.com and blogs at World Affairs Journal. He lived and worked in China and Hong Kong for almost two decades, most recently in Shanghai, as counsel to the American law firm Paul Weiss and earlier in Hong Kong as partner in the international law firm Baker & McKenzie.
You can follow him on Twitter @GordonGChang
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The Chinese economy, according to most analysts, has gone through two phases:
Phase #1: The turbulent decades dominated by Mao Zedong.
Phase #2: The time of “reform and opening up,” started by successor Deng Xiaoping.
Now China’s economy has passed important inflection points and is in the third phase: collapse.
There are two broad reasons for the transition to the third stage.
First, apart from changes required by World Trade Organization membership, liberalization stagnated under Hu Jintao, China’s supremo from 2002 to 2012. The latter years of Hu’s rule were even marked by the general reversal of reform.
Hu, a relatively weak leader, surrendered the initiative to state enterprises, which moved to close off opportunities for foreign business in China. During this time the Chinese central government pushed the notorious “indigenous innovation product accreditation” rules, which in many ways defined Beijing’s efforts to seize technology and know-how from multinationals.
The second reason was Premier Wen Jiabao’s state investment program, initiated in November 2008. Wen, to minimize the effects of the global downturn, sponsored a $486 billion stimulus plan, which accompanied a much larger effort by the state banks to channel cash to local governments and state enterprises.
The plan, inevitably, starved private business of credit. State enterprises, spending large amounts of dough, became especially influential in Beijing, and they used clout to partially renationalize the economy. The Communist Party had, in effect, become the arbiter of the economy.
As such, the Party made sure there was growth. Beijing built high-speed rail lines to nowhere, and localities put up “ghost cities.”
In my dad’s hometown of Rugao, a small city in Jiangsu province across the Yangtze River from Shanghai, state money transformed a dusty town into a metropolis of office towers, an uncountable number of 20-story apartment blocks, a stadium almost large enough for an NFL franchise, and wide boulevards densely lined with street lights… all in just five years.
“I don’t know where all the people will come from,” an elderly Rugao resident told my wife last year.
The problem: China’s current investment-led growth is not sustainable, a fact evident in a sharp fall off in the efficacy of state spending.
In 2007, China created 83 cents of output for every dollar of investment. That figure had fallen to 17 cents at the beginning of last year, and now it is probably no more than a dime.
This has resulted in sharply lower growth rates.
China was last in double-digit territory in 2010, when the economy expanded 10.4%, according to official estimates. The National Bureau of Statistics reported 7.7% growth for last year, but independent data and surveys reveal the real figure was in the low single digits.
Whatever the real rate was, Wen and his successor, Li Keqiang, incurred indebtedness at unprecedented speed, perhaps at a 25% clip. The country, as a result, has been accumulating obligations two- to seven-times faster than its economy has been expanding, putting itself in an impossible situation.
Today total country debt is probably more than 300% of gross domestic product. This is dangerous territory.
It’s clear China must transition from investment-led growth to consumption-driven growth, yet, since 2008, its economy has been headed in the opposite direction, thanks to the massive state stimulus program.
China’s leaders, however, are implementing only minor reforms. They’re not willing to tolerate a significant decline in growth that the investment-to-consumption transition would initially cause.
Every time there appears to be a slight downturn in growth — as occurred at various times this year, for instance — Beijing spends more government money, making the economy even more state-oriented.
Chinese technocrats are trapped, unable to implement structural reform.
The resulting continual need for stimulus is a sure sign the economy has reached the limit of what it can accomplish within the confines of the existing growth model.
The inability to implement change means China must have a crisis, a point on which Harry Dent and I agree.
Only a minority of analysts sees a crash as virtually inevitable, yet those who think Beijing can engineer a “soft landing” understand that the price for avoiding a disaster now is years or decades of stagnation. Yet because of the rapid buildup of debt, an era of low growth nonetheless must result in a sharp adjustment downward.
Mark these words: China is transitioning from a high-growth period to a low- or no-growth one, and there are no good outcomes to this.
And I’ll talk about what this third phase of the Chinese economy will mean for you, and your investments, when I speak at the Irrational Economic Summit in Miami this October 16 to 18. China’s failure changes the world, probably overnight.
So don’t be surprised that most every assumption we make about the direction of markets will become obsolete.
Hope to see you there.