The worrying thing about China…
China’s rise has been relentless over the last four decades. But where is China really heading? Victor Hill investigates some important recent developments out East.
The rise and rise of the Chinese dragon
First off, let us give credit where it is due: China’s achievement over the last four decades has been monumental. The China visited by President Nixon in 1972 had an economy a small fraction of the size of America’s and had a largely rural population living in poverty. When Mao Zedong died in 1976 China was the most populous nation on Earth but still largely closed and of little importance in world affairs. Today, China is the second largest economy in the world and is knocking on America’s door – economically, politically and militarily.
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2019 marks the 40th anniversary of China’s opening up to the world. Since then 740 million people have been pulled out of poverty. China’s GDP has grown by an average of 9.5 percent over the last 40 years and is now 33.5 times bigger than it was in 1979. The Chinese economy now represents 15.2 percent of global GDP as compared with just 1.8 percent 40 years ago. Disposable incomes have increased by 22.8 times. Average life expectancy is up from 67.8 in 1981 to 76.7 today. Ordinary Chinese people have access to state retirement pensions, healthcare and social housing.
One of the most striking aspects of China’s development is how global it is. China has received more than $2 trillion of foreign investment over the last 40 years and has funded a similar amount of its own investment overseas. China is the largest trading partner of about 120 countries across Asia, Africa and Latin America. The Belt and Road programme is all about consolidating those trading relationships through foreign direct investment and the development of infrastructure, using Chinese construction companies, of course.
A slowdown with Chinese characteristics
The clip of Chinese GDP growth has been attenuating of late, however, since before Mr Trump began to slap tariffs on Chinese exports to the USA. From double-digit growth in the 1990s the rate fell to around 8 percent before the global financial crisis of 2008 and thereafter to just over 6 percent. This year Chinese growth is likely to bottom out at around 4 percent according to Capital Economics. Berenberg Bank thinks that Chinese growth has already fallen to just 3 percent. A Renmin University professor has even suggested that Chinese growth has already gone negative: his lecture went viral before the state censors pulled it from the internet. What has gone wrong?
After the financial crisis the Chinese authorities encouraged banks to lend to Chinese businesses on a profligate scale to forestall a slowdown. This has resulted in debt saturation. The ratio of corporate debt to GDP has risen from 95 percent to 160 percent in ten years. In 2018 there were a record 119 bond defaults in China’s corporate sector. The latest firm to run into trouble is the property developer Yingyi Co. Ltd. (SHE:000981) which failed to redeem its outstanding 3-year bonds in the last week of December.
The Chinese PMI for December fell below the critical 50 level to 49.4. There are reports that Chinese exporters have accelerated shipments to the US in order to avoid expected increased tariffs in the near future, meaning that Q1 2019 export numbers are likely to fall. Car sales in November were 16 percent down on the previous year and corporate profits are also down.
Nomura recently warned that China is leading much of East Asia into a credit crunch given waning liquidity, falling property prices and deflation in some countries in the region. In Hong Kong property prices dropped by 3.5 percent in November – the steepest fall since the financial crisis. That is particularly significant in a property market which is highly leveraged – and where interest rates are rising.
China’s managed slowdown is proving harder to stabilise given the trade war with the USA – despite the recent truce further to the G-20 summit in Argentina and the promise of a deal. The People’s Bank of China (PBC) cut the bank reserve requirement ratio four times in 2018. The central government is pushing through tax cuts and increased infrastructure spending while provincial governments have been instructed to increase bond issuance to finance new projects.
China’s long-term strategy
In the short-term the Chinese economy is likely to slow – but the country is still set to overtake the United States in a decade or so from now. The more interesting question is what the Chinese regard as their long-term future when and if they become the number one economy. In 2018 there were some clues as to what they think that is. In a keynote speech in July last year, marking the 90th anniversary of the foundation of the People’s Liberation Army (PLA), President-for-Life Xi said that China loves peace but that it will never compromise in defending its sovereignty[i].
The trend of President Xi’s more recent comments suggests that his China does not want to live within the current Westphalian system of nation states. Some suspect that President Xi is thinking of overthrowing it altogether. The system derives its name from the Treaty of Westphalia (1648) which established the doctrine of the inviolability of national borders and non-interference in the domestic affairs of other sovereign states. The Westphalian system was completed with the international framework, largely developed after WWII, of treaties, conventions, covenants, and norms which underpin the modern international order.
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During the Ming dynasty (1368-1644) China called itself the Middle Kingdom (Zhōngguó) – though the Chinese term might better be rendered into English as the Kingdom at the centre of the world. China saw itself in contemporary terminology as the sole superpower with all other neighbouring kingdoms in orbit around it in cultural, political and military terms. Chinese emperors claimed they had the Mandate of Heaven over tianxia, or All Under Heaven. They believed they were compelled to order and rule the entire world.
Charles Horner of the Hudson Institute recently explained to Gordon G Chang of the Gatestone Institute[ii] that the Communist Party of China remains committed to ordering China as a one-party dictatorship. This is China’s starting point for thinking about how it will order the world.
Xi Jinping has employed tianxia language for more than a decade – but recently his references have become unmistakable. “The Chinese have always held that the world is united and all under heaven are one family” he declared in his 2017 New Year message. Foreign Minister Wang Yi, in Study Times, the Central Party School newspaper, in September 2017, wrote that President Xi’s diplomacy “transcended the traditional Western theories of international relations of the past 300 years”. Some Western analysts have even written about an emerging Eastphalian system[iii].
This goes someway to explaining what China is really up to in Africa and elsewhere. Unsullied by the history of colonialism, as most European powers are, China is able to pose as a friendly partner. China has no interest in criticizing African governments for their human rights abuses or for their endemic corruption. What it wants most is contracts for resources – in return for which it offers grandiose projects such as the new Mombasa-Kigali railway line. Gradually, countries like Kenya and even large African countries like South Africa are being pulled inextricably into China’s orbit. Over time, their freedom to diverge from China’s bidding will lessen.
Colonialism – maybe not; tianxia – yes.
Preparing for war
On 05 January the South China Morning Post reported that in President Xi’s New Year message to the People’s Liberation Army he urged them to be ready for battle as the country faces unprecedented risks and challenges[iv]. “Preparation for war and combat must be deepened to ensure an efficient response in times of emergency” he said. “Over the coming year, the US might use Taiwan and the South China Sea as bargaining chips to get what it wants from China with regards to the trade war,” he continued.
Separately, in a speech delivered on December 20 to the 2018 Military Industry List Summit in Shenzhen, Rear Admiral Lou Yuan declared that China’s new anti-ship ballistic and cruise missiles were more than capable of hitting US aircraft carriers. “What the United States fears most is taking casualties,” he declared. The loss of one super carrier would cost the US the lives of 5,000 service men and women. Sinking two would double that toll. “We’ll see how frightened America is”[v].
We know that China has built up formidable capacity in cyber-warfare. Just before Christmas UK Defence Secretary Gavin Williamson expressed “very deep concerns” about Chinese technology firm Huawei’s (SHE:002502) participation in the roll-out of the UK’s 5G mobile network[vi]. (Actually, the UK government has known about this issue for some time.) A spokesman for China’s Ministry of National Defence countered that Mr Williamson’s remarks represented “deep-rooted pride and prejudice” against China. (Someone obviously gave him a box-set of Jane Austin dramas for Christmas.)
China in space
On 03 January China successfully landed a spacecraft – Chang’e – on the dark side (correctly the far side) of the moon – the first nation to do so.
The Chinese moon programme can be seen as the enactment of a national myth. Chang’e is the name of a Chinese mythical goddess who flew to the moon. In the days of Mao Zedong such myths were regarded as backward and redundant but more recently the Chinese government has revived ancient legends and wisdom traditions such as Confucianism – at home and abroad – in order to mobilise national self-awareness and patriotism. China’s space programme is eloquent testimony of that sentiment.
It is also evidence of China’s rapidly advancing technical sophistication. The Economist leads on that theme this week: Red moon rising – will China dominate science? The newspaper points out that China’s scientists published more academic papers than any other country in 23 of the 30 busiest fields last year.
America’s response
On 31 December Jimmy Carter, 39th President of the United States, wrote in an editorial piece for the Washington Post:
I hear prominent Americans, disappointed that China has not become a democracy, claiming that China poses a threat to the American way of life…That claim is a dangerous notion.
Mr Carter thinks that China and the US can resolve all their differences by amicable discussion and implies that Mr Trump’s approach smacks of aggression. No doubt Mr Obama would agree with him. But the fact is that Mr Trump is the first US president to make the containment of China one of his main policy objectives, previous presidents having given China an easy ride. The US-China trade war, as I said in the November edition of the MI magazine, is about much more that the USA’s trade deficit with China.
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What is shaping up now in US politics is the emergence of different factions, based on their attitudes towards China. On the one hand the Doves (one might call them Appeasers) believe that China should be handled with kid gloves and that she should be indulged with favourable treatment as per the Paris Climate Accord whereby America and Europe were compelled to slash their carbon emissions but China not at all. On the other hand are the Hawks, of which President Trump, Vice President Pence and the Commerce Secretary Wilbur Ross. They believe that China has had things its own way for too long and must be checked and, if necessary, challenged.
With the early entry of Senator Elizabeth Warren into the 2020 Presidential election race it seems quite likely that the battle between the China Doves and Hawks will loom large in the contest for the White House. That is probably another reason why Mr Trump will be re-elected.
Many western investors are currently attracted to the Chinese market as a result of prevailing low valuations – not least our Chairman, Jim Mellon. Those who seek to invest in China should be aware not only of the possibility of a pronounced slowdown in China in the first half of 2019, but also that political risk is likely to rise as tensions between the US and China increase. Even if some kind of deal is secured on tariffs and trade this spring, the great power rivalry is unlikely to abate.
[i]See: https://uk.reuters.com/article/uk-china-defence/president-xi-says-china-loves-peace-but-wont-compromise-on-sovereignty-idUKKBN1AH2Y5
[ii]See: https://www.gatestoneinstitute.org/13497/china-sovereign-state
[iii]See, for example: https://www.upi.com/How-to-handle-rise-of-China-a-treaty-of-Eastphalia/2721529687641/
[iv]See: https://beta.scmp.com/news/china/politics/article/2180772/chinese-president-xi-jinping-gives-army-its-first-order-2019?fbclid=IwAR2fSg2k0ug4f-QtU5-Cx33YWR3fYTnh-ToBJMzje80tLxRTJwJbi4i4HXo
[v]See: https://www.news.com.au/technology/innovation/military/sink-two-aircraft-carriers-chinese-admirals-chilling-recipie-to-dominate-the-south-china-sea/news-story/aaa8c33d57da62e7d5e28e791aa26e0f
[vi]See: https://www.aol.co.uk/news/2018/12/26/williamson-has-a-gravea-concerns-over-chinese-telecom-giant-h/?guccounter=1
jane austen – not austin.
with the economic dream going sour the chinese government is turning disappointed citizens’ ire outwards – it’s kick johnny gweilo time.
I seem to recall a quote (Napoleon ?) Beware, when China awakens, the world will tremble.
Ed – Austen, quite so – sometimes such pesky typos get through – apologies to Jane fans everywhere…On your main point – if China re-focusses to domestic consumption away from export-led growth then Johnny Gweilo becomes less important…I think the interesting question is – if GDP growth falls to “normal” developed nation levels of 2-3 percent and large parts of the Chinese corporate sector default, then will the one-party state apparatus be challenged…? Regards, Victor
An interesting balanced view. Master Investor is for us as investors, not politicians; but there is a clear warning to us that giving our money to a communist dictatorship is not without risk.
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I have no liking for President Trump, but if his actions deter China from stealing US technology it can only help our investments in the USA.
I don’t like China . Don’t like the culture nor the cheap shoddy goods flooding the rest of the world. I do not wish to inject any capital into that country.