This is the advice given by college professors to a generation of young business students.
“China is an economic powerhouse,” they say. “In a few years they will overtake the U.S. And from then on all business will be conducted in Chinese. You’ll regret it if you don’t start now.”
Now these days, I’m getting too old and stubborn to be learning Chinese. But for a time, it seemed like there might have been a lick of truth to this line of thinking.
Year after year, reports of an unstoppable economic boom have been coming out of China.
Hundreds of millions have escaped poverty. Shining, modern cities have popped up seemingly overnight. But all this fanfare only serves to obscure the darker side of China’s apparent success.
China is caught in its own debt trap with no way out except inflation or default.
Jim Rickards goes in depth in today’s issue of Money & Crisis.
All the best,
Editor, Money & Crisis
P.S. After 15 years of secrecy, Jim is finally able to reveal this sensitive information on camera. It has everything to do with a powerful tool he developed while working with the U.S. government… that can predict surprising political and economic events before they happen. Click here for Jim’s shocking confession.
China’s Economy is Failing
I’ve written for years that Chinese economic development is partly real and partly smoke and mirrors, and that it’s critical for investors to separate one from the other to make any sense out of China and its impact on the world.
There’s no denying China’s remarkable economic progress over the past thirty years. Hundreds of millions have escaped poverty and found employment in manufacturing or services in the major cities.
Infrastructure gains have been historic, including some of the best trains in the world, state-of-the-art transportation hubs, cutting edge telecommunications systems and a rapidly improving military.
Whistling Past the Graveyard
Yet, that’s only half the story.
The other half is pure waste, fraud and theft. About 45% of Chinese GDP is in the category of “investment.” A developed economy GDP such as the U.S. is about 70% consumption and 20% investment.
There’s nothing wrong with 45% investment in a fast-growing developing economy, assuming the investment is highly productive and intelligently allocated.
That’s not the case in China. At least half of the investment there is pure waste. It takes the form of “ghost cities” — empty cities fully-built with skyscrapers, apartments, hotels, clubs and transportation networks.
This is not just western propaganda. I’ve seen the ghost cities first hand and walked around the empty offices and hotels.
Chinese officials try to defend these ghost cities by claiming they are built for the future.
That’s nonsense. Modern construction is impressive, but it’s also high maintenance. Those shiny new buildings require occupants, rents and continual maintenance to remain shiny and functional.
The ghost cities will be obsolete long before they are ever occupied.
Other examples of investment waste include over-the-top white elephant public structures such as train stations with marble facades, 128 escalators (mostly unused), 100-foot ceilings, digital advertising and few passengers. The list goes on, including airports, canals, highways and ports, some of which are needed but many are just pure waste.
Borrowed Money, Borrowed Time
Communist party leaders endorse these wasteful projects because they have positive effects in terms of job creation, steel fabrication, glass installation and construction. However, those effects are purely temporary until the project is completed. The costs are paid with borrowed money that can never be repaid.
China might report 6.8% growth in GDP, but when the waste is stripped out the actual growth is closer to 4.5%. Meanwhile, China’s debts grow faster than the economy and its debt-to-GDP ratio is even worse than the U.S.
All of this would be sustainable if China had an unlimited ability to rollover and expand its debt and ample reserves to deal with a banking or liquidity crisis. It doesn’t. China’s financial fragility was revealed during the 2014-2016 partial collapse of its capital account.
China had about $4 trillion in its capital account in early 2014. That amount had fallen to about $3 trillion by late 2016. Much of that collapse was due to capital flight for fear of Chinese devaluation (which did occur in August 2015 and again in December 2015).
China’s $3 trillion of remaining reserves is not as impressive as it sounds. $1 trillion of that amount is invested in illiquid assets (hedge funds, private equity funds, direct investments, etc.).
This is real wealth, but it’s not available on short notice to defend the currency or prop up banks.
Another $1 trillion of Chinese reserves are needed as a precautionary fund to bail-out the Chinese banking system. Many observers are relaxed about the insolvency of Chinese banks because they are confident about China’s ability to rescue them.
They may be right about that, but it’s not free. China needs to keep $1 trillion of dry powder to save the banks, so that money is off the table.
That leaves about $1 trillion of liquid reserves to defend the Chinese currency, if so desired. At the height of the Chinese capital outflows in 2016, China was losing $80 billion per month of hard currency to defend the yuan.
At that tempo, China would have burned through $1 trillion in one year and become insolvent. China did the only feasible thing, which was to close the capital account (interest rate hikes and further devaluation would have caused other more serious problems).
This distress might have been temporary if China had managed to maintain good trading relations with the U.S. But that proved another chimera.
Trump Holds All the Cards
The trade war that has broken out between the U.S. and China has damaged Chinese exports and raised costs on Chinese imports at exactly the time China was counting on a larger trade surplus to help it finance its mountain of debt.
Now trade is under threat and China is stuck with debt it can’t repay or rollover easily. This marks the end of China’s Cinderella growth story, and the beginning of a period of economic slowdown and potential social unrest.
The coming Chinese crack-up is not just theoretical. The hard data supports the thesis. Here’s a real-time data summary from the Director of Floor Operations at the New York Stock Exchange, Steven “Sarge” Guilfoyle:
The greater threat to financial markets will come, in my opinion from the slowing of global growth, at least partially due to the current state of international trade.
This thought process is lent some credence by last night’s rather disastrous across-the-board macroeconomic numbers released by China’s National Bureau of Statistics.
Growth slowed to the slowest pace since this data was first recorded back in 1992, printing in decline for a fifth consecutive month.
Industrial Production: Missed expectations for a third consecutive month, while printing at a growth rate equaling the nation’s slowest since February of 2016.
Retail Sale: Finally showing a dent in the armor, missed expectations while slowing from the prior month.
Unemployment: This item has only been recorded since January. Headline unemployment “popped” up to 5.1% from June’s 4.8%.
Oil Production: The NBS reported that Chinese oil production fell 2.6% in July, and now stands from a daily perspective at the lowest level since June of 2011.
Depending on the veracity of the data, one must start to wonder if China can indeed hang on to growth of 6.5% going forward.
This unpleasant picture Sarge paints is based on official Chinese data. Yet, China has a long history of overstating its data and painting the tape. The reality in China is always worse than the official data reveals.
This slowdown comes just months after Chinese dictator Xi Jinping was offered a dictator-for-life role by the removal of term limits and was placed on the same pedestal as Mao Zedong by the creation of “Xi Jinping Thought” as a formal branch of Chinese Communist ideology.
The Book of Proverbs says, “Pride goeth before destruction, and a haughty spirit before a fall.”
Xi Jinping now finds himself in precisely this position. His political ascension inflated his pride just as he now faces the reality of a falling economy and possible destruction of any consensus around his power and the lack of accountability.
Trump continues to tighten the screws with more tariffs, more penalties and a near complete shutdown of China’s ability to invest in U.S. markets.
Only Trump and Xi can salvage the situation with negotiation and reasonable compromise on trade and intellectual property. But, Trump won’t blink first; that’s up to Xi.
P.S. This could be my most important message of 2018.
It contains sensitive information that I’ve only just revealed. I can’t reveal everything, for national security reasons. But I say as much as I can legally say. And everything’s true, I promise.
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