The Wall Street Journal has an interesting article up this
week, about the coming Debt Crisis in China.
Mr. Sharma appears to have the credentials to speak on this,
not only in his role at Morgan Stanley, but also as a published author on
national economies. Forbes also had a
recent article about China’s debt,
with similar warnings although somewhat less dire. I found it interesting from a personal
perspective, because it echoes impressions I received in my own, admittedly
amateur, consideration of the situation.
To put it bluntly, everything has to be paid for by
someone. There may be such a thing as a
free lunch for you, but only if you get someone else to pay for it. This is
where all risk consideration starts, the fact that someone has to pay for
things and by definition if you are involved in a transaction with someone who
may not pay, then you are at risk of paying for something used or taken by
someone else. As a credit manager, I am
well aware of customers who aren’t good credit risks, and it should really not
be a shock to consider that most governments are none too trustworthy on that
count. After all, most government
contracts of which I have been involved in or knew about, involved poor
performance by the government, in many cases because the government is well
aware that you can’t do much about it if they pay slow or give themselves
discounts not allowed in their contract.
What are you going to do, after all?
Sue them? Give them a bad credit
reference? Actually, there are reasons
that the government ought to be better at paying its bills, but that shows up
only at the high level consideration. If
the government fails to pay in a reasonable time to its suppliers and service
contractors, those companies will stop doing business with the government, out
of a need to survive as much as anything else.
But in the short term, governments tend to be poor-performing
customers.
And as you might guess, in a government which is based on
both a single political party in a strong central government, and an economic
philosophy that the people have no individual rights, government spending is
unlikely to be criticized at all, let alone challenged. So China has basically done whatever it
pleased for the last sixty-four years, with sometimes disastrous results. They seem to have good intentions this time,
building roads, bridges, and power plants for infrastructure, but they have
planned no better for this than they have anything else in their past several
decades. The problem is that basic
question of how they pay for the things they want.
President Obama made
many blunders in his first term, largely because he did not understand how
things work, nor did he really seem to care.
It should be obvious that throwing trillions of dollars around is bound
to have an impact, though it will do more damage than good if you are not very
careful with it, since all that money comes from the wealth of the nation. Too much spending by a government is, in
essence, eating your seed corn and dooming the future. But at least in the U.S. there is the
potential for an elected official to be held accountable for his decisions, and
for all the gloom and doom from the media, the U.S. is far and away the most productive
nation on the planet. China, on the other
hand, is not equipped to handle a debt crisis, neither on the political front nor
in economic terms.
The political dimension for China would seem to be apparent.
The problem is that following the Sichuan Earthquake, China found itself facing
serious criticism for the failure of basic systems and the deaths of children
and elderly people. On the surface,
China handled the crisis much the same as they have addressed previous
disasters, but there are indications the Central Committee demanded more than
face-saving gestures this time, in part due to the sense in many parts of the
country that coastal regions have received much better capital support because
of foreign investment and China’s high-tech PR spin, while rural and highland
areas have been ignored, to the point that lives have been lost. To allay these rebukes, China’s Politburo has
spent unprecedented monies on infrastructure, especially roads, bridges and
construction of housing. Funding for
high-profile projects (such as aircraft
carriers, a China-only hypernet system, or new resort communities along the east
coast), however, has not been changed, so China is spending money in larger
amounts than it can justify in the long term, partly because neither
alternative is politically palatable.
While unthinkable in the West, the potential for catastrophic events
like a civil war or a military coup attempt have been quietly voiced by
intelligence analysts, possibly as soon as 2018.
The economic facts are even more harsh. The WSJ article noted a figure of $2.7
trillion budgeted for these projects in FY2013, which is roughly comparable to
the entire federal budget for the United States, a nation which has the GDP to
support most of such spending. China,
bluntly, cannot come close to producing the revenue needed to support such
spending. China’s GDP is still about
half that of the US, and that does not even consider the purchasing power of
the two currencies. China, essentially
has built its economy with a combination of sound principles and financial
tricks. The most obvious of those tricks
would be the combination of China’s tight controls to keep the RMB low and to
manipulate all financial data sent outside the nation. To truly compete for global economic
domination, China would first need to either embrace GAAP or a similar
international accounting standard, then create effective internal controls
statutes, instill transparent reporting practices in its public markets, and
then – only then – could China hope to present its products and services with a
reasonable expectation to challenge the US, Europe, Japan, or any other
established major economic power on level ground. It is, essentially, impossible for China to
do so and continue to operate as a Communist regime, not least because the
central government would face the irreducible conflict between state control of
information and power, and the necessary
decentralization required for a national economy to be truly responsive to
economic opportunities and dangers.
China 2013 is no more prepared for the global arena than Russia was in
1985.
The short explanation is that there will not be a soft
landing. When China realizes its debt
cannot be hidden or simply transferred to perceived ‘wealthy’ businesses or
citizens, probably between 2015 and 2017, the crisis will be sharp and almost
certainly lead to bad decisions, like the initial 1997 decision to punish Hong
Kong with debilitating tax rates. Hong
Kong is again likely to be hit with high tax rates on everything Beijing thinks
it can charge, but this time Shanghai and other major coastal cities and
regions will also be hit with taxes and sanctions, as punishment for
non-communist behavior in creating business opportunities. Companies may expect to see a streak of
nationalizations, especially if the business engages in any technological
industry where intellectual property is a major part of the company’s competitive
advantage. While a return to the
Cultural Revolution of a half-century ago may not occur, a similar desire to
punish the ‘greedy Gwai-lo’ is
certain to show up again, especially when China experiences sharp inflation and
high unemployment, which will be the hallmarks of the debt crisis.
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