China's Emergence as a Superpower (till 2014)

[Firn]

Sometimes it is good to look once again at some older articles, The End of Hypergrowth: Political and Economic Responses to a Slowing China by Naughton in late 2012.

The Opportunity for a Revival of Broad Market-#Oriented Reforms

These challenges have created a rich new opportunity for China’s frustrated market reformers. Reformers have been sidelined for years, especially since the muscular response of the Chinese government to the global financial crisis in 2008–2009. Now their fortunes have changed. Reformers can now get a hearing, and find outlets for their views. Many reformers today strike a note of doom and gloom: without major reforms, there would be big trouble ahead.

I did already write about the many issues, especially in the financial sector. China did the right thing in stimulated the economy big time in 2008 when the export-driven economy faced a collapse in demand. However they lacked in execution especially after the quick initial response which could of course not be perfect given the dire circumstances. I think the Chinese government got too complacent about the economy and their Chinese way and now China is paying the price for the lack of liberal market reforms. This has changed in the last year or so and some of recent reactions point into the right direction. For example the interest rates, partly responsible for the shadow banking system are no longer controlled. I explained my rather similar view a couple of posts earlier.

China certainly faces big problems and will face big problems in the future. The hyper-growth of the last decades has been amazing and likely unmatched on that scale. There is IMHO still considerable scope in China for the 'old' type of growth we saw in the last decades, with a still relatively large rural population and much demand for big infrastructe, social security, education, health spending. The deep integration into the global value chain will be a key element from the market side. A very big question mark is the political aspect of China. So far only rather democratic countries have achieved a high standard of living without sitting in on a sea of oil, and for good reasons touching the heart of economics.

[Dayuhan]

China did the right thing in stimulated the economy big time in 2008 when the export-driven economy faced a collapse in demand.

I'm not entirely convinced that the stimulus will turn out to be a good move, though only time will tell. Aggressive stimulus in an economy plagued with high-level corruption and credit-sector cronyism can be a risky business. The construction boom did effectively take up the slack left by weakening exports, but the financing of much of that construction was... creative, to use a polite term, and it remain to be seen how sustainable that solution will be, and how long it will take before that creativity snaps back.

[Dayuhan]

More on the pessimistic side... much discussion of economic implications, less on potential security/stability issues:

http://www.ibtimes.com/chinas-econom...owdown-1361579

[Firn]

It is a good catch which addresses some of current issues and the recent reactions on the state level.

I tend to believe that the stimulus was a too big and not aimed all too well but if you think back in 2008 the world seemed to come to an end and time was dear. This plus corruption, a partly cheating hand of the state and the implications of a increasingly mature economy were headwinds against a highly efficient allocation of that captial.

We should see in a couple of years roughly how big the multiplier of all that public spending was and how wisely the private sectors invested. In the end for all that talk about an Asian or Chinese way economics are everywhere the same, even if we still have a hard time to figure some of those laws out.

[davidbfpo]

Patrick Porter, an Australian academic strategist, writes an occasional blog column and his latest examines:

...a clash over the Taiwan Strait... in the end predicting the outcome of a China-Taiwan clash would not be about the absolutes of military victory narrowly conceived, but about the issue of cost tolerance and the fear of a Pyrrhic result.

Relations between Taiwan and Beijing have eased in the latest ‘detente.’ But some worry that their mutual aims regarding Taiwan’s ultimate sovereignty are still irreconcilable and that they could still deteriorate. One thing driving this anxiety is the shifting military balance between the two, moving in China’s favour. But assessments of the clash are still predominantly quantitative. The debate should focus primarily not just on China’s superior mass and technology, but on whether it would be willing to absorb the costs of an invasion compared to the Taiwanese’ willingness to tough it out.

Link:http://offshorebalancer.wordpress.co...iwans-defence/

[Dayuhan]

Is an actual invasion really a likely scenario? I always figured that if it came to shooting the Chinese would try to force Taiwan into submission with missile barrages. An invasion would be... complicated. It would be an invasion on the scale of the Normandy landings, in the age of satellite surveillance and guided missiles (the Taiwanese produce their own). There would be no element of surprise. Many Chinese coastal ports are well within the range of Taiwanese missiles. It's potentially a very costly affair.

[carl]

Patrick Porter, an Australian academic strategist, writes an occasional blog column and his latest examines:

Incorporated in Mr. Porter's calculations is the possibility that the Reds might have to deal with a post invasion Taiwanese insurgency and that might be a dissuasive factor. I don't think so. The Red Chinese have enough men to garrison Taiwan extremely heavily. Taiwan is an island and would be easy to cut off from outside supply, no guns for the guerrillas. And no sanctuary but the deep blue sea either. Finally, there are only about 23 million Taiwanese and with a birth rate per woman of .9 there aren't very many young men to do the insurging. The Reds could literally almost put 1 soldier for each Taiwanese male between 15 and 29 on the island to control it. And none of this is to mention the CCP proclivity for extreme brutality. If the island were ever taken, I think the chances of any kind of insurgency are zero.

[Ray]

China’s Deceptively Weak (and Dangerous) Military

In April 2003, the Chinese Navy decided to put a large group of its best submarine talent on the same boat as part of an experiment to synergize its naval elite. The result? Within hours of leaving port, the Type 035 Ming III class submarine sank with all hands lost. Never having fully recovered from this maritime disaster, the People’s Republic of China (PRC) is still the only permanent member of the United Nations Security Council never to have conducted an operational patrol with a nuclear missile submarine.

China is also the only member of the UN’s “Big Five” never to have built and operated an aircraft carrier. While it launched a refurbished Ukrainian built carrier amidst much fanfare in September 2012 – then-President Hu Jintao and all the top brass showed up – soon afterward the big ship had to return to the docks for extensive overhauls because of suspected engine failure; not the most auspicious of starts for China’s fledgling “blue water” navy, and not the least example of a modernizing military that has yet to master last century’s technology.

Indeed, today the People’s Liberation Army (PLA) still conducts long-distance maneuver training at speeds measured by how fast the next available cargo train can transport its tanks and guns forward. And if mobilizing and moving armies around on railway tracks sounds a bit antiquated in an era of global airlift, it should – that was how it was done in the First World War.

In many ways, the PLA is weaker than it looks – and more dangerous.Yet while there is ample and growing evidence to suggest China could, through malice or mistake, start a devastating war in the Pacific, it is highly improbable that the PLA’s strategy could actually win a war. Take a Taiwan invasion scenario, which is the PLA’s top operational planning priority. While much hand-wringing has been done in recent years about the shifting military balance in the Taiwan Strait, so far no one has been able to explain how any invading PLA force would be able to cross over 100 nautical miles of exceedingly rough water and successfully land on the world’s most inhospitable beaches, let alone capture the capital and pacify the rest of the rugged island.

The PLA simply does not have enough transport ships to make the crossing, and those it does have are remarkably vulnerable to Taiwanese anti-ship cruise missiles, guided rockets, smart cluster munitions, mobile artillery and advanced sea mines – not to mention its elite corps of American-trained fighter and helicopter pilots. Even if some lucky PLA units could survive the trip (not at all a safe assumption), they would be rapidly overwhelmed by a small but professional Taiwan military that has been thinking about and preparing for this fight for decades.

Going forward it will be important for the U.S. and its allies to recognize that China’s military is in many ways much weaker than it looks. However, it is also growing more capable of inflicting destruction on its enemies through the use of first-strike weapons. To mitigate the destabilizing effects of the PLA’s strategy, the U.S. and its allies should try harder to maintain their current (if eroding) leads in military hardware. But more importantly, they must continue investing in the training that makes them true professionals. While manpower numbers are likely to come down in the years ahead due to defense budget cuts, regional democracies will have less to fear from China’s weak but dangerous military if their axes stay sharp.
http://thediplomat.com/2014/01/china.../?allpages=yes

The article does a very interesting analysis of the Chinese forces and its capabilities.

How far is the author valid in his contentions?

[Firn]

First I'm actually surprised that my posts were actually not that bad regarding the huge challenges facing the Chinese economy. I covered at least partly the inefficient overinvestment, the too heavy & cheating hand of the state the dangerous nature of the banking system, the financial repression and the WMP.

However I failed to note the key link between the high saving rate and the public overinvestment plus the financial repression. I likely overestimated the positive effect of the large rural labour pool and I was rather blind to the switch of a vast sector of the Chinese economy towards a capital-intensive one. All that capital with it's likely negative costs and all the bad incentives in the often corrupt public hands won't bring the corresponding return in public wealth. It is important to point out that the export sector with it's small and medium private enterprises is still labour-intensive.

A cool videographic of the Economist regarding migration. Keep in mind that the 'move to the West' makes me now think about Italian's strategy of closing the North-South gap. Short-term growth was achieved by big public works but in the long term it was a mostly a big waste of national ressources with much getting sliced off by corruption and the organized crime. It generally more inefficient to bring work places to the people instead of supporting people going to the work places. Brazil failed with a similar project in the some forty years ago. *

I have no idea how strong or able the Chinese military but there are at least two likely big problems for the Chinese leadership:

1) Taiwan on it's own seems unlikely to (quickly) fall to an invasion or to give up after conventional missile 'strategic bombing'

2) Taiwans allies could, as noted in the other thread, inflict in the longer run terrible damage on the Chinese economy by choking it's martime international and possibly coastal trade.

*I think there are strong arguments that some of the big public spending in Far-Wes is intended to incentivise the settlement of Han Chinese, to 'pacify' those provinces in the long term. This is of course a classic in history, with the Roman colonists and the British settlers in Ulster and the New World being famous examples.

[carl]

Ray:

I think that report is quite tendentious. Some of the things he says are meaningless. For example when he says the Reds still use Badger bombers as if that is a horrible fault. It doesn't matter if the Badger is old, what matters is the missile it carries. Shoot, we still use the B-52. The whole report if filled with things like that.

He also says the Reds can't do something they probably wouldn't even consider, heading straight across the Strait. A very large part of Taiwan's regular forces are on Kinmen island which is right off the mainland and depends upon the mainland for water. Another large chunk of their forces are on some other islands in the middle of the strait. I read an article that said the smart thing to do would be to take those places in sequence. Besides Taiwan is an island. You can blockade the place into submission.

[Ray]

Carl,

Thanks.

So, it a bit of propaganda, right?

Firn,

What do you think of this:

World asleep as China tightens deflationary vice
http://www.wnd.com/2014/02/world-asl...ationary-vice/

I am asking these of you out here, to get a better perspective of issues, beyond what I read and what are said on other fora.

[Dayuhan]

Not entirely propaganda.

The article makes many legitimate points, particularly on the very conservative and limited training process in the PLA and the emphasis on loyalty rather than competence in promotions. It would be worth adding that the PLA is one of the most corrupt institutions in one of the most corrupt societies on the planet. How that will affect their ability to fight a war remains, of course, to be seen. I would agree with the author that too much of the talk on the subject of capacity focuses on hardware (even that is largely an unknown quantity) and ignores the human factor.

All of this of course is an unsettling picture for the Philippine armed forces: if China ever does decide to stage a war, it will want a short one with a sure victory, the proverbial "splendid little war", and that points directly to the Philippines. The most likely scenario would be the seizure of some islands and the sinking of some ships. The average Filipino would be unaffected, of course, but not an attractive prospect if you're in the Philippine Navy.

[Firn]

Nobody knows what will happen. In my view Evans does link events in Europe and the US too robotically to a possible hard landing in China. The USA and the EU are huge markets in which the internal developments are generally in relative terms much more importent then in smaller economic entities. Other reactions are indeed considerably less contingent, for example crashes in the commodity markets with the rather dire consequences for countries like Chile, Australia and Argentinia. This 'commodity shock' is a positive supply shock for the EU or USA (or India) with smaller 'export' demand shock stemming from the reduced demand for exports by the countries which rely on their commodity exports.

The central bank (PBOC) is tightening methodically, allowing the benchmark 7-day repo rate to ratchet up by 200 basis points to 5.21pc over the last year. It drained a further $50bn from the system this week

Its latest quarterly report has turned hawkish, even though producer prices are in steep deflation, and the M2 money supply is slowing. It complains that “reliance on debt is still rising” and that “hidden risks in the financial sphere require attention”.

Zhiwei Zhang from Nomura says China has entered a "prolonged period of policy tightening" that will push up bank lending rates by as much as 90bp this quarter, leading to a chain of defaults.

The tell-tale signs are obvious in the central bank's handling of reverse repos and maturing bills. The yield on corporate AA 1-year bonds has jumped 272 basis points to 7.15pc since June. "We think the PBOC intends to raise the whole spectrum of interest rates to push deleveraging," he said.

The Chinese central bank does what it should have done (or allowed to do) a long time ago. In short it is bringing the capital costs closer to it's natural band. Capital costs have been sometimes negative in practical terms and united with many other bad incentives this made malinvestment very likely on a vast scale. There is very little doubt that there has been much overinvestment and that part of the economy has to slow down or even contract. If we consider the dominant role Chinese demand has played in some commodities it is very likely that the price of those will come down considerably. As I sad bad news especially in countries Down Under.

China did of course blink in January when the authorities stepped in to cover the $500m liabilities of the trust fund, “Credit Equals Gold No. 1”. It is the fifth trust rescue in opaque circumstances in recent weeks. Yet it would be hasty to conclude that President Xi is backing away from his Third Plenum vows to end to the bad old ways.

The financially repressed households had to find some way to invest other then giving debitors their money away for basically free and much went into the shadowy WMP. There are good arguments to prop them up and of course strong political pressure, but the economic opportunity costs are also high.

Haibin Zhu says there is mounting risk of "systemic spillover". Two thirds of the $2 trillion of wealth products must be rolled over every three months. A third of trust funds mature this year. "The liquidity stress could evolve into a full-blown credit crisis," he said.

Officials from the International Monetary Fund say privately that total credit in China has grown by almost 100pc of GDP to 230pc, once you include exotic instruments and off-shore dollar lending. The comparable jump in Japan over the five years before the Nikkei bubble burst was less than 50pc of GDP.

I knew about the short-term nature of the WMP but the rollover rate of two/thirds of $2 trillion of three months is something new, unheard off and very frightening. I almost can not believe it. Looks like a fuze snaking through the legs of a group of chain smokers to a big bomb. Just think of the reaction to a breakdown in trust and thus lending. In a very short time the whole WMP markets could implode with the sell-offs spreading to housing and other markets.

In this case the Chinese state and in the end the households will have to pay most of the bill. A good deal of the GDP could become a write-off, because a vast amount of the building/investment is just not worth what it was calculated to be. Simple accounting logic.

It is a very delicate, vast job for the Chinese leadership in the face of much political pressure within the party. It won't be the end of China, but it could cause severe economic pain for a longer period of time. Supporting the household consumption of the lower and especially the middle class by removing the fetters of financial repression is a key elemen for 'quality' long term growth.

[Firn]

Just a quick upgrade. What do bank share prices tell us about growth?. is likely a bit technical or wonkish for most. I have little doubt that the book value of Chinese banks is inflated by a far too optimistic, to put it that way, evaluations of loans. It is quite likely that, with a corrected balance sheet, some of big state banks have infact little or negative equity.

It is funny that the recently rescued Jilin Trust, muscled by the big Chinese Construction Bank was a coal-financer, as it reminds me about those massive coal plants getting build in Xinjiang, south of Toksun IIRC. See my post in the Chinese insurgency thread.

The German FAZ also has an interesting info about the guys who were rescued by the state:

Doch das Minenunternehmen geriet in Schieflage, weshalb sich die Vermgensverwaltungsgesellschaft nicht in der Lage sah, die flligen 3,3 Milliarden Yuan (400 Millionen Euro) an die 700 vermgenden Geldgeber zurckzuzahlen. Der Beistand in letzter Minute ersetzte zwar die versprochenen Zinsen nicht, aber immerhin die Anlagesumme konnte erhalten werden.

So the investment per capita averaged 600.000 Euros , not exactly the working poor. The middle class and the poor get financially repressed while the wealthier get an interest rate 4-5 times as high with the capital practically getting guaranteed by the state. Nice, the political pressure from the well-connected must be indeed huge.

[Firn]

FTSE 100 pushed down by Chinese jitters. Perhaps more interesting then the exact movements are the biggest losers in China and abroad.

China:

Shanghai recorded its worst day in seven months with the composite index dropping by over 2% as fears are heightened that a collapse in the property bubble is getting ever closer.

It’s been property development companies that have borne the brunt of the sell-off, but the real fear is that any slowdown in the property market will be felt across the board with consumption of everything from small electronics to cars likely to suffer.

the World:

Mining firms led the fallers, dented by the news that the Shanghai composite index had recorded its biggest fall in seven months (see 8.25am for details). Rio Tinto and Anglo American are both down over 3%, on speculation that the Chinese property market is heading for a fall.

Australia be aware.

[Firn]

Krugman does once again look to China. Check the links in the original.

RED SPREADS

Uh-oh. Chinese equivalents of the TED spread and other gauges of financial stress in the US have widened sharply. The widening in the TED spread was one of the key reasons I was already very scared in late 2007. If past is prologue, we should be very worried about China now.

He points to Bloomberg which has a nice article about the resent moves in the financial world of China. As usual I find the development of the trust porducts/WMP interesting. A huge growth indeed. As I have written before the combination of much capital on a short leash is big trouble if you as a counterpart have troubles to get liquidity. Even more so if the cost of capital goes up and your loans turn bad. You will get squeezed from both sides.

Trust Products

About 5.3 trillion yuan of trust products will come due this year, up from 3.5 trillion yuan in 2013, Haitong Securities Co. estimated last month. Assets in all trusts surged 46 percent in 2013 to a record 10.9 trillion yuan, the China Trustee Association said in a Feb. 13 statement.

China averted its first trust default in at least a decade in January as investors in a 3 billion yuan high-yield product sold by China Credit Trust Co. to fund a coal miner that collapsed were bailed out days before it came due. A similar product created by Jilin Province Trust Co. is also missing payments, Shanghai Securities News reported.

Careful readers will have noticed that quite a few argue for short-term interventions by the Bank of China which go against the stated long-term goals.

Default Concern

In a sign of default concern, the premium for five-year AA rated corporate notes over the sovereign widened to 337 basis points on Feb. 12, the most in two years. At least a third of China’s 200,000 steel-trading firms will collapse because of the credit crisis, the official Xinhua news agency said Feb. 7, citing industry estimates.

The slowdown may fuel bank bad loans, which surged 28.5 billion yuan in the final quarter of 2013 to 592 billion yuan, the highest since September 2008, according to China Banking Regulatory Commission data. The economy will probably expand 7.5 percent this year, the slowest since 1990, according to the median estimate in a Bloomberg survey.

Credit-default swaps on Bank of China rose 32 basis points to 153 this year while those on Industrial & Commercial Bank of China Ltd. climbed the same amount to 165, CMA prices show.

At least in that aspect the Red economy works practically the same way we have seen in the West, not surprising indeed. In the long run a higher cost of capital should be help to allocate it far more efficiently. Obviously this is bringing much pain.

[Firn]

I forgot to mention perhaps the most important aspect of the rapid increase of money flowing into the trusts, the ponzi-like stability. It is of course no pure Ponzi, but most like most bubbles it incorporats more or less of it's logic. As long there are big gains money keeps flowing in so even if the trust is unable to earn enough in the short-term there is enough liquidity to pay out the investors. Given the staggering increase of roughly 50% in wealth managed only the dumbest, most arrogant or most unlucky trust managers could blow it recently. It is perhaps no suprise that the last big fund had seemingly concentrated all the loans regionally and in single sector, coal. In this case the severe difficulties within that industry hit the trust with full force.

Overall far more trust assets are chasing good enough returns to match the ~10% promise to the rich and influential clients. They roll over mostly under a year. As I said before it feels like a fuse snaking to a big bomb through the legs of chain smokers.

It is important to point out that a similar bubble happened back in the 2005-2007 in the Chinese stock market when everybody seemed to speculate there. Prices rose incredibly fast to incredibly heights only to come crashing down to deep lows. The memory of that crash has kept many out of that particular market which would be actually quite cheap if the earnings of the SOE would be sustainable. Now the smart money seems to be mostly in trusts aka WMP.

Nobody knows when the trust bubble will burst but if something can not go on forever it will end. Hopefully the Chinese manage to make the landing as softly as possible.

[Dayuhan]

Another perspective on economic issues:

http://blogs.reuters.com/anatole-kal...ancial-crisis/

[Firn]

It is always good to see a contrarian view. Personally I think that the respected author argues himself into a bind over credit growth.

A severe slowdown in China is viewed as among the greatest risks facing the world economy this year, and Thursday’s dismal news on Chinese manufacturing output exacerbated these fears. But the really important news from Beijing pointed in the opposite direction: Bank lending in China, instead of slowing dramatically as many economists had expected, accelerated in January to its fastest growth in four years.

...

To welcome stronger bank lending in China is not to deny that credit growing at double the gross domestic product growth is unsustainable and will ultimately have to be curbed. The Chinese authorities themselves clearly believe this. The government and the central bank want to reduce credit growth and to replace the unregulated, opaque “shadow lending” system with properly supervised, well-capitalized modern banks.

It is importat to keep in mind just how big the intertia of credit growth and how high the pressure from many sides is to keep clubbing. Public entities, SOE, banks, trusts want to keep the party going as everybody has profited for such a long time and continues to do. The behaviour has become deeply ingrained and there is no doubt that most of those credit has not gone to consumption but to investment...

Policy will therefore have to be prioritized. And the financial reform objective is proving a less important priority than industrial restructuring and maintaining an acceptable rate of growth.

Whenever possible, China will likely try to move ahead on all three objectives. But if there is a serious conflict, maintaining an adequate growth rate will trump credit restraint and financial reform

Without going into the details it seems to me very likely that under such circumstances the priorities are not caused by clear overall economic analysis by the leadership (doing also much clubbing) but by the all the understandable pressure against financial reforms.

[Firn]

There have been a few positive steps in various areas lately. Clearly it is far too early to see how those get implemented in depth and width and how they will work. I will write a longer comment in the next days.

A short video shows Chinese buying, effectively, a good deal of European security. This is just one example of the 'attraction value' of soft power. Perhaps more revealing then the property market are the investments in classic Portuguese agricultural business such as vineyards and pig farms. High-quality 'European' food has become increasingly attractive for the better off due to the status and all those scandals in China. This snippet pales of course in importance compared to problems above, but it fits nicely into the narrative.