Commentary: China's Lost Decade?

By: Christopher Burnham, CGA Chairman

No big news that China’s economy is the slowest it has been in decades. It had to slow, just the way Japan’s economy doubled every ten years from the ashes of World War II to become the second largest in the world, and then crashed in 1990 starting Japan’s “Lost Decade” (the Nikkei crashed more than 80%).

China’s economy has been growing much faster than that, and even if you cut their reported GDP numbers in half, which one World Bank analysis said was appropriate—see my Forbes column from last November – it is still a massively impressive resurrection from the failure of Mao’s “Great Leaps”.

Recent reports, however, portend a troubled economic future for China, which they could avoid through a trade deal with the U.S.

The three drivers of immediate concern for this potential catastrophe are the following: their massive credit expansion, African swine fever, and a Fall Armyworm infestation. Longer term items that threaten a stable China are a rapidly aging population and soon to be shrinking work force, the inability to restructure bloated and inefficient companies, an asset/real estate bubble similar to what Japan experienced, and increasing competition in manufacturing driven by robotics. The restructuring issue is an interesting one, because the Chinese Government prevents companies from downsizing their labor force. Many companies have systemic and unsustainable fixed labor costs that can’t be restructured lest the companies be criticized and punished by political authorities. 

For the immediate concerns, the International Institute of Finance’s recent Global Debt Monitor Report, and the well-articulated interview with Ariel Investment’s CIO, Rupal J. Bhansali, points out that China’s credit growth for the past ten years has ballooned from about $9 trillion to over $41 trillion. This is more than twice the debt load of the U.S. and more than four times that of Japan. 

The good news is that the Hong Kong-based data company, CEIC, estimates that there is more than $27 trillion in private deposits in China, and with a government as powerful as President Xi’s, certainly they can use the power of eminent domain to seize some of those deposits to stave off economic collapse—this is actually been relabeled by some of the Democrats running for president this year, a “wealth tax”. Perhaps that is why the real estate bubble continues to grow as it may be safer to keep money in real assets versus the local state owned bank—or the mattress, given an additional threat of inflation.

The second immediate threat is the growing spread of swine fever in China that is devastating the hog population. China loves pork, which accounts for 60% of all meat consumption in China, and they produce almost 50% of all pork in the world (compared with only 11% for the U.S.) But the Chinese government has reported that the sow herd in China has dropped over 24% and private estimates have doubled that figure.

China’s agricultural ministry has estimated that pork prices could surge as much as 70% this year. You might as well double that as well. There are 500 million Chinese poor who live on less than $5 a day, and perhaps as many as 150 million who live on less than $2 a day. Surging pork prices, and the concurrent increase in demand (and prices) for chicken, will not be good for impoverished rural China.

The third shoe to drop is the Fall Armyworm (FAW) infestation. A USDA report from May stated, “FAW has no natural predators in China and its presence may result in lower production and crop quality of corn, rice, wheat, sorghum, sugarcane, cotton, soybean and peanuts among other cash crops.”

In previous infestations, the United Nations Food & Agricultural Organization has estimated that up to half the country’s crop could get wiped out. This is more bad news for China’s poor. With protests in Hong Kong attracting as many as 2 million participants, one wonders how long it will be before 500 million “peasants”—the word used by a very senior Chinese official to me ten years ago in reference to China’ rural poor—rise up. There is an old expression in China, “In order to keep the mandate from heaven, you must fill the bowls.” Filling the rice bowls could become Xi’s number one problem this year.

As Ms. Bhansali points out in her interview, the slowdown in China has nothing to do with the tariffs, but more with the Harvard educated central bankers of China finally saying “no more credit expansion.” However, with potential food shortages in the near future, China needs to lower their retaliatory tariffs on US food products immediately. President Xi can say that this is out of a gesture of good will to restart a broader trade agreement and fudge the real reason.

Regardless, China is in deep trouble and they need a trade deal now. President Trump rightly continues to push for fair (pari passu) trade with China, something the past six U.S. administrations have failed to achieve. The Trump administration and American industry also want China to stop stealing our technology and stop their massive subsidy of state-owned enterprises which undermine reasonable competition from ALL other nations. 

For their part, China wants the U.S. to stop blocking Huawei from participating in building out the worldwide 5G network. Besides the obvious security concerns, Huawei also lacks interoperability with other providers, reminiscent of 19th Century railroad robber barons who built their tracks to different gauges to stifle competition. Keeping competitors from being able to share their tracks was and is, a classic monopolistic tactic. However, there can be no trade deal without 5G interoperability as part of it. 

China needs a trade agreement now to keep the rice bowls full and to stave off a Japan-like “lost decade.” It cannot wait until November 2020.

This piece originally appeared in Forbes on July 19, 2019.