Platt Perspective on Business and Technology

China and its transition imperatives 19.5: China’s expanding economic bubble and a prediction for the coming year

Posted in macroeconomics by Timothy Platt on June 16, 2015

This is my 23rd installment to a series on China that I began writing to this blog in early 2014, just over a year after Xi Jinping assumed Party and government leadership over China in their 18th National Congress of the Communist Party of China This is also my third supplemental posting to this series, as added into the flow of my more regularly scheduled installments to it. To clarify what would appear to be a numbering discrepancy here, I write this as a supplemental posting because I have already written and uploaded my 20th and I add final posting to this series, scheduled to go live to this blog on July 3. I chose not to edit and update that, so it will cite itself as being the 22nd installment, which it actually is if you consider the order of writing. (See Macroeconomics and Business, postings 154 and loosely following, and its Page 2 directory continuation, postings 201 and loosely following for other postings to this series.)

With that minor bookkeeping issue out of the way, I write this posting today, beginning here with my conclusions:

• The People’s Republic of China is currently facing a deep recession at the very least as it is operating in a government policy and private sector driven economic bubble, and one that it does not have the resiliency or resources to prevent bursting. It has been able to stave this off by for example manipulating the value of its currency and by manipulating the stock market valuation of its private sector businesses, at least in China’s own stock markets. But China, its economy, its Communist Party led government and its leadership do not have a lot of room left to continue that.
• And this emerging reality is a big part of why China has been acting so aggressively, and not just in the South and East China Seas, and with regard to neighbor nations that flank those waters. China and its leadership seek to expand their available natural resource base, and to gain a more controlling influence over their international neighbors to help themselves to buffer any negative impact from this bubble bursting, even if they cannot keep that from happening.

I first began writing here about China and its economy, and about its strengths and its fundamental structural weaknesses there in December, 2010 when I added my first posting about that country to this blog with The China Conundrum and its Implications for International Cyber-Security – 1 And I have continued writing about China’s one Party government, its largely government owned, partly privately owned private business sector, and its economy ever since then.

China holds what at least in principle should be very important positive resources:

• Its government holds the equivalent of trillions of dollars in foreign currency in its reserves and in US dollars, Euros and a variety of other currencies.
• China has a robust and growing infrastructure and business sector and has promoted them both to the world through ongoing government policy. And that includes policy that both creates opportunity in support of their own interests, and controls and limits opportunity for foreign competing interests and certainly as they would function within China itself. And they can do this because China has one of the largest marketplaces in the world, and one that every nation that sells anything internationally would want to effectively do business with.
• China holds effective control over at least immediately available production of a variety of natural resources of crucial need, globally. I cite their domination of purified rare earth minerals production, as initially noted in the above cited December, 2010 posting as a starting point for that discussion. And they have been even more of an essentially sole source for the rarer and more expensive of these specific resources: the so called heavy rare earth minerals. To put a number on this, when I wrote my first 2010 posting on this topic, domination of this field meant China producing and selling some 96% of all rare earth minerals that went to market globally. And they sold over 99% of some of the heavy rare earth minerals produced at that time. These percentages have not substantially changed since then.
• China has a vast educated workforce and a willingness to follow through on long-term plans in how this resource is developed and utilized.

China has vast positive resources; China also has vast off-setting negatives too.

• Its government holds a combination of local municipal, provincial and national debt that matches in scale their foreign currency holdings and more. And their state owned and controlled business sector has accrued the equivalent of trillions of US dollars of debt too.
• China has been rife with corruption as a Communist country from its birth as one, with Party favoritism and nepotism and corrupt practices at all levels. I have written of shoddy infrastructure development here using faulty materials and corner cutting construction methods – personally enriching those in charge of these building efforts. Much of their infrastructure does work, but much of it has been built below standard for safety and durability and this has led to seemingly endless cost overruns too, with all of this contributing to the debt cumulatively accrued. Xi Jinping has fought back against corruption and against corrupt Party officials and ever since he rose to power in his country. I have noted that point, in the context of how Xi is accumulating and consolidating personal power by challenging and destroying any possible voice of dissent through China’s courts of law, and that perspective is still valid. But he is also and just as actively pursuing his anti-corruption campaign to try to stop the losses that would arise from new corruption and from new failure prone, corruptly built infrastructure and related development. The problem with that is that so much bad had already been built into China’s underlying infrastructure systems from before he rose to power that effectively correcting all of this would cost China the equivalent of yet more trillions of dollars that his country does not have for that. China is actively and I add at great cost seeking to develop a true 21st century industrial base and military and if they were to step back from that to rebuild and correct older infrastructure already in place, what would happen to Xi’s and China’s dream of China becoming a leading global superpower?
• And this brings me to my third bullet point of my list of positives and to those rare earth minerals – and to the incredible levels of pollution that China and its peoples are saddled with: befouling their air, their water, their soil and their food and health. Rare earth minerals can be found in a great many places globally. One reason why so few of them are developed for this type of resource production is that mining and refining rare earth minerals is so incredibly polluting. And this type of mining and processing certainly is polluting if costs for conducting this business would have to be contained enough to make it competitively cost-effective on a global market and when competing with China’s pollution-tolerant business enterprises.
• And referring back to my first series on China: The China Conundrum and its Implications for International Cyber-Security, and its multi-posting discussion of these issues, this is where China’s black market and its economy, and their grey market and its economy enter this picture, where combined they outweigh China’s official economy (see Ubiquitous Computing and Communications – everywhere all the time and its postings 69 and loosely following for this series’ Parts 1-23.) A tremendous range of production and manufacturing are carried out in China through its black market – with well over half of all rare earth mineral production carried out that way, and still as of this writing, and even though there have been official crackdowns on this for years now.
• China has its black market economy, and its official white market economy, and a vast middle ground grey – not quite white or black, economy in the middle and where business processes and their output cross the barrier between. And to clarify the scale and scope of their black market economy and to highlight that this is not entirely a matter of hidden business bookkeeping, illicit raw materials production, off-books manufacturing and sales – this is at least as much about the reporting, or failure to report of personal income and wealth too. And here I report on practices that I have seen with my own eyes. Chinese Communism takes from its citizens and gives to those in power in that one permitted, all-controlling Party. It always has. So if China now has an economic “middle class,” that numbers over 400 million strong, it also has a population into the hundreds of millions who seek to hide at least some of their personal income from the government and from the Party. As a small part of this, both Hong Kong and Vietnam have thriving tourist industries that are focused on meeting the needs of now-wealthy mainland Chinese citizens, who go to these places, outside of direct full control from Beijing to buy and buy and buy – the most expensive and luxurious goods and services that they can, and with money they have earned and for the most part not reported as taxable income. Chinese tourism of this type significantly contributes to the overall economies of both Hong Kong and Vietnam, and of a variety of other nations as well. And for Vietnam and particularly in places such as Saigon where you see vast multistory shopping malls filled with high end brand name stores, packed with these visitors, this is all palpably visible to any and all.

Now let me turn to the specific issues and events that have prompted me to offer this posting and right now. I have been reading lately, as have many, about how Chinese company stocks are tremendously overvalued and particularly in their own and in Hong Kong’s stock market exchanges. For one of many possible references here, I cite the June 1, 2015 news piece: China Stocks Nearly a Quarter Overvalued: Credit Suisse.) And millions of Chinese speculators are buying all of this tremendously overvalued stock on credit – with funds they do not have themselves.

The Chinese economy is in fact beginning to slow down and at a rate that is not being accurately reported by the Chinese government. That government has been moving vast amounts of its reserves to manage the international valuation of its currency: the renmimbi in an attempt to keep Chinese goods and services competitively priced in international markets and to prop up their economy. Now their citizens who are spending unreported income rather than saving and investing it, to keep from having it taken by the State through taxes are speculatively buying vast amounts of stocks with borrowed money. What part of this narrative, which I admit is briefly sketched out and incomplete, would suggest long-term economic strength and growth?

I usually write my postings on the order of a month or more in advance of their going live. I write this on June 15, 2015 for it to go live on the 16th and with my eye on an editorial that came out in the New York Times print edition today: China’s Unsettling Stock Boom. China and its economy are in a vast bubble right now and they lack the resiliency and the fundamental resources that would be needed to find their way out of it without an equally profound recession of a market correction too. And as I have been intimating and suggesting for a while now, this bubble cannot last forever.

• Will it burst this year or next?
• Lacking a crystal ball and any pretext of clairvoyance I could only guess. But when reality catches up with hope and intent in China,
• And for the rest of the world as nations and their economies that have become vulnerable to spill-over problems from this have to face the consequences too,
• This bubble will burst.

You can find this and related postings at Macroeconomics and Business and its Page 2 continuation. And you can also find related postings about China at Ubiquitous Computing and Communications – everywhere all the time as noted above.

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