Platt Perspective on Business and Technology

China and its transition imperatives 27.5: is China too big to fail?

Posted in macroeconomics by Timothy Platt on January 10, 2016

I was initially planning on titling this supplemental posting with the tag line “rethinking China in the light of its recent stock market convulsions” after its series title, posting number and the full colon that follows them. Then I sat back and reconsidered, and decided to use a title that more fully captures my real concerns here. So I begin it with that uncomfortable question of whether or not China is too big to fail. And I begin addressing that with a flat assertion that some people, at least as of this writing would see as at least faintly ridiculous hyperbole:

• If the Renminbi is trading in international currency exchanges at better than 50 to the US Dollar now, which it is, it is ridiculously overvalued. This point of observation is already true now and the coming year is likely to increase that benchmark number from 50 and even considerably so.

I am going to come back to that number: 50, later in this posting. But for now I simply offer it as a possible benchmark that I would argue is at least oriented in the right direction. Why did I decide to add in this supplemental posting to this series, and now, and particularly when I am already writing so actively to this series? Let’s start there and with that question first.

I have been writing for a long time now, about China’s fundamental structural economic weaknesses. And as a perhaps minor recent detail from that, I made note of how China’s government has recently prevailed in convincing the International Monetary Fund (IMF) to include the Renminbi in its basket of preferred global benchmark currencies. There is an old adage to the effect that you should be careful what you wish for because you might get it. This event can be seen as a perfect example of that admonitory advice in action; as soon as the Renminbi was included in that premier group of globally recognized currencies, China lost its ability to manipulate and control its recognized exchange rate valuation in global markets. And given China’s real situation as far as its economic fundamentals are concerned, that has helped push their Renminbi into what might very easily become freefall.

• China is burdened with an economy that is built upon a foundation of completely inefficient, corruptly led state enterprises and state controlled businesses. These business enterprises have survived by borrowing and borrowing and borrowing, and under conditions where no repayment would ever be expected. And they have survived by spending funds that they do not have and that they cannot pay back, to cover for their ongoing flow of loss and red ink.
• Essentially the same point could be raised with regard to China’s active infrastructure development programs as carried out under local and provincial government and Party control – and ultimately by essentially the same people who hold control over those state run and owned businesses. And in both cases, personal power and self-aggrandizement over-rule need and its prioritization, or quality of product produced. I have touched upon a number of examples of this over the past several years, and simply cite one of many of them here when I raise the specter of how so many publically constructed buildings, including virtually all schools collapsed as a result of the 2008 Sichuan earthquake , while proportionately far fewer privately constructed buildings did – with the loss of many tens of thousands of lives including a great many children. Shoddy construction and corner cutting was responsible there with local government and Party officials pocketing funds that should have gone into making these buildings safer and more secure.
• Looking back to the business side of this, China has a sham stock market that was initially set up as a means of bringing a share of their citizen’s individual life savings into this ongoing effort, to shore up and support these structurally unsound businesses and to shore up and support their one allowed political Party and government. Initially, the only businesses that were allowed to offer stock shares in China were their state owned and run businesses, and only then and with very stringent controls in place, select privately owned businesses were allowed in too.
• But China did create a stock market, and even if a very restrictive one that did not allow in foreign investors. And now and as a much more far-reaching step they have successfully lobbied the International Monetary Fund to upgrade the status of their currency the way they did in November, 2015. And this opening of outside accountability has set up China for economic failure, and of a type and at a scale that it cannot hide.

This past week, China had to completely halt all trading in its main stock market twice because across the board stock valuations fell so far and so fast, from mass sell-offs in a single day as to trigger that as an emergency response (see Morning Agenda: China Stops Trading After Less Than Half an Hour.) The only reason why this free-fall event stopped and with only a roughly 10% drop in overall valuation listed, was because China’s government imposed stringent across the board limitations on stock share trading to prevent further drops. This represents a stunning loss of faith on the part of Chinese investors, and real fear on their part of losing their life savings, or at least significant portions of them.

Is China too big to fail? When I read the news analyst pieces as they respond to recent and current events there, and when I read op-ed pieces about China, I keep seeing the same points highlighted. One is that China is big. It accounts for the equivalent of some two trillion US dollars worth of global trade annually, out of some 60 trillion in play (for 2015 as the most recent year.) And China, at least on paper has the second largest national economy on Earth. And with over 1.2 billion people, they represent one of the largest markets on Earth, and on paper at least they are still a growing economy, and even if that means growing at a slower (roughly 7%) rate, which is still very good.

• But look at their fundamentals and at what they have build this economic edifice upon. Ultimately, if China and its Communist Party and government leadership have built their economic house on sand, and even on what amounts to quicksand, what do they actually have?

Too many pundits note that China’s leadership should stop micromanaging their stock market and turn to work on their more core issues – such as divesting themselves of failed state owned and run business enterprises that are unsalvageable failures. Yes, both of these points are true, and so are essentially all of the related suggestions that are also offered. But all of this misses the point. Why does Xi Jinping and his Party and government work so hard to prop up their failing and fundamentally rigged and flawed stock market? Why do they simply stand by while their failing and dysfunctional state run businesses plod along, draining crucially needed economic value at every turn and with no possibility of their turning around and becoming sources of positive value?

Ultimately, China’s biggest underlying economic failure is its one Party system, set up and run in a way that makes corruption and inefficiency inevitable and incurable, at least from within their current system. Is China too big to fail? That may be the wrong question. In a fundamental sense, China already has, and it is their continuing insularity, as for example in who can trade in their stock market, that maintains the illusion – along with the image of their size. That is why their gaining IMF recognition of their currency, the Renminbi was such a devastating Pyrrhic victory. And that is why I perhaps overly cautiously chose the number 50 as my benchmark valuation point towards the start of this posting.

I wrote another supplemental installment to this series the day before Christmas, 2015 to go live that next day and I offer this as a continuation of that piece (see Part 26.5: remembering China’s straw dogs.)

You can find this entire series and all of its postings at Macroeconomics and Business as postings 154 and loosely following for Parts 1-12 and for a supplemental posting: Part 12.5. And see Page 2 to that directory for subsequent main sequence and supplemental installments to this. You can also find other, China-related postings and series at those directory pages, and at Ubiquitous Computing and Communications – everywhere all the time too. (Note: I wrote this posting over the course of a couple of days, finishing and uploading it on January 9, 2016.)

Nota bene: I approach China and its issues from a business operations and strategy perspective, and as if that nation was in fact a business enterprise, and one that faces essentially the same reality check requirements that any other organization would if it is to thrive and prosper. In this, think of China as a business that seeks to function according to a very specific, nation-state type of business model. This perspective can be found at the foundation of everything that I have written about China, and it is how and I add why I see its challenges as being so fundamentally grounded, and so much more so that most economists would consider.

I posed a very challenging question in this posting, starting with its title. And I ended this supplemental installment by stating that it can reasonably be argued that China has already, in many crucial respects fundamentally failed, and certainly economically. And this brings me back to my particular business and technology grounding and perspective. I have in effect set up China in this discussion as being in need of fundamental change management – as if it were in fact a vastly huge business, but one that was lacking in fundamentals and that was not supported by a solid foundation. I have already written and uploaded a Part 28 to this series that is scheduled to go live on February 4, 2016. And I have started planning for a Part 29 that is tentatively scheduled to go live on March 9, 2016. I am going to at least begin to address some of that challenge there. And in anticipation of a more complicated discussion to come, I note here that simply suggesting that China jettison its failing state run and owned businesses as if by a wave of the hand, as some economists blithely do, cannot suffice – and even if you leave the People’s Liberation Army and their vast state-owned business empire out of this. Change management is neither simple nor easy, and China and its challenges are not simple. The best precedents that I can think to draw from for that are national rebuilding efforts, as have taken place as post-war recoveries, and when the nations involved are more likely to be open to the fact that they need fundamental change than China’s government and Party leaders do now. This brief digression only sets up a more detailed discussion to come, and one where the devil really is in the details. And with this final after-thought note I really do end this posting. (Tim Platt, January 9, 2016.)


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