Why China Is In Trouble
The common wisdom for many years has been that China will grow to be the largest economy in the world. I think there is a very good chance it will never get there. Here’s why:
- They have severe internal problems
- The economy is slowing and will slow further
- Debt is at astronomical levels and is getting worse
- Corruption is rampant and getting worse
- Demographics are working against them
Let me start at the bottom.
Right now China has a shrinking working age population! The peak was several years ago. All other things being equal, a shrinking working age population causes a shrinking economy. See Italy and Japan for examples.
Fortunately for China, risiing productivity can mean that a country can grow even with a declining population. For example, productivity growing 6% and a population declining 1% will generally cause the economy to grow the difference or 5%. This is exactly where we are in China right now.
Corruption is a serious problem in many countries and China is one of them. Corruption is a form of tax on the people and also creates an uncivil society where power is more important than morality.
We see Mayors of cities sending their kids to private Swiss school yet their official income is only $700 per year. Amazing frugality! Uh, maybe not.
Corruption causes people to waste capital bribing officials rather than going into productive uses. As a result, we will see productivity decline in China over the next few years.
Debt is astronomical levels. Not as bad as Japan but worse than the US. Debt is a drag on growth because income has to be created to pay for the interest and principal. Debt can be a good thing if it is used for investment but not for consumption. Debt is for both investment and consumption in China.
The problem is that Chinese debt is not tethered to reality but to guan xi. You get money from a bank not because your project is a great project and you can easily pay back the money but because you have guan xi, or connections. As a result, Chinese banks are already bankrupt but not allowed to declare bankruptcy.
A major reason that Japan has been in a recession since 1990 is that all excess money earned goes to pay off debt and interest on that debt. That process is already starting in China.
This all adds up to a secular decline in the growth of the economy.
Which all leads to the first point: the problems.
One major problem is ethnic strife. One obvious place is the situation with the Uighurs.
A second problem is that China is not creating jobs fast enough as literally millions of people leave farms and come to the city. They then work illegally in the cities because they don’t have the right documents to leave their province. Why do they want to move to the city? Because they see people in Shanghai driving Buicks and they are still working on a farm using physical labor.
Another problem is the centralization of power into the hands of the central government. The central government is clipping the wings of super popular companies like Alibaba. They are choking off credit to private industry and putting it into State Owned Enterprises, thus reducing the growth of the private sector.
China still has a lot of gas in the tank but the factors above will surprise the market above and cause Chinese stocks to underperform expectations.
