Why China is Spending Dollars to Make Dimes

The Sinowatcher
Aug 22, 2017 · 6 min read

Last article showed how the environmental disaster that is unfolding in China is a complex governance issue. In the name of the “people’s dictatorship” the party has exercised unlimited power without the check of civil groups or law, and will continue to merely pay lip service to the people’s — and the world’s demand for a cleaner economy. So what more can I call the country’s financial issues?

This is an economy that increases its debt level by 40% every year to generate a meager 6–7% of GDP growth adjusted for inflation, that is approaching a private debt ratio of 300% to total GDP, and has begun to resort to base speculation and borrowing at higher and higher interest rates to pay back on bad loans. Productivity, despite so-called prosperity, has barely grown. If that arithmetic does not show one that China’s economy is not healthy let alone vibrant, the only possibility is that the person is willfully ignorant. On the data, I rest my case.

The story is this — after Mao’s death the communist party was at a crossroads. In the late 70’s they finally did the unthinkable by calling their implementation of communism on agriculture a disaster. They eliminated communal enterprises on agriculture, and in the early 80’s, on the rural economy as a whole, and begun to allow farmers to bring their goods to somewhat legal markets. Along with the silence of the communist party at this time to making more revolution, the genius of the Chinese people took over and productivity started to increase. China would not have a famine again.

Yet events would cut this renaissance short. The late 80’s saw growing civic unrest in the cities, and the opening economy saw a ton of Taiwanese and Hong Kong money flowing in. The result was a series of challenges that the communist party perceived as ideologically unacceptable. To Taiwanese and Hong Kong financing, this attitude was absolutely justified. I will be charitable and say that their approach to civic unrest was justified by the inherit paternalism of communist and Chinese political ideology in general. Tienanmen and the crackdown on entrepreneurs are indefensible. What is fascinating about Tienanmen is the degree of division within the party on how to handle it. Key figures like Hu Yaobang and Zhao Ziyang were sympathizers, who may have actually shown up at the protests to encourage the rioters. The Beijing military could not be counted on to hold the line — Inner Mongolian regiments were brought in to lead the charge that would kill thousands.

Either way, the party was divided. What happened next was a compromise solution that was crafted by Deng Xiaoping. Capitalism would be allowed — but the party would be its Leviathan. This is what was called “Capitalism with Chinese characteristics”. The Leviathan proceeded to take control of the economy, and using its access to the national banks, created a gigantic slush fund that has startled the world. Now that slush fund is burning away money, wasting billions of hours of people’s times, and creating illiquid assets like airports, remote housing complexes, and Silk Roads that will probably not return the money required to build them. The oligarchs who really profited are running to the hills, leaving a mess for the Chinese people and communist believers to clean up.

There are many reasons why this has occurred, but three stand out as important: the party as a state within the state, the consequences of compromise, and the information and signalling problems.

As someone who was interested in how communism works on a day-to-day basis, what really shocked me when I first learned about China’s economy was the policy of creating GDP expansion goals for provinces. What a perverse and disastrous policy! GDP expansion without consideration of any other consequence, such as debt accumulation or environmental policy, could not have worked out well. But what could the Chinese people have done to prevent it? The communist party is a group of around 80 million people, the vast majority of whom are irrelevant, that rules by the mandate of the “people’s dictatorship”. They have their own rules, procedures and lifestyle. Fulfilling the wishes of the party means promotion, while failing means something not so good. It doesn’t matter if the policies are actually the good of the state, because on a political level, the party was at one point trusted blindly on this matter, in a way that the readers probably cannot fully appreciate. Yet instead of doing what was good for the people as they should have, the party abused their power and did what was good for themselves instead.

Secondly, the creation of a communism that coexisted with capitalism is the result of a poisonous compromise between the red communists and the “capitalist roaders”. On a basic level, true capitalism is impossible if the banks are mere tools of public policy. Banks that have full government backing have no profit motive, which means that there is no logical reason for its actors to behave with any discipline or economy. A banking system that has no profit motive at all can be trusted on some level to do what is right by socialist logic, but a bank with all the privileges that it receives in socialism and with the opportunities of capitalism will inevitably incur the worst of both. Capitalism with Chinese characteristics is a system created by committee with little critical thought by either communists or capitalists about whether it would work in the way intended. That battle is slowly being opened up again. Xi Jinping, the silver-spooned Yan’an princeling who now is the country’ head of state, is realizing after decades of enjoying a Communist ivory tower just how far it has gone.

What has gone most wrong is what has gone wrong with the information sharing. If you actually read a book by Adam Smith, and you read between the lines, what you realize is that capitalism isn’t about capital at all: it is about information. A rich man in a town is not capitalism on its own, but a rich man who is trying to make more money by assessing public demand is beginning to create a capitalist system. The targets of investment in capitalism are those things that are profitable, which means that they create value. Over time entrepreneurs, entrepreneurial people, consultants, economists and investors begin to learn what is valued and what is not (although the recent fad of speculative investment is breaking this system down).

Snapchat is the perfect example. Snapchat was originally a piece of software for the phone designed to facilitate sending time-sensitive photos, a function that could easily be accomplished by many other means. The company that produced it went to market, and the IPO was a miss. Now Snapchat is adding news services and promotional elements to its technology, which may actually create real value for people. That could never happen in China. There are massive companies like Tencent that are legitimately innovative, but China does not even have a functioning stock market. The point is not about stocks — it is about the fact that information is not shared effective, and thus signals are not created for business people. There are other problems too — for example, the social and business studies in colleges are considered suitable only for the lowest achieving students. The higher achievers go into mathematics and science. At the same time, the economists who have been warning China’s society about the underlying problems have been ignored. Chinese society devalues the “bourgeoisie” studies, and that is a big problem for maintaining a modern knowledge-based economy.

There are exciting innovations in retail, logistics, entertainment and so on that China will very likely miss out on as a result of its debt. The gleaming towers and infrastructure created by spending the future are going to be the shoddily constructed relics of communism tomorrow. All of these things are holding back the genius of the Chinese people, who love knowledge, are hard working, and hold each other higher. It is not for us to say what they should do differently, but to learn from their mistakes:

  1. We must attempt to eliminate our own “state within the state” which has made good governance a joke and a fantasy rather than an achievable goal.
  2. We must look more critically at the compromise policies that we have allowed to proliferate. I am not saying that either side is right or wrong, but for example can we have both private and universal healthcare coexisting? What are the logical consequences of this system?
  3. We must reverse the American trend towards devaluing knowledge. Intelligent people who love to learn are essential for helping our society to make good decisions. We have to put away the screens and turn on the real computers — the ones that sit inside ourselves.
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The Sinowatcher

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The Economist was 5 years late getting the story straight on China. With the Sinowatcher, you can be on time

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