Resurgence of the China Collapse Theory

The famous American military expert and politician Dr. George Friedman said in a 2011 interview with South Korean media that China, under the conflict of an export-oriented structure and poverty, would fall into a “crisis” in the next 10 years. His opinion was based on the single reason that China was a country with no internal economy; if Europe and the United States did not buy Chinese products, the country could not survive. In his view, China was like a hostage of the outside world.

Besides, poverty was also a big problem that troubled China's economic trend. He said that the daily incomes of 600 million households were less than $3 and 440 million people’s earnings were less than $6 (but above $3); among the 1.3 billion population, more than one billion lived like the African poor. Exactly based on this, he believed that China was in a position like Japan before the 1989 collapse. He said that after the dazzling growth Japan’s financial system was on the verge of collapse and this was also the signal that predicted China's growth cycle reaching its limit; every country sought different solutions, Japan slowed down the growth rate. Of course, in his capacity as the CEO and chief intelligence officer of Stratfor, a political, economic and foreign affairs think tank seen by the U.S. media as a "shadow CIA,” he was apparently not alone.

In the December 2011 issue of The New York Times, Paul Krugman, the 2008 Nobel Laureate in Economics and Economics Professor at Princeton University, wrote the following in his column (http://kaichenblog.blogspot.hk/2011/06/george-friedman-china-miracle-is-mirage.html):

 “Recent growth has relied on a huge construction boom fueled by surging real estate prices, and exhibiting all the classic signs of a bubble. There was rapid growth in credit — with much of that growth taking place not through traditional banking but rather through unregulated ‘shadow banking’ neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting — and there are real reasons to fear financial and economic crisis.”

“Am I describing Japan at the end of the 1980s? Or am I describing America in 2007? I could be. But right now I’m talking about China.”

In the article, one of his important arguments was the export issue.  “The most striking thing about the Chinese economy over the past decade was the way of the household consumption, although rising, lagged behind overall growth. At this point consumer spending is only about 35 percent of G.D.P., about half the level in the United States.”

“So who’s buying the goods and services China produces? Part of the answer is, well, we are: as the consumer share of the economy declined, China increasingly relied on trade surpluses to keep manufacturing afloat. ”

His concern was: “…with consumer demand relatively weak, what motivated all that investment? And the answer, to an important extent, is that it depended on an ever-inflating real estate bubble. Real estate investment has roughly doubled as a share of G.D.P. since 2000, accounting directly for more than half of the overall rise in investment. And surely much of the rest of the increase was from firms expanding to sell to the burgeoning construction industry.”

“Do we actually know that real estate was a bubble? It exhibited all the signs: not just rising prices, but also the kind of speculative fever all too familiar from our own experiences just a few years back…”

Compared to these experts, the foreign media are even more discouraging. The U.S. Foreign Policy magazine recently published an article stating that companies were reducing borrowing, manufacturing industries stagnated their output, interest rates were unexpectedly lowered, imports stopped growing and gross domestic product (GDP) growth expectation was down (some people even believed that China's economy was already in recession); these were regarded as the five signs of the Chinese economy facing a major disaster. Accordingly, The New York Times columnist Mark McDonald thought that a Chinese disaster was about to come. In his article published on July 9, Mark McDonald, in addition to referencing the point of view of the U.S. Foreign Policy, also cited the view of Robert Subbaraman, an analyst at Nomura Securities. This largest financial services company in Japan thought that there was at least one-third chance for China to experience a “hard landing” before the end of 2014.

In support of the above view, Mark McDonald also cited the travelogue about China by columnist Rosemary Righter. She recently wrote an article for the Times Literary Supplement, in which she mentioned that during her recent trip to China she discovered that a large number of houses, apartments, magnificent public buildings and factory plants shared the same fate of being empty, although they were of different exterior shapes. She said that there were a large number of uninhabited buildings in various parts of China; this situation existed not only in the eastern coastal cities but also the remote southwest inland areas; the same scene - empty ghost towns - could be seen in the dirty mining towns of the central Chinese plains like Henan as well as Inner Mongolia in the northern part of the Chinese territory.

In addition, a recent cover story of the weekly financial magazine Barron’s further bluntly stated that “…it looks like the Great China Growth Story may be falling apart” (http://online.barrons.com/article/SB50001424053111903857104577467200405790354.html?mod=bol_share_tweet#articleTabs_article%3D1).  The Wall Street Journal in the United States put it more euphemistically, but they viewed the rapid decline of the rate of expansion of Chinese manufacturing industries and thought that China's economy was not only deteriorating, but also bleaker.

However, those who were truly pessimistic were not overseas but within the country. On October 22, 2010, when Lang Xianping (郎咸平), Professor of the Chinese University of Hong Kong, gave a lecture to business management personnel in Shenyang, he made a detailed analysis on the current economic situation of the Chinese mainland. With a lot of economic data and examples, Lang proved that currently the Chinese investments were displaying two different extremes (the property and stock markets were down whereas luxury real estate, cars, high-end goods, antiques and arts, and up-scale clothing were in high demand); the Chinese economy already showed a manufacturing crisis resulting from serious excess capacity. He thought that the wrong economic policies had brought disasters to the country. During the lecture, Lang repeatedly used “cry,” “cry together,” “I cannot do anything about it,” and other words to describe the seriousness of the current economic crisis.

Of course, the people in the country who believed in a China economic collapse were far more numerous than just our Professor Lang. So, will China really crash?

Favorable Elements that Are Indispensable

My viewpoint is that even if the euro collapses and triggers a burst of the global debt bubble, China still can largely be spared in the global financial crisis. So, once again, how can China limit the effect of the recession resulting from the global deleveraging process of the debt bubble burst?

A few reasons for the United States to avoid repeating Japan's mistakes were mentioned by Krugman in The New York Times column on August 16, 2002 (http://www.nytimes.com/2002/08/16/opinion/mind-the-gap.html?ref=paulkrugman&pagewanted=print). I think that they can also apply to China in this period. At that time, Krugman cited four reasons:

1. The Fed has plenty of room to cut interest rates, which should be enough to deal with any eventuality.

2. The U.S. long-term budget position is very strong, so there's plenty of room for fiscal stimulus in the unlikely event interest rate cuts aren't enough.

3. We don't have to worry about an Asian-style loss of confidence in our business sector, because we have excellent corporate governance.

4. We may have a stock bubble, but we don't have a real estate bubble.

Among these four, we must be fair and objective that the third and the fourth reasons obviously do not constitute proper reasons for us to withstand the recession. First of all, if China's corporate governance mechanism is not too bad, it is at least not too outstanding. The “Relationship System” proposed by Fei Xiaotong (Fei Hsiao-Tung 费孝通, a renowned sociologist and anthropologist of China. He is a Functionalist; in the study of ethnology and sociology, the key of the theory of function is to take culture as a whole) in 1948 was the first attempt to depict the characteristics of Chinese culture. It has since been frequently referenced in the social science community. In the book Rural China (《乡土中国》), he viewed people in the Western individualistic societies as separate pieces of firewood with their social organization tying them together as bundles of firewood; the Chinese social structure seemed to be the ripples introduced by the circles after a stone was thrown into water; every man was the center of the circle resulting from his social impact, which interacted with the ripples produced by the circle;  this spider web-like network had a center, and that was the man “himself.”  In the theory of the Relationship System, Fei Xiaotong pointed out a major characteristic of Chinese culture and it is the concept that Chinese social relations work through family networks with the self at the center and decreasing closeness as one moves out. Later, when scholars, for example Xu Langguang (Francis L. K. Hsu 许烺光), conducted research, they basically continued the thinking frame of Fei Xiaotong. In Xu Langguang’s view, Chinese credit relationship was a kind of close kinship in the form of parent-child axis, which thus affected the operation and content of the other social relations; ultimately it became the subjective consciousness ideology (subjective consciousness refers to the inner, private experience of (mainly) human beings); it controlled social structures, systems, and cultural tendency, and naturally also included the modern enterprise system.

Francis Fukuyama in his book Trust: The Social Virtues and the Creation of Prosperity (《信任——社会美德与创造经济繁荣》) mentioned that Wang Laboratories’ failure was led by this credit relationship. In 1951, Wang An (王安) left Harvard University and founded Wang Laboratories in Massachusetts with only $600. Under his leadership, the Wang Laboratories went public at the end of the 1950s. With the help of a successful listing, Wang increased investment in research. In the subsequent 20 years, because there had been continued new innovations and moves, the business was flourishing. By 1984, the company's operating revenues reached $2.28 billion and it ranked 146 in the Fortune 500 large enterprises of the United States. However, this was about to reverse itself.

For health reasons, in 1984 Wang An began to prepare for retirement. But his preferred successor was his son, Frederick Wang. With this Chinese-style successor in mind, Fred was rapidly promoted. Such blatant practice of nepotism was very difficult to accept by the non-Chinese managers and soon they left the company. Accompanied by the loss of the company talents and Fred’s accession to power, the performance of the company went on a slippery slope. By 1992, the company had to choose bankruptcy protection.

Although it was merely a personnel decision, what was being revealed was a great social and national problem. Just as Francis Fukuyama discussed in his book, although Wang Laboratories had the appearance of a high-tech and modern enterprise, it was still built on the basis of the family relationship. Family had provided the social capital for the creation of the new enterprise while at the same time it equally limited the structure of the enterprise, thus preventing its long-term vitality. Wang, although living in the U.S., had in fact a truly Chinese approach. Wang did not advocate opening up investment, nor did he believe in the U.S. system. He had repeatedly said that because he was the founder, he had the complete control over the company so that his children could have the opportunity to prove their management capabilities. In other words, he never trusted the people outside his family, nor was he prepared to trust them. If this were a phenomenon of just one Wang family, it would not be worth mentioning. But unfortunately, this is a common phenomenon in Chinese society. The Chinese-style credit has precisely become a fundamental obstacle to our current effort of establishing a modern enterprise system.

As for the fourth reason, does China have a real estate bubble? Let us look at a set of data: in September 2009, the China Securities Journal (《中国证券报》) published a report which stated that the total value of China's domestic housing had exceeded 90 trillion yuan. Then in 2011, the then chief economist Li Xunlei (李迅雷) of Guotai Junan (国泰君安) Securities published an article entitled “Inflation Makes the Poor Injured and the Rich Fearful” in the 21st Century Business Herald, in which he pointed out that China's residential property market capitalization was about 100 trillion yuan. Corresponding to this data, the statistics released by the National Bureau of Statistics of China showed that in 2011 China had a GDP growth of 9.2 percent over the previous year, valued at 47,156.4 billion yuan for the whole year. In accordance with the viewpoint of “the bubble being the part of the asset price that has nothing to do with the real economy” by Professor Yukio Noguchi, let us do some primary school arithmetic: residential real estate total market capitalization of 100 trillion yuan - annual gross domestic product value of 47.2 trillion yuan = 52.8 trillion yuan which is the Chinese real estate bubble. This was exactly one of the major arguments for Paul Krugman to judge that the Chinese economy would collapse. As shown by the experiences of the United States and Japan, it is sufficient to enable a national fatality.