Kevin M. Wilson Blog | China Will Collapse From Economic Wasting Disease Long Before We Are Caught In “Thucydides’s Trap” | Talkmarkets - Page 3
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Kevin was the CEO and founder of Blue Water Capital Advisors, which he retired from in late 2017. He is now semi-retired, working part-time for Great Waters Financial, LLC (which is part of the AdvisorNet RIA) as a consultant.  He has been in the financial advisory business since 1992. ... more

China Will Collapse From Economic Wasting Disease Long Before We Are Caught In “Thucydides’s Trap”

Date: Monday, September 11, 2017 3:03 AM EDT

This is not to say however, that some kind of accident couldn’t happen, as I’ve mentioned elsewhere.  China and the US each have allies whose interests and security they are committed to defend, and this could still lead to trouble.  The ultimate fates of Taiwan, North Korea, the South China Sea, and the East China Sea are still big political problems in the region, and it will take continuous diplomatic efforts to avoid greatly increased tensions.  It is not at all clear that such efforts will ultimately succeed, but Allison’s case for this being due to Thucidides’s Trap seems tenuous, based on the long-standing nature of most of these disputes, and China’s inherent weakness.  We should not forget that there is also much residual anger in China about Japan’s depredations during World War II, in which some 14 million Chinese lost their lives; the potential for this resentment to flare up again is not trivial, but it has nothing to do with a US-China Thucidides’s Trap.

Any future war between China and the US or its allies would almost certainly result in a loss of trade, and this would likely be disastrous for the Chinese economy.  This last point is indicative of the real problem facing China: it is still quite dependent on (internal) fixed investment and the growth in international trade, but since 2008 both of these have been in decline (Charts 6, 7).   Indeed, exports are now contributing only 19% of GDP, but China’s much-vaunted switch to a consumer economy has not yet gathered much steam.  The bulk (45%) of Chinese GDP is still generated by capital investment, with only 35% coming from personal consumption, according to Daniel Ben-Ami (2016).  This is in sharp contrast to the typical composition of GDP in developed economies, which is about 60-70% personal consumption and about 15-25% capital investment; indeed, this suggests that China’s economy is still “dangerously unbalanced.”  The most alarming aspect of this situation is not just that China’s economy is unbalanced, but that it has built this massive imbalance upon a foundation of extremely unproductive debt.  For the uninitiated, unproductive debt is debt that is essentially a waste of resources, because it has no economic purpose and thus cannot generate enough income from its associated projects to retire that same debt over time.  China’s famous ghost cities provide compelling anecdotal evidence for this kind of waste.

Chart 6: China’s Capital Investment Has Been Declining

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Chart 7: China’s Trade Volume Growth Has Eroded Since the Big Fiscal Stimulus of 2009

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Overall economic (i.e., GDP) growth in China, however suspect its measurement, has thus also declined sharply (Chart 8) since the great fiscal stimulus of 2009, and China now faces daunting economic problems arising from its attempts to re-balance its economy towards consumption, its efforts in fighting corruption, and its ever-growing pile of unproductive debt.  Indeed, China expert Michael Pettis (2017) has recently written about the huge overstatement of China’s GDP measurements when compared to those of other countries, based primarily on its penchant for unproductive debt.  George Friedman (2016) has repeatedly pointed out that China’s economic problems suggest that it is already in decline, not in any sort of ascendancy.  James Rickards (2017) has claimed that at least half of Chinese investment is unproductive, or wasted.  Subtracting this waste from reported GDP (similar to a write-off under GAAP rules) would drop actual (productive) GDP into the range of around 5.2%, down from the 6.7% reported for 2016.  Michael Pettis also supports this idea of a Chinese write-off of unproductive debt against GDP.  Because so much debt burdens its economy, and because so much of that debt is unproductive, it now takes $4.00 of debt to produce $1.00 of actual growth in the Chinese economy.  So China’s Keynesian multiplier is about 0.25, a clearly unsustainable dynamic.  This is reflected in comparisons of the credit intensity of growth between China, the US, and the Euro area (Chart 9).  In effect then, China is afflicted with the economic equivalent of a wasting disease (cachexia), and its economy will continue to decline as a result.  The US is on a similar but much less severe path.

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