Following the Party Congress, Is China on Path to Global Ascendancy or a Nasty Bust?
Veteran China watchers have spent the past week parsing speeches given at the week-long Communist Party Congress, which concluded with the announcement of members of the Politburo Standing Committee. Last week in New York there was a luncheon discussion with a leading scholar of China’s political elite. It was an off-the-record affair, so I can’t give you his name. But he is someone who is regularly quoted when Western reporters are trying to make sense of the maneuvering inside of Zhongnanhai, the CCP headquarters that sits adjacent to the Forbidden City in Beijing. Joining the conversation were a few very sharp economic experts, fund managers, and bankers with decades of experience reading China’s political tea leaves. Here are a few of the key takeaways.
The China watchers agreed that it was not terribly important who the other members of the Standing Committee would be, because Xi Jinping has managed to neutralize any competing factions within the Party with astounding efficiency. In fact, “Xi Jinping thought” has now been elevated to the new socialist orthodoxy in China by being written into the constitution, meaning anyone who opposes his policies will be branded a heretic. While some party officials may question the wisdom of the One Belt, One Road foreign economic policy or other domestic initiatives, they will keep their opinions to themselves. At the closing of the Congress, official state media Xinhua cast Xi's vision in epic terms: "By 2050, two centuries after the Opium Wars, which plunged the 'Middle Kingdom' into a period of hurt and shame, China is set to regain its might and re-ascend to the top of the world." Xi’s maxims and themes are being woven into curricula from grade school through universities, such that the rising generation will be imbued with his thought in a manner not seen since the Great Helmsman. The fact that no one young enough to be a credible successor to Xi was elevated to the Standing Committee underlined that Xi has no intention of a being a “lame duck” and will move on at the time and in the manner of his own choosing. He is playing the long game and taking no prisoners.
Supply-Side, China Style
Another term that was heavily featured at the Congress was “supply-side structural reform.” But if you are thinking this means Arthur Laffer-style tax cuts, think again. Supply-side reform is the Party’s answer as to how to continue a brisk clip of GDP growth, while managing the various asset bubbles in China’s economy and avoiding an outbreak of inflation. Supply-side reform relies upon the wise guidance of the Party and government bureaucrats to allocate investment into sectors believed to be promising, while consolidating overcapacity in older industries. The term is confusing, because to Western ears “reform” sounds like giving more weight to the market in allocating capital. But China is headed in the opposite direction under Xi. Supply-side reform is just another term for state planning, said the guest of honor, wondering why they don’t simply say what they mean. In practice, this policy is being used to bolster the market share of State Owned Enterprises (SOEs) at the expense of private enterprises, who are often consolidated right out of business. Advanced infrastructure, power generation, passenger aircraft, robotics, and shipping are among the capital intensive industries where China intends to muscle its way into the global front ranks. Neither the concentration of economic resources under SOEs nor the strategy of substituting high value imports with Chinese replacements is particularly good news for foreign companies hoping to win any meaningful share of the China market. Elon Musk’s efforts to set up Tesla’s domestic manufacturing without entering into a joint venture with a Chinese partner or Mark Zuckerberg’s efforts to get Facebook a toehold in the China social media market will both be steep hills to climb. Expect more aggressively nationalistic trade policies on both sides of the Pacific.
Bubble, Bubble, Toil & Trouble
The Beijing watchers are fairly evenly divided between China bulls and China bears. The bears are licking their paws after being caught early in predicting a massive currency devaluation, whereas the bulls admit that the growth model was fraught with risk. Everyone agrees that China was riding a massive debt escalation on both government and corporate balance sheets. The expansion in liquidity has fueled a massive housing bubble, and China’s top-tier cities now have the most expensive real estate in the world when measured against household income. Much of this housing stock is held by speculators betting on ever increasing prices. In the provincial cities the local governments have responded to excess capacity by becoming the buyers of last resort, scooping up 18% of the square footage sold nationwide. This circular cycle of ballooning bank loans, speculative purchases, and local government incentives to keep new construction humming appears to have the makings for an eventual spectacular correction. But thus far the Chinese government has defied all predictions by deftly turning on and off the credit tap to keep the party going, without letting it get out of hand. It is said that there is a special firefighting brigade at the People’s Bank of China keeps an eye out for stress in the financial system and then douses troubled financial institutions with new liquidity.
China’s New Economic Model?
Under Xi Jinping China has clearly moved away from Western models of economic development based on free markets and secure property rights and towards a more autocratic, state-led approach financed by massive amounts of debt-financed capital investment. The more admiring China watchers felt that this was now a powerful alternative model that would pull an increasing share of nations into China’s gravitational sphere. China is building its own alternative set of global economic institutions, even as the U.S. appears to be abandoning the established financial infrastructure we created in the post-war era. The China Development Bank and China Import-Export Bank fund major infrastructure and trading agreements that replicate its model in other developing countries. China has a coherent industrial policy that is executed according to disciplined 5-year plans. Bulls believe that China has become so large that it has created its own economic force field in which the laws of market discipline no longer apply. The China skeptics continue to believe that it will end in tears and that the asset bubble will collapse of its own weight, setting off a contagion of insolvency across the financial sector. They believe that state planning is always funding the industries of yesterday’s future and is incapable of true innovation.
So will China be the great exception to the crashes that litter the history of debt-driven investment booms? For now, I am still unwilling to make a wager against the seven men who guide China’s fate or the commercial energy of the Chinese people. But the answer to this question will determine if Xi’s “China dream” — in which the population continues to be lifted into prosperity while China resumes its rightful place at the center of the global power structure — is indeed realized, or devolves into a vision considerably less pleasant.