Saturday, December 17, 2022

China's Future Remains Cloudy And Uncertain (Part 1)

OROB Could Result In Creating Massive Conflicts

The article below is a summery of China today. China has been moving away from its dependence on America but its path forward may be more difficult than people imagine. China has huge problems that make this planned decoupling a risky gambit. Still, this move has already started and that is unlikely to change. Over the years China has invested heavily in its One Belt One Road (OBOR) initiative. The brainchild of Chinese President Xi Jinping, OBOR is an all-encompassing and confusing "work in progress" that, as it unfolds will reshape world trade and the relationships China has with many countries.  

Now that the Chinese Communist Party has finished holding its 20th National Party Congress, things can move along as planned. OROB consists of two major parts or projects that are known collectively as One Belt, One Road, Belt and Road, or the New Silk Road. According to Chinese state media, some $1 trillion has already been committed to OBOR, with several trillion slatted to be spent over the next decade. The plan aims to pump this huge sum of money into railways, roads, ports, and other projects across Asia, Africa, and Europe.

OBOR is so overpowering it has morphed into a "philosophy" or "party line," rather than anything concrete. This massive endeavor includes more than 68 countries and impacts 4.4 billion people, or around 60% of the world's population. This means it touches just over a third of the world economy. Its boosters tout its massive economic promise and claim it could benefit the entire world by lifting millions out of poverty. Still, for all its rhetoric about trade and development, OBOR is primarily a political project.

China's state media claims OBOR will benefit: the Middle East peace process, start-ups in Dubai, currency trading, global poverty reduction, Xinjiang's medical industry, Australian hotels, nuclear power, Polish orchards, and, darn near the entire world. This clarifies and extends a trend that has been going on for years. It should be noted, in the past, several Chinese overseas investments have also earned China a bad reputation when it comes to delivering on its promises. This includes some local economies claiming allegations of exploitation.  

Emboldened by an influx of wealth over the last few decades, China has played fast and loose with creating and loaning out new funds. As debt service rises, this can create a serious balance of payment challenges. OBOR to move forward has to provide the financing for infrastructure that many countries desperately want and need but will they be able to repay the loans in coming years? 

The Center for Global Development, a Washington-based think tank, has highlighted in a report entitled Examining the Debt Implications of the Belt and Road Initiative from a Policy Perspective, the underlined the problems of extending credit to poor or unstable countries. It has been pointed out that as many as 23 countries could be prone to “debt distress.” This group includes Pakistan, Djibouti, the Maldives, Laos, Mongolia, Montenegro, Tajikistan, and Kyrgyzstan which were rated in the “high risk” category. This brings us to the question of whether OBOR will become a massive expensive bridge to nowhere.

More Debt Has Failed To Speed Up Growth

Many China skeptics argue that China continues to prop up the unpropable, and yes, while no such word exists, when it comes to China's economy it should. Unpropable  describes China's financial collapse that can only be postponed but not stopped. A major problem for China is that it has become addicted to debt and any slowing of the economy places tremendous pressure on those already having difficulty servicing debt. The fact is most Chinese companies fund through bank credit so the stock market in China is not as large a factor in their economy as we might expect. 

Another issue is all this debt plays a role in lowering the value of China's currency. A lower yuan is a double-edged sword. While it helps exports, it makes importing raw materials more expensive and tends to raise the ire of trading partners. Still, more important may be whether a falling yuan causes more wealth to exit China in search of a safe more stable environment. The lack of good investment opportunities in China has caused more and more money to leak across the border inflating asset bubbles in other countries.

 China Is A Small Player (click to enlarge)

It could be argued that much of what is occurring in global currency markets is getting scrubbed away by our complex financial system. While many Americans tout that China has us by the throat it is not true. Considering how rapidly debt and credit have increased over the years, it could be argued that the trillion dollars of debt America owes China is not nearly as relevant as it was a decade ago.

China Only Holds A Small Percentage Of US Debt

The main reason China bought up so many U.S. Treasuries over the years is that it wanted its currency pegged to the dollar. Dollar-pegging has in the past added stability to the yuan since the dollar is viewed as one of the safest currencies in the world. It must be pointed out that even though China owns these U.S. Treasuries, China is running a massive U.S. dollar shortage both on a corporate and a national level.

Much of China's problem stems from its companies having roughly $3 trillion or more which it owes to international investors. Loans of this type are not uncommon, especially in developing nations. This "global debt" being denominated in U.S. dollars means the companies owing it needs to pay both the principal and the interest payments to their lenders in U.S. dollars. This demand for dollars creates a constant flow of dollars out of the country. 

Remember, like all politicians, even those in China, tend to go to extreme efforts to avoid taking responsibility for the problems they create. History shows that one way a country can kick its gross domestic product higher is to build a false economy based on infrastructure or war. The OBOR initiative and China's growing space program may be an extension of this idea.

Up until now, China's big misallocation of resources has been in housing. One of the biggest challenges china has going forward is that, in some ways, the Chinese residential real estate market could be called a Ponzi scheme of massive proportions. It is the most overvalued asset class in the world. Much of China's so-called wealth is tied up in poorly constructed overpriced homes. Chinese leaders knew this was a problem and tried to slow and halt growing valuations over the years but failed to follow through.

China's real estate bubble is apparent in its bizarre housing market and "ghost cities." This is where 75% of its peoples' wealth is stored. The excesses in China's real estate market have not yet been resolved. After becoming an estimated 30 percent of China's economy, housing is now an albatross around the neck of economic growth. With housing prices falling the wealth effect it created is varnishing, when all is said and done, it is very likely the process will be deflationary.

While many people think China has become the most important player in world trade, they are discounting America's role as a major consumer of its goods and capital investment. China is an export-driven economy and the numbers it puts out are suspect. The money from trade flowing into China from the west is the biggest factor keeping China afloat. Played fast and loose by creating and loaning out new funds will only mask China's dilemma for so long.


Footnote: Part two has now been published. It looks at several other problems currently playing out in China. Following is the link to that post.

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1 comment:

  1. A recent video posted by Business Basics makes a case that China is lying about its GDP and it's not anywhere the 16 trillion dollars claimed. It argues the true GDP maybe 60% smaller than the CCP reports. Here is the link to this video.