The year was 1979. Not a lot was known by the public about China, its people, its politics, or its economics. Nixon’s historic visit to the mainland had only happened about 7 years earlier and it was still a common occurrence to hear China referred to as Red China. On March 16th of that year, the movie entitled The China Syndrome was released in theaters. The idea behind the movie was that negligence and corporate malfeasance at a nuclear plant led to a nuclear meltdown where the core metaphorically sinks through the earth all the way to China. Eerily, a scant 12 days later, the accident at the Three Mile Island (TMI) plant in Dauphin County, Pennsylvania occurred. Suddenly, it seemed, all our worst fears about nuclear power were realized and the word ‘China’ had suddenly taken on a sinister meaning independent of the nation in the Far East.
Now with the benefit of hindsight, we can see that the TMI disaster, while serious, was not the catastrophic event that we feared. Even the far more serious nuclear accidents at Chernobyl and Fukushima-Daiichi have had little in the way of global impact. Simple analysis of the size of the stored energy in these plants relative to the size of the planet suffices to show that.
However, we are witnessing a meltdown of the Chinese economy, and the impact of this event promises to have a global impact. Curiously, there weren’t any prescient tales speaking the precarious nature of the Dragon’s economy released to theaters. Not even a book that made it onto the best-seller list.
Just to set the stage, let’s consider for a moment where we were just a few short years ago, and what the popular wisdom was. The common idea, spoken by pundit and plebian alike, was that the ‘Middle Kingdom’ was soon to be the dominant player on the world stage. The reign of the US dollar as the reserve currency was drawing to a close and soon the Yuan Renminbi would be what all the cool countries used.
I was deeply skeptical because I have a long memory and remembered the depressing and relentless drum beat of the 1970s and 80s heralding the United States’ economic doom at the hands of Japan (footage from Johnny Dangerously).
By the early 1990s, it was clear that the strength of the Japanese economy had been exaggerated and its systemic weaknesses ignored. By the turn of the century, the world started talking about Japan’s Lost Decade, and their economy has yet to recover from that slump, now roughly a quarter of a century later.
I can’t be certain why this cautionary tale was forgotten 10 years later, when economists were all agog with the ‘new economy’ engendered by the internet, and the dot com bubble came and went. Nor why the message was lost again about 5 years later when almost everybody was considering flipping houses, and the sub-prime bubble grew and burst.
All that is certain is that the message got lost once more – drowned in incessant chatter about the new powerhouse on the world stage. Never mind that China was following a ‘if you build it they will come’ strategy that piled up debt. Never mind that China played with its currency and subsidized oil purchases to keep gasoline costs low. Never mind that the Chinese government built entire cities in which no one lived. All that mattered to the intelligentsia was that the Dragon of the East had figured out what we in the West couldn’t – how to get around the law that says there is no such thing as a free lunch.
Of course there were voices out there that said something was wrong, but they were in the minority and weren’t heeded then. Now you can’t hear anything else but words of woe on China.
So how bad is it and for how long should we have known? It isn’t clear how to answer either of those two questions. By some measures, China is much better off than other countries. Consider the following table that shows the ratio of Government Debt to GDP for select countries. Compared to the US and Japan, China’s central government holds significantly less debt (source: http://www.tradingeconomics.com/)
|
Government Debt to GDP Ratio |
|||||||||
|---|---|---|---|---|---|---|---|---|---|
| Country | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 |
| US | 63.9 | 64.8 | 76.0 | 87.1 | 95.2 | 99.4 | 100.8 | 101.2 | 103.0 |
| UK | 43.4 | 44.5 | 52.3 | 67.1 | 78.4 | 81.8 | 85.8 | 87.3 | 89.4 |
| Greece | 106.1 | 105.4 | 112.9 | 129.7 | 146.0 | 171.3 | 156.9 | 175.0 | 177.1 |
| Peru | 33.1 | 30.4 | 26.8 | 27.1 | 24.4 | 22.4 | 20.5 | 20.3 | 20.7 |
| Brazil | 56.4 | 58.0 | 57.4 | 60.9 | 53.4 | 54.2 | 58.8 | 56.8 | 58.9 |
| Germany | 67.6 | 64.9 | 66.8 | 74.5 | 80.3 | 77.9 | 79.3 | 77.1 | 74.7 |
| Japan | 172.1 | 167.0 | 174.1 | 194.1 | 200.0 | 211.7 | 218.8 | 224.2 | 230.0 |
| China | 31.5 | 34.8 | 31.7 | 35.8 | 36.6 | 36.5 | 37.3 | 39.4 | 41.1 |
But, by other measures, China is in bad shape. According to Forbes Contributor Kenneth Rapoza, its total debt to GDP ratio is approximately 280%. Is that bad, it’s hard to tell since the US’s total debt ratio is about 332%. What is needed to put debt into perspective is a measure debt to assets, something I am sure is hard to come by for China's economy. That said, it is likely that the ratio of China's total debt to its assets is much higher than that of the US. Further on, the same article has this to say about China’s growth in debt:
…China led all emerging markets and was ahead of most developing markets in terms of an increase in total debt to GDP over a seven year period ending in the first half of 2014. Only Portugal, Greece, Singapore and Ireland saw their debt burden increase, but that is mainly due to massive corrections in economic output
Perhaps the most telling point is that China itself feels that it is in trouble. It took the unheard-of step of adjusting its currency three times in a short period of time this summer. It also has been buying stock on its own exchange.
Will China fall? It is hardly likely. What is more likely is that its spend-now-and-pay-later expansion is coming to an end. China will still be an economic giant, and that’s probably good; after all, it has an incredible comparative advantage just due to population size. But it is very unlikely that it will ever dislodge the West from its pre-eminent position until it corrects its internal problems with liberty and human rights. Unfortunately, that isn’t a movie plot that can sell.