Michael Gentile, Johns Hopkins University
A gambler that owes two years’ salary, Chinese corporate debt has doubled its GDP. Since the Great Recession, the Chinese government has forgiven and assumed stakes in its largest and most indebted, today known as State Owned Enterprises. As such, these SOE’s have survived to play again and, in the last nine months, have grown their output by 2.6%; their privately owned, less leveraged counterparts have grown 7%.
Inefficiency first expresses itself in excess supply and, while deleveraging comes with costs, overhangs of debt weigh down market forces. Without an effort to recognize losses and restructure, the Chinese government will punish a billion potential consumers, whose credit remains modest, with the impotent fates of Spain, Japan, and Thailand. Though China has yet to liberalize its economy, its recent resilience deems today a fateful opportunity to tighten its monetary policy, expand property rights, and fill the United States’ role as the trading center of Europe and the Pacific.
Economists have long prophesized China’s retreat from central planning, a future of middle-class consumption and diverse financial systems. Such folklore overlooks the pain behind an economic reboot, how sharply asset prices fall once its biggest betters go home. Though the leverage cycle sometimes booms unnoticed, its busts never do, which is why the Chinese must seize this moment to come clean, to instill conviction in citizens and investors. Inflation is ripe, above 2%. Target growth has sustained at 6.5%, despite currency mishaps. And a wave of robotic engineering has swept China’s marketplace, lowering the cost of its products beyond what’s saved by the yuan’s devaluation.
Liquid and transparent capital markets predate sweeping national consumption, per the American example. The pervasiveness of ‘zombie’ businesses, however, whose defaults the Chinese government has prevented, has obscured the investor confidence essential for this progress. From accusations of cooked books to deliberate monopolizations of certain industries by the Communist party, the Shanghai Stock Exchange is no stranger to sell-offs, especially after its 40% plunge about eighteen months ago. Most lately, Donald Trump and many others have indicted the People’s Republic for keeping its currency artificially low. All these backlashes against capitalism’s Invisible Hand have kept China’s financial system in infancy. To avoid the history of nations who emerged and burnt out at the hands of capital expenditure, volatility must be consigned to market forces rather than the whim of ruling bodies; corporations near default must bear that risk to the public; and expected returns, indicated by interest rates, must rise.
Still shying from its primary Central Bank Rate, the People’s Bank of China has instead raised its seven, fourteen, and twenty eight day reverse repo rates. These repurchase agreements comprise much of the Republic’s money market liquidity and, thus, entail a tightening similar to the Federal Reserve’s on Friday. Though necessary, given the nation’s need to deleverage, a bear market almost certainly waits on the other side of this decision. This is largely a product of rising interest rates’ propensity to appreciate currencies, which hinder demand for exports. Taking such as inescapable, however, Trump’s recent slashing of the Transpacific Partnership could spell an inroad that may offset some declines in growth, that signal now as the time to hit the brakes.
The Regional Comprehensive Economic Plan has long labored as the TPP’s understudy, an alternative trading framework in which China, instead of the US, reigns supreme. Purposely excluded from TPP, China can now ease its dependence on American demand and contract fluid commitments with much of South Asia, Japan, Australia, and perhaps even India. In conjunction, the Chinese have already overtaken the United States as Germany’s top trading partner, a sign of growing cooperation with a European Union prowling for sources of appeal. Before the effects of monetary tightening take hold, China can propagate and anchor itself throughout the Eastern hemisphere, allow its currency to appreciate in the place of lesser tariffs, and permit America to be great again on its own.
It is precisely the diversity of their trading portfolio that suspends China from the devastation of debt, which most notably followed Japan’s boom. While Japan’s exports relied disproportionately on the US and overexposed itself to dollar-yen fluctuations, China’s reach is far greater. Various neighbors have already pegged their currencies to the yuan and built their foreign reserves around it as well. This trend will intensify going forward, given how difficult it has become for emerging powers to pay off dollar-denominated debt, as the greenback continues to appreciate. And given Xi Jinping’s renewed enthusiasm for globalization, Donald Trump’s very battle against it, China can rise into a new light, though they first must risk darkness.
The asymmetry in China’s portfolio of debt, however, demands further reform, namely in the expansion of property rights to non-corporate entities. As mentioned earlier, China’s general population has not expanded its credit in line with the corporate sector, nor with its American and European counterparts leading up to 2008. The average citizen’s limited ability to own property has stifled collateralization and, thus, innovation. In fact, such inflexible purchasing power has led corporate production to outstrip demand, most evidently shown in miles of vacant apartment complexes. As a result, over a billion people have seen their wealth stagnate and inequality expand, a force that further dampens consumption. Thus, without acceptance of capitalism’s more complex principles, the Chinese economy will continue along its curve of diminishing returns, which converges to a limit of 2.6% growth, and to lackey an ever-enlarging and toxic debt.
As innovation comes increasingly from the consumptive public, China’s robotic technology will ground itself as the world’s premier. Especially in manufacturing and even farming, these advances will lower the input costs of production. As such, more laborers will enter the economy elsewhere in the name of technological productivity. Communism’s rigid hold on growth will evaporate and deliberate yuan devaluations will prove unnecessary, as already meager costs will plunge further and maintain past margins.
The stability of the yuan at a higher value, without the associated destruction of trade, spells a profound transformation for the global economy. Prior to World War II, the United States also narrated a story of manufacturing and capital investment, productive dominance and growth. Great Britain found itself on the other side, as the pound’s preeminence deemed it the world’s reserve, its crown atop global financial markets. Of course, a war occurred, the likes of which today could never replicate. However, in aggregate, Britain’s following recovery required that it turn away from the world, at least for some time. The United States readily filled the void and liberalized itself into the new benchmark. Since, the pound has limped laggardly along while the dollar has kept the world afloat. The stress has been now passed along to the US, with obvious caveats, and only one competitor remains; that is, unless debt keeps China chained down.
The Chinese economy has painful days to come, but to accept that those days will indeed come represents its first step to redemption. To best take advantage, those days need to be soon, in the midst of tight domestic conditions and opportunities left them by the United States. As such, deleveraging can inhabit a vision that not only compensates output elsewhere, but inspires the surrounding world to take notice and part, to believe. Only then can China attain the prize of economic stability, in which external shocks both lean on them and present no danger. Only then can the gambler leave the table.