Peak China?

You may be wondering why I am writing about all the problems that are confronting China and how its economy is slowing. Or how I can write about China without repeating what all the other reporters and think tank fellows are saying. Today’s Wall Street Journal had three articles about China’s decline including Yes, There Is a Bull Case for Investing in China. There are four articles about “Troubled China” in this week’s Economist magazine including, Why China’s economy won’t be fixed. And four articles in this month’s Foreign Affairs magazine including, Xi’s Age of Stagnation.

Why, indeed! Well one reason is that many decades of work in financial markets has taught me that when all the talking heads on CNBC’s Squawk Box are shouting hosannahs about the bullish stock market it is time to sell. And when those same talking heads are moaning about how the ruinous recession is cratering the stock market it is time to buy.

It is not that I am an inveterate contrarian. Its just that when all the pundits are professing one point of view it raises red flags in the back of my mind. Besides, I have been commenting on China’s imminent decline for years starting with Xi’s Dilemma four years ago. Highly concentrated control of the economy just doesn’t work very well. If the ultimate autocrat makes a good decision, such as Xi Jinping’s determination to build hundreds of new nuclear power plants, things can turn out very well. But invariably, the great leader will make a bad decision, like putting a Communist Party of China cadre on the board of directors of an entrepreneurial high-tech company, and things don’t turn out so well. Worse yet, because the decision was made by a leader who not only controls a person’s career but their very life or death, they don’t change that decision – ever. Even worse than that, they are about to urinate in their pants at even the thought of telling the leadership how bad things have turned out so they fudge their reports on the real state of things. So the great leader has no clue as to the awful decision he has made. And so it goes until the entire economy is in ruins.

So why is Xi Jinping doing it? China was doing great. Growing faster than anyone had ever seen. Lifting hundreds of millions of people out of poverty. China was the factory for the entire world. Sure, there were some nagging problems. The real estate market was a huge bubble with row after row of empty apartment buildings in overbuilt cities springing up across the country. And much of that construction was fueled by debt collateralized by unsold and unsellable real estate. Party cadres in the countryside were getting rich from the land sales to the developers. But these were solvable problems. The US has recovered from overblown real estate markets. You take the pain, lick your wounds and then, eventually, recover. Why couldn’t China do the same?

Why couldn’t China reform? Why couldn’t China adjust? The West had welcomed China onto the world stage. Allowed it to participate in its Western institutions. Had granted the country most favored nation trade status. Because America and the West understand that free market economics is not a zero sum game, they do not begrudge other countries prospering and becoming wealthy – at least not too much. Our leaders thought that once the Chinese realized that their country could prosper and their people become wealthy by being a participant in the Western inspired rules-based world order, that they would happily join in and we would have happily welcomed them. So what happened?

We did not understand Xi Jinping. In part because we never understood Deng Xiaoping. Deng was (and Xi is) a communist – true believers the both of them. Deng realized that China could not become rich and powerful without mimicking western style capitalism. So he instituted reforms to allow a partial market economy. But he also advised that the Chinese must “hide our capacities and bide our time.” The reforms were only meant to be temporary. Deng believed that the problems China encountered in the implementation of communist rule by Mao Zedong arose, at least in part, because China was too backward. Marxist theory is based on the view that capitalist societies inevitably would become communist because of the inherent conflict between capitalists and the workers (the proletariat). But China wasn’t a capitalist society back then. It was a rural agricultural backwater. Deng believed that China must become a wealthy capitalist society before it could transition into a communist society. But the Chinese capitalist society that arose from Deng’s reforms was a sham. The Communist Party of China still ruled. There was no political reform. They were just going through the capitalist economic motions. And waiting.

Xi Jinping has always been wary that economic reforms might drive people to want political reforms as well. The Tiananmen Square protests were an example of this drive that had to be put down. In a 2013 meeting with the leaders of the People’s Liberation Army Xi quoted Deng Xiaoping as saying that the PLA had “passed the test” by obeying the commands of the party. As noted by Hoover Institute fellow Stephen Kotkin in a recent podcast, What Drives Putin and Xi, he also closely observed the collapse of the Soviet Union, blaming Gorbachev’s glasnost and perestroika reform efforts. In the end, Xi is a Leninist which means that the power of the communist party must be absolute.

Xi Jinping is slowly but inexorably tightening the Communist Party of China’s grip on the Chinese people, creating a wealthy high-tech AI enhanced version of the Soviet Union that will not be weakened or undermined by political or even economic reforms.

Has China already reached its peak? I think Xi Jinping would denounce that idea as a lie, an imperialist plot to push China down and to keep it from achieving its rightful position in the world. But I guess that the correct answer would depend on how you define peak and also how you understand what China’s rightful position in the world should be. But even if China has peaked does that mean that it is less of a threat to US interests?

China will continue to grow economically but more slowly than before. Wealthy western countries that can afford to buy China’s manufactures are increasingly concerned about politically controlled supply lines. Chinese exports in the last couple of years have been trending downward, although admittedly two years is a pretty short time frame to make long term estimates of global trends. Youth unemployment is so high that China has stopped reporting that statistic. This too may be a short term trend but it is indicative that the Chinese economy has lost the dynamism it exhibited over the last four decades. And the Belt and Road initiative that was intended to win friends among key developing countries (while supplying infrastructure for future Chinese bases along with critical raw materials) has backfired with many countries on the verge of default.

But even if China has reached its peak economic power, that does not mean that China’s military power has peaked. The Arms Control Association reported in 2021 that China has constructed 250 new silos for intercontinental ballistic missiles and has begun to deploy its most advanced hypersonic missile, the DF-27. And the US Naval Institute reports that China plans to expand its naval fleet to 400 ships by 2025 (compared to the US fleet of under 300 ships and declining according to the Center for Strategic and International Studies).

A weaker China (at least on a relative basis) does not make China less of a threat to the US and the rest of the world. I would assert that weakness makes China more of a threat. If Xi Jinping recognizes the fact that, like the Soviet Union, over time the Chinese economy will struggle to meet the needs of its people and the needs of its military he will be forced to act. There will be a time in the future where its military power is great and the inability of central planning to provide a better life for the Chinese people has not caused such great unrest among the people as to undermine their faith in the Communist Party of China. That will be the optimum time to take action.

The timing of this opportune moment does not just depend on China. A resolute US along with its allies can change that timing and perhaps forestall China from taking rash action. The strong reaction by the US and its NATO allies to the invasion of Ukraine has given China pause. But the resolve of the US and its allies cannot be limited to the fate of Ukraine. The US must not only immediately replace the ammo and equipment being sent to Ukraine but also prepare for an extended struggle in a new cold war. The US and its allies need to have energy independence to have the freedom of action necessary to be a world leader. And, especially, America must not sacrifice its energy independence in a naive attempt to go green that is dependent on Chinese technology and materials. Just this week, the Biden Administration cancelled leases in the 10.6 million acres of the National Petroleum Reserve to the cheers of environmental activists (accompanied by the quiet smiles of Mohammed bin Salman, Vladimir Putin and, of course, Xi Jinping).

If China has reached its peak of economic power, the countdown has already begun. We may not hear the ticking of the clock but it is ticking none the less. And that means that our time to prepare is running out.