Chinese Economist: "Sino-U.S. Relations are at a Crossroads"

Written by Tim Triplett

Editor’s note: Steel Market Update’s source in China reports on recent remarks by Chinese economic expert Xiang Songzuo, who warned that the nation’s economy is showing signs of crashing. Xiang showed courage in being publicly critical of the government, which later banned his remarks from the internet.

“You can look at the history: Only the Wall Street Crash of 1929 can compare to the steep decline that the Chinese stock has experienced this year. Many stocks are down 80 or even 90 percent,” said Professor Xiang Songzuo in a speech in early December. Xiang is the Deputy Director and Senior Fellow of the Center for International Monetary Research at China’s Renmin University.

In his speech, Xiang backed up his concerns with numerous facts and figures. Such speeches are normally dismissed, but in this case the speech has so alarmed Chinese officials that it was banned from the internet, though it was translated into English and posted outside of China before it was banned. Furthermore, a number of financial firms are taking Xiang’s conclusions very seriously.

As many problems as the U.S. economy has, China’s economy is much worse because of real estate bubbles, ghost towns, shadow banks and a hugely leveraged credit bubble that could crash at any time. While some can make a general statement like that, Xiang has backed up those concerns with specifics.

Many people believe that since China is a Communist dictatorship, the country cannot have a recession because the Chinese Communist Party (CCP) will control the economy enough to prevent it. It does not work that way. Like every socialist economy, China’s economy was headed for disaster until it was opened to free markets in the 1970-80s. In fact, every socialist economy has either opened up to free markets to some extent or ended in disaster and massive bloodshed. Today, only Venezuela and North Korea have refused to open up to free markets, and both of those are disasters, with bloodshed in the future.

China today is subject to the same market forces and the same generational forces as every other country. People fool themselves into believing that politicians can actually change things. In China, the politics may be different, but the outcomes will be the same.

Xiang’s Headline Statistic: Only 1.67 Percent GDP Growth for China

The headline statistic in Xiang’s speech was his claim that China’s GDP rate of growth is at most 1.67 percent, or may even be negative. China’s official National Bureau of Statistics claims that China’s rate of GDP growth is at 6.5 percent. This one statistic alone could explain why the CCP felt it necessary to censor Xiang’s speech.

Nobody is surprised that China lies about statistics. Mao Zedong lied about agricultural statistics during the Great Leap Forward in 1958-59, with the result that tens of millions of Chinese died from starvation or were executed.

You can lie about statistics only for a while, and then reality causes a financial crisis, which is what Xiang is predicting. Since the CCP can pump money into any business at will, it would seem that any financial crisis can be prevented. The problem is that any business that can count on being bailed out has no motivation to become efficient, and so loses money.

In his remarks, Xiang said that the following has happened with almost all Chinese businesses: “Look at our profit structure. To put it plainly, China’s listed companies don’t really make money. Then who has taken the few profits made by China’s more than 3,000 listed companies? Two-thirds have been taken by the banking sector and real estate. The profits earned by 1,444 listed companies on the SME board and growth enterprise board are not even equal to one and a half times the profit of the Industrial and Commercial Bank of China. How can this kind of stock market become a bull market?

“When we buy stocks, we are buying the profits of the company, not hype and rumors. I recently read a report comparing the profits of China’s listed companies with those in the U.S. There are many U.S. public companies with tens of billions dollars in profits. How many Chinese tech and manufacturing companies are there that have accomplished this? There is only one, but it’s not listed, and you all know which one that is. [Xiang is referring to Huawei, the Chinese tech company.] What does this tell us?”

Xiang told his audience that there are major risks in the economy, and major battles to be fought: “China’s economic decline indicates that there is a major issue with the focus on expansion and growth—it has deviated from the fundamental and moved to speculation.… What are our current financial risks? They are hidden, complex, acute, contagious and malevolent. Structural imbalances are massive and violations of law and regulations are rampant.… We have rampant speculations everywhere, in too many aspects.”

According to Xiang, “Basically China’s economy is all built on speculation, and everything is overleveraged.” This is significant, because when a company is overleveraged and there is an economic downturn, it will not be able to meet its debt payments. If every company is like that, then when one company goes bankrupt it creates a chain reaction that sends every company into bankruptcy. Thus, China’s stock market is facing a huge crash, even greater than America’s 1929 crash, he explained.

China’s Five Phases of Consumption

According to Xiang, in the four decades following economic reform, China has undergone five phases of consumption:

  • Solve the food problem.
  • The “New Big Three”—short for refrigerator, color TV, and washing machine.
  • Consumption of information.
  • Automobiles.
  • Real estate.

“But these five waves have essentially all come to an end,” Xiang said. “Car sales have dropped sharply and real estate spending is also substantially decreasing, so we are facing serious problems. This is the crux of the six stabilities called for by the Politburo—stable employment, stable finance, stable foreign trade, stable foreign investment, stable investment and stable expectations. Or as some internet users have joked, the six Tender Kisses [kiss is a homophone for stability in Chinese].”

Xiang said that China made a historic mistake by relying on consumption: “Look at these numbers. That China faces a long-term economic downturn is not a problem by itself. But you may have noticed that the consumption and the service sectors now make up 78.5 percent of GDP. Going by the government’s logic, this should be a good thing, since it means the economic transition to a consumption economy has been successful; we used to rely on investment and export, now we rely on consumption and the service sector. This sounds reasonable, but think about it: In a country like China, as investment slows dramatically, how can we maintain economic stability by solely relying on consumption?”

Xiang said that consumption and services comprise 78.5 percent of GDP, which is good news to some extent, but that is far eclipsed by the negative implications of low investment.

Major Misjudgments About China’s Economy

Xiang said that in the past year, China has made major misjudgments about the economy. The first misjudgment was vastly underestimating the negative effects of the U.S.-China trade war on China: “First, the trade war between China and the U.S. Did we make some inaccurate assessment? Did we underestimate the severity of the situation? Let’s recall some slogans from the mainstream media at the beginning of the year:

  • In the trade war between the U.S. and China, the Americans are lifting rocks only to smash them on their own feet.
  • China is sure to win.
  • China will win the trade war without a doubt, be the battles big or small.

“What’s behind this kind of thinking? To this day, we keep suffering from a cognitive dissonance between our understanding of the Sino-U.S. trade war and the international reality. This calls for deep reflection.”

The second misjudgment has caused private businesses to lose confidence in the national leadership, with the result that investment by private business owners has fallen substantially, Xiang said. This has occurred because the Chinese media have been suggesting that the economic reforms of the past 40 years will be reversed, and there will be a return to full-scale socialism:

Since the beginning of the year, all kinds of ideological statements have been thrown around, Xiang said, such as:

  • Private property will be eliminated.
  • Private ownership will eventually be abolished if not now.
  • It’s time for the private enterprises to fade away.
  • All private companies should be turned over to their workers.

“Remember that line in the Communist Manifesto—abolition of private property? What kind of signal do you think this sends to private entrepreneurs?” he asked.

With regard to the trade war, Xiang said it is really a clash of value systems, with no solution in sight: “In addition to this, there are three major external challenges. The first is the trade war, which is in fact no longer a trade war but rather a clash between two opposed value systems. It can be said with certainty that the Sino-U.S. relationship has come to a crossroads right now and faces significant historic challenges. What are we to do? To be honest, I don’t think we have really found much of a solution.

“You are aware that Huawei’s CFO Meng Wanzhou was recently detained in Vancouver. In the past two days, mainstream media such as the BBC and CNN have been reporting on how the U.S. is going at Huawei on all fronts. What this tells us is that this issue is not simply about trade or economics.

“Unless the date is postponed, China and the U.S. have until March 1 to reach agreement on a huge list of trade and trade secret protection issues, before the U.S. substantially increases tariffs on Chinese imports. What this almost certainly means is that the can will be kicked down the road. This could mean that the March 1 date will be postponed or it could mean that President Trump will simply increase the pressure on China by increasing tariffs by a small amount,” Xiang said.

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