Something like this? Zeihan's analysis is pretty bleak.
China’s regions have little in common and do not naturally cohere. Getting nationalist, security-minded northerners to cooperate with the business-savvy central Chinese as well as the occupied southerners is not an easy task. And that is before you take into account that the interior is a chunky, seething morass of dissatisfaction or that the primary hub of the south is Hong Kong, until recently part of the free world.
China needs a social binding agent. It needs to be a strong adhesive and applied in huge volumes. Without it China not only spins out into its constituent fragments, but large numbers of its citizens tend to gather into large groups and go on long walks together. None of this is a surprise to the Communist Party. After all, its founders took advantage of China’s many regional and socioeconomic cleavages in their rise to power in the first place. Rather than deny contemporary China’s origin story, they instead have used the opportunities presented by Bretton Woods to forge a solution.
It comes down to money. The Chinese government starkly limits what its citizens can do with their savings. Rather than allowing a wealth of investment options as exists in the capital-rich American or British system, private savings are instead funneled to state goals in a manner somewhat similar to the German system. Specifically, there are very few banks in China, with some three-quarters of all deposits held in four large state-owned institutions: the Agricultural Bank of China, the Bank of China, the Construction Bank of China, and the Industrial and Commercial Bank of China.
Those four banks have very clear mandates. They are to use the citizenry’s deposits to maximize bank lending to the economy as a whole. The goal of the policy is a simple one: maximum possible employment. While this is technically a lending model, it is more accurately thought of as a system of subsidization. Since Chinese citizens have so few investment options, the banks have access to their deposits at rates that are ridiculously low. Consequently, internal interest rates in China are artificially held well below global norms and are certainly far below what they would normally be in an economy at China’s level of development.
Loans are available for everything. Want to launch a new product? Take out a loan to finance the development, to pay the staff, to cover marketing expenses, to build a warehouse to store output that doesn’t sell as planned. Find yourself under the burden of too many loans? Take out another to cover the loan payments. The result is an ever-rising mountain of loans gone bad and ever less efficient firms, held together by nothing more than the system’s bottomless supply of cheap labor and cheap credit.
The distortions this system creates are ones very familiar to all of us living in the contemporary world:
• The Chinese financial system subsidizes prices for finished outputs. This drives down the price of Chinese finished goods and allows their exports to displace most global competition. Normally such price crashes would induce producers to reduce output, but in China profits and even sales are not the driving rationale for business. Employment is. And Bretton Woods, by its very design, gives the Chinese access to a bottomless global market.
• The Chinese financial system subsidizes the consumption for inputs. In effect, the Chinese system doesn’t care whether oil costs $8 a barrel or $180 a barrel. Everything is paid for with borrowed money you don’t have to pay back anyway, so demand builds upon itself. Chinese demand is the primary cause for the drastic price increases of the past fifteen years in everything from oil to copper to tin to concrete. It’s not just happening abroad, but at home as well. The Chinese property boom is ultimately caused by huge volumes of loans chasing a fixed supply of a product, in this case housing.
• When you don’t care about prices or output or debt or quality or safety or reputation, your economic growth is truly impressive. China has achieved over 9 percent economic growth annually now for thirty years, elevating it to its current status as the world’s second largest economy.
• China has expanded so much that in some sectors its demand has swallowed up all that remained of several industrial commodities in the world at large, forcing its state-owned firms to venture out and invest in projects that otherwise wouldn’t have happened—LNG in Australia, copper in Zambia, soy in Brazil. Chinese overseas investments are a who’s who of what is technically possible but economically ridiculous.
• Finally, as cheap and plentiful as Chinese capital is, it isn’t available for everyone. Because the Chinese system is ultimately managed by the Communist Party and because the leaders of localities hold so much power versus the center, there is extreme collusion between bank management and the local Communist Party leaderships. This collusion funnels capital to local state firms affiliated with friends and family of the local governing elite, often depriving smaller—and typically more efficient—firms of the loans that they need to expand. The result is a system skewed toward larger firms that, from an employment point of view, become too large to fail. Any meaningful reform of the Chinese system will not only break the links between national and local authorities, but gut the very firms that are achieving social placidity.
So how big is this problem? Pretty big. In 2007, total Chinese lending topped 3.6 trillion RMB ($600 billion). How much is that really? Well, that’s more than total lending into the U.S. economy when the U.S. subprime bubble was at its maximum inflation, and that in a year when the Chinese economy was less than one-third the size of the U.S. economy. As the 2007–9 global financial crisis bit, the Chinese government discovered that demand for goods was collapsing on a global scale, with Chinese goods being no exception. In other countries, the drop in demand for goods forced companies out of business along with the expected impact upon employment levels. Not in China. Following such a normal business cycle in China would have resulted in unemployment and social unrest (or worse).
Instead of the credit crunch that the rest of the world suffered, Chinese companies were encouraged to borrow ever larger volumes, allowing them to finance their way through the downturn. Overall lending not only increased, it tripled in just two years. Normally, such a credit explosion would generate massive inefficiencies, bubbles, and other distortions that would be damning to an economy—but such problems were already embedded in the Chinese system, so the change didn’t really register.
Nevertheless, the Chinese government isn’t actively looking for problems, and it dialed back the credit expansion… or at least it tried to. Since the banks operate just like the rest of the country—on throughput rather than profit—they needed to keep forcing money through the system. The result was a proliferation of new methods of lending, ranging from bogus insurance policies to corporate bonds. None of these programs work in China the way that they do elsewhere.
For example, in most countries, firms seeking to raise money issue corporate bonds that are purchased by interested investors. In China, the large banks issue bonds to each other and use the money raised to support their own phalanx of corporate customers. It is simply another means of force-feeding capital through the system to maximize short-term economic activity.
The various means of capital profusion had become so many and so lax that the government actually lost control of its own financial network. The government knew it had to somehow rein in credit, but it wanted to find a way of doing so that wouldn’t actually cause a recession, much less an economic crash and the unemployment that would go along with it. The government dared not risk changing the fundamental method of handing out credit, nor the large-scale absence of quality checks, nor the absence of due diligence. The “solution” was to issue a centrally imposed quota on bank lending every month. In most months, the quota was reached well before month’s end, causing the entire financial sector to seize up when the credit suddenly dried up.
This led to two outcomes. First, the central bank had to (repeatedly) pump in emergency credit the day after the quota was reached, or else face the sort of systemic financial crash that U.S. subprime caused in late 2007. Second, banks, firms, and retail investors, appalled by the idea that the government might actually deny them credit because of something as silly as a lending quota, built their own financial network to run in parallel to the existing system.
This shadow system includes everything from loan-sharking to financial products with even fewer quality controls than official bank lending (after all, they were formed expressly to bypass government authority). By the first quarter of 2013, China’s own central bank estimated that such shadow lending was exceeding all other forms of credit combined.
Just as the United States meted out access to its market to bribe its way into the world’s largest ever alliance, the Chinese used finance to bribe both its often conflicting regions and ever restive populations into quiescence and even cooperation. It is a brilliant strategy, but it has limits.
Japan followed a similar system in the 1950s through the 1980s, eventually reaching a level of overextension that brought the entire system to its knees. In the quarter century since the Japanese crash, the Japanese banking sector has retreated completely from the global system, and the Japanese economy as a whole has not grown. Such stagnation is China’s best-case-scenario future.
Unfortunately, it is also not a very likely one. The Japanese economy is largely domestically held and demand-driven, so while loose credit certainly helps, it is not the hedge against doomsday that it is in China. Additionally, Japan is over 98 percent ethnically Japanese, and over four-fifths of the population lives on the island of Honshu. China is considerably less unified regionally, ethnically, and spatially.
The United States even experimented with this system: the idea that growth and throughput were more important than profitability and a positive rate of return on capital. The result was a mess of graft, abuse, and unwise lending that created the failed company we knew as Enron, and the property bubble we now know as subprime. Both experiments created impressive growth for years. But such investments were geared to maximized throughput, not profits or efficiency. And so they collapsed. In essence, the entire Chinese system is subprime, in every economic sector.