May 22, 2011
China is going to collapse !
“China is going to be the world’s next superpower.”
“China is the next United States.”
“China has been growing at 12% per year…and it will keep growing that fast for decades to come.”
“China is taking over the world.”
It seems I can’t go more than a few days without hearing one of these sentiments expressed, usually with a strange mix of dread and admiration. The prevailing opinion seems to be that China is the wildly successful, semi-evil empire that the Soviet Union never could be, poised to crush the United States and achieve total world domination, presumably cackling maniacally the whole way.
This belief doesn’t come without reason. China’s average annualized GDP growth rate since 1978 has been somewhere around 12.5%, an insanely high number by any standard. The United States is thrilled to grow by even 6% a year, and averages more like 4%. China is forging economic and political alliances across the globe, building aircraft carriers, and inventing new technologies. In 30 years it has propelled itself away from being an agrarian economy and well into industrialization, and is now starting to move into the post-industrial phase, a process which took about a century and a half here. It’s easy to see why people think China is going to take over the world.
I, on the other hand, expect China to collapse within ten years.
What the heck?
Yes, within ten years, I’m convinced that the Chinese government will either cease to exist or at least lose most of its power. The country is likely to fragment into several smaller nations. This isn’t the wishful thinking of a hawkish neoconservative who wants to see America’s rivals fall, nor of a human rights activists who wants to believe that oppression is destined to fail. In fact, I think human rights will only be a secondary cause of China’s collapse, and I also believe that the ensuing chaos and power vacuum will make China’s fall something less than a victory for the United States.
I’ll be examining this issue in three parts. Part one will cover the basic reasons why China is going to hit a brick wall in the next few years. Part two will delve into some of the finances behind this prediction, as well as address some common objections to this theory. Part three will explore the likely consequences of China’s economic and political collapse.
China is not fully capitalist.
This is probably a shocker to just about all of you. It was to me, when I first heard it. First off, I probably need to clarify what capitalism is and is not. It’s not, as many people think, just an economic system where people try to get rich. All economic systems, including communism, are full of people trying to get rich. It’s also not just a system characterized by private enterprise; other systems have that too.
Capitalism is characterized by the free-market allocation of capital. This allocation is largely impersonal and driven by market forces. This is the crucial difference: money should go to the person who has the best business plan, but in China, it often goes to whoever knows a good financier. Yes, connections matter everywhere, but in the west, they usually get you face time and the opportunity to make a sales pitch, not millions of dollars for a bad business idea.
This crony capitalism comes from a combination of traditional Chinese social relationships (guanxi), communist-style patronage and poorly implement free-market capitalism. It’s the reason why China is building more offices than it has workers to populate them.
China’s growth rests on shaky finances
China’s growth is being financed primarily by bank loans, whereas American businesses are financed more on equity. This isn’t a problem in and of itself; it’s just another way of structuring a company’s finances. The problem is that many of these loans aren’t getting paid back. China’s delinquent (or non-performing) loan rate is somewhere between 25% and 40%. I can’t understate how bad this is; if an American banker gave out bad loans topping ten percent, he would be fired in a heartbeat. If a quarter of his loans defaulted, he’d be drawn and quartered. For comparison, delinquency rates in the U.S. have risen as high as 10% during the recession, and can be as low as 1% during boom times. Remember, China is supposedly booming right now.
A related problem is lack of profit. Chinese companies run some very slim profit margins, and their returns on equity pale in comparison to western firms. Even a slim profit margin will keep a company afloat when times are good, but the problem is that it only takes a minor downturn to put such a company deeply in the red. This lack of profit stems from two things: the aforementioned crony capitalism, and government policies which demand growth at all costs, even at the expense of profit. Speaking of which….
China’s growth is partly faked
The Chinese government has mandated rapid growth for the past 30 years, and many officials stand to lose their jobs if growth goals are not met. The result is fairly predictable: people lie to keep their jobs, Enron-style. China’s annualized GDP growth since 1978 has been around 12.5%, though it’s gradually slowing down. There’s no telling exactly how overstated the figure is, so I’m using a conservative estimate.
Assume that China’s stated annualized GDP growth rate is 12% (it will fall to 12 from 12.5 within a few years). Assume also that its growth rate is actually 11%, and the last percentage point is baloney. After 40 years, China’s GDP will be 30% lower than stated. If the actual GDP growth rate was only 10%, after 40 years the real GDP would be 51% lower than the stated GDP! I’ll be explaining this math in part 2. Yes, 10% growth is still phenomenal, but people get angry when they find out they’ve been lied to.
Education makes people hard to control
This is where China’s human rights abuses and lack of freedoms come in. Education has a well-known liberalizing effect. Further, when people become educated, they start to demand more freedom and more power. The effects of this started to be seen during the Tianenmen Square protest, and are now being seen again, with greater scope, in the Jasmine movement.
This presents a dilemma for any authoritarian government that wants to catalyze strong economic growth. Growth requires improvements in education, and better education makes citizens less pliant. This wasn’t a major concern when China began industrializing. An urban factory worker may be a little more worldly than a rural peasant, but he isn’t particularly better educated. But China is now going high-tech, which means factories are using more and more college-educated workers in place of mass human labor. Parts of China are also moving into a post-industrial economy, with educated workers being used in R&D and service industries.
China’s educated middle class now numbers over 60 million, and will likely top 100 million before China collapses. These people are wealthy and educated enough to demand a say in government affairs, but not powerful enough to be above the law. Their lack of freedoms are starting to become an issue again, and they won’t be bought off with bread and circuses forever.
China is fractious
This probably comes as a surprise to you if you’re used to thinking of the Chinese as a collectivist culture. In fact they are collectivist, although that oversimplifies things quite a bit. Collectivism doesn’t necessarily mean identification with one’s country, however; it just means strong identification with a group of some sort. In China, collectivism is expressed by family, province, and sometimes company identification, more so than national identification. The Chinese tend to feel a stronger connection with their home province than with China.
The government used to counter this tendency by using communism as a unifying ideology. No, however, that ideology has disappeared. The old values of self-sacrifice and service to the state are still paid lip service to by communist officials, but few truly believe them. The communist party itself now attracts recruits more for the networking
benefits it offers than for its ideology. China is now held together not by ideology, but by force and the promise of wealth. Force alone can’t be enough. The money will hold China together as long as it keeps coming, but…
Recessions have to happen eventually
This is the big elephant in the room that nobody seems to want to acknowledge. Recessions are a natural part of the economic cycle. We treat them like some kind of disaster that should have been avoided, and occasionally they are, but they have to happen every so often. After many years of expansion, economies tend to become unbalanced and overly reliant on speculation. Recessions provide a re-balancing and a wakeup call, putting the economy back on track for further growth. China has gone 30 years without a recession, partly due to generous credit and partly because, after decades of the government preventing growth, the country is making up for lost time.
This can’t last forever. China is likely to hit a recession within five years. When that happens, massive unrest will ensue, particularly among the large majority of the population who still live in poverty.
Stay tuned for part 2 of this blog series, in which I’ll be responding to some of the more common criticisms of this prediction. In part 3 I’ll be looking at the likely downstream effects of China’s collapse.
Also, I’d like to thank George Friedman, CEO of the private intelligence firm Stratfor, for opening my eyes to China’s instability. If I hadn’t read his books, The Next Hundred Years and The Next Decade, I would probably still believe the hype about China. He’s written other books too, but I haven’t gotten around to reading them yet.
May 26, 2011
In Lianyungang, China, a pipeline moves raw coal. Coal plants produce three-fourths of the nation’s total generating capacity.
China’s Utilities Cut Energy Production,
by Keith Brasher
YIYANG, China — It is a power struggle that is causing a power shortage — one that has begun to slow China’s mighty economic growth engine.
Balking at the high price of coal that fuels much of China’s electricity grid, the nation’s state-owned utility companies are defying government economic planners by deliberately reducing the amount of electricity they produce.
The power companies say they face financial ruin if the government continues to tightly limit the prices they can charge customers, even as strong demand is sending coal prices to record levels. The chairwoman of one giant utility, China Power International, recently warned that one-fifth of China’s 436 coal-fired power plants could face bankruptcy if the utilities cannot raise rates.
The utilities’ go-slow tactics include curtailing the planned expansion and construction of power plants, and running plants for fewer hours a day. And in a notable act of passive defiance, the power companies have scheduled an unusually large number of plants to close for maintenance this summer — right when air-conditioning season will reach its peak.
So far there have been no public confrontations between Beijing officials and utility executives. But the dispute indicates that China’s unique marriage of market competition and government oversight may be starting to fray after three decades of phenomenal economic success.
“The Chinese electricity companies are firing a shot across the bow, and essentially saying they’re not going to just sit there and take massive losses,” said Jeremy C. Carl, a Stanford University researcher on Chinese energy issues. “It’s almost the equivalent of a corporate sick-out.”
The official Xinhua news agency reported late Monday that the country’s main electricity distribution company, the State Grid, had warned that power shortages this year could be worse than in 2004, when China had its worst blackouts in decades. That year, the problem involved railroad bottlenecks in getting coal to power plants — an issue largely resolved with the subsequent investments in more rail lines.
This time, the impasse between government and industry is not the only cause of China’s electricity shortages. Surging electricity demand is also a factor.
China’s 700 million rural residents have been on a two-year buying spree of electric devices, purchasing hundreds of millions of air-conditioners and other energy-hungry appliances with government subsidies aimed at narrowing the gap in living standards between cities and rural areas.
In a little-noticed milestone, the latest data from Beijing and Washington shows that China passed the United States last year as the world’s largest consumer of electricity.
Since March, responding to the power shortages, government officials in six provinces have begun rationing electricity, including here in Hunan province. At least five more provinces are preparing to do so, according to official reports.
In Yiyang, a town of 360,000 in south-central China, electricity shortages are so severe this spring that many homes and businesses receive power only one day in three. Even gasoline stations in this region are silent more days than not, because the pumps lack electricity.
Meanwhile, blackouts are starting to slow the nation’s torrid growth of energy-intensive industries like steel, cement and chemicals. Unlike garment makers and other small manufacturers, the big factories cannot easily switch to backyard diesel generators.
To accommodate businesses that do use diesel back-ups, China last week banned exports of diesel fuel to conserve scarce supplies.
The power cuts are a reason the year-on-year growth rate of China’s industrial production dipped last month — to 13.4 percent in April, down from 14.8 percent in March — and seems to be continuing to fall.
The lower productivity of factories, plus high diesel costs for those using generators, is likely to further raise average prices of American imports from China. Prices of Chinese exports are already up 2.8 percent in the last 12 months, after years of gradual decline that helped restrain inflation in the United States.
As power-deprived factories in China have less demand for raw materials, the impact has rippled around the world among China’s suppliers as well, contributing to 10 percent declines in global prices for commodities like iron ore and copper. That is impinging on the economies of countries like Australia and Brazil, for which China is a big customer of natural resources.
China’s energy debate includes Yiyang and Changsha
Looking ahead, China has placed big bets on wind turbines for generating electricity. And despite Japan’s recent nuclear travails, China is also cautiously proceeding with plans to lead the world in the construction of nuclear power plants in the coming decade.
But coal is still king in China. The country has nearly half of the world’s total coal-fired capacity, and coal plants currently represent 73 percent of this nation’s total generating capacity.
Hydroelectric power, at 22 percent, is a distant second and has been hampered by droughts this year.
If Beijing and the utilities can resolve their differences, China plans to build even more coal-powered plants. Doing so would produce another big surge in emissions of greenhouse gases, of which China is already the world’s largest emitter.
“Only coal can provide new capacity in the time and scale needed,” said David Fridley, a China energy expert at the University of California, Berkeley.
The idea of recalcitrant utilities balking at Beijing’s dictates might seem to contradict the popular perception of China’s government-guided economy. But while the electric utilities are majority-owned by the government, they are also profit-motivated companies accountable to the other holders of their publicly traded stock. So the power companies’ incentives are not necessarily aligned with those of central planners in Beijing.
The government, for its part, has imposed an array of price controls, including on electricity rates, as it struggles to insulate the Chinese public from inflation. Consumer prices are rising 5.3 percent a year according to official figures, and Chinese and Western economists say the true rate may be nearly double that.
But coal prices, which the government deregulated in 2008, are rising even faster in China, which is a net importer of coal despite having its own extensive mining operations.
Huaneng, China’s biggest electric utility, said last month that electricity rates it charges customers should have been 13 percent higher last year to match the increase in coal prices. But regulators held utility rates essentially flat.
Spot coal prices in China have surged an additional 20 percent this year — to a record $125 a metric ton for top grades — partly because of floods in Australia’s and Indonesia’s coal fields and partly because Japan is buying more from the global market to offset its lower nuclear power output.
But Chinese regulators have let electricity prices climb only 2.5 percent this spring. Residential users in China’s cities pay 8.2 cents a kilowatt-hour. That compares to a national average of 11 cents in the United States and 15 cents in the heavily urban mid-Atlantic region. Chinese industrial users in cities are supposed to pay 12 cents a kilowatt-hour, although politically connected businesses receive discounts; the average industrial rate in the United States is 7 cents, and 9 cents in the mid-Atlantic region.
Big power generators like Huaneng buy nearly half their coal on the spot market and the rest on long-term contracts with prices that rise more slowly.
The government has put pressure on China’s coal mines, also largely state-owned, to continue supplying power companies with coal at below-market prices under long-term contracts. But the mines, which are also profit-oriented operations, have responded with their own form of passive resistance — by sending their cheapest, lowest-quality coal with the most polluting sulfur.
As a result, many power plants are now paying penalties to yet another arm of the government — environmental regulators — for burning the sulfur-spewing coal. That has further added to the utilities’ cost of doing business, said Howard Au, the chief executive of Petrocom Energy, a Hong Kong company that builds coal-blending facilities.
Trying to help utilities reduce those environmentally and financially costly emissions, Petrocom has built a series of gray silos and red conveyor belts at Lianyungang port in northern China to dilute high-sulfur Chinese coal with low-sulfur imported coal.
Blackouts appear to be the worst in smaller towns like Yiyang here in Hunan, one of China’s largest and most populous provinces. The power shortages are threatening to curb the explosive growth the province has experienced since the opening in late 2009 of a high-speed electric train link to prosperous Guangdong province to the south, which helped companies tap Hunan’s cheaper land and labor force.
In rationing electricity, Hunan officials have given priority to big cities like Changsha, the provincial capital. Even there, though, industrial districts are blacked out one day in three.
In Yiyang, meanwhile, multiday blackouts have ruined a tiny restaurant run by Xu Zhanyun, 48, who now must cook meals over lumps of coal instead of his electric stove. “I have so much food in my refrigerators that all went bad,” he said.
There is running water only every other day because the pumping station requires electricity. And so he must haul water from a well — as he did as a boy, before China’s economy surged.
In other cities, factories require employees to work at odd hours when electricity is available.
“They shut down the electricity for a day every three days,” said Jin Jianping, manager of an umbrella factory in Ningbo, in east-central China. “We just arrange night shifts for everyone.”