China: Decades Of Growth Ended By Debts

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September 16, 2022: China’s GDP growth rate continues to slide and its bank failures are growing. The government has stopped announcing annual GDP growth rates and is now announcing it will make its best effort to keep economic growth going. Those efforts are concentrating on preventing a collapse of the financial system. Unofficially, the government expected 5.5 percent growth in 2022. Foreign economists estimate a more realistic 3.5 percent growth.

China’s economy was already slowing down when the current covid19 government shutdown of Shanghai and a growing number of cities made matters worse. There is also an unresolved real-estate bubble and more Chinese banks are suffering liquidity (cannot meet demands for withdrawals) problems. The economic damage done by all this led to a $5 trillion dollar stimulus program to alleviate suffering among workers and provide businesses with cash needed to keep operating. The actual decline in GDP growth is a state secret but is believed to be bad enough to produce GDP shrinkage and an official end to the decades of high GDP growth. China’s economy is, at $18 trillion (or less) a year, the second largest in the world. The Americans have economic problems but not to the extent China suffers from.

This is mainly about the size of their $117 trillion (before the new stimulus) government debt, which is nearly four times the size of the U.S. debt. This Chinese debt is 6.5 times GDP while the American debt of $29 trillion is 1.26 times GDP. It’s worse when you take population size into account. China has about four times the population of the U.S. meaning the average Chinese has about 16 percent of the income of an American while carrying far more government debt per capita. Much of that debt comes from millions of housing units built by local governments that not enough Chinese can afford, or will not consider, because many of these “Ghost Cities” are too far from where the jobs are. China’s bond market is the second largest in the world after the United States. With this kind of debt, quality (the ability of debtors to repay) is a major factor. The quality of Chinese debt is much lower than in the U.S. or the West in general and the extent of this problem was deliberately hidden by debtors, especially local governments, for decades. Some of that bad debt is related to BRI (Belt And Road Initiative) projects, which is currently about $60 billion. Poor management, covid19 and local violence and corruption turned most of that debt into a liability, or worse because default either means China assumes ownership of the project or the local government interferes and creates a diplomatic as well as economic problem. All this makes China’s real estate bubble far more dangerous than previous ones encountered in major economies.

Then there is the war in Ukraine, which Russia is losing militarily as well as economically. This is useful to China. Russia has become a lucrative trading partner with China because of Western sanctions on Russia because of its invasion of Ukraine. Russia thought they had NATO under control because most natural gas used in Europe was from Russia. NATO nations surprised Russia by canceling their contracts for Russian natural gas and oil. China was the only other nation capable of paying for much of that Russian natural gas and oil. There was a catch, China demanded a price cut of fifty percent. China also has an alternative to the U.S. dominated SWIFT bank transfer system, computer operating systems and the Internet. Since 2014 China and Russia have already created their own versions of SWIFT, called CIPS (Cross-Border Interbank Payment System) and are planning to link with the Russian counterpart, SPFS (System for Transfer of Financial Message.). Currently SWIFT has about 10,000 member organizations (banks and other financial institutions). Created in 1974 as a restricted and secure messaging (email) system, it is used mainly to arrange money transfers between members. Its Chinese and Russian competitors have fewer than 500 members. India is considering joining the China/Russia combined network. For handling export sales of all that Russian natural gas and oil, the China/Russia SWIFT alternative sort of works. Russia is selling a lot more to China than it is buying from China. That hurts the value of the ruble.

China continues to provide public support for the Russian “special operation” (not a war) in Ukraine. China will not violate any sanctions to help Russia with its problems building more missiles or maintaining modern aircraft. China sees the Russian situation in Ukraine as similar to what China faces in the South China Sea. In both cases the United States and other Western nations are interfering where they should not. Recently, as Russia suffered a series of defeats in Ukraine, China has become more reserved in its support for Russia. Another problem is that China is facing more criticism from its most lucrative Western trading partners. As long as Russia is in Ukraine, Russia is a flawed trading partner because of the international economic sanctions. China never believed that Western nations could unite and sustain sanctions on Russia that cost the Western nations a lot of trouble and expense. European nations had become too dependent on Russian natural gas and oil supplies. Over the next year these nations will have a hard time establishing other energy sources but are proceeding despite the economic and political cost. Such determination could be used against China during a major confrontation.

Pakistan Panic

Pakistan is under pressure from China to allow China to base troops, combat aircraft and warships in Pakistan. This is mainly about the existing Chinese-built port/protected enclave at Gwadar. Anti-China violence in the southwest (Baluchistan province) is getting worse and the Chinese proposal is about Chinese forces protecting Gwadar while the existing special Pakistani security force concentrates on Chinese working outside of Gwadar.

There has always been some separatist violence in Baluchistan against whoever was currently in charge there. This escalated when Pakistan and China agreed in 2013 to build the CPEC (China-Pakistan Economic Corridor) project. This cooperation began a decade earlier when China agreed to expand the port of Gwadar in Baluchistan. Many Pakistanis, not just the Baluchis, saw such cooperation with China, especially the CPEC, as a threat to Pakistani independence and Baluchi separatism. This was made clear in 2021 when the Pakistani Navy and Coast Guard refused to give up 47 hectares (116 hectares) at the site of the expanded Gwadar port project. The commanders of the Navy and Coast Guard were making a public protest against the policy of being so economically and militarily dependent on China. This opposition was also growing within the military leadership, who see this dependence on China as a surrender of independence which also puts Pakistan at risk of becoming collateral damage if China decides to fight India and its Western and East Asian allies for control of the Indian Ocean. The Pakistani naval officers have done the math and believe China has little chance of prevailing against that kind of coalition. Worse is the fact that Pakistan is becoming economically and diplomatically dependent on their northern neighbor. This public protest, which the Chinese demanded be resolved quickly, began in late 2020 and surfaced in 2021 because the Chinese were visibly upset at such insubordination. There is growing opposition within Pakistan, and the Pakistani military, towards the increasing brutality of the military against elected officials, critical media and anyone who opposes the military getting its way, and not just among junior officers but also some senior commanders, especially those who are retired.

The military decided over a decade ago that Pakistan should be willing to pay a high price to get CPEC done because it meant Pakistan had an ally against India, Iran and even Western powers that might have some violent disagreement with Pakistan. China addressed that by pointing out that China does not have allies, just powerful trading partners (the West in general) and client states (like Pakistan). That has always been the Chinese outlook and it hasn’t changed.

While China is picking up most of the $60 billion cost of CPEC, it means that China owns many of those new economic assets, especially the new port of Gwadar. In early 2017 China and Pakistan signed an agreement granting China a 40-year lease on new Chinese-built facilities at Gwadar. The lease granted China most (over 80 percent) of the revenue brought in by port and free trade zone operations.

China usually imports its own workers from China to do most of the work on projects like this. By 2022 China had several hundred thousand Chinese in Pakistan, some of them with their families. The easiest way to provide protection is to have most of them live in a heavily guarded and restricted access area. Gwadar is a key part of CPEC and it has the misfortune of being in a province (Baluchistan) that does not want to be part of Pakistan. China and the Pakistanis try to ignore this by not reporting on non-Islamic terror attacks on CPEC construction projects. The government has long been accused of suppressing news of tribal separatists in Baluchistan attacking government targets and especially those related to CPEC. The separatists claim they regularly carry out attacks on CPEC construction projects, but most of their attacks are still directed at Pakistani security forces and government facilities.

September 15, 2022: Taiwan has taken note of the high rate of missile use during the Ukraine War. This is not a new phenomenon. There are never enough key weapons and munitions that would have to be produced during the initial stages of a modern war. This was demonstrated during the 1973 Arab-Israeli war when everyone underestimated the speed at which modern weapons and munitions would be used or lost in a modern war. Israel pointed out that this problem was often ignored or played down because a solution was politically difficult and expensive. This problem is now harder to ignore. Taiwan designs and manufactures some of these weapons and now has to decide if it should increase production now to build a larger stockpile and to maintain the ability to quickly resume a high rate of production. NATO nations learned this the hard way while simply supplying Ukraine with missiles. Ukraine designs and manufactures such missiles but these manufacturing facilities were attacked with Russian missiles early in the war. Russia has now used nearly all of its most effective guided missiles and is unable to manufacture replacements because of the sanctions. Maintaining sufficient stockpiles and manufacturing capacity is expensive and most countries simply look the other way and hope they don’t get involved in a war that requires a lot of missiles. Taiwan is more vulnerable to such an attack because of Chinese threats and a buildup of short-range ballistic missiles and amphibious assault forces. The Americans will come to the aid of Taiwan but not on day one, or day two. China is preparing to take advantage of that delay and any possible lack of defensive missiles Taiwan might have.

September 13, 2022: In the south, on the Indian border, China and India confirmed their mutual withdrawal of troops from portions of the LAC (Line of Actual Control) in India's Ladakh State. Also known as the Macartney-MacDonald Line the LAC is the unofficial border between India and China. The LAC is 4,057 kilometers long and is found in the Indian States of Ladakh, Kashmir, Uttarakhand, Himachal, and Arunachal. On the Chinese side it is mostly Tibet. China claims much territory that is now considered part of India. There have been several thousand armed and unarmed confrontations over the last decade as one side or the other accuses “foreign troops' ' of crossing the LAC. The mutual troops withdrawal in Ladakh reduces tensions there but not along other LAC segments where there are still a lot of Chinese and Indian troops confronting each other.

September 10, 2022: Currently China has 33 cities and about 65 million people under covid19 lockdowns. Those cities account for a disproportionate amount of the national GDP because factories in these cities supply vital components for manufacturing operations all over China, and the world. The heavy use of lockdowns to achieve zero covid19 cases Initially (2020) this was a success and allowed China to claim far fewer covid19 deaths than it actually suffered. Other industrialized East Asian nations (South Korea, Taiwan, Japan and Singapore) adopted similar policies with similar success but also accurately reported covid19 deaths. This annoyed China, but worse was yet to come. Covid19 evolved into strains that spread more easily but were much less likely to kill. The other East Asian nations adjusted to this and did not use large scale shutdowns because of the economic damage. These nations trusted their citizens to test themselves and self-quarantine if infected. China was not as trusting of its citizens and continued with large scale lockdowns that did more damage to the Chinese economy without reducing covid19 deaths much. Another difference with China was their refusal to buy the more effective Western mRNA vaccines or license the technology. There were hacking efforts against the mRNA vaccine developers early on but those hacks failed to get the mRNA tech. China used less- effective vaccines developed locally. These vaccines were less successful in preventing infections and this resulted in strict lockdowns to overcome this problem. China now has an mRNA vaccine design that is being tested.

September 9, 2022: Chinese coast guard ships increasingly enter Japanese territorial waters (within 22 kilometers of one of the Senkaku Islands). The Chinese usually do this to harass Japanese fishing boats that China insists are there illegally. China has been regularly sending coast guard ships to the Senkanus for years in an effort to force Japanese fishing boats out of what China claims are Chinese waters. In early 2021 China enacted a law authorizing their navy and coast guard to “protect” Chinese coastal waters off the Senkakus. Anticipating this, in early 2020 Japan established a military base on Miyako Island (between Senkaku Island and Okinawa). The Miyako and Senkaku islands are between Okinawa and Taiwan. All three of these island systems dominate the seas between Japan and Taiwan and China has been making claims to some of these islands, especially the Senkakus and indicating that all of these Japanese islands are actually Chinese. The new garrison on Miyako Island has 380 troops and is equipped with anti-aircraft and anti-ship missiles. Chinese naval ships have frequently entered Japanese territorial waters (within 22 kilometers of land) around the Senkaku islands and remained in Japanese waters for an hour or more. Miyako Island is 210 kilometers from the Senkakus and Japan plans to put garrisons on more of these small islands. China and Japan are competing to establish the most dominant position within the Senkaku coastal waters. So far it’s a stalemate.

September 8, 2022: Evergrande, a major Chinese real estate firm, sitting on over $300 billion of bonds and other forms of debt had its Hong Kong headquarters seized as part of the program to provide lenders with some of the money they had loaned Evergrande. Back in July Evergrande had negotiated a $1.7 billion sale of their headquarters but that fell through. At the end of 2021 Western credit rating agencies declared that Evergrande was now officially in default and unable to repay its debts. Evergrande debt is as toxic as it comes and in a normal world that can trigger the long-feared financial crisis in China. The Chinese solution was not normal. The government declared the situation was under control and that apparently means priority will be given to the many individual Chinese who are at risk of losing large down payments on apartments Evergrande has not completed or in some cases not even begun construction on. The fewer individual Chinese hurt by the Evergrande default and less damage is done to the reputation of other major Chinese real estate developers. Chinese banks and institutional investors are next in line and they are expected to write off (forgive) as much of the debt as they can. The government insists on this. Foreign bond holders, who have between ten and fifteen percent of this debt are last in line and the government is ordering Evergrande, and other Chinese real estate firms with a lot of foreign debt holders, to handle this as best they can, even though this “screw the foreigners” approach will make it more difficult for Chinese firms to get foreign investors in the future.

In the two months before being declared in default, Evergrande bonds went from “high yield” (junk bond) status to default. The junk bond segment is the first to fail when a national economy suffers from too much bad (unlikely to be repaid) debt. China can avoid the bankruptcy of one real estate firm, but only for so long because several other similar firms are also close to default.

The Chinese bond market is the second largest in the world, after the United States. With debt, quality (the ability of debtors to repay) is a major factor. The quality of Chinese debt is much lower than the U.S. or the West in general and the extent of this problem was deliberately hidden by debtors, especially local governments, for decades. This makes a Chinese real estate bubble far more dangerous than previous ones encountered in major economies. China was known to have been developing a novel situation to this and now it appears that solution involves the government deciding which Chinese institutional bond holders will have to eat (absorb) a portion of bad debt in order to spare the millions of individual Chinese from suffering major losses. While this approach maintains popular faith in the financial system, Chinese institutional investors (banks, insurance companies, investment funds and endowment funds) will struggle to survive and if any of these institutions fail, many individual Chinese will see the value of their insurance and stock market holdings shrink.

Evergrande pledged to resume construction on stalled residential projects by the end of September. This announcement may be more about preventing further economic pressure on Evergrande than actually resuming construction. Evergrande may be out of cash but they still have plenty of excuses for their situation.

September 5, 2022: In Afghanistan an ISIL suicide bomber attacked the well-guarded Russian embassy, killing two of the embassy staff and four others. At least ten others were wounded. The Taliban IEA (Islamic Emirate of Afghanistan) government is welcoming the reopening of foreign embassies, even though none are being used as embassies but a lesser diplomatic post staffed by consular staff. India recently joined China, Pakistan, Iran, and Russia in maintaining low-level diplomatic ties with the IEA.

August 14, 2022: China conducted two weeks of air and naval military training operations around the island of Taiwan. The Chinese sent a number of their J20 stealth fighters aloft armed with air-to-surface and air-to-air missiles carried externally, degrading its stealth capabilities. American and Taiwanese radars and 0ther ELINT (electronic intelligence) equipment got a chance to test the stealth capabilities of the J20. China has been trying to develop world-class stealth fighters since the 1990s. A decade ago the J20 appeared, described as a true stealth fighter. It sort of was but eventually turned out to be close but still a work-in-progress. That was probably confirmed as J20s flew near Taiwan and were tracked by American and Taiwanese radars.

 

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