Wednesday, March 16, 2011

China's Weaknesses

The Wall Street Journal pointed out some uncomfortable truths about China's oil vulnerabilities. China became the biggest importer of crude oil from Saudi Arabia in 2009, surpassing the US. Most of China's crude comes from Saudi Arabia:

The Middle East provides 2.9 million barrels of oil a day to China, more than half its total imports, and Saudi Arabia alone accounts for about 1.1 million barrels a day.

Chinese officials say they want to boost trade with Saudi Arabia by about 50% to $60 billion by 2015, further increasing Beijing's dependence on the kingdom.



China realizes its vulnerability, and has been doing what it can, mostly increased military spending and overt political alliances with Saudi Arabia, to decrease its vulnerability by gaining power. China's aircraft carrier program is aimed directly at gaining naval power and dominance over the Gulf, to assure the oil keeps flowing.

"Asia has been something of a bystander in the Middle East and importantly, in the case of China, an increasingly anxious bystander," said Andrew Shearer, director of studies at Australia's Lowy Institute for International Policy.

That anxiety comes from the economic implications of possible major disruption to energy supplies coming through the Persian Gulf's Strait of Hormuz and Beijing's unease that the calls for democratic change sweeping across the Middle East will set an unwelcome precedent at home. According to Mr. Shearer, the U.S. still has the military capability to intervene if the flow of oil from the region was threatened.

In an extreme scenario, U.S. troops could seize control of oil installations in the region, leaving China and most of Asia dependent on the goodwill of Washington to guarantee their supplies. In such circumstances, "the oil would follow the gray naval ships" of U.S. forces in the Persian Gulf, Mr. Shearer said.

China may be racing to catch up. It has increased defense spending by almost 13% and is developing its own aircraft carriers. But its ability to project power beyond the South China Sea remains limited. Beijing sent one of its latest and most powerful warships, the Xuzhou, to help evacuate its nationals from the fighting raging in Libya, but this effort was dwarfed by the rapid U.S. navy buildup off the North African coast. "China has naval aspirations but they're still a long way from realizing that," said Mr. Shearer.


China remains hobbled by a fiscal system that is a mess. As the WSJ reports:

More important, the banks were relieved of their bad loans by what Messrs. Howie and Walter accurately describe as "accounting legerdemain."

In 1998, the People's Bank of China—the state's central bank—reduced the Big Four's reserve requirement. This freed up reserves for the banks to acquire a special-purpose treasury bond issued by the Ministry of Finance. The loan proceeds were then used to recapitalize the banks. Beijing also created asset-management companies to buy the nonperforming loans from the banks at face value. In exchange, these repositories of toxic credit issued notes to the banks. (When these notes became due in 2009, they were extended for another decade.)

For the financial magicians' next trick, in 2005, other nonperforming loans were put into a "co-managed account" with the Ministry of Finance, which in return issued IOUs to the banks that were to be repaid through a combination of loan recoveries, bank dividends, sale of bank shares and tax receipts from the banks. To make matters even more convoluted, in 2009 the banks started acquiring large stakes in the asset-management companies that were still sitting on nonperforming loans from the previous decade.


As noted in the article (the review of "Red Capitalism" by Carl E. Walter and Frasier J.T. Howie), what this has done is given Chinese banks a guaranteed spread, between borrowing costs (artificially low) and what they charge for borrowing (high), but at the cost of artificially low rates on Chinese consumer bank accounts, aka "financial repression." Chinese have to save, save, and save, because they get in effect negative real returns on savings accounts. This accounts for all sorts of destructive bubbles in real estate, and the like. Empty apartments in Shanghai and elsewhere that Chinese families have purchased as investments, desperate for returns. Household deposits have financed the industrial banking system and export driven economy. Making Chinese domestic consumer consumption a joke (and a bad one on Western companies betting on it).

Bad loans are routinely hidden, and the various local, provincial, and special district liabilities for bad loans, often connected to White Elephant projects like high speed trains that will never recoup their investment costs, is probably on several orders of magnitude larger than the US state/local/county levels of indebtedness.

China is a formidable country with many advantages, but they are not world-beating supermen with no flaws. Their interior remains dirt poor and functionally illiterate. They have massive ethnic/racial/religious tension and separatism. [Tibet and XianXing Uighurs and Hui Muslims on the coast.] China has huge gaps between rich and poor, massive gender imbalance (roughly 30-40 million young men will never marry.) China is hideously vulnerable not just on its own sake for oil, but cheap Chinese goods rapidly increase in price if oil increases, by trans-Pacific transportation alone. Let alone cost of production. And as noted, its financial system is a shaky house of cards continually propped up, driven by insolvent State Owned Enterprises that must be continued to keep employment up (and the social safety net which is tied directly to employment, including schooling and welfare.)

China has been lucky, propping up its broken financial system. Betting on luck forever is not a wise move. It may well be that Japan's earthquake exposes China's weakness, as Japanese companies pull back from Chinese investment to focus on reconstruction at home and Japanese led export growth (to pay for reconstruction). Japan is highly indebted, aging, and with very little growth domestically. The only way for Japan to reasonably pay for reconstruction is export-led economic growth, in direct competition with China.

15 comments:

JJT said...

China is greenbacking their currency. The WSJ/FT don't like this, so they describe it as unstable etc. C

JJT said...

http://www.youtube.com/watch?v=ln-BV4dT_7g

http://www.chinadaily.com.cn/business/2009-06/08/content_8260388.htm

"Four major State-owned banks showed unprecedented credit support to small and medium-sized enterprises (SMEs), according to a recent report."

bgc said...

Don't forget China's ongoing neo-colonization of Africa - this may solve their problem in the longer-term:

http://online.wsj.com/article/SB10001424052748703460404575243892823004542.html

By The Sword said...

If only we'd start drilling offshore and selling them the oil that they need so badly....

Anonymous said...

To hold down their assets in the Middle-East, the ChiComs will need to send most if their military there. These troops are more used to bossing around provincials rather than combating full scale insurgencies, and while they'll be experiencing real war for the first time out there, the provincials might take this opportunity to rise up.

DR said...

"Their interior remains dirt poor and functionally illiterate."

Perhaps, but Shanghai and other major city centers now have per capita incomes at or above Western European levels. Also the rural poor unlike a lot of other emerging markets (e.g. Brazil, India) are basically the same gene pool as the urban workers, meaning that it shouldn't be too hard to bring them up to that productivity level. Also in China, unlike the United States, they have massive plans to relocate people from poor regions to growing regions:
http://www.telegraph.co.uk/news/worldnews/asia/china/8278315/China-to-create-largest-mega-city-in-the-world-with-42-million-people.html

So those poor regions are strong source of future growth, rather than (like in the US) a perpetual drag on the government in the form of welfare, corporate protectionism for dying industries, and unnecessary subsidized military bases.

"They have massive ethnic/racial/religious tension and separatism. [Tibet and XianXing Uighurs and Hui Muslims on the coast.]"

The groups you mention are relatively tiny. Han Chinese make up 92% of the population. Then after that you have Zhuang and Manchu groups which are basically as culturally assimilated with the Han as people of English and Scotch-Irish descent in America are. The largest group that would ever be seperatist is the Hui or Uyghurs (both muslims), each of which is less than 1% of the population, and together less than 2%.

"China has huge gaps between rich and poor, massive gender imbalance (roughly 30-40 million young men will never marry.)"

A lot of societies throughout history have had giant wealth and gender imbalances. The only reason we view these things as unstable in the West is because they tend to precipitate revolutions and political instability. Unlike governments in the West, China is not wishy-washy about crushing opposition, and doesn't care about breaking a few eggs to maintain stability, as Tianneman demonstrated. Nor is it small, defenseless or dependent enough on foreign support to be pressured to respecting "Western human rights", like Mr. Mubarrak.

"China is hideously vulnerable not just on its own sake for oil, but cheap Chinese goods rapidly increase in price if oil increases, by trans-Pacific transportation alone. Let alone cost of production."

This is true. Like all emerging markets, China uses far more oil per unit of GDP. This is because they're lower down in the value chain of production. Proportionally they tend to produce a lot more manufactured goods, we produce a lot more software, insurance, financial services, entertainment. However if you look at consumption, instead of production it's a lot less specialized. We consume a lot more energy intensive goods than produce. The people who pay for that increase in oil are going to be the end producers, not the manufacturers.

And as for that transportation issue, it works in China's favor not against it. If China produces their products domestically, and we have to ship our manufactured products over across the pacific, who's going to have to cut back more on manufactured good consumption?

"And as noted, its financial system is a shaky house of cards continually propped up, driven by insolvent State Owned Enterprises that must be continued to keep employment up (and the social safety net which is tied directly to employment, including schooling and welfare.) "

This I agree with you. However I will say that it's a lot easier, and requires a lot less efficiency to maintain a social safety at $2k/yr compared to the middle class social safety net of government employment in America that costs about $100k/yr after salary and benefits.

DR said...

"Japan is highly indebted, aging, and with very little growth domestically. The only way for Japan to reasonably pay for reconstruction is export-led economic growth, in direct competition with China."

I think this is backwards. Japan's government is highly indebted, but Japan, unlike America is a huge net saver, not net consumer. America's situation is one that (at some point in the future) requires export growth. Both American consumers and the American government owe huge amounts of debt, and they primarily owe it to foreigners. Thus America needs to run a sustained period of trade surpluses to pay off its debt.

Japan on the other hand has a government that borrows a lot, but a population that saves even more. Japan doesn't have to export a single cent to pay its government debt. It simply has to raise taxes or inflate until its government revenue matches its debt servicing (and since the debtholders and taxpayers are the same people, this wouldn't even hurt like a tax increase in America).

Furthermore if Japan's government stopped keeping the yen artificially low and let it appreciate (cranking up their imports, and decreasing the cost of consumer goods in Japan), they could keep their country's standard of living the same through cheap imported goods and compensate by raising taxes to service their (internal) debt. They could also rollover their debt from internal debtholders to external debtholders and cheaper levels with a more expensive yen. Thus reducing their debt burden further.


The being the thesis that Japan will crank up their already astronomically high exports in the wake of this earthquake is I believe wrong. Just the opposite they're going to need to reduce export levels and re-orient production for domestic reconstruction purposes. Furthermore not only will China have less export competition, but since Japanese will be saving less and spending more to reconstruct, this will reduce demand for American Treasuries.

I believe over the next few months will see a smooth increase in treasury rates, putting further pressure on America's budget and enriching China's rate of return on their foreign currency reserves.

Anonymous said...

While a surplus of $2 Trillion sounds like a lot, when divided by a population of 1.3 billion Chinese it equals to $1,500 per every man, woman, and child. It has been said that the main pre-occupation of China is waking up every morning and trying to feed a billion Chinese. Now it is feeding 1.3 billion Chinese.

Anonymous said...

quote:
"Household deposits have financed the industrial banking system and export driven economy. Making Chinese domestic consumer consumption a joke (and a bad one on Western companies betting on it)."

Ever since Marco Polo visited China the white man has been desperately trying to penetrate the Chinese domestic consumer market with little success other than selling opium.
*yeah that's not PC but there's much truth to it*

In the mid-19th. century,a Lancashire mill-owner reckoned that "if only the Chinese could be persuaded to lenghthen their shirts by a foot, the cotton mills of Lancashire would run for ever."

The most successful exporters to China are nations that sell either raw materials or capitol goods. As an investor I would NOT bet my money on an American company trying to break into the Chinese consumer market.

JJT said...

The people pushing drugs in China were Jews, who at that time were using the cover of the British.

Look into David Sassoon, "The Rothschilds of The Far East".

There is no reason for whites to hold guilt from Jewish behavior. Next, let's talk about slavery.

Anonymous said...

The Chinese need to step up the colonization of Africa. They could get all the resources they need and we could be rid of the Somali pirates.

Anonymous said...

Two unrelated things of interest:

Author confirms Bill Ayers helped write 'Dreams'
http://www.wnd.com/?pageId=110784

Netflix to make its first TV show
http://www.zacks.com/stock/news/49292/

Anonymous said...

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black men are really swooping in and stealing our women.

War Blogger said...

China's main weakness - on the erssource aquisition side of the equation - is that it still lacks a true blue water navy, even though that most likely will have changed in five years' time. Other than that, it's a stable autocratic regime with a way better grasp on economics than most western nations.

& The Revolution said...

In 1950 the US manufactured 40% of all the worlds goods. Today, the US manufactures. . .40% of all the worlds goods. That's right. All this dearth of manufacturing talk you've been hearing is really just that: talk. Certainly, there are less jobs in manufacturing. The us does not tan leather en masse, or manufacture paint solvents and chemicals. The chinese can HAVE these types of low paid, pollution- filled pursuits. Car and other heavy equipment manufacturing has moved south of the border or offshore. As an economy evolves along with the society which surrounds it, this kind of shift is inevitable.

The chinese are making a huge mistake by basing their economy on manufacturing. They're just going to be undercut by the thai. . .who will then be undercut by the vietnamese. In the end it won't really matter because the robots will undercut them all. India is trying to build more of a knowledge based and service economy--along with some manufacturing--just like the US and other first world nations. This is the way to go.