George Soros speaks out on the Chinese Economy – A Sad Day for All of Us

I haven’t written on this blog in a long, long time. I left China nearly 2 years ago now and at the time I really needed a break from thinking about the country. In the interim, I have been having a single discussion over and over again with almost everyone I meet. It begins like this…

They say; “China is the answer to everyone’s prayers soon the country will be the global superpower and everyone will be richer.”

The trouble is that none of these people come to the table with any evidence. It’s a belief and as I often paraphrase Heinlein here; “When everyone believes such and such, you know it ain’t so by at least a factor of 10,000 to 1.”

China, guaranteed success for the world? Sadly, probably not.

My argument has been simple. China cannot be the answer to everyone’s prayers economically. Why?

Here goes:

1. China is not a rich country – I explored this in a piece on here two years ago and nothing has really changed in the interim.
2. China is an export driven economy. With no internal economy the country needs people overseas to buy their stuff. A global economic crisis makes China poorer. As other economies grow, China grows.
3. China’s manufacturing is in trouble. The lowest end manufacturing depended on low wages – now China’s wages are rising, low end manufacturing is moving to places like Bangladesh and Cambodia.
4. Mid-tier manufacturing is in trouble too. With decades of quality problems, major changes in costs, etc. there is a growing trend to onshore manufacturing in the West.
5. High-end manufacturing doesn’t exist at all. In fact this is a major problem for China. Japan made its transition to a first-tier economy by transitioning to high-end manufacturing. China cannot emulate this. Why? Because China has 1.3 billion people to feed. There aren’t enough consumers of high-end products on earth to keep this many people working full-time in high-end industries.
6. China’s internal debt (also touched on in this blog 2 years ago) has spiraled out of control. There’s more than a year’s GDP tucked up in toxic debt that has no hope of repayment. Worse is that much of this debt was designed to inflate employment figures and growth figures in China; massaging the real growth of the economy. When the money needs to be returned; hundreds of millions may lose their jobs.
7. China has stockpiles of products that no-one wants or needs as massive over-investment in mid-tier industries ran out of control too. The auto industry has been producing an excess of 20 million vehicles a year, the low-end solar panel market is so oversupplied that the current trade dumping of panels was a natural consequence of this, the low-end LED mountain is also spilling over, etc.
8. China is slowly poisoning itself to death. I’ve touched on the environment lightly before but last year was the year people started dying in droves from air pollution in Chinese cities. There’s been a largely unreported drought in large parts of China thanks to environmental erosion. Even if the world economy could support endless growth for China, China can’t support endless growth.

Pollution in China is beyond incredible now. As you can see no country can sustain this kind of living. It’s estimated that in Northern China pollution is reducing life span by 5.5 years per person!

That’s Just Your Opinion, Isn’t It?

I’ve been ridiculed for this again and again. The power of belief is an amazing thing, so many people can’t imagine that China will hit trouble they’ve forgotten the old financial disclaimer; “Past performance should never be taken as an indication of future performance.”

The endless rush to invest in China is similar to the real estate rush in the West or the dot com boom at the start of the century. People have been ignoring their common sense and the numbers and throwing money at “the next big thing”.

Today, George Soros, the billionaire financier who brought the UK to its financial knees in the ERM (European Exchange Rate Mechanism) fiasco has come to the same conclusion. China’s boom is unsustainable. Internal toxic debt has risen at an incredible pace. In fact the amount of internal lending in China in the last 5 years is equivalent to all the money in the United States’ financial system.

This vindication doesn’t make me happy. Unfortunately, I agree with his analysis on the political front – major problems in the Chinese economy are almost certainly likely to lead to military action. As every dictator knows, when times are hard, invading other countries distracts from the cold reality of daily life.

The saber rattling between Japan and China has been escalating over the last few months. Including a delightfully silly moment when both countries compared each other to the villain in the Harry Potter series.

This is perhaps the most astonishing spat in the history of diplomacy. All credit to J K Rowling for the pervasive influence of her work on an international scale though.

Vietnam is at boiling point over China’s claims to the South China Sea and other South East Asian countries are grumbling about the problem too.

The Philippines and China’s relationship has never recovered from the gunman on the bus tragedy.

And so on…

Given that I now live in South East Asia which is very likely to be a battleground in any form of military action from China – I’d rather I’d been wrong about their economy. I don’t expect things to spiral out of control today and there is the possibility that when Chinese savers work out what’s happened to their savings that civil insurrection may prevent the outbreak of war. However, I’m not hopeful on either front at the moment. We’re at the dawn of a new Asia and possibly the start of the 3^rd World War.

Why should you care?

You may not realize how tightly your own economies are bound with China’s today. China is the world’s biggest consumer of commodities; a collapse has stark implications for Western economies and in particular for Canada and Australia who have been riding high on selling commodities to China.

If your money is in gold… you may be even more exposed. China buys as much gold as it can get its hands on and that’s kept prices at a high level; if the bubble bursts you expect to see much of this gold dumped onto the open market in exchange for hard currency. The price will deflate like a balloon with a hole in it.

Even if it glitters it may not be golden for too much longer… time for investors to find a new safe haven.

The overall knock-on effect will be less severe than it might have been had China been freely trading its currency. The RMB was once touted as a potential alternative to the dollar as a medium for global financial exchange. Today it’s more likely to be used as kindling in the event of a Chinese recession or worse depression. This lack of free trade in the currency has muted the amount of cash flow moving from Chinese banks to overseas institutions. However, it’s not true that there’s been no cash flow and the impact will still send shockwaves throughout the world’s banks and that includes your bank.

If the worst should happen and China goes to war over this; the price we all pay for China’s collapse may be higher than anyone conceived at the turning of the Millennium.

Does this piece mean that Shards of China is coming back?

I think that the answer to this question is yes. This blog has received over a quarter of a million visitors in its short two year existence. Traffic to the site has been consistently high even since I stopped writing here. I would like to return to the subject of China personally, I feel there’s a lot more to say. I’ve gotten over my issues with China; I just needed some space. However, I don’t think that Shards of China will be officially relaunched until March – I have a lot of projects on at the moment and they deserve my full attention first.