Ray Kroc, the businessman who bought McDonald’s from the McDonald brothers not only knew a thing or two about fine food, he also understood competition: “If any of my competitors were drowning, I’d put a hose in their mouth and turn on the water.”
Which brings me to China.
Beijing’s rejection of Maoist economics and half turn toward a market economy under Deng Xiaoping was — and is — something to celebrate. If Deng does not deserve all the credit for launching China on a new course (there were already some signs of change at ground level), he legitimized it (“to get rich is glorious”) and paved the way for the later acceleration away from communist dogma. The result was to lift some eight hundred million people out of poverty, a journey that for many ended up in modest prosperity, or, indeed, more. China’s middle class is now estimated to be over seven hundred million strong, or more than half the country’s population.
Simply abandoning Maoist delusion was always going to give China’s economy a major boost, but it was the adoption (however incomplete) of market mechanisms that proved key to a far deeper transformation. However, in any developing economy, there comes a point when growth begins, quite naturally, to slow (much of the easier lifting has been done, and, besides, as the saying goes, trees don’t grow to the sky). Thus Japan’s growth rate tapered off fairly sharply about thirty years after its postwar recovery began, and China’s has followed a not dissimilar course. But this was less easy to accept in a middle-income authoritarian state than in a (by then) prosperous democracy. With authoritarianism, however, comes the ability to conceal inconvenient truths. In more recent years, China has been able to goose up its growth using methods that were not only unsound, but now threaten a major economic crisis.
Making matters worse has been the regime’s turn away from markets and toward heavier state control, a shift closely connected to its increasingly aggressive international ambitions. China is large enough and wealthy enough to stand in the first rank of global powers, and it intends to use that position to challenge American, and indeed Western, “hegemony.” The notion that growing prosperity would lead to an increasingly democratic China has proved to be yet another bit of junk historical determinism, not that much more ridiculous than the idea that countries that trade together are going to be friends.
China is today more adversary than competitor. The West’s best chance of avoiding a conflict with Beijing is to recognize that reality. In the economic sphere that should mean steady disengagement and, for that matter, putting a halt to climate policies that are a gift to China both geopolitically as well as economically.
There’s a key passage in a speech on March 30 (which I discussed in this article for National Review), by Ursula von der Leyen, the President of the EU Commission (the EU’s top bureaucrat), in which she summarized China’s ambitions:
The Chinese Communist Party’s clear goal is a systemic change of the international order with China at its centre. We have seen it with China’s positions in multilateral bodies which show its determination to promote an alternative vision of the world order. One, where individual rights are subordinated to national security. Where security and economy take prominence over political and civil rights. We have seen it with the Belt and Road Initiative, new international banks or other China-led institutions set up to rival the current international system. We have seen it with China’s set of global initiatives and by how it positions itself as a power and peace broker, for instance through the recent Saudi Arabia and Iran agreement. And we have seen the show of friendship in Moscow which says a thousand words about this new vision for an international order.
That China’s ruling party calls itself communist is largely irrelevant. To be sure, it is capable of Leninist ruthlessness, is run in a way that contains echoes of Lenin’s “democratic centralism” and makes use of phraseology from the Maoist catechism. However, it is more interested in harnessing capitalist energy, and subordinating it to the needs of the state than in crushing it, an idea that owes more to twentieth century fascist theory (and sometimes practice) than to the comrades’ old fantasies.
To many free marketeers, “harnessed capitalism” is inherently doomed to fail, but that is not so. The economic results it delivers will, as we are now seeing in China, be inferior to those generated by the free market, but they can be enough to power a successful authoritarian regime, at home and abroad. And when it comes to abroad, those aims are not a global revolution but, as von der Leyen recognized, a reorganization of the world order with the Middle Kingdom at its center and, to a greater or lesser extent, in charge.
Writing for the Financial Times (August 22), James Kynge picks up where von der Leyen left off:
When Xi Jinping, China’s leader, delivered an “important speech” at the UN in September 2021, it appeared to be little more than a list of feelgood clichés. He said that the world needed “harmony between man and nature” and added that economic development should bring “benefits for all”.
So short on specifics was his address that the international media mostly ignored it. Through subsequent elaborations, however, that speech has taken on a crucial significance. This is because Xi used it to propose a new scheme called the Global Development Initiative, which is now gaining recognition as a foundation stone in China’s blueprint for an alternative world order to challenge that of the US-led west.
Ostensibly, the GDI is a Chinese-led multilateral programme to promote development, alleviate poverty and improve health in the developing world. But along with two follow-up initiatives also announced by Xi — the Global Security Initiative and the Global Civilisation Initiative — it represents China’s boldest move yet to enlist the support of the “global south” to amplify Beijing’s voice on the world stage and build up China’s profile in the UN, Chinese officials and commentators say.
“[Xi’s initiatives] show China’s clearest intention yet to update the rules of global governance that were written by the collective west in the aftermath of world war two,” says Yu Jie, senior research fellow at Chatham House, a think-tank in London…
And so (via the FT’s Joseph Cotterill, writing on August 25):
South Africa’s Cyril Ramaphosa was the official host of the Brics summit this week that agreed to more than double the membership of the emerging-markets bloc, but the true VIP was his Chinese counterpart Xi Jinping…
The real evidence of Xi’s importance was the expansion that looks set to add Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the United Arab Emirates to the five-member bloc. This fits into Xi’s plan that China should lead the developing world in confronting US “hegemony”, even as he also grapples with an economic slowdown and deflation at home.
Great power rivalry is nothing new, and, whatever transnationalists in Brussels or Turtle Bay might claim, is never going away. China’s current turn is not a reason for panic, or for lashing out wildly, but with Beijing mounting a powerful challenge to the West for it to face “an economic slowdown and deflation at home” is not the worst thing.
In last week’s Capital Letter, I looked at China’s growing economic difficulties, focusing primarily on the property market, but touching too on the way that problems there were connected to an increasingly rickety shadow banking system and to hugely over-borrowed local governments.
Bloomberg News (August 24) examined one aspect of the debt load now burdening local governments, “the off-balance sheet liabilities built up by local government financing vehicles [LGFVs], companies set up across China to borrow on behalf of provinces and cities but not explicitly in their name.” LGFVs (appropriately enough their name conjures up unsettling memories of the special purpose vehicles of financial crisis infamy) were meant to become self-sufficient, an ambition only lightly moored in reality, not least because of the way LGFVs muddle social (“promoting public welfare”) and commercial goals.
LGFVs have piled up $9 trillion in debt. Quite how that can be safely reduced remains unclear. Injecting profitable state-owned businesses into them can help, but that only works in richer areas. Meanwhile, LGFVs from poorer regions are, in the absence of promises of a bailout, are finding it expensive and difficult to secure the additional or continuing financing they need. A good number will find it very hard to weather this storm unaided, implying financial turmoil to come. But, even if they do survive, their glory days of funding infrastructure development are over, which will make it even harder for China to grow its way out of its current difficulties.
For infrastructural development has made a massive, if not always beneficial, contribution to China’s growth. According to the Wall Street Journal’s Lingling Wei and Stella Yifan Xie:
[D]omestic investment in infrastructure and other hard assets…accounted for about 44% of GDP each year on average between 2008 and 2021. That compared with a global average of 25% and around 20% in the U.S., according to World Bank data.
Large scale infrastructural development is hardly unknown in developing economies. In China’s case, reflecting in part at least, the absence of democratic oversight and control, this spending went on and on:
Guizhou, one of the poorest provinces in the country with GDP per capita of less than $7,200 last year, boasts more than 1,700 bridges and 11 airports, more than the total number of airports in China’s top four cities. The province had an estimated $388 billion in outstanding debt at the end of 2022, and in April had to ask for aid from the central government to shore up its finances…
With so many needs met, economists estimate China now has to invest about $9 to produce each dollar of GDP growth, up from less than $5 a decade ago, and a little over $3 in the 1990s.
The news out of the real estate sector which, which, if associated activities are included, has accounted for as much as 25-30 percent of GDP, continues to be grim. As mentioned last week, Country Garden, a developer that was meant to be too big to fail, lurches towards the cliff edge. Meanwhile (via Bloomberg News, August 23rd):
There are signs the situation is spiraling, too. More developers are on the brink, home prices are collapsing in smaller cities, and fears of contagion have spread to the nation’s $60 trillion financial system. When shadow bank Zhongrong International Trust Co. missed payments on dozens of high-yield investment products this month, investors protested outside its headquarters in the Chinese capital.
As it is:
Almost a third of all 498 dollar bonds issued by Chinese developers are in default, according to data compiled by Bloomberg, leaving $60 billion in unpaid debt to investors including Pacific Investment Management Co. and Fidelity International Ltd.
And the state-sector developers, a supposed safe haven that I also discussed last week, are looking vulnerable too:
Almost half of the 38 publicly traded state-owned real estate companies reported preliminary losses for the first half of this year.
According to Keith Bradsher in the New York Times, China has accumulated enough empty apartments to meet seven years’ worth of demand, real estate’s equivalent of all those unused bridges and airports. Even if the market somehow stabilizes, it’s hard to see a return to the roaring real estate markets that, like the LGFVs, did so much to fuel China’s growth in recent years.
None of this is helping consumer confidence, which is plummeting. The government is trying to help with a patchwork of measures (from interest rate cuts to lower costs for electric vehicle charging) that fall far short of bailouts or any “bazooka.” This mess is likely to leave ordinary Chinese much more risk averse when it comes to buying real estate in future. Equally, as the economy slows, China’s far from generous welfare and social security systems will encourage saving rather than spending.
If Beijing is hoping that foreign capital will come to the rescue it may well be disappointed. Investment in securities is, of course, much more volatile than investment in plant or equipment, but the continuing selling by foreign investors of Chinese stocks and bonds is, so to speak, a red flag.
Foreign funds have ditched $10.7 billion of holdings in mainland China’s blue-chip companies across 13 straight days of outflows, the longest streak since the financial data firm Bloomberg started measuring the figures in 2016…
Data last week from China’s foreign exchange watchdog showed bond holdings of overseas institutional investors fell Rmb37 billion (£4 billion) over the last month, taking their holdings to Rmb3.24 trillion (£349 billion).
On the other hand, £349 billion ($440 billion) is still a substantial amount.
It’s also worth noting this:
Investors had piled into Chinese assets after politicians signalled at a politburo summit in July that they were prepared to inject widespread stimulus into the economy to rekindle growth.
That was remarkably trusting of them. As a speculative trade — buy a potential bounce, and then move on — I can see why some might be tempted. But any new long-term investment in China by Western enterprises seems unwise. Despite some friendlier words and gestures directed towards private enterprise, the CCP will remain a silent (or not so silent) partner in any enterprise, foreign or Chinese, doing business in China. And the current focus on more secure supply chains is also likely to act as a further brake on Western investment in China.
Moreover, there is something perverse about Westerners putting money into an economy being retooled in ways intended to underpin China’s challenge to the West, a challenge that, despite the current economic turbulence, will remain formidable. Westerners investing in China would do well to remember Lenin’s apocryphal comment that “the capitalists will sell us the rope with which we will hang them.”
Meanwhile (via the Wall Street Journal’s Wei and Xie):
The International Monetary Fund puts China’s GDP growth at below 4% in the coming years, less than half of its tally for most of the past four decades. Capital Economics, a London-based research firm, figures China’s trend growth has slowed to 3% from 5% in 2019, and will fall to around 2% in 2030.
And:
Returns on assets by private firms have declined to 3.9% from 9.3% five years ago, according to Bert Hofman, head of the National University of Singapore’s East Asian Institute. State companies’ returns have retreated to 2.8% from 4.3%.
We don’t give investment advice at Capital Matters, but slowing growth, political uncertainty, and a hostile government do not, to me, make for attractive investment territory. And asset managers who claim to take ESG scores seriously should have nothing to do with China. China or ESG. Choose one or, preferably, neither.
But if a Chinese slowdown may well offer the West some geopolitical advantage, it only merits two cheers. In an article for the New York Times (August 23rd), David Wallace-Wells quoted President Joe Biden:
“China was growing at 8 percent a year to maintain growth, now close to 2 percent a year…That’s not good, because when bad folks have problems, they do bad things.”
Taiwan was clearly on the president’s mind.
There’s also the small matter of what a Chinese slowdown could mean for the global economy and for its trading partners.
Wallace-Wells:
According to World Bank data, between 2008 and 2021 — as the world’s per capita G.D.P. grew by 30 percent and China’s by 263 percent — China accounted for more than 40 percent of all global growth. If you excluded China from the data, global G.D.P. over that period would have grown not by 51 percent but by 33 percent, and per capita growth would shrink to 12 percent from 30 percent. In other words, recovery from the Great Recession was so robust in China that alone it nearly tripled per capita growth worldwide in those years. And that wasn’t even the most impressive period. In 1992, China’s G.D.P. grew by 14.2 percent; in 2007, it reached the same peak; in the 15 years since, it has averaged barely half that.
Even if Chinese statistics are unreliable, and even if, more recently, the basis for much of the country’s growth was unsound, and even if China cannot have been expected to maintain the blistering pace of growth experienced in its earlier years, it’s likely that the current slowdown in China, if it persists, will also mean slower global growth. The direct impact on the U.S. may, however, be relatively small. Writing for the New York Times, Paul Krugman observes that total U.S. investment in China amounts to a little over $500 billion, a large enough number, but, notes Krugman, about one-fifth of the total value of America’s office buildings, something which, now I think about it, may not be that comforting. U.S. exports to China (around $150 billion), explains Krugman, amount to only one percent of GDP, a number, I suspect, that will be less reassuring to those in specific sectors more reliant on Chinese demand.
That’s true outside the U.S. too, of course. To take one example, writing in Populyst, Sami Karam highlights the importance of Chinese consumers whether at home or as tourists for luxury goods companies such as LVMH, Kering, Hermes, Richemont, Swatch and Burberry. Rather less glamorously, China is a major buyer for commodities such as copper, but, to the extent that those are used in goods for export, that may mean that their prices will fall — something that might alleviate inflation — less than would otherwise be the case. And on the topic of Chinese exports, the combination of falling domestic demand and a weaker yuan will mean that more are likely to be coming the West’s way.
Krugman believes that the effect of a Chinese slowdown “would be larger for countries that sell more to China, like Germany and Japan, and there would be some ricochet effect on America via sales to these countries. But the overall effect would still be small.”
But there will be unknown unknowns, as we will doubtless find out.
Adam Smith 300
All year, the Adam Smith 300 essay series from National Review Capital Matters has been celebrating the tercentenary of the birth of the father of modern economics. Each month, a new essay has reflected on Smith’s legacy from a different perspective.
Now, we’d like you to join us in person to hear from some of the leading voices on Smith’s thought. January author Dan Klein of George Mason University and October author Anne Bradley of TFAS will talk with National Review Institute Rhodes fellow and Capital Matters contributor Dominic Pino about Smith’s continued relevance today. May author Samuel Gregg of AIER will give a keynote address, followed by a conversation with NRI trustee David Bahnsen.
Whether you’re already a Smith expert or only loosely acquainted with his works, this event is a unique opportunity to celebrate the life of the author of The Theory of Moral Sentiments and The Wealth of Nations. More than a mere symbol of free markets, Smith possessed deep insight into human interaction, and his analysis of what he called the “system of natural liberty” still holds up today. With free markets under attack, it’s important to return to intellectual foundations, and remember why William F. Buckley Jr. wrote in the mission statement for National Review that “the competitive price system is indispensable to liberty and material progress.”
If you are interested in attending, more details here.
The Forgotten Book
Capital Matters has a fortnightly feature, The Forgotten Book, which is written by our new National Review Institute fellow, the writer and historian, Amity Shlaes. We live in an age of short attention spans, and one of Amity’s objectives is to introduce readers to books or other primary sources that warrant a second look.
With her Capital Matters column, Amity will dedicate herself to sharing with Capital Matters readers older, forgotten books, along with new books that aren’t getting the attention they perhaps warrant.
Her latest column can be found here, and is focused on taxes and presidents.
An extract:
Since, contrary to rumor, 2023 is not a presidential election year, it might be worthwhile to take a step back to analyze how this all came to pass. All the timelier then is a new book that traces both the code history and the manner in which leading political families attempt to navigate the tax thicket: All the Presidents’ Taxes, by Charles Renwick.
Renwick commences his account with the original enforcer, George Washington. Though we associate Washington with the Revolution — a tax revolt, after all — Washington later personally led 13,000 militiamen in suppressing America’s first domestic Tea Party, the Whiskey Rebellion…
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and National Review Institute trustee, David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 132nd episode, David was joined by well-known pundit and conservative thought leader, Stephen Moore. They talk about economic growth, antitrust fallacies, right-sized monetary policy, and the three pieces of advice Steve has for the 2024 presidential candidates.
No Free Lunch
Earlier this year, David Bahnsen launched a new six-part digital video series, No Free Lunch, here online at National Review. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson, and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
Mutual Aid Societies
Iain Murray & Samuel Peterson:
More blue-collar American men aged 25–54 than ever are no longer employed and seeking work. That sad trend started in the late 1960s, coinciding with President Johnson’s “Great Society” welfare policies, and has strengthened ever since. Today, more than half of “Not in Labor Force” prime-age men are on some form of government disability and not working.
Five decades of welfare dependency seems to have led to the demoralization of these men, and that represents a tragic loss to them, to their families, and to the economy. What can we do to help these men succeed again?
Sweden
The myth of Sweden as the country where socialism works is too convenient (for some) to be allowed to drop.
Nevertheless, Johan Norberg has been doing his best for years to refute it whenever the matter has come up…
The Moon
Being a leader in space exploration will mean making the moon into a way station. Its lack of atmosphere and reduced gravity make it an ideal refueling station on the way to other objects in the solar system, but the resources and investments necessary to see that project to completion are the exclusive province of governments. Developing the lunar surface is a force multiplier for commercial enterprises making tentative forays into lower orbit — tourism, yes, but also industrial applications and a platform to explore and extract materials from the resource-rich asteroid belt. But commercial space exploration enterprises such as SpaceX, Blue Origin, and Virgin Galactic won’t be developing lunar infrastructure anytime soon.
Argentina
Last week Javier Milei, an unconventional politician and economist, shocked the world by coming in first place in Argentina’s presidential primary, with 30 percent of the vote. The general election, which will decide who becomes the next president, will take place in October.
Milei holds staunchly libertarian views. He supports privatizing state-owned enterprises and dramatically cutting taxes and government spending. Perhaps Milei’s most controversial economic proposal is to abandon the Argentine peso, close the central bank, and adopt the U.S. dollar as the country’s new currency. While “dollarization” would come with steep costs, Argentine policy-makers should seriously consider the idea.
The Argentinian peso has been on a long, miserable slide over the last five years. The most accurate indicator of what it is worth, the informally traded “blue dollar,” currently trades at around 720:1 with the U.S. dollar compared with 37:1 five years ago.
Argentina is also famously wild about soccer…
Inflation, now running at 116 percent, has driven some 40 percent of Argentines into poverty. That combination is not a recipe for social calm, meaning that this story from the Buenos Aires Times is worth noting…
I wrote the other day about the introduction by the Argentine government of a “price agreement” with supermarkets to limit monthly price increases to a maximum of 5 percent for 90 days. The move, explained the economy minister, Sergio Massa, was designed “to stabilize prices” until the election. By a strange coincidence, Massa, a Peronist, is running for the presidency.
I missed the fact that the government has also put in place similar measures with regard to fuel prices…
Defense Spending
I have written previously about why the $900 number is disingenuous. It takes the total amount of money spent on Ukraine aid over the entire conflict, $113 billion, and divides it by the number of households in the U.S. The $900 is accurate arithmetic, but the conclusion Heritage wants people to draw from it does not follow.
The U.S. spent $39,100 per household on Covid relief, so the government spends far more on domestic emergencies than on foreign ones. National debt per household is $256,000, so $900 is not driving the debt. The total on Ukraine aid, on an annualized basis, comes out to the equivalent of 9.2 percent of our defense budget. That money is being used to effectively fight one of America’s top adversaries and degrade that adversary’s military capabilities, all while putting zero American lives at risk.
Industrial Policy
While China’s economy struggles, one of the bright spots is supposed to be its electric-vehicle industry. China pursued an industrial policy for years to become the world’s top EV manufacturer. It now makes more EVs than any other country by a long shot.
But a recent article in Bloomberg shows that this apparent success isn’t all it’s cracked up to be. China is home to EV graveyards, where unwanted vehicles are rotting amid tangles of weeds. They’re a visual manifestation of the problems with industrial policy.
Limited Liability
Until 2019, members of the Sackler family controlled pharmaceutical company Purdue Pharma. Should they be liable for civil suits following the company’s pending bankruptcy settlement for its deceptive marketing of OxyContin?
Economics
Arguments for supply-side economics (as that term should be understood) are making a comeback, and that’s good news. The conversation on boosting economic growth is redolent of the 1980s, when top-down planning gave way to bottom-up commerce. Unfortunately, high officials in the Biden administration, such as Treasury Secretary Janet Yellen, fundamentally misunderstand the sources of sustainable prosperity. What they too sometimes describe as “supply-side economics” is anything but. Blowout spending on green energy and health care won’t make the economy more productive. We need a return to fundamentals. Thankfully, a coalition of Freedom Conservatives has penned a statement of principles to show us the way…
China
The world’s largest asset class is Chinese residential real estate. The chart below illustrates that the aggregate value of Chinese homes was twice that of the U.S., 50 percent greater than the entire U.S. stock market, double Japan’s total assets, and triple that of China’s entire stock and bond markets. Could it be that the bigger they come, the harder they fall?
Subsidized Job Creation
Some economists (some of them my Mercatus colleagues at the time) wrote a case study about Foxconn’s incentive package. It shows that the only difference between the failure of this particular deal and failures of targeted economic-development-subsidy deals is the size of the subsidies.
It’s one thing to overpromise and underdeliver. But there could be more troubles ahead for the localities involved…
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