Update on China

 

Ghost cities, fleeing millionaires: China’s rudderless economy

President Xi’s obsession with security and party control is hobbling tech companies and scaring off the foreign investment the country so badly needs

Ian Williams

Sunday July 21 2024, 12.01am, The Sunday Times

Asia

China

Economics

Technology

Xi Jinping

If economic growth was measured by the output of empty slogans, then China would surely be booming again. There will be “high-quality development” and “innovation vitality” to “comprehensibly deepen reform” and achieve “national rejuvenation on all fronts”, the Chinese Communist Party (CCP) declared at the end of a key meeting last week aimed at rebooting the country’s ailing economy.

All this under the leadership of “supreme reformer” Xi Jinping, who was hailed as the heir to a modernising predecessor, Deng Xiaoping — even though his principal achievement since coming to power in 2013, 16 years after Deng’s death, has been to put “reform and opening” sharply into reverse.

That era of change is over and the economy is rudderless and beyond reform — and Xi is the biggest obstacle to change.

President Xi has been in power since 2013

WU HAO/EPA

As the grey men (and they are overwhelmingly men) of the CCP’s central committee gathered, economic sentiment was dismal. The five-yearly meeting — the “third plenum”, in party speak — was delayed from last year, amid rumoured wrangling over how to tackle mounting economic problems. It coincided with figures showing a sharp slowdown in growth and continued falls in property sales and prices. Soaring youth unemployment, plunging levels of inward investment and widespread signs of social stress, including a spike in protests, all added to the gloom.

China’s National Bureau of Statistics cancelled a news conference that usually accompanies new data — perhaps wary of warnings from the Ministry of State Security, the country’s main spy agency, that gloom about the economy is a foreign smear and that “false theories about “China’s deterioration” are being circulated to attack its “unique socialist system”.

It is not as though Chinese officials do not see the problems with the country’s economic model — “unco-ordinated and unsustainable”, in the words of China’s last premier, Li Keqiang. This model, and the heady rates of growth that used to accompany it, was heavily reliant on cheap exports and on massive and wasteful state-led investment in property and infrastructure, which sent debt soaring amid diminishing returns.

A building frenzy has left China littered with ghost cities containing 60 million to 100 million empty or incomplete homes. Property accounts for up to a third of the economy, and CCP efforts to reinflate the bubble have fallen flat. A recently announced $42 billion (£32 billion) fund to buy up empty apartments is a fraction of the $533 billion that developers estimate is needed to finish housing they have sold to buyers and then failed to complete. Companies accounting for 40 per cent of China’s home sales have defaulted — an army of zombified firms that will not be put out of their misery for fear of social unrest.

Local governments, which depended on land sales to developers for a substantial share of their income, have run up debts of more than 66 trillion yuan (£7 trillion), equivalent to half of China’s GDP. They have resorted to desperate measures to boost their coffers: almost all traffic fines issued in Hebei province in northern China in 2023 were exposed as bogus, while a local government in the southwestern province of Guizhou had a local contractor arrested after she demanded the full payment of an invoice for building schools.

It’s widely agreed that Chinese consumers need to spend more, since private consumption accounts for just 39 per cent of the economy — extremely low by world standards (the figure in the US is 68 per cent). But with 80 per cent of family wealth tied up in property and no meaningful social safety net, they are reluctant to splash out.

Officials also talk of creating a self-sustaining innovation economy to turn China into the world leader in cutting-edge technologies. They want to move from an economy based on copying and applying western technology — re-innovation, as it has been dubbed — to one driven by home-grown tech. Ever since Deng launched China’s reforms in the late 1970s, obtaining foreign know-how by all available means has been central to modernising the economy and military, spawning industrial-scale cyber-espionage and the forced transfer of technology as a routine price for doing business in China.

This strategy is no longer so easy, amid growing western restrictions on technology transfers and heightened wariness over Beijing’s espionage and high-tech tie-ups in business and academia.

Yet the most effective way of encouraging domestic innovation — giving more sway to the market and to private companies — has been thwarted by Xi’s obsession with security and party control. He has hobbled China’s most innovative technology companies, which have faced tightening restrictions. Leading entrepreneurs have been forced out of the companies they founded; many, including Bao Fan, one of China’s most famous and respected financiers of tech deals, have simply disappeared amid vague accusations of corruption.

Last year, China led the world in the number of millionaires leaving the country, according to the Henley Private Wealth Migration Report. The party’s tightening grip, increasingly in every boardroom, lab and classroom, hardly seems conducive to innovation or reliable science.

BYD cars are readied for export. China spends billions subsidising its electric vehicle industry

GETTY

In the medium term, Xi hopes that renewable-energy tech can replace property as a new motor of growth, and mouthwatering subsidies have been thrown at industries ranging from solar panels to electric vehicles (EVs) and batteries, leading to massive overcapacity and vicious price wars. Between 2009 and 2023, China spent $230.8 billion supporting its EV industry alone, according to estimates from America’s Center for Strategic and International Studies.

Yet the benign international environment that accompanied China’s earlier export splurges has gone; both the US and EU have imposed hefty tariffs on Chinese EVs that, they allege, are being dumped at below cost.

Meanwhile, China has become a hostile place for overseas businesses. Last year, direct foreign investment into the country fell to a 23-year low. Even China’s most enthusiastic corporate cheerleaders in the West appear to be having doubts; Apple, for instance, is quietly diversifying its supply chains away from China. “Resilience” has become the watchword in western boardrooms, with the Ukraine war exposing the danger of over-dependence on autocrats with hostile ambitions. Foreign companies have never enjoyed a level playing field, and the days when they would put up with almost any indignity for a share of the mythical China market are fast disappearing.

A building frenzy has left China littered with ghost cities stuffed with empty or incomplete homes like these in Huai’an, Jiangsu Province

GETTY

Top western business leaders are due in Beijing this week to meet officials in an effort to understand what the latest pronouncements mean. Good luck with that. The loosening of political control necessary for real economic reform to take root is contrary to everything Xi stands for. Under his leadership, the use of trade, investment and market access as weapons of coercion has become routine, belying the platitudes of reassurance from the third plenum — a meeting that can best be seen as a requiem for the era of reform and opening.

Ian Williams’s new book, Vampire State: The Rise and Fall of the Chinese Economy, is to be published by Birlinn on September 5

Article on Belt & Road - failings of:

 

Kenyan train to nowhere reveals China’s debt trap diplomacy

Work has long since stopped on a Belt and Road project to connect Kenya and Uganda Jane Flanagan

,

Great Rift Valley

Goats are free to graze at the end of the unfinished railway line in Suswa

NATALIA JIDOVANU FOR THE TIMES

Since Chinese engineers routed a $4.7 billion railway through the Kenyan village of Emurutoto, residents no longer worry about being cut off by flooding. Or being hit by a train.

After soaring over their valley on vast concrete pillars, the tracks stop dead in a maize field. Goats graze on weeds between the concrete sleepers, and the railway bridge has become a multimillion-dollar walkway.

Emurutoto has done well out of China’s African investment project, which promised to connect the Kenyan port in Mombasa to neighbouring Uganda, and far beyond.

Local incomes had relied on small-scale farming or the nearby town of Duka Moja (which means “one shop” in Swahili) before the Chinese arrived in 2016, and set up camp.

Samuel Kiseentu, who at the time was a goatherd, was taken on as a labourer. “After some months I had savings for this,” he said, patting the motorbike beneath him.

There were hundreds of jobs for locals who benefited from a new dirt road and extended water pipes. Farmers with land along the route were given three million Kenyan shillings ($18,114) per acre in compulsory purchase agreements.

“Life became better here,” said Isaac Shonke, 30, who was trained as a steel fixer and made enough money to have his children to schooled privately.

Isaac Shonke did well — for a time — from the construction project

NATALIA JIDOVANU FOR THE TIMES

By 2017, the first half of the Kenya-Uganda line was operational, though losing money. In April 2019, work in the Great Rift Valley stopped. As alarms were raised about the mounting costs of the line, and secrecy around borrowing terms between Beijing’s banks and other African countries struggling to repay debts, China balked at financing the final 200-mile stretch linking Nairobi to the border with Uganda.

The single most expensive infrastructure project in Africa had become a case study in China swamping poorer nations with colossal debt. “The managers told us there was no more money to finish, and they went,” Shonke said.

The Times’s arrival in the village drew a small crowd asking for news that work would start again. A watchman living in rusting tin huts with his family had stuck around since the Chinese departed. The spoils of a three-year building flurry that had sucked investment away from basic services were dwindling.

Most of those gathered said they had never seen a train, let alone the huge, pristine station 15 miles up the tracks at Suswa, where rolling stock is plastered with slogans boasting prematurely: “Connecting Nations. Prospering People.”

Passengers on the 55-mile journey back to Nairobi were in festive mood. It was the last day of term and children on primary school outings were crammed into seats that cost 150 Kenyan shillings (91p) for a child’s day return.

The Nairobi to Suswa train was intended to continue on to Uganda but work has stopped

NATALIA JIDOVANU FOR THE TIMES

For a few miles near Mai Mahiu station, the train runs parallel to the century-old line built by the British, which was known as the Lunatic Express for its huge cost to both the Westminster government and a workforce preyed upon by disease and lions.

Kenya had deliberated for years on whether to renovate the old railway or invest in a new one. A report by the World Bank was among many that said the route chosen in the 1890s was still the best and recommended upgrading the existing network. But a new one with a wider gauge was settled on, designed, funded and built by China with no competitive tendering. A stretch of the old line is now being untangled from the bush to get cargo, offloaded on to older rolling stock, to the Ugandan border.

Children on a train from Nairobi to Suswa

NATALIA JIDOVANU FOR THE TIMES

The Chinese train leaves the Great Rift Valley through the Ngong Hills. East Africa’s newest and longest tunnel helps to explain why the line runs at such a great loss. The darkened windows draw alarmed wailing and prayers before the carriage emerges, its inhabitants cheering and blinking, on the other side. In another engineering phenomenon, the train is soon soaring over Nairobi National Park along a four-mile bridge high enough for a giraffe to comfortably pass underneath.

As the sun lowers on the capital’s skyline, someone shouts: “Elephant!” It is not clear whether they mean a white one.

Win-win? Xi’s project has had mixed results

If one policy is synonymous with President Xi’s China, it is the Belt and Road Initiative (Richard Spencer writes). Descriptions are awash with the Chinese Communist Party’s favourite slogans — “win-win co-operation” and “China meets the world” — but its underlying ideology is Xi’s.

The initiative poured huge sums of China’s surplus foreign exchange holdings into potential trade partners, particularly those in the global south. State-led by both Chinese and partner governments, it would also involve private enterprise and the market economy.

The “win-win” was obvious. Countries short of cash would receive an infusion of investment, while China would have faster access to natural resources and bigger potential markets for its manufacturing industries.

The side-effects would also, Xi hoped, be useful for China. It would show off Beijing as an alternative “hegemon” to the United States and its western allies — and one that did not ask questions about human rights. It would also confirm the potential of China’s state-led economic model, a more attractive proposition to many governments than the West’s present insistence on privatisation.

Belt and Road has undoubtedly had some successes. Chinese companies have built ports in Latin America and railways in Indonesia. Trade has flourished. Three quarters of Brazil’s soybeans, for example, are now exported to China, the quantity more than doubling in eight years.

However, just as the Chinese economy has had a poor few years — particularly since Covid-19 exposed flaws in Beijing’s “command, control and no questions asked” system of government — so Belt and Road has also had problems. Kenya’s financial crisis, in part owing to debts incurred on Belt and Road projects, is one example.

Other countries were also taken aback by the unsentimental approach of their Chinese partners. Loans were handed down with tough terms, often disguised from voters by secretive contracts.

In Sri Lanka, a port built with Chinese money could not repay the debt and was eventually leased to a Chinese company instead. As Sri Lanka fell into a broader debt crisis, China was blamed, though its loans were only a tiny fraction of the total.

With Chinese banks wondering how many projects would offer a return on their money, and governments growing wary of the leverage China now had over them, the scheme began to wind down, or at least focus on smaller projects.

As with much of Xi’s legacy, many Chinese people are proud of Belt and Road’s results, but it is not only the Chinese Communist Party’s western critics who have noticed cracks starting to appear.

Now here's a thought - have central banks got it wrong (again)?

 

Central banks will have to slash rates as the world’s fiscal bubble bursts

The main prop of global economic recovery is wobbling

AMBROSE EVANS-PRITCHARD15 November 2023 • 9:00am

The consensus at the Fed, Bank of England and ECB is that the ‘natural’ rate of interest has jumped to a permanently higher level CREDIT: JIM WATSON/AFP

The world economy has been kept afloat for a quarter century by serial bubbles. Each has masked the weakness of underlying growth.

As successive bubbles pop, the economy fails to self-correct by the normal process of the business cycle. It takes ever more monetary stimulus to right the ship.

It was the dotcom equity boom in the late 1990s, the US and Club Med property booms in the 2000s, the QE asset boom and China’s credit spree in the post-Lehman 2010s.

Today we are in the final phase of the great fiscal boom. Budget deficits ballooned to wartime levels on both sides of the Atlantic during Covid. These have yet to come down to tenable levels.

“Politicians have got into the habit of spending money like there is no tomorrow, and the population likes it. Sooner or later the bond market is going to throw another tantrum,” said Mark Dowding from BlueBay Asset Management.

Once this fiscal bubble bursts, or simply sputters out, the contractionary effect will in my (unfashionable) view knock away the central prop of the global economic recovery. It may already have begun.

Central banks will then have to slash interest rates much faster than their “higher for longer” protestations would suggest, and perhaps revert to emergency QE to head off a deflationary bust.

The consensus view at the US Federal Reserve, the European Central Bank and the Bank of England is that the Wicksellian “natural” rate of interest – known as R* – has jumped to a permanently higher level.

Henceforth the economy can cope with sharply higher borrowing costs. We are never going back to zero rates and negative bond yields, or so goes the thinking.

If so, this has vast implications for global borrowing costs and the market value of $140 trillion of outstanding bonds. It is the burning question in world finance today.

But not everybody thinks they are right, least of all Wicksellians. A recent article in the journal Central Banking argues that this flies in the face of both orthodox monetary theory and what is actually happening to global credit.

Philip Turner, a former top official at the Bank for International Settlements, and Marina Misev from the University of Basel, warn that central banks are being misled by false assumptions about R* into dangerous overtightening, risking a global credit crunch and an asset crash.

They argue that the natural rate is determined by whether private credit aggregates – bank loans and debt securities – are rising or falling. They have been falling at alarming rates across the West.

Bernard Connolly, author of You Always Hurt the One You Love: Central Banks and the Murder of Capitalism, predicts that the neutral rate will plummet as soon as fiscal worries force countries to tackle their budget deficits, a process already underway in Europe.

“I do not think that real long rates at their present levels are sustainable,” he said.

The average deficit was stable near 2.4pc of GDP in the advanced economies before Covid. It is 5.2pc this year, according to IMF data, but is starting to fall rapidly.

The US is an egregious exception with a deficit near 8pc on a quarterly basis. “It should be in balance at this stage of the cycle. It doesn’t get better than this,” said Moritz Kraemer, former head of sovereign ratings at Standard & Poor’s.

The IMF predicts US deficits of 7pc as far as the eye can see, pushing public debt to 137pc of GDP by 2028 if nothing is done. Nothing is being done.

S&P and Fitch have already stripped the US of its AAA rating. Moody’s put the US on negative watch last Friday, citing the perennial soap opera over the debt ceiling. Needless to say, such downgrades change nothing. America issues the paramount reserve currency and is still the world’s military colossus. It can get away with fiscal murder.

Others are not so lucky. America is lifting borrowing costs across the world by crowding out the bond markets with debt issuance and roll-overs running at an $8 trillion annual pace. Spillovers have pushed a clutch of countries into the crosshairs of the bond vigilantes.

“I think the UK could be vulnerable again if the Tories cut taxes too much or if they do it in a fashion that doesn’t raise economic productivity. The bond markets can turn on you very fast if they don’t believe what you are doing,” said Mr Dowding.

It is hard to see how putative cuts in stamp duty and inheritance tax, being floated as a pre-Christmas bonus, can help to lift the British economic speed limit. What the UK needs is lower business tax and infrastructure projects with a multiplier above 1.0 that pay for themselves via higher growth.

The iron law of sovereign debt management is that you don’t have to outrun the cheetah, you have to outrun the weakest herbivores of the herd. Fortunately, the UK is no longer the first target.

The UK is still on probation after the Truss episode but Rishi Sunak’s technocrat government has won a degree of Davosian respectability, no doubt enhanced further by the defenestration of Suella Braverman and the return of David Cameron as the face of British diplomacy. Davos hates the culture war.

Revised data shows that the UK economy has performed no worse than the eurozone over recent years. What I notice in global economic commentary is less and less talk of Britain as a Gothic horror story.

The vigilantes are instead eyeing Italy, where Giorgia Meloni’s honeymoon is over and what remains is the same old story: a half-reformed economy with a poisonous mix of near-zero growth, bad demographics and a debt ratio of 140pc of GDP.

“The really ugly mix will come in countries where interest rates are pulled up by global or regional factors without a corresponding increase in growth,” said Neil Shearing, chief economist at Capital Economics.

“Italy’s long-term debt dynamics are grim and the country operates within the straitjacket of monetary union. We doubt it will stay out of the firing line forever,” he said.

Euro membership twists the knife for the eurozone periphery. These countries no longer have a sovereign central bank and cannot print their way out of trouble. They are like a company and can go bankrupt, à la grecque, unless and until Germany agrees to rescue them.

You could argue that debt markets have already pricked the global fiscal bubble, setting in motion slow debt deflation. The eurozone has one foot in recession and the collapse in credit points to a protracted slump.

The jump in 10-year US Treasury yields to 4.5-5pc is percolating through the financial system and commercial real estate markets. The damage accumulates month after month as borrowers must refinance on hostile terms.

In a sense, the bond vigilantes have shown by their actions that they will not fund America’s fiscal degradation at tolerable cost. They will not cover the hole left by two sets of major tax cuts. They are demanding a premium to pay for a welfare state (entitlements) that has risen to 75pc of all US federal spending and is patently out of control.

The consensus New Keynesian view is that the world has jumped to a new regime of much higher interest rates and governments must cut their fiscal cloth accordingly.

The rival Wicksellian view is that the world economy cannot endure such high rates for long. If the Wicksellians are right, central banks will discover that R* has crumbled beneath their feet.

The ECB and then the Fed will have to carry out a violent policy pivot, slash rates, and ultimately mop up debt with fresh QE.

Almost nobody in the markets is prepared for that surprise.