The New Cold War
America, China, and the Echoes of History
Over the past three months, uncertainty over the course of Chinese development has intensified, with a steady flow of mostly bad economic news: yet another plunge in the stock market, which was already crumbling and kept afloat only by massive state intervention; mounting corporate debt; and a hemorrhaging of foreign exchange reserves, to name a few. The reality is that China is staring economic stagnation in the face, and the ruling Chinese Communist Party (CCP) is panicking. The party appeared to have acknowledged the seriousness of its economic woes, which can only be worsened by a declining and aging labor force, when it announced in late October that it would replace its decades-old one-child policy with a two-child policy in March. China desperately needs more young people not only to fill the factories and staff the offices and schools but also to increase consumption so that the country can shift from an investment- to a domestic consumption–led model of economic development.
But such a strategic shift cannot possibly succeed in time to prevent China’s rise from ending. Not only must there be a period of time after slashing investment (which is only barely beginning now) to allow private consumption to step in to fill the void in demand, but slashing investment itself will also reduce demand for consumption in absolute terms; people will lose their jobs, and the already heavily indebted corporate sector will earn less money to invest in sectors that genuinely need investment. No country in history has relied as heavily on investment to both fuel GDP growth and maintain the existing structure of GDP as China. But as investment increases relative to domestic consumption, a country can either increase its exports to sell off the surplus production or else double down and invest even more, hoping for a miracle down the road. China rapidly increased its exports during the 2000s, but all that had to end when the global financial crisis hit in 2008. After the crisis, the only viable option was to double down on investment by launching the greatest monetary stimulus program the world has ever seen. (Otherwise, the CCP would have to accept a period of long deflation as it abandoned investment-led growth. By 2009, the CCP was far too politically reliant on special interest groups to accept a long deflation, which would also mean the end of its rise.) As a consequence, the CCP avoided a recession and even created a false image of invincibility. But in fact, the stimulus program made the problem of economic imbalance substantially worse.
In 2009, the Chinese central bank presided over a gross expansion to the nation’s money supply, with new money and loans issued that totaled the combined increases from the previous four years. The central bank even briefly lost control over the issuance of credit as local governments and the economic elites to which they are attached devised creative new ways to expand loans and make new investments. The inevitable outcome was countless ill-conceived loans issued to state-linked entities and individual elites, who used the credit to speculate in real estate or increase productive capacity in industries (such as steel) that were already producing far more than China could ever consume. Debt soared. The debt-to-GDP ratio increased from roughly 170 percent in 2007 to 280 percent in mid-2015, and it probably continued to increase after the party launched another stimulus package in May: this one was in anticipation of the stock market plunge over the summer (although small stimulus programs have been initiated almost every spring). Servicing and repaying the debt—most of which is owed by both private and state-owned corporations—will siphon resources away from urgent social needs such as cleaning up the environment and providing social security for the elderly and the sick. That is because the interest and principal payments debtors pay back will go to banks and underground lenders. Unless these institutions radically change their ways, they will then recycle the money back to the same old elites in real estate and infrastructure investment—including state-owned enterprises eager to invest in dubious projects abroad. In China, the market is far too weak relative to the state to shift this national trend. So even if market forces expressed a need for resources to be reallocated to important national projects, such as public health and ecological preservation, the party-state would exercise an effective right of refusal. For example, Chinese President Xi Jinping’s “one belt, one road” policy, among other things, built an enormously costly network of high-speed rail lines throughout central Eurasia.
Meanwhile, whatever genuine benefits there might have been from the domestic stimulus programs are fading fast. Compared with the late 2000s, it now takes several times more money in new loans to increase GDP by a percentage point. That is primarily because many of the new loans are being used to pay back the old loans, which were wastefully invested in profit-losing projects. Eventually, the new loan-to-GDP ratio will reach a point at which the cost of more stimulus exceeds any imaginable gains. At this stage, the CCP must logically stop injecting money into the economy and accept a long period of deflation. From an economic perspective, this historic transition should be imminent. But politically, it will be brutally difficult for the CCP to face the music.
No country in history has relied as heavily on investment to both fuel GDP growth and maintain the existing structure of GDP as China. But as investment increases relative to domestic consumption, a country can either increase its exports to sell off the surplus production or else double down and invest even more, hoping for a miracle down the road.
Even though China’s rise seems to be on the verge of setting, outsiders should exercise caution in how they interpret this dramatic shift. It need not, for example, lead to China’s “collapse.” Some who predict a Chinese collapse point to the dissolution of the Soviet Union: another half-reformed communist superpower. A more appropriate comparison would be to Japan and its “lost decade” from approximately 1990 until, well, today. Following an “endless” (or so it seemed at the time) period of rapid growth that was linked to inflated real estate and stock market prices, Japan’s asset price bubble burst and the country tumbled into a long deflationary spiral out of which it has still not emerged. Japan’s phenomenal rise thus ended, but far from collapsing, it has remained one of the world’s top economies. China, of course, differs radically from Japan, not only in that it is far poorer today than Japan was in 1990, but also because its authoritarian political system seems inherently ready to inflict harm on its own people and cause perpetually mounting frictions with foreign countries. The end of China’s rise will most likely hurt the CCP far more than Japan’s did its elites.
Even so, saying that China’s rise is ending is not the same as saying the country will collapse. Poor, authoritarian countries can stagnate for decades and yet never face political collapse. Moreover, China today is not a poor country. The value of Chinese assets has surely been exaggerated by excessive monetary growth, but China is still the second wealthiest country in the world in aggregate terms and is a formidable military power. China will retain that status and continue to abrade the United States and other countries, especially throughout Asia, over territorial disputes in the South China Sea, the hacking and theft of intellectual property, and climate change, among other issues.
What will be most interesting to watch for is how the end of China’s rise will affect the CCP itself. China’s gifted economists clearly recognize the country’s bleak economic prospects—as does, almost certainly, Premier Li Keqiang. The economists in particular have been harshly, and compellingly, criticizing the country’s economic arrangements for years—and Li, at least, seems to share the economists’ views.
It is far from clear, however, that other members of the elite coalition—including Xi—realize how serious and urgent the problems have become. Nationalistic military officers and ambitious foreign policy grand strategists (including well-known blowhards as well as the quietly influential security policy elites) are so clearly interested in pursuing an assertive and abrasive foreign policy that it is questionable whether they have any idea how untenable China’s situation has become. Of course, sooner or later, these head-in-the-sand elites must face the reality that China’s rise is ending, especially as the post-investment-binge deflationary spiral begins to play out. At that time, the urgent foreign policy challenge for both China and the rest of the world will become how to conceptualize and address the complex ramifications of a world in which China is no longer rising: how will the world deal with a blow to the confidence of the world’s economic elites or the more concrete challenges posed by a Chinese state that may lose some of its rigid societal control? The Uighur bombing at a Bangkok shrine in August—evidently to kill Chinese tourists (and succeeding)—could become more frequent as China both fails to reform politically and ceases to rise.
Probably sooner rather than later, the party will face challenges to its political legitimacy, which will be hammered by the end of the economic rise. This is serious. The CCP no longer publishes the data consistently, but so-called mass incidents (protests, strikes, riots) already tripled during the 2000s and probably have continued to increase in the years since. Some 650 million Chinese people now regularly access the Internet. If worsening economic conditions and the realization that the national rise is ending intensify political dissatisfaction, the regime will probably find it far more difficult than in the past to use coercion or violence to maintain power. Today, society is far stronger relative to the state than it was during previous periods of economic underperformance, including 1989–91 and 1997–98. The economic difficulties China now faces are also far more serious: it is not simply experiencing cyclical slowdowns as it was in the past.
There is, however, some hope for an ultimately positive outcome. Those same 650 million Chinese people who regularly access the Internet are linked—in spite of the Great Firewall—not only to one another but also to friends and associates in myriad other countries. Worldwide, Internet users are more likely to be young, prosperous, well informed, and global in their thinking than other groups still outside the network. Because of China’s aging population and declining work force, Internet users are precisely the people China will need to rely upon more heavily in the future to address the complex economic, environmental, and demographic problems the country now faces. Logically, younger people should become more “valuable” to Chinese society as they come to constitute a shrinking but critical minority. There is some evidence to suggest that younger Chinese are, like their counterparts in other societies, becoming increasingly “postmodern” in their political and cultural outlooks: more tolerant of diversity, exploratory in their studies and careers, and spiritually rather than materially focused. In particular, they have become strongly conscious of an imperative need to preserve and nurture the environment. As the CCP increasingly finds itself beholden to this segment of society, it may be compelled to accept a gradual transformation in the party itself, one that results in a more open and enlightened institution. This is a long-term vision. It may not even be realized in the next ten to 20 years, but it is an outcome for which everyone with an interest in the situation should, at the very least, hope.