Blain’s Morning Porridge 26^th July 2024: Where is China Going?

“War is economic competition by a different name…”

The recent Third Plenum, the economic plan for the Chinese economy, hints China seeks to compete with the West, build its own tech ecosystem, and reform the economy under increased state control. Historically, that didn’t work for the USSR. Could it work for China?

“To discern the future… understand the past, grasshopper.’

There seems to be something inevitable in the tides of human affairs whereby the alphas inevitably square off against each other. The same is equally true of nations. Inevitably strong nations compete and most often squabble. Violently. This years’ Western political cycle means the growing divide between China and the US (representing the West) could further widen – which could be tragic in terms of opportunities foregone. Economic history is all about bad choices and their consequences.

I’ve been watching China in a new light for many months – pondering the risks of the many fantastic investment opportunities I see versus rising pushback from investors. I’ve been reading everything I can – trying to figure out what is likely going on. I try to have an open mind, yet I trust nothing. China is difficult to decipher. It wants its place in the global economy, and that is not sitting at the West’s feet. It should be standing alongside other successful nations – which would ultimately be best for the global economy. Fears that China seeks to dominate others is what drives Western pushback.

China has achieved the fastest and largest transition from poverty to prosperity ever seen. That growth created internal tensions and rising inequality, triggering social concerns – but generally worked. Yet, China now seems driven by the insecurity of the Chinese Communist Party (CCP), ruled by the increasingly Imperial President Xi, successor and living embodiment of Chairman Mao – and is moving back towards greater state control. A key factor that motivates the CCP is the fear of reversion to the Century of Embarrassment, when Western Armies, Warlords, and Civil War successively stalked and pillaged the land.

China has now reached a critical point. It has grown as fast as it could, but now challenges the West and is beset by essentially the same economic problems as the West. What economic path it chooses today – which will be part-determined by Western policy, politics and pushback towards it – will set global growth for the coming decades.

To use a Chinese idiom, there seem to be three “realisations” underway in China:

• There is the economic slowdown of the economy, a deflationary bust brought about by multiple factors including;
  1. China’s spectacular growth and success as the World’s cheapest to export producer have made it expensive and less competitive,
  2. The crackdown on successful entrepreneurs and the dearth of real actionable economic data, plus Western Pushback, has crashed foreign direct investment (and thus a slowdown in new technologies) into China,
  3. Ill-directed infrastructure and housing spend across the economy means China’s debt has risen as fast as in the West,
  4. There is growing under-employment raising social tensions,
  5. The costs that will be incurred by the rapidly aging population are a future obligation the economy may struggle to meet – unless it can maintain high growth.
• The Chinese Communist Party (“CCP”) is acutely aware its attempts to demonstrate its economic and geopolitical heft as the next global hegemon has created massive pushback from the West, the rising threat of tariffs and trade war, the bellicosity towards China’s plans to “recover” Taiwan, and the perception China’s interests lie in dividing the Western Hegemony – which clumsy Chinese geopolitical posturing and its alignment with Russia, Iraq and North Korea have inflamed.
• The choices available to China to address the problem of “protracted competition” with the West, under which growth could be constrained in the face of Western pushback, while also resolving the “old-before it got rich” conundrum of a domestic economy which never quite completed a transition from export led to domestic consumer led, are limited.

Parts 1 and 2 are how China got into this position. Part 3 is the interesting bit. What are the policy choices will pursue to resolve the economic difficulties?

Last week “The Third Plenum of the Central Committee” took place. It involves all the top leadership of the CCP in setting Economic Policy – think of it as something akin to the Five-Year Plans so beloved of other communist states. Previous plenums set China’s path towards market led growth and economic reform. But, you won’t find anything easily described in in the communique of last week’s Third Plenum. It is snappily titled: “The Resolution of the Central Committee of the Communist Party of China (CPC) on Further Deepening Reform Comprehensively to Advance Chinese Modernization”. It is long slogans and CCP political correctness, and clear as mud.

Yet, the deliberately vague comments from the Plenum provide clues on how the Party intends to direct the economy. The fact the plenum was delayed for nearly 9 months (to give them time to consider all the options) demonstrates just how concerned the Party is on the ailing economy and future growth prospects.

The policy decisions are buried among a cornucopia of statements about “national resilience”and “self-reliance” and the 10-year ambition of achieving a “high-level socialist economy” by 2035. They acknowledge the need to reform to galvanise the economy, including the build-up of social security, healthcare and medical services to motivate workers and create a more equal society. It calls for “a new scientific and technological revolution” providing the productivity breakthrough that will enable the nation to keep growing and pay off the costs thus incurred.  Yet, while it intends to attract foreign investment, they also seek to increase Party control of the economy while confirming the pre-eminence of the party’s interests in the economy. These things are mutually exclusive in capitalist societies.

Debt, inequality, reform, productivity, growth, and technology – are pretty much the same things we worry about in the West. China’s problems are the West’s Problems and could probably be solved through trade, co-operation and a stronger, more stable, more certain geopolitical ecosystem. When China opened the doors to the West from 1970 onwards, its rapid growth was largely down to engagement and adoption of open markets, opening up an export led economy and a market for western manufacturing goods.

That isn’t likely to happen today. China is not a medium sized Asian nation on the cusp of becoming a wealthy developed modern society. It sees itself as the Middle Kingdom, the centre of the world. It now defines itself in terms of history and the current threat from the West.

The crisis comes if the relationship between China and the West is now headed towards inevitable showdown – the same historical thread that’s run through economic history since Rome vs Carthage. Every day you read about Western goods finding Chinese markets closed, and the amount of investment into China has fallen off a cliff. In effect, the Chinese and Western economies are already sharply diverged.

The take-away from the Economic Plenum is China will seek to further formalise control of the Chinese economy under the party, and compete directly with the West where it can in exports while seeking to build its own tech ecosystem, and draw other nations into it. In effect, China seeks to win the economic war, and is likely to revert to a non-capitalist system to do so.

While this morning’s Porridge is all about China, there are warnings from history why that doesn’t work.

The One-Minute Economic History of Russia

In the 1920s and 30s many in the West believed the rapid electrification and industrialisation of the Soviet Union presaged its’ future global economic dominance. Each successive 5-year Plan achieved double-digit growth. Stakhanovite Soviet workers produced unprecedented amounts of coal to fire the foundries of communism. Western firms and governments, including Germany, scrambled for partnership and licencing agreements in the USSR. (The best tank of WW2, the Russian T-34, was pretty much filched from an American design.) Even when the weakness of the Red Army was exposed… Economists were shocked by Russia’s ability to put much of its vulnerable industrial capacity on trains and ship it to Siberia just meters ahead of the advancing Wehrmacht.

Following the Hot War, the USSR economy apparently thrived on its oil and gas reserves and challenged the West both in the Cold War and in technology – particularly in weapons as it exported communism around the globe. Khrushchev promised to bury The West as the USSR’s productive might looked set to come online. The workers’ paradise of luxury flats, freckle faced toddlers, Olympic dominance, and equality for all, now look terribly dated in the propaganda of the time.

These aspects of Soviet success papered over the cracks.  Russia won the early laps of the Space Race – but no one really knows at what cost. Reality was swaddled in the perfume of cheap and copious vodka to dull the pain.

The USSR economy proved to be a Potemkin village – fake. While the nation spent its riches on weapons, while the domestic economy was schlorotic – characterised by queues and shortages, poor health and relative poverty. The economic strength was a myth. Ronald Reagan, Star Wars (the defence shield rather than the film), plus deflation in energy prices, exposed Russia’s glaring internal inefficiencies, bureaucracy and corruption. Collectively (a word that cursed the Soviet economy), these brought the USSR to its knees. Walls came tumbling down. (China supposedly learnt these lessons from the Cultural Revolution.. but… Xi now models himself in that era.)

The new Russia became a beggar at the West’s table till it reverted to type – a new capricious Tzar. Putin’s Russia is cosmetically rich on energy, but shallow as a ditch as kleptocracy surpassed corrupt bureaucracy as the surest way to hollow out a nation….. Yet, we are told by Republican Fanboys and Kremlin Shills that Putin is admirable, and Russia is strong.

I suspect the truth is very different. Russia can’t afford to lose further face in Ukraine. One strong push (which could include determined Western rearmament at speed) and Russia will topple.

The country that knows Russia’s weakness best is China.

The CCP are not daft. They don’t want China to mimic Russia. They want success and a strong economy. They want to preserve the Iron-Rice-Bowl compact between the People and Party to maintain social cohesion. As the economy matures, and the population ages, its economic weakness could rise or be addressed through trade and growth within the global economy. Any decision that moves the economy back towards an imperial version of communism is likely to struggle – breaking the Iron Rice bowl.

I therefore suspect the answer is China will avoid conflict and seek a better relationship with the West, but one that is also on their terms. Perhaps, as Churchill famously said, “it is better to Jaw, Jaw, than War, War…”

(Let me clear, I am not a China expert, I have not visited in nearly a decade. I am just an interested observer. A whole shelf of my library is on China, with history books jostling for space with my favourite epic Journey to the West, copies of which sit next to dissident author Ma Jian’s China Dream. Our home has a room of Chinese art. (I have been fascinated by China since my Grandad showed me Chinese “mountains and clouds” paintings.) I am equally attracted yet repelled by what China could be and might be.)

Out of time, and back to the day job. Have a great weekend.

Bill Blain

Author of The Morning Porridge,

Wind Shift Capital

Billblain@morningporridge.com

www.windshift.capital