by Cameron B. Mill – November 12, 2022

Although I am used to using data and charts to confirm my views, occasionally we need to examine the present from a historical perspective and make some subjective long-term judgments. This kind of judgment sounds more like an insight, and more commonly it is a hypothesis. Of course, these assumptions are based on our daily observations and feelings about China’s economic data, news, and financial markets. Due to space limitations, I can only briefly explain my views and more detailed views. I hope that there will be time in the future to form a special discussion.

1. The basic paradigm of China’s economic success in history

Historians who pay attention to China increasingly recognize that China has been a unified country since the Qin Dynasty, which we call the Confucian-Legal system. The economic characteristics of this system are: the government controls the most critical resources in the economy, such as land, salt, iron and other bulk commodities and basic living materials. Many so-called big businessmen rely on the government to obtain monopoly resources to get rich. At the same time, traditional China lacks the rule of law, and in conflicts between the government and the people, private capital is easily confiscated by the government. Therefore, the private wealth accumulated during the economic prosperity was easily plundered or destroyed, and the Chinese merchant class has never been able to become an independent social force. Some scholars have found that the so-called middle class in modern China is still largely attached to the government and the state-owned economic system. Although they have obtained relatively high income, they cannot form a church similar to that gradually formed in Europe after the 11th century. Small communities such as trade unions, trade unions, and commercial circulation centers have independent interests and the ability to resist the king. Therefore, the merchant groups in ancient China and the entrepreneurs and middle class in modern times did not have independent interests and political opinions.

But the strength of the government’s economic control and absorption is different. We often see periods of economic prosperity in Chinese history. The root of economic prosperity is that the government passively gave the private economy freedom to a certain extent, and China’s huge population size and unified market, under the premise of stability, are often prone to economic prosperity. The early Han Dynasty, the early and middle Tang Dynasty, the Song Dynasty, the middle and late Ming Dynasty, the early and middle Qing Dynasty, and the Republic of China before 1937 all had so-called prosperous times in Chinese history, that is, periods of rapid growth in per capita GDP and population. However, historical research has found that the so-called prosperous times in China are often very short-lived. For example, the Kaiyuan prosperity that the Chinese like to talk about lasted only 30 years in total, and one of the prerequisites for the formation of the Kaiyuan prosperity was precisely that a coup had just happened at that time. draw. This is the basic pattern of China’s high-speed economic growth period in history.

Therefore, if we look at it from a historical perspective, there is nothing special about China’s economic success in the past 40 years. The so-called reform and opening up refers to the liberalization of more economic controls, so that more entrepreneurs have the opportunity to display their talents, instead of spending time on getting fame and becoming an official; the so-called opening up means integrating into the global economic system , especially the global industrial division chain, taking advantage of China’s huge population base, easily trained workers, and most importantly, the land that the government can control almost at will, has formed a world manufacturing center. 

This is relatively the most salient point in China’s economic success over the past 40 years. Of course, current historical research has also found that China has been the center of global manufacturing and commodity exports since ancient times. During the economic prosperity of the Tang and Song Dynasties, we can also see China’s integration into the global economic system. The current research on the history of Chinese in Southeast Asia shows that southeastern China has always maintained close ties with the outside world. In 1949, a large number of Shanghai businessmen arrived in Hong Kong, started businesses and accumulated wealth, and several large-scale escapes from Hong Kong in the 1960s and 1970s. The businessmen later became the first batch of investors in China’s opening up. This was the basis for Guangdong and Fujian taking the lead in economic take-off after China’s reintegration into the world in 1979. However, the integration in the past 40 years has been based on new technological and financial conditions, and its depth and breadth cannot be compared in the same breath. At the same time, the global discourse system on justice and value has undergone earth-shaking changes after 1945, but China has not kept up with the pace of global changes in ideology. 

In short, the nature of China’s prosperity in the past 40 years is still the same as that of traditional China. It is still an opportunity for economic development formed during the process of government delegating power to the market intentionally or unintentionally, but this time it coincides with the climax of globalization after the end of the Cold War.

2. Characteristics of China’s economy in the era of reform and opening up

From China’s accession to the WTO in 2001, to China’s stock market crash and 812 exchange rate reform in 2015, it can be considered as the golden 15 years of China’s economy. Observers in China and abroad began to analyze the Chinese economy in a similar way to a mature market economy. Institutions such as the National Bureau of Statistics of China and the People’s Bank of China have begun to adopt globally accepted economic data statistics and release rules, and some independent economic analysis institutions have also begun to emerge, which allows foreign observers to better observe and understand China’s economic phenomena. Of course, this process has always been accompanied by huge disputes. For example, in 1998, there was an international debate on the authenticity of China’s GDP data. But in general, with the increasingly detailed division of labor, specialized economic information and analysis institutions have provided enough analysis on China’s economic status and prospects. The National Bureau of Statistics of China has also cooperated with foreign countries for a time, including cooperating with Goldman Sachs to develop the China Business Cycle Prosperity Index. All these have improved the transparency of China’s economy and facilitated international investors’ understanding of China’s economy.

This era developed some basic economic features. China is a mixed economy, that is, the government is highly involved in the economic process, creating new wealth together with private economic forces. China’s economy has always been a semi-market economy, that is, final consumption and services have achieved complete market competition and pricing, but the supply and pricing of assets such as land, capital, and infrastructure among factors of production are often in the hands of the government . As a subordinate department of the government, the People’s Bank of China is not legally independent. Together with the Ministry of Finance, the People’s Bank of China has become the main tool for the government to control the economy. On the other hand, China’s unique Development and Reform Commission has become the chief architect of economic structural policies. They formulate various market access rules, investment norms and approvals, etc., which are unimaginable and understandable in a complete market economy system. After World War II, the Ministry of Finance and the Ministry of International Trade and Industry have fundamentally different influences on Japanese companies.

This kind of mixture is highly confusing, because even highly monopolized central enterprises still appear in the market as independent identities and engage in economic activities seemingly identical to private enterprises. Many analysts automatically compare their behavior with Analyze the behavior of private enterprises together.

These state-owned enterprises not only enjoy unique advantages in market access, subsidies, financing, judiciary, land acquisition, etc., but they are also a mixture of contradictions. On the one hand, they need to emphasize profits and shareholder returns in accordance with market rules; on the other hand , They have to fulfill the government’s instructions, and the leaders of many large state-owned enterprises are themselves members of the Central Committee. For them, climbing the bureaucracy is more important than running a business, and the Organization Department is far more important than shareholders and creditors.

However, in the past 15 years, the framework of a market economy has been maintained on the whole, because the power of the government is relatively restrained, and the power of the private sector and multinational companies dominates the economic process, especially in the early days. In this era, China’s macroeconomic policies are also developing towards transparency and regularization as much as possible. For example, the People’s Bank of China and the Bureau of Statistics will announce the release time of economic data in advance, and they have also begun to learn to communicate with the market. In this era, global analysts have formed some inherent views on the Chinese economy, mainly including:

• 1. The government has always prioritized economic growth. The government comprehensively uses structural policies, fiscal and monetary policies to maintain macroeconomic stability; ideology is actually not important in economic decision-making, and China’s economic policies are quite flexible;
• 2. The actual goal of the government’s decision-making is to focus on the economy Growth rate, new jobs and inflation; the Chinese government can well grasp the Chinese-style Phillips curve, that is, maintain a dynamic balance between economic growth rate and inflation;
• 3. China’s economic management department is an efficient professional bureaucrat Many people have received modern economics education in the West;
• 4. In the economic system, market-oriented forces are still dominant, and industries such as natural monopolies controlled by state-owned enterprises will not have an impact on the economic cycle itself; the government plays an important role in the real estate industry.
• 5. China will not give up its status as a global manufacturing center, and will try its best to develop upward in the industrial chain. Many people think that the division of labor in the global industrial chain cannot exist without China ;
• 6. China’s political cycle will affect the economic cycle, but the economy will return to normal after major political meetings.

These are some default assumptions in China’s economic analysis in the past. It should be said that before 2016, these assumptions were generally valid. However, it would be naive to think that the Chinese economy is really an economic system comparable to that of the United States. At the same time, few observers realize that China’s economic policy, like its political system, is fragile.

3. The New Normal of the Chinese Economy

Mr. Soros mentioned that an important change in China is the loss of flexibility. I agree with this conclusion very much. Here I expand a little bit to summarize how the six aspects mentioned earlier have become rigid. According to my observation of China’s economy and experience in market transactions, I believe that China currently has six economic policy goals. It is this conflicting multi-policy goal that is causing the Chinese economy to lose its original flexibility and ability to respond to changes. ability.

First and foremost, the command economy is replacing the market economy as the mode of driving economic behaviour. The so-called command economy means that political leaders start from their own preferences, perhaps to realize some kind of dream, or to carry out some kind of preparation, such as war, and use coercion and inducement to influence the economic process. In order to make the order more smooth, political leaders often tend to build their own economic power, and state-owned enterprises have become the tools of this political power. The difference between a command economy and a planned economy is that a command economy relies more on the arbitrariness of leaders. Under the command economy, the most important thing is the economic goal of the management, rather than the behavior of economic entities pursuing profit maximization under the market economy. The following are the six most important directive directions for the Chinese economy.

First, supply-side reform. The original idea was to improve China’s production efficiency and transfer to the upstream of the industrial chain, but in the implementation process, it became a suppression of private enterprises, output compression and market share transfer, allowing state-owned enterprises to obtain excess profits;

Second, financial de-leveraging and housing and housing do not speculate. Mr. Liu He’s reflections on the two financial crises in the United States concluded that real estate is a potential black swan for the Chinese economy. Controlling real estate prices and leverage levels is one of the core financial policies, but it has become a continuous suppression of the private real estate industry during implementation. ;

Third, common prosperity. The original intention is to reduce social injustice, but in the implementation, it has become a regulatory policy that suppresses capital and various industries, especially the arbitrary regulation of Internet platform companies and the education and training industry. This kind of regulation is essentially the government’s control of large Internet companies. and the banning of the unofficial teaching aid industry;

Fourth, dual carbon emission reduction goals. The idea is to improve China’s ecological environment and sustainable development, but the implementation has turned into a reduction in output, which covers a wider range than the supply side; at the same time, the impact on the energy structure is comprehensive;

Fifth, hard technology. Heavy reliance on hard technologies with military prospects. The idea is to comprehensively enhance China’s military manufacturing capabilities, but in the process of implementation, it has turned into supporting enterprises guided by the government. However, the executors responsible for this support policy are government-led funds. This kind of guidance fund has exposed huge corruption. Corruption, such as China’s ongoing investigation into the National Chip Fund;

Sixth, national security. The idea is to ensure China’s self-sufficiency in extreme situations, including food, energy, data, etc., but these parts are very different in implementation. Data security is the first to break the situation. Food and energy have been raised for many years, but little progress has been made, because Too difficult to implement.

This is the multiple goals of China’s economy now. The economic growth rate is no longer the only goal, and these economic policy goals have destroyed the original Chinese economic process, especially the proportion of non-market factors is getting higher and higher. These conflicting factors Because the goal was proposed by the top leader, in the era of political correctness, it has become an untouchable forbidden zone, which violates the reality of China’s economy. As a result, the economic flexibility created by the market system before 2015 is being completely lost.

4. Will China’s economy repeat Japan’s in the 1990s?

Here we make a brief outlook on the future of the Chinese economy. In China, many people like to discuss Japan’s experience in the 1990s. But in fact, there are very few comparable parts between China and Japan. For example, China’s per capita GDP in 2021 is US$12,000 (ranking 58th in the world), which is far lower than Japan’s US$29,000 in 1991. Japan was the sixth country in the world with per capita GDP at that time. The United States was 13th that year. GDP per capita means opportunities for economic growth. Therefore, theoretically, China cannot be compared with Japan in 1991.

Therefore, we need to understand the prospects of China’s economy from a deeper level. We believe that the current multiple economic goals pursued by the Chinese government and the anti-epidemic zero policy have a huge impact on the prospects of the Chinese economy, and China may experience a long-term and sustained economic downturn.

First, the real risk of China’s economy lies in the fact that the rigid multiple goals seriously dampen the entrepreneurial spirit and business environment, leading to a rapid decline in the potential economic growth rate;

Second, the anti-epidemic zero policy has historically run counter to the epidemic prevention and control measures of countries around the world. It has brought great harm to the Chinese economy. The current decline in China’s economic cycle is faster than that in March 2020. This is the world’s largest economy. is unique in the body. At the same time, China is the economy with the least subsidies for damaged consumers and SME owners among the major economies in the world, resulting in a large number of business closures and worker unemployment;

Third, risks in the real estate and financial industries are spreading, and the probability of a financial crisis is increasing. The credit policy for real estate and the anti-epidemic policy are the real driving forces behind China’s real estate crisis. The epidemic has accelerated the outbreak of the real estate crisis from two aspects. During the epidemic, the income of residents fell, resulting in a decline in the ability to buy houses; at the same time, the deterioration of income expectations led to lower residents’ willingness to buy houses. More importantly, the Chinese government has forcibly tightened credit policies for developers, and a large number of private developers have defaulted on their debts and failed to deliver housing on time. This is the first step of China’s systemic financial crisis. Real estate-related loans are one of the main components of China’s financial industry assets. The current payment crisis exposed by some rural banks in China is just the tip of the iceberg. We expect that larger city commercial banks and joint-stock banks will be at risk of default in the future, and eventually there may be a crisis of national commercial banks. This situation was unthinkable in the past because the government would avoid it, but it is becoming a reality in the context of an increasingly rigid system.

Fourth, the global supply chain is being reconfigured, and China will gradually decouple from the global economic system. The Trump era once hoped that American companies would leave China, but with little success. It is China’s anti-epidemic zero policy that has caused a large number of multinational companies, international traders, and even local Chinese companies to leave or are preparing to leave China. Apple, for example, is shifting more and more production of its products out of China. Many Chinese observers believed that industrial chain transfer was a long process. However, we have seen that China’s anti-epidemic policy has made many countries around the world feel the huge negative impact of an unstable region on production and inflation, which makes the transfer of the industrial chain likely to happen faster than expected. This is a very bad prospect for the Chinese economy, because it means the loss of tens of millions of jobs. For a country with a large working population like China, these jobs will not come back after being lost.

Therefore, China will not simply repeat Japan’s story. China has its own rhythm, which is a tragedy. Although China’s own potential economic growth prospects are still good, tragedies are happening due to wrong economic policies. This erroneous economic policy is part of China’s historical tradition, and the world is still very insufficiently prepared for the downside risks of China’s economy.

(The author is a global macro trader in China.)