The U.S. and China Come to the Table

40 years after the "walk in the woods", Presidents Xi and
Biden walk around the Filoli Gardens in Woodside, CA (ABC)

When China adopted a hybrid version of capitalism, it was nearly a foregone conclusion that China would eventually become the world's dominant power. Although its per-capita GDP was "only" USD $13,000--a fraction of the United States' $75,000--China's GDP of $17.7 trillion was rapidly approaching the U.S.' $23.3 trillion in 2021. China was marching inexorably toward number one.

Not so fast. As Presidents Xi and Biden met today at nearby Filoli Gardens, China is struggling with a number of worrisome economic issues. [bold added]

China’s economy is beset by multiple challenges, from a deflating property bubble and unmanageable local government debts to slumping confidence and deflation. The U.S., meanwhile, has just recorded its strongest quarter in nearly two years while inflation subsides. China’s gross domestic product, which was 75% the size of the U.S.’s in 2021, had slipped to 64% in the third quarter, roughly where it was in 2017...

China’s growth, which averaged 10% a year from 1980 to 2012, was always bound to slow around now because of an aging population, less rural-to-urban migration and diminishing opportunities to catch up to wealthier countries.

But the slowdown has been sharper than expected. The World Bank now expects China’s annual growth in the next two years to average 4.5%, roughly a percentage point slower than it projected a decade ago. The International Monetary Fund sees growth averaging just 3.9% over the next five years...

During the global financial crisis of 2007-09 China launched a massive stimulus program aimed at infrastructure, housing and later, technology. Local governments and developers financed this investment by borrowing from banks and the Chinese public, using new financing vehicles to get around borrowing restrictions imposed by Beijing...

Whereas the U.S. has too few houses and infrastructure, China now has too much of both. Millions of apartments are vacant. Guizhou, a relatively poor province, is home to 23 of the world’s 100 highest bridges. High-speed railway track is growing more than twice as quickly as passengers, according to Rogoff and Yang.

Much of the debt to finance that investment, issued by developers and local governments to ordinary Chinese or Chinese banks, is in danger of default. The IMF estimates 30% of local government debt is nonviable. Collapsing revenue from land sales and business taxes have saddled local governments with yawning deficits. An August Rhodium report co-authored by Wright concluded that China has much less fiscal space than widely believed to finance industrial policy, defense and its Belt and Road Initiative of foreign infrastructure loans...

China’s declining population is a slow-moving problem that suddenly accelerated in the past two years. In 2017 the fertility rate, the number of children a woman could expect to bear over her lifetime, was around 1.6, below the 2.1 needed to maintain a stable population...

Chinese authorities are ideologically opposed to boosting consumption, such as through more generous healthcare and retirement benefits, which would reduce the need to save. Meanwhile, Xi has worsened confidence through “a series of profound policy choices…that are now coming back to hobble the Chinese economy and its recovery,” said Barry Naughton, an expert on Chinese industrial policy at the University of California San Diego.

Starting in 2020, the Communist Party unleashed a regulatory crackdown on private businesses in online commerce, online education and gaming, ostensibly to clamp down on privacy and anticompetitive abuses but mostly to cement its control over the private sector.

Despite these recently surfaced weaknesses, China still has immense power, particularly in manufacturing. It can easily disrupt supply chains of major industries around the world if it so chooses. And China's quest to expand territory, most notably to annex Taiwan, will threaten political and economic stability for decades.

The interesting aspect of this civilizational contest between China and the West is that, for the first time in memory, time is not on China's side. Its aging, shrinking population will force China to turn inward, while immigration and open markets are likely to continue growth for the U.S. and its allies.

Of course, President Xi is aware of these demographic realities. The near-term danger is that he may be tempted to accelerate his expansionist plans before the West gets stronger and China gets weaker.

Let's hope that President Biden can offer him deals that will help the Chinese people and their economy while at the same time defusing the prospect of military conflict.

The Xi Jinping Put: Still Operational

It appears that President Xi has allowed
Evergrande to live a while longer (WSJ).

A good part of the stock market swoon in September has been due to the possible insolvency of China Evergrande Group, one of the world's largest real estate companies.

How big is Evergrande?
Evergrande had nearly $78 billion in revenue last year and hundreds of projects in more than 200 Chinese cities. For years it used borrowed money and presold apartments to aggressively amass land and develop projects. Along the way the company paid out billions of dollars in dividends to shareholders, including the equivalent of more than $5 billion over the past three years to founder, top shareholder and Chairman Hui Ka Yan.

Why is Evergrande facing a crisis?
Problems started to emerge last year when pandemic lockdowns hurt property sales for months, and they snowballed into concerns about a cash crunch last fall. Meanwhile, China’s efforts to crack down on borrowing by real-estate developers via limits known as the “three red lines” kept the company from taking on new debt. Cash is so short the company this summer started paying some suppliers with unfinished apartments instead of money. Its struggles sparked protests at its headquarters in Shenzhen.

How much does Evergrande owe?
The company had the equivalent of around $88 billion in outstanding debt at the end of June, about 42% coming due in less than a year. Its total debt burden is the most of any publicly traded real-estate management or development company globally, according to S&P Global Market Intelligence. Research firm Capital Economics estimates Evergrande also has sold an estimated 1.4 million apartments, worth $200 billion, that it hasn’t yet completed.

In past years investors outside China wouldn't have been too worried about the collapse of an Evergrande because of the belief that the Chinese government would back the debt obligations of large Chinese companies. (This is the Chinese version of the Fed put, a market understanding based on past Fed behavior, that the U.S. government would stop losses from becoming too deep and widespread and possibly jeopardize the entire financial system.)

In the latter half of the month there have been signs that the "Xi put" is operational, with some steps being taken to shore up Evergrande which nevertheless did miss debt payments in September.

The U.S. stock markets continued to drop in late September because of higher interest rates (the cause of the drop in late 2018), supply shortages, and inflation. The Chinese economic slowdown is part of the reason for pessimism, but at least for now a financial crisis is off the table.

Some investors have seized on these government signals as an opportunity to bargain-hunt Chinese bonds and stocks. Too soon and too rich for my blood.