Fragile China a Risky Bet

Michael Orme - Wed 26 Mar, 2008

The path of China is far from a one-way bet and its problems have been overlooked.

China ’s outstanding economic achievements doesn’t necessarily make it a one way bet for investors says Fleet Street Letter contributor Michael Orme.

Let's set aside the airline magazine hype, and ask the big question. Is China - the next political and economic superpower - riding roughshod over the world with its huge growth? Or rather, is it on course to be a disastrous economic pile-up, torn to pieces by terrific upheavals?

Talk to businessmen, investment bankers, and economists, and you get a totally different perspective than if you talk to political scientists, historians and international relations experts. The former tend to stoke the common public perception that China is an unstoppable juggernaut that will dominate the world by 2030, give or take a year or two. The latter point to its fragility, unworkable internal power structures and a social pressure cooker about to blow its lid. Some forecast that the Chinese Communist Party's one-party rule will not survive the fifth generation of CCP leadership, which begins in 2012.

Andy Grove, the co-founder of microchip giant Intel, and a member of most peoples' business halls of fame, wrote a famous management book a few years back, Only the Paranoid Survive. This would be an apt title for a study of China. It seems to be a half mafia, half corporate board set-up where the top leaders in Beijing and in the cities and provinces have two overriding objectives: to stay in power by keeping the lid on the social pressure cooker - 'avoiding chaos under heaven' - and to keep the spoils flowing to their families and friends.

The Chinese economy sometimes seems to resemble a giant pyramid scheme. Corrupt state companies float on an ocean of grants that masquerade as bank loans. These 'grants' or, more correctly, non-performing loans (NPLs) are now reckoned to top $1trn in value. They could potentially bring the whole house of cards tumbling down, or absorb the lion's share of China's vast foreign reserves in a clean-up operation.

The prevailing atmosphere among the Beijing technocrats is one of fear, paranoia and a lack of grip, according to diplomats who've talked to President Hu Jintao and some of his top colleagues.

Leading sinologist Susan Shirk has spoken often to Hu along with three generations of Chinese leaders in her role as a former top US China diplomat. In her recent study China: the Fragile Superpower she states that '' China is ruled by a brittle authoritarian regime that fears its own citizens.''

The CCP leadership is fully aware that its legitimacy gets thinner by the day. The current leaders don’t have much political capital to deploy because none of them were on the Long March. Their only chance of staying in power is to preside over a protracted economic boom such as the world has never seen; and/or foment a series of foreign adventures against (for example) Taiwan, Japan or Russia (with whom there are longstanding territorial disputes). They also need to keep building what is already the world's most advanced and pervasive police state.

The regime survived Tiananmen Square - just. It was amazing that it did given the depth, width and determination of the public revolt which spread to 132 cities. Not to mention that at the time the Soviet Union was imploding, and the Kuomintang in Taiwan was liberalising nearly 40 years of harsh one-party rule. It was only because Deng Xiaoping and his fellow gerontocrats persuaded a reluctant Peoples Liberation Army (PLA) to put down the revolt that the regime managed to dodge the bullet.

Ever since that time, the CCP leaders have been paying the price to the PLA. Twenty years on, it is by no means clear that the civil leadership controls the PLA generals in terms of foreign policy, military activities and budget allocations.

For example, the PLA is widely believed to have orchestrated the collision between a Chinese jet and an American EP-3 reconnaissance plane in April 2001. It is also believed to have knocked out a satellite with a missile last January and tapped into US Defence Secretary Gates' personal computer. This was all without the CCP civilian leadership's knowledge, never mind their sanction.

And it's a nice point that telecoms group, Huawei, China's biggest single high-tech success story, is the creation of the PLA. Huawei famously won a chunk of the work to turn BT's network into a network fit for the 21st century. Apart from its obvious success in winning foreign orders, it remains a closed book to all but a handful of the Chinese elite.

The Beijing leadership actually controls precious little - principally the very active internet police force of at least 50,000 'cyber cops', and the country's core electricity grid. But it is held accountable for a great deal more: the country's epic corruption, the choking and toxic pollution, the almost total lack of property and individual rights, the imbalance between city and countryside, and the inability to create jobs fast enough to combat rising unemployment.

Any one of these, let alone in combination, could well trigger the 'chaos under heaven' that has the CCP leaders in an almost permanent state of fear and trembling. For example, the Beijing technocrats are well aware that the country's 'killer' pollution could topple the regime. This affects hundreds of millions of Chinese. So the CCP introduced a grand project at the end of 2006, dubbed the 'Green GDP'. But it collided with the priorities of the provincial cadres, and was quietly dropped last Spring.

And again, at least two-thirds of the dirty, new polluting coal-fired power plants (at least one new such plant comes on stream every 10 days or so somewhere in China) are not authorised by Beijing. They are 'bootleg' plants, but they fit in with the economics, contacts, and procurement practices of the provincial cadres. And it is these 'dirty' plants, supplying 70%-80% of China's electricity, that are primarily responsible for the country's appalling air quality.

The attitude of the provincial cadres, rich on kickbacks, is that ''heaven is high and the Emperor is far away”. It has always been thus throughout Chinese history.

Meanwhile, food and fuel inflation is leading to riots as pollution chokes and poisons Chinese society. Bulldozers flatten homes, neighbourhoods and human rights to make way for large-scale developments. Power cuts cascade through the ailing grid. The latest outcry occurred when 13 power stations shut down in central and southern China over the Chinese New Year, just as the savage winter hit.

When Deng Xiaoping let the capitalist genie out of the bottle, having just introduced the demographic 'time bomb' of one child per family nearly 30 years ago, China was launched into an extraordinary experiment, the like of which the world has never seen before.

Much may become clearer at the August Beijing Olympics - despite the smog - about what may result next from the experiment. The international media, which the Beijing leadership is intent on muzzling, will try to expose China's deep fault lines. No doubt local protest groups will use the occasion to coordinate and gather forces to set the scene for an imminent replay of the 1989 'chaos under heaven'.

Aside from its permanent fear of another Tiananmen Square, the CCP regime is well aware that the Kuomintang in Taiwan was forced to end strict one party rule and martial law between 1986 and 1989. The reason? The island's large and prosperous middle class was no longer prepared to tolerate the horrendous pollution caused by two decades of economic growth and material gain. The CCP regime is hemmed in by compounding threats.

In the longer term, China needs to become 'rich before it becomes old', given the demographic fallout from the one child per family policy. This means the creation of a huge, less energy-intensive service economy built around an urban middle class that accounts for at least 40% of the population. And quickly; the urban middle class forms the basis for a vast consumer society whose consumption can only increase.

Economic pile-up? Chaos under heaven? The ultimate police state? Giant consumer society? China teeters, as so often, on a tightrope straddling a deep gorge. It has a history of unbelievable upheavals and anarchy; it has often reverted to being a cock-pit for feuding warlords. Think twice before committing to long-term Chinese investments.

Regards,

Michael Orme
For the Daily Reckoning