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  January 25, 2017

Is China's Economy Headed Towards Financial Crisis?

Economist Richard Vague says China is acting much like Japan did in the decade before its crisis in the 90's
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SHARMINI PERIES: It's The Real News Network. I'm Sharmini Peries, coming to you from Baltimore.

With the incoming Trump administration, the topic of U.S. trade relations with China, have recently moved to the forefront. Trump and his advisors are saying that China is violating international trade rules, and that the U.S. should retaliate.

Meanwhile, China is warning Trump not to launch a trade war with it. It is also fortifying its military presence in the vital trade route, known as the South China Sea. Left out of this debate is, how is China doing economically? Its economic growth, and still you would find that China is among the strongest in the world when it comes to the economy, however it has significantly slowed down in the past few years.

One economist, who is warning that China could be facing a serious economic crisis, is Richard Vague. Richard is joining us today to take a closer look at the Chinese economy. He's the managing partner at Gabriel Investments, and chair of Governor's Woods Foundation, and he's the author of "The Next Economic Disaster: Why It's Coming and How to Avoid It". Thank you so much for joining us today, Richard.

RICHARD VAGUE: Thank you for having me.

SHARMINI PERIES: So Richard, in your book, "The Next Economic Disaster," and in your article, that we've read here in Democracy Journal, you provide a fairly comprehensive explanation for why China's economy is facing a serious problem, and could enter into a major financial crisis. Similar to that one that the U.S. experienced in 2008, so, give us a better sense of what your key arguments are for that.

RICHARD VAGUE: Yeah. Well, all major financial crises, certainly ours in '08, certainly Japan's in the early '90s, Asia's in '97, and many others we could name, have all been built, or caused by, very rapid run-ups, or increases in private debt –- non-government debt. In the U.S. it was housing. We just built way too many houses. We made way too many mortgages at unrealistic valuations. And it kinda all came tumbling down.

Japan, in the early '90s... during the '80s, their private debt had grown astronomically, primarily in commercial real estate, but in other areas, as well. We've observed that when private debt to GDP, private debt in ratio to GDP, increases by about 20% in five years, and private debt levels are already at a relatively high level, you almost always end up with a financial reversal, financial calamity, or even a financial crisis.

The threshold being 20%, China's been growing its private debt to GDP over a five year period at 30-plus percent, and that hasn't slowed down at all. For all their rhetoric, and all that private debt has ended up in ghost cities, in overproduction of commodities. They've just over-produced on an unprecedented scale, and they kinda have to slow down. There has to be a reversal over the next few years to compensate for that.

SHARMINI PERIES: And you are saying a slowdown would be what would be required, to avoid impending financial crisis?

RICHARD VAGUE: Well, I think there's going to be a slowdown, no matter what. China is awfully skilled at propping up zombie banks, and they did that in '99, and in a profound way, they can probably do that again. They can paper over, they can create accounting fictions, they can do whatever. But the amount of overcapacity that China has, means that ultimately China's GDP has to slow down, probably to a low single digits type of array.

What they're doing is eerily parallel to what Japan did in the '80s and early '90s, and you can see the overcapacity and over-lending that happened there. The recapitalization that had to occur at the banks in the '90s, and you can also see that their growth has been near zero in the 25 years since then. It hasn't been a lost decade; it's been a lost generation. That was really because they overdid it in a massive way in the '80s.

SHARMINI PERIES: Because the world economy has been slowing down, there's less a need for some of the Chinese goods produced. Is that causing a slowdown as well, or is there internal demand that's compensating for that?

RICHARD VAGUE: The internal demand isn't even close to compensating for that. China had almost 10% to its GDP net positive exports in the 2000s, really built on the debt bubble that was occurring in Western Europe and the United States. When that went away in '08, China was really faced with a decision: to allow its growth to slow down precipitously as a result of the world slowdown, or to try to compensate for it elsewhere.

And the way they've compensated for it, is through private debt growth. Since that time, China's non-government private debt has increased by the equivalent of $19 trillion U.S. dollars. It's unprecedented.

SHARMINI PERIES: Now, turning to our new administration here in Washington, as I mentioned in the introduction, Trump has been arguing that the U.S. ought to retaliate against Chinese violations of international trade rules. What do you make of Trump's approach to U.S./Chinese trade relations, and how is this attitude going to impact the actual trade balance?

RICHARD VAGUE: Unlike many economists, I'm not a religious... I don't have a religious belief in free trade. I don't think it's always the best thing there. The United States was the most protectionist nation on earth, from the mid-1800s to the early 1900s, and we grew from an also-ran, to being the largest, most powerful country in the world in that very period. Ronald Reagan, in the '80s, got tough a couple of times with Japan. He announced a 100% tariff on certain categories of Japan imports and got fairly quick cooperation.

I think there's an argument to be made that we have been a little soft on trade issues, often in exchange for political gains. And I think the American worker has gotten the short end of things, really since... in a kind of a profound way, when China entered the WTO –- I believe that was under Bush –- no, no, it was under Clinton. So, I think, there's reason to think we should be tougher with China, and frankly I think we hold a few more cards than China does in any dispute that we might have.

Nevertheless, these things are hard, they're often ugly, and a lot of the big trade deals have long since been made. There's not a lot of room for re-trading. But I do have some sympathy with the idea that we ought to be a little tougher with China. Their markets aren't particularly open to the U.S. They do a lot of things that make it very difficult for U.S. businesses to do business in China, which has gotten markedly worse recently, especially with the capital controls that they're putting in place.

So, you know, there's not really good reciprocity. I think there's room for a little more tough stance.

SHARMINI PERIES: Now, the U.S. does rely heavily on China in terms of its own growth. Now, given that the U.S.'s major production now is dependent on the financial sector, and not actually on producing and exporting goods, and it's been like this for a very long time. But China also buys the bonds that... American bonds, and so we are heavily tied to the Chinese economy doing well -- for the U.S. to do well.

In fact, the Chinese foreign ministry actually fired back to some of Trump's comments recently, by saying it would be counterproductive and contrary to the best interests of the United States to pursue these lines of trade war, that they call. What do you make of that?

RICHARD VAGUE: Well, I think that the financial side of it, respectfully, I think the financial side of it is a bit of a red herring. We have about $19 to $20 trillion in aggregate U.S. debt and China holds about a trillion, maybe a trillion-three at this point in time, and that amount has been declining. I don't think the fact that China holds our debt is really an issue to us one way or the other. We're going to be fine. The markets globally, are deep and wide for our debt.

So, putting that issue to the side, however, there's a lot of complexity in our relationship with China. Apple manufactures a healthy percentage of its iPhones in China, and alternative manufacturing sources for that are going to be difficult to establish quickly. It's a complicated issue. I think we're holding a few more cards. It's going to be a hard one to play through.

But, I'd repeat the idea that the United States probably holds a few more cards than China does. The U.S. is double the size of China, from a GDP standpoint, and other markets are starting to emerge as manufacturing powerhouses in South East Asia. I've seen an analysis recently that shows that Mexico's manufacturing, the cost to a United States concern for certain types of manufacturing in Mexico, is actually at parity, or maybe even slightly better than China. So, there's alternatives for us. It's just certain areas are complicated, and going to be hard to navigate.

SHARMINI PERIES: Right. Regardless, our economies are intertwined. What do you think sensible trade relations with China would look like?

RICHARD VAGUE: I think, ask... If you'd asked me the question five or ten or even fifteen years ago, I would've said then, that being more assertive in what we require of China to be open to China, would've been in order.

The problem today is, we're so much more intertwined than we were, plus –- and this is a fundamentally underappreciated fact –- China's in a very fragile situation. We could be the entity that precipitates the crisis in China that I've written about. And I don't think that's to anybody's advantage, because there'll be a kind of a spillover effect of that, or contagion effect of that. China's one third of GDP growth now, so we've got to navigate that carefully.

So, I think, somewhat more assertive, with very intelligent requests for the kinds of things we want is in order. Whether Trump is capable of handling that remains to be seen.

SHARMINI PERIES: All right, Richard. I thank you so much for joining us today, and very enlightening conversation.

RICHARD VAGUE: Well, I'm grateful that you reached out. Enjoyed the conversation.

SHARMINI PERIES: All right, and thank you for joining us on The Real News Network.




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