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They Were Wrong: Forget Brexit, Focus on Slowing Chinese Demand

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The Chinese bubble readies to burst. It’s already started. We’ve got 8 years, tops, before the house of cards starts to seriously topple. In the meanwhile, expect reduced economic growth globally.

“It’s Worse Than You Know (But Not For Why You Think)”

The months and weeks leading into the Brexit vote, which separated Great Britain away from the sclerotic European Union, was dominated by news articles and broadcasts indicating that the sky was falling. Everyone who had a camera and a microphone nearby, it seemed, were acting as though we were on the eve of Armageddon. Leaders of both political parties in the United States, for the most part, were in agreement that Brexit would be disastrous for the economy.

The Europeans were issuing threats to the British. The Russians remained eerily quiet on the issue. The Chinese hoped for economic stability. Indeed, the British themselves were deeply divided on whether to opt out of the European Union or not. Even as the so-called experts were panicked over the very notion of Brexit, most of them wrote it off as the fantastical musings of Thatcherite throwbacks, Nigel Farage and Boris Johnson. They consoled themselves that this could not happen.

Yet, happen it did.

And, while the British economy lost roughly $3 trillion in the immediate aftermath of that decision, since the passage of the referendum, the British economy has surged ahead. Also, the global economy has rebounded as previously unexpected (except here at The Weichert Report). Even still, the very same financial houses that were claiming they would pack up their operations and leave London upon Brexit, confirm that they will remain in place (giving Fox Business Network’s Charlie Gasparino no indication of when they planned to move out).

However, there is one country that all others should fear for rendering another global downturn. That is not Britain. In fact, with all due respect to the British, Britain could never damage the global economy in the way that the Stay crowd in Britain claimed. The threat to the global economy emanates from the economic juggernaut of the People’s Republic of China.

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Growing Chinese demand is causing a massive slowdown throughout Emerging Markets and the surrounding Asian markets. If this slowdown continues, the global economy is going to be in for one long anemic economic period.

The world, particularly Emerging Markets, have come to depend upon Chinese economic growth to sustain them. China is a primary consumer of commodities. As such, it is a primary consumer of products from places like nearby Asia, Latin America, and Africa.

Recently, Chinese demand for these products has begun to slow. This coincides with the sudden downturn in the Emerging Markets. Such a turn should not be surprising, considering that China has significant economic issues that it must contend with, if it is to continue the kind of meteoric growth it has sustained for over twenty years.

For several months, analysts have noted how exports from Asian states into China have been on a steady decline. This is also confirmed by the decline in the Purchasing Manufacturers’ Index (PMI), which indicates that Asian factories are receiving fewer orders from China for their goods. China hasn’t only slowed its importation of Asian goods, it has also slowed its demand for all imports. This includes its demand for imports from both the U.S. and the EU.

Dragon SNAIL

As the world continues to wring its hands over Brexit, which has had little negative impact and, as I argue in “On Brexit: Culture and History Still Matter,” will likely be good for the British, EU, and global economy, the real threat to everyone is the inexorable slowdown in Chinese demand. What else does it portend?

While the world was consumed with fearmongering Britons into remaining in a European Union that they no longer wished to be a part of, no one was really worrying about the ongoing slump in Chinese demand–and what that portends.

As it proved with its Brexit vote, Britain is nowhere near as important to the world economy as China. As a key driver of growth due to its consumption of commodities and its manufacturing base, the Chinese economy is key to ensuring another global downturn does not occur. Yet, should something go wrong in China (i.e. a reduction in Chinese demand), then that will have reverberations throughout the rest of the global economy.

And, while the kinds of doom-and-gloom claims that dominated the run-up to the Brexit vote were unwarranted (for most economic situations such talk is unwarranted), a slowdown in the Chinese economy will have far greater negative impacts than any state deciding to leave the EU will ever have on global markets. What’s more, just as the experts said a Brexit vote wouldn’t happen, they are also saying that a Chinese market collapse won’t happen, either. While I’m not in the prediction business, I am in the pattern identification business, and I see some disturbing cultural and historical patterns aligning with political and economic realities that makes me very pessimistic about China’s future.

How Will America Contribute to China’s Slowdown?

In one respect, given the integrated nature of the world economy, any action taken by another large economy, such as the United States, will have disproportionate impacts on other economies around the world. The one thing that the Brexit vote did do was to make many investors abandon their holdings of the British Pound and seek refuge in the U.S. dollar (USD).

The dollar serves as the world’s reserve currency. This means that when things go upside down in the global market, many investors kind of run back home to mommy, dropping whatever problem currencies they hold, and reinvesting in the USD, until the sailing gets a little smoother again. Also, going into June, there had been ruminations that the Federal Reserve (The Fed) was about to slightly increase interest rates. As such, most analysts were convinced that a huge rally on the dollar was about to occur (meaning that the value of the USD was about surge upward).

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Fed Reserve Chairman Janet Yellen’s decision not to raise interest rates has kept the dollar’s value lower than it would have been post-Brexit. However, the USD is still valued up to five times higher than China’s yuan, prompting fears of a yuan devaluation.

However, the actions of the Japanese and European central banks prevented such a surge. The Japanese and Europeans both decided to introduce negative interest rates, which had the effect of sending potential investors into the waiting arms of the higher-yielding assets of Emerging Markets. This, coupled with poor jobs data in the U.S., and the revelation that The Fed was unlikely to raise interest rates, has helped to keep the dollar at a lower value than what it should be.

However, as it stands, the USD is a form of a safe haven currency for the Chinese. That means, should there be a run on the dollar–at any level–it would likely precipitate the Chinese devaluation of their currency, the yuan. Shortly after the Brexit vote, the value of the yuan plummeted compared to the dollar.

It seems perverse, but the stronger that the American dollar does, in global trade terms, the greater the instability in the Emerging Markets–particularly China.

Debt Load, Currency Value, and Repayment

For Emerging Markets that service debt in USD, a weaker dollar makes it easier for these countries  to make repayments, as the value of the debt currency is lower, and the financial burden is not that great on their developing economies. Holding debt that is tied to the USD not only has the benefit for these markets of repaying that debt more cheaply than they ordinarily would, but it also tends to act as a booster for commodities, which I identified above as a developing country’s best export.

The role of commodities in Emerging Markets, tethered to lower valued USD debt repayments is key to understanding how these markets not only survive but are able to prosper. After the Great Recession of 2008, the Emerging Markets had a very convenient cushion in the form of their commodities, which helped to prevent the economic downturn from affecting their countries the way that it did those economies in the Developed World (particularly of the Western democracies). However, this kind of rally did not achieve its full potential, due to the diminished demand in China. This is why shortly following the Great Recession of 2008, there was a litany of articles indicating that China was building “ghost cities.”

Now, the conditions in the global market are quite similar to what they were during the 2008 Recession in regards to China’s ability to supercharge the Emerging Markets with their demand. With the dollar getting stronger compared to the yuan, coupled with China’s decreased demand, a devaluation of the yuan would have precarious effects upon the global economy. This kind of devaluation would be highly detrimental to Chinese companies that have borrowed money in USD, which would only act as an accelerant onto fiery fears that China is indeed undergoing a severe slowdown.

In such a scenario of a precipitous Chinese economic slowdown, things could become so tough that China might actually be in threat of defaulting on its loans. It sounds extreme, but Brazil and several other Emerging Market economies have already been downgraded and are themselves at risk of defaulting. China is part of that nexus. It is, in a way, the center of that nexus.

Indeed, we’ve already seen how those Asian countries closest to China have been struggling to cope with the loss of demand for their exports. These struggles are now reverberating in other parts of the Emerging Markets, like Latin America. This is mostly because of China, not Brexit.

China’s Economic Future: Politics Will Trump Prosperity

We should be worried about what’s going on in China and being prepared for whatever shockwaves emanate from there in the coming months. But, thus far, we’re not. No one is listening. All the Wizards of Smart on TV and in print keep saying that everything is fine. Now, as it stands, the sky is not falling. People are not running around with their hair on fire.

Indeed, this Chinese slowdown has been occurring for the past few years. Yet, the trends seem to be getting worse. In fact, many Chinese leaders have asserted that China’s growth has slowed to such a degree that the world should expect a significantly reduced level of growth from China indefinitely.

Under these conditions, I contend, it is simply impossible for the Chinese Communist Party to maintain its grip on power. And, if the Chinese history of dynastic shifts is any indication, we should expect a monumental politico-economic shift from within China within the next decade.

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Now, let’s touch on some of the good news. It should be noted, that whatever slowdown China may be facing–which is partly self-induced by its own government–the Chinese central banks still have considerable abilities to counteract any serious economic slowdown (which is more than can be said about Western banks, which have spent years in endless bouts of quantitative easing and reduced interest rates).

However, if the Chinese prediction (which match the predictions of several of these “experts” in the West) that reduced growth shall be China’s indefinite economic state, then the Chinese government’s ability to manage will become increasingly constrained.

China’s economy is in the state that it’s in primarily because the country is trying to make a transition from that of a Developing economy, that is dependent on commodities, relies heavily on State Owned Enterprises (SOE) to buttress their economic gains, and is predominantly a place of cheaply produced goods, to a Developed economy. Under these conditions, we should expect a natural economic slowdown in China. Yet, the kind of slowdown that has occurred is troubling, particularly in the context of political stability and regional security.

As the economy transitions away from the economic model of a Developing country and toward that of a Developed country, we should expect to see the Chinese government reining in investments into infrastructure and pointless real estate projects, such as the aforementioned ghost cities, and redirecting its economic energies into growing its consumer economy, the kind of economy that a Developed country should possess.

Yet, oddly enough, the Chinese leadership continues to invest in large infrastructure projects to prop up sluggish growth rates–which has stopped yielding the kind of returns that the Chinese had seen in earlier times. So, rather than being these technocratic wizards, as so many financial writers would have us believe, I tend to assume that the Chinese leadership is baffled.

They have no idea of how to dig themselves out of the hole that they’ve created for themselves, so they’ve decided to just keep digging, as any great bureaucracy would do. This, in turn, sets up for the size and scope that their financial devastation that their “shift” (read, “collapse”) will have on the rest of the world–particularly the U.S., which is so intimately tethered to China’s economy.

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President Xi Jinping, more popularly known as “Grandpa Xi” in China. His succession marked a change in the style of leadership from his predecessors. Indeed, not since Mao has a Chinese leader incorporated so much of his own personality into his public leadership persona. Xi is also known to be a stalwart party loyalist. Could he be readying to shift the country inward, should this ongoing slowdown produce the kind of historical backlash that has been witnessed during other, similar periods in China’s history?

We have already witnessed President Xi’s government begin this shift toward a consumer economy by his ceaseless pursuit of “corrupt” figures in the Chinese Communist Party as well as his attempts at legal, administrative, and economic reforms. Just some examples: President Xi has gone after shadow banking, he has attempted to begin a regulatory regime of financial institutions in China.

However, these attempts have been met with mixed results. What they have done, across-the-board, is to position President Xi as the unchallenged leader in the Chinese Communist Party. Their effect on the country’s financial system has been limited. This is especially true, since many of the Chinese people have been stashing their newfound wealth in places like the U.S. in the sum of many billions of dollars–far exceeding simple diversification of assets that most responsible investors partake in.

In fact, this massive capital outflow from China to Western states has prompted President Xi to enact laws severely limiting such actions. This only continues to play into the increasing political instability and economic misfortune that is slowly befalling the Chinese juggernaut. Indeed, it is in the realm of politics and geopolitics that people should be worried that a Chinese economic slowdown will have the greatest negative effects.

Consequently, the elevation of Xi to the Chinese presidency is a powerful indicator of the dire circumstances that China is in. Whereas many assumed that the selection of a more bellicose, personable, and confident personality, such as Xi, meant that China believed that it would continue to prosper and not need the kind of technocratic leadership of former Chinese President Hu Jintao, I believe that the Chinese leadership was keenly aware of the problems that the country faced.

I agree with many who claim that China wanted Xi because he would act as more of a statesman in international affairs than his stodgy, technocratic predecessors did, but I am dubious about that being the result of true Chinese confidence. Indeed, I believe the selection of such a leader to be the tell-all sign that things are probably even worse than they already seem in China.

China financial markets in steep decline

The Chinese economy is in for a serious downturn and it is going to hit the U.S. and the world.

Also, despite what many view as a robust capability for China to weather whatever economic storm may befall them soon, the fact is that those countermeasures are not indefinite.

At some point, the Chinese economy will have to make up for whatever losses this transitionary period has created. If this period should go on indefinitely, or some time period longer than a few years, I cannot imagine that the Chinese economy will ever be able to get near the levels of output that it experienced even up until a year ago. This is where those pesky political realities come into play.

Getting Old Before It Gets Rich

Right now, China has a population of roughly 1 billion people. Indeed, its massive population has historically been its greatest natural resource: it can provide cheap labor to mass produce the things that the world needs. However, beneath the surface, the reality is much more stark. Thanks to a combination of poor government policies over the years, and the natural progression of fertility patterns from those a Developing economy to a Developed one, it is likely that China’s population is not going to be the source of any strength for much longer.

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As you can see from this graph, fertility rates have been in a steep and steady decline in China since 1961. These trends are not only persisting, but they are likely worst than what’s reported. It is well known that all official statistics from China, given the nature of the regime there, are not to be trusted and should be assumed that they are worst than what is being reported.

Beginning in the 1970s, the Communist government in China bought into the notion that they had to curb overpopulation in their country. As such, they instituted the One-Child Policy. Essentially, couples were allowed one child per family. While there were special exemptions conferred, generally, having more than one child was an egregious error that normally resulted in punishment of some sort for the family that violated this edict.

Therefore, parents focused heavily on preparing to have one child and no more. Since China has long-valued males over females (just remember foot-binding, if you question my assertion), they have set up a disturbing (and unnatural) gender imbalance that will only result in lowered fertility rates over a longer period.

As such, over the decades, not only has China essentially ensured that it will have far fewer workers at its disposal, but it has also guaranteed itself a disproportionate number of males. Thus, even though the government overturned the ridiculous One-Child Policy, in order to enforce baby making rules, the coming dearth of women to men in the country would make a program designed to increase fertility rates in China difficult to implement.

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A projection on where China’s GDP will be, as positively correlated with its declining fertility rate, circa 2013. Courtesy of The Economist.

The Chinese fertility rate is estimated to be about 1.4 children per women. The estimated fertility rate for a country to have what’s known as Societal Replacement (the number of children required to maintain the same level of production as the preceding generation) is 2.1 children per women. China is not alone. Indeed, much of the rest of the world is facing declining fertility rates–we have been for several decades now, despite what Paul Ehrlichmann claims.

At the same time, the proportion of Chinese who are of working age (16-64), has dropped precipitously. Also the age dependence ratio (those who are 64 and older) is skyrocketing (like most of the rest of the Developed world economies dealing with the aging Baby Boomers). This is compared with the steady decline in the working-age population that will ultimately be used to financially support–on some level–these elderly. Of course, the Chinese government has enforced strict savings rate, but savings only gets one so far, particularly the older one gets.

Lastly, forty years of the One-Child Policy in China has created a massive distortionary effect on the ratio of boys-to-girls in China (106 boys to 100 girls), which is higher than any other state in the world. What’s more the most recent crop of Chinese newborns has the worst imbalance to date: 120 boys to 100 girls. Essentially, if trends persist, there will not be enough future wives for nearly one-fifth of Chinese boys born today. Not only will this have powerfully negative economic consequences for China, but it will also have staggering social ones as well.

Think about it: you will soon have military-aged boys, unable to find a woman to settle down with (because she was aborted as per the One-Child Policy), living under one of the most repressive regimes around, faced with diminished economic opportunity, and having to provide for the much-larger elderly population of China. If that doesn’t spell political upheaval, I don’t know what will!

If, as Adam Smith, the founder Capitalism, believed that rising prosperity was positively correlated with increased population density–specifically fertility rates–then China is in for it big. Indeed, we here at The Weichert Report have long suspected that the general global economic turndown has been related to the overall decline in human population. This is especially pronounced in China. Put frankly, the Chinese economy is destined for a massive slowdown.

This trend will be exacerbated by their staggeringly poor demographics, meaning that it is likely the Chinese will get old before they get rich. With an inadequate replacement of workers following the current aging generation, this will mean that further economic dislocations will occur, as the state struggles to direct extra resources toward the huge elderly population, at the expense of the smaller, younger working population.

A New Mandate of Heaven?

China is a country that is almost more than 2,000 years old. Throughout that time, it has grown from the Longshan Civilization along the Yellow River into the massive nation that it is today. China has invaded and expanded. It has been invaded and subjugated. It has warred with itself. It has warred with its neighbors. It has threatened war throughout history.

Indeed, China had roughly twenty-six dynasties that ruled it throughout its history. It also had a period of contentious warlordism in between the fall of the Qing Dynasty and the rise of the Communist Party. What’s more, for a brief period of time, China was led by Chiang Kai-shek’s Nationalists. To the Chinese, time is cyclical, and it is on an extremely long-count, compared to how us Westerners view time.

To cope with all of the changes in life, the Chinese of the Shang Dynasty developed a concept known as the Mandate of Heaven. Although, the Chinese version of Heaven was not the version of Heaven that you or I, having been raised in the Judeo-Christian Western world would understand. It was not the place from whence God and his angels emanate. It is merely the place that you see when you look up at the stars in the night’s sky. Thus, the Mandate of Heaven came to signify a process of constant and, sometimes, orderly, change as the seasons and the years passed.

When the Shang were overthrown, as so many countless future dynasties in China would do to one another, their usurpers, the Zhou dynasty, would claim that the Shang had lost the Mandate of Heaven. According to the Zhou, the last Shang king had grown weak, corrupt, and feckless. Therefore, the Mandate of Heaven passed onto a new group that would lead the people justly; a group that was untainted with the extravagances and corruption of the Shang dynasty. It was a simple and yet powerful narrative that most Chinese embraced.

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Here is the cycle of Mandate of Heaven. It matches perfectly with what may be occurring in China, if the CCP cannot get back to anywhere near the economic growth it was at before 2008.

Each new dynastic shift would be preceded by years of civil war (and/or external war), peasant rebellions, and the central ruler being made unable to cope with the changes consuming his society. As such, eventually, a usurper arises from nowhere to challenge the king.

If the usurper is successful in his challenge, then most Chinese assumed that he was in possession of the Mandate of Heaven, and they would follow him. They may not have liked the new dynasty, but at least they weren’t weak, as the dynasty that person may have supported before the usurper arose would end up being weak.

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Mao Tse-tung, the founder of the Chinese Communist Party who took over China after a long period of civil war and Japanese occupation. After his death, the CCP would be ruled by a series of technocrats who removed the CCP’s ideological purpose and replaced it with an unspoken promise of continued economic expansion and prosperity for a large portion of the Chinese people. But, what happens when that expansion turns into a contraction? What happens when the CCP no longer delivers?  A dynastic shift, that’s what happens.

This pattern happened for the Communists. When Mao rose to power, he had an aura of invincibility around him. His sayings and exploits were popular stories, the world over. Yet, he was a brutal and vicious Communist leader. However, he was strong and the people respected that.

After his death, his successor, Deng Xiaoping, emphasized closer ties with the West and advocated for a  limited modernization of the Chinese economy. With the abandonment of Communism as its unifying ideology, and the replacement of it with reactionary conservative imperialism for its political structure, and State Capitalism for its economy, the legitimacy of the Chinese Communist Party was forever bound to how much prosperity it could provide its people.

To be fair, it did preside over the greatest expansion of wealth in the shortest amount of time in Chinese history. Yet, this regime has never been truly popular. Now that the trends indicate a permanent declination in growth and a major contraction of the economy, coupled with the fact that the government has no idea how to stimulate growth (and it won’t relinquish its power without a fight), I believe that the Communist Party is in for some big trouble. While I do not know whether the Chinese actively subscribe to the Mandate of Heaven view any longer, it certainly applies.

I believe, just like other dynastic shifts in Chinese history, the establishment of a new order will be largely preceded by economic strife, internal struggles, and foreign policy imbroglios, as the desperate CCP tries to distract their population as much as possible away from the fact that they are no longer providing unprecedented levels of prosperity, the one thing that they promised in exchange for being given the repressive monopoly of state power. This pattern has played out countless times in Chinese history. It will play out again.

This is when China will be most dangerous, not just to the financial stability of the world market, but to the regional security architecture. To keep their people distracted from the economic woes, the Chinese government may initiate a series of hostile actions against their Asian neighbors. In order to crackdown on protests, expect a serious wave of repression, so as to assure that the CCP retains its grip on power. Ultimately, this could eventuate into a larger crisis, either civil war or regional conflict. However, the point is that the crisis will sort out the succession.

2015 strikes by month

As you can see, strikes increased going into 2016.

Point in fact, since Chinese demand has been in free fall, the number of civil protests has increased by two times what it was in the previous year. The strikes have been mostly in the manufacturing sector and have tended to revolve around the fact that many workers are not being paid. This is because the slowdown is negatively impacting manufacturers’ margins and they are looking to save some cash in such troubling times.

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A Chinese soldier physically attacks a female Chinese protester in 2014, during the opening session of the National People’s Congress of China, circa 2014. Things have only gotten worst, testing the authoritarian limits of the CCP’s night watchman state.

What comes next? Who knows. Democracy? Maybe. But it wouldn’t be anything that we recognized in the West. Monarchy? Possibly. The U.S. needs to prepare itself for when the Mandate of Heaven passes from President Xi Jinping to another leader. If there is one thing that is a constant it is this dynastic cycle throughout Chinese history. The economics don’t lie. China is going through a slowdown, which will precipitate a political and security crisis in China and its surrounding environs as never before seen. But also, we must be prepared for what comes after. China will not recover so easily–if at all.

The U.S. needs to be ready for this eventuality.

Blood in the Pacific

Asia is probably the most dynamic economic region on the planet right now. Much of that economic dynamism is driven by the Chinese demand for imports from its neighbors. As that demand has slowed down, so too has the overall Asian economy. This has put a strain on the economies of states like South Korea, Vietnam, the Philippines, Taiwan, and Japan, just to name a few–all of whom are American allies. With the transition away from an export-driven, commodity-obsessed economy and toward a consumer economic model, this will create a permanent reduction in prosperity among the Asian states. A reduction in economic prosperity will be negatively correlated with an increase in interstate hostility. Indeed, this has already been evident in Asia since 2009.

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A Chinese Coast Guard vessel in disputed waters, fires its high-powered water cannons at a Vietnamese fishing vessel attempting to fish in the disputed South China Sea area from 2014. Things have only gotten worst.

Whereas the Pacific Ocean was once an American Lake during the Cold War, since the Great Recession of 2008, this fact has slowly changed. China has become increasingly belligerent with its neighbors. It has increased the size and scope of its military.

It has violated international law and the sovereignty of its neighbors over petty territorial disputes. It has waged a ceaseless campaign of military aggression directed against the United States in cyberspace. It develops methods and means to debilitate the perceived U.S. military superiority in the region. Also, instability has increased as U.S. allies have begun questioning America’s commitment to protecting their interests.

After all, the U.S. has been so singularly focused on its Global War on Terror, that Asian states have been forced to try and increase their own ability to defend against Chinese aggression. China has always been somewhat of a Free Radical on the world stage, but in recent decades it has tried to generally comport with the standards and expectations of the international system (kind of).

However, its military brinkmanship, I believe, is directly related to its increasing economic weakness. While the Chinese are certainly wealthier than they have been at any other time, the fact remains that double-digit economic growth is simply impossible for any state to maintain indefinitely. This means that reforms will have to be made to the Chinese system to keep China prosperous. If China does not remain prosperous, then, the Chinese people will begin to challenge the domination of the Chinese Communist Party.

The CCP lost its ideological legitimacy the moment it was perceived to have embraced capitalism. Even as it embraced capitalism, it fought desperately to maintain its political monopoly. The Chinese people were mostly fine with this arrangement, so long as they could get rich. However, should the CCP fail to deliver its economic promise, then the political disagreements will come to dominate the Chinese political discourse. Such a turn of events, would undoubtedly threaten the CCP’s tenuous hold on power.

Chinese slowdown

The Chinese economy has suffered an across-the-board slowdown that is beginning affect the global market. Is this a temporary blip? Or the shape of things to come? I believe the latter.

It is for this reason, in the near term, that China has a chance of weathering the economic storm that is slowly befalling it. However, if these negative changes to the economy are longer lasting, then the CCP will be in big trouble. At the most recent CCP Work Conference, it is believed that the potentiality of Chinese economic collapse was addressed. While no one is quite sure whether the Chinese economy is actually going to collapse or not, an attendee of the Work Conference reported to the Wall Street Journal that, “the economy will follow an L-shaped path, and it won’t be a V-shaped path going forward.”

The CCP is fully cognizant that, in the medium-term, they have to embrace fundamental economic, legal, and potentially, political reforms to usher in this necessary transition away from a Developing economy, dependent on manufacturing and commodities to get by, and into a Developed, consumer economy. However, reform is the very path that the CCP seems most allergic to.

Of course, President Xi and his ilk have engaged in reforms. But, as I said above, many of those reforms have been directed against Xi’s political rivals. I do not yet know if Xi and the CCP have the wherewithal to negotiate this fundamental turn in Chinese development. Thus far, they have feverishly tried to nibble around the edges, continuing their ad hoc reform implementation whilst relying heavily on the diminished returns of stimulus spending. However, they have not fully embraced what needs to be done to transition their economy into a more robust one.

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For most China watchers, energy consumption levels in China is a key indicator of the economy there. As you can see, judging from the graph provided, things are getting bad and they may get still worse. Courtesy of Bloomberg.

Instead, the Chinese leadership favors mostly stimulus. While there have been mild attempts to rein in ridiculous stimulus projects, such as infrastructure enhancement and those damned ghost cities, these have not gone far enough. The shift toward a consumption economy is fraught with difficulties.

This is most notably so in China, because it is likely that consumption has been the result of growth rather than the cause of it. And, as we have seen already, explosive stimulus spending remains insufficient to jog the Chinese economy back to even the lowered growth numbers of last year. In best case scenarios, if this transition was managed properly and all went well, China would grow at anywhere between 4%-5%. That’s a big “if.” And those numbers, by the way, are 1-2% lower than Chinese expectations.

Indeed, the Chinese obsession with stability to keep the CCP in power seems to be driving all of these “reforms” much more so than any realistic plan for economic transmutation. And this, my friends, is where we should begin to grow concerned. No matter how “well” the CCP has managed the Chinese economy thus far, the kind of economy that they are seeking to create–a modern, consumption-based economy–cannot come into being with the kind of leadership that the CCP provides. What will follow will undoubtedly be political turmoil at home and increased aggression abroad.

Recently, the Chinese have intensified their military modernization efforts. They have purchased or produced a vast array of weapons and equipment, they have developed tactics, and enhanced their ability to function as a serious modern military force. Furthermore, they have begun investing in the kinds of military systems necessary for implementing their Anti-Access/Area Denial (A2/AD) strategy.

This is a strategy that is aimed at preventing the U.S. military from operating in regions near what China deems to be its area of interest, in the event of an international crisis. So, for instance, should Chinese aggression get really out-of-hand, and should they decide to invade Taiwan, the Chinese have developed tactics and tools necessary for making an American military intervention against them far costlier to Americans than they believe Americans will have the stomach to withstand.

In fact, most analysts project that the Chinese have roughly a decade (the projections began in 2013) to engage in this military ramp up before economic and demographic reality sets in. At which point, by around 2023, the Chinese will have hit a wall in their economy and/or their population will have begun to get old before it gets rich. All of this does not bode well for the stability of the global system.

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This is where China is likely headed again: a balkanized version of itself.

It is during the economic slowdown, at the point in which a new group will receive the Mandate of Heaven, that China will become most dangerous. American military forces need to be prepared to not only rebuff Chinese aggression in the Asia-Pacific, but also to be prepared for a China that subdivides and begins to resemble more of what it looked like during the closing days of the Qing Dynasty–divided, broken, and utterly chaotic.

Get Ready for Some Real Change

The U.S. should be ready for the Chinese slide to begin. Indeed, it may have already started. What many optimistic analysts are calling a “natural correction,” others are seeing as the beginning of the end. And, as the political system goes, so goes peace and stability in Asia and, perhaps, the wider world–at least for a time. However, as the song goes, “this is not the end.”

Far from it.

Just as the so-called experts were wrong about Brexit, whatever dislocations the impending Chinese economic deterioration causes can be dealt with effectively. It is true that China is undergoing truly momentous changes. The CCP will likely be unable to keep up. They will, undoubtedly, resort to force to keep their restive populations in check and to antagonize their neighbors, to keep their perceived enemies at bay.

The U.S. was caught unawares by the Brexit vote. Most of the purported experts got the results wrong. What’s more, their predictions of economic armageddon were completely off. We here at The Weichert Report have been insisting that the real concern is China. Yet again, the experts are telling us one thing: in this case, not to worry; they tell us that the Chinese economy is simply going through a change. To some degree, their assessment is correct. The Chinese economy is slowly making a transition away from a Developing economy and toward a Developed one.

However, the political situation and cultural context–things they never factor into their assessments–indicates that regional instability will follow. It is likely that the kind of chaos I am describing here will not come for another 6-8 years, if trends persist, but they are likely to come. And I believe that China has already started on the path toward this kind of collapse with its permanently diminished demand, which is driving down the Emerging Markets.

The U.S. needs to brace itself for the kinds of negative reverberations that such a momentous shift will have not only in China and in Asia, but throughout the world. Therefore, it should have its military in place and ready to respond to regional insecurity. Meanwhile, it must have in place economic safeguards that will protect it from whatever chaos a seismic shift in China’s economy will have on world markets. China and America’s economies, right now, are fused. God help us if China’s house of cards should come crashing down before America is ready for that.

So, all in all, forget about the manufactured panic over Brexit and focus your energy on China’s slowing demand. That’s the real cause for concern.

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