Monday, April 14, 2014

The Problem with China

I must admit having been fascinated with China for some time. Similarly as a young man I was fascinated with the Soviet Union, you know they had all those nuclear missiles pointed at us and all. The USSR was a construct nation, not unlike America in that it was built on an idea not necessarily on a culture. Russia aside the Soviets only lasted 70 years. America is just a few hundred years old. China on the other hand is an ancient culture, thousands of years old. China's known history extends back further than any in the west, rivaling the Middle East's pre-biblical times. China's history is as rich and intriguing as any in the West. So one might be compelled to ask - what happened? It seems that China failed to progress on pace with the West. Is it as simple as China was looking inward while the West and Great Britain was looking outward? Whatever the case may be it's safe to say China is not merely looking inward any more.

Since the great cultural and economic awakening of the past 40 years China has made incredible strides, now rivaling the United States as a dominant economic power. Take a look at these comparison charts for a moment.

However remarkable China's ascent has been the problems facing the emerging giant are huge. The causes span the range from as simple as the growing pains of a rural society transforming into and urban society to rampant corruption from the top of the Communist party down to the local building inspector. Look at these headlines randomly pulled from the Internet...

China’s Massive Water Problem

There's no denying it: China's got a debt problem.

China's Massive Pollution is Indicative of Broader Problems

There's just one problem with China's economic recovery 

The Ten Grave Problems Facing China

The Real Problem with China’s Ghost Towns

Why Americans Should Worry About China’s Food Safety Problems

 True, several of these could easily have America replacing the word China and no one would bat an eye. However, when you add them up and understand the depths of the issues you start to see not everything is coming up roses in China these days.

It's hard to say which of these challenges China will rise up to face, but the pollution problem and the debt problem float to the top. The pollution in China is worse than industrial America at it's peak. Rivers are choked with industrial run off and the air in the major cities is literally toxic. These things seem odd to Westerners who began to tackle these issues decades ago. Air pollution was a huge concern when the Olympics were held in Beijing in 2008. The problem does not end at the Chinese borders, toxic clouds easily traverse the Pacific Ocean and have bee detected in Canada and the U.S. China is an ecological disaster by any standards. Recently the central government announced pollution was a top concern, it remains to be seen if industry and locals make it one.

The debt problem is trickier, just as it is in the U.S. and the West. Debt is obviously vital to economic growth and it's been badly mismanaged in the West and there's no doubt it's being mismanaged in China too. In China the concern is that the Shadow Banking system rising up at the local level will have nothing to back it up when the credit market collapses in the face of slower growth - which is inevitable as the economy matures. The issue with debt fueling economic growth for the sake of economic growth - to keep workers working - is a question of demand and therefore repayment. You need one to achieve the other. Yet building continues even when demand is light or non-existent as is the case of the famous Ghost Cities. It would be like building Detroit (or re-building as the case may be) with no one being able to afford to live there. There is zero demand for the new buildings, shopping centers and housing in these Ghost Cities. Overbuilding is one thing, but to do it over and over is bizarre.

Despite all the problems one cannot fail to be awed by the rise of China in such a short time. As American's struggle to find anything on the shelves of our big box stores not made in China we wonder what will become of our workers, our economy. Clearly China can manufacture quality stuff, particularly consumer electronics under the guidance of American and Japanese companies. They also produce a lot of cheap junk. Junk so cheap we don't get too upset when it falls apart or breaks, we just buy another.

Therein lies the problem.

American's can look high and low for American made products but they aren't likely to find them. The very nature of the cheap junk paradigm means that American manufacturers have pulled up stakes and left for China too. Only the suits live back in the States. Their former workers have the luxury then to go to Walmart and buy - very cheaply - what they used to make and pay for it with their government assistance check. Is it me or is there something very wrong with this picture?

American companies are between a rock and a hard place. To stay in the picture they have to abide by the laws of jungle which means capital will follow the cheapest labor when all else is equal. For low cost consumer goods there's not much that can be done. Cheap labor is cheap labor. American companies can choose then to go with quality and high end luxury goods where the margins are higher. The problem with that is the Europeans and the Japanese have already staked that territory out and they do a pretty good job of it.

Well then, American companies can rely on innovation, right? We've always been the innovators, right? Not so fast. An increasing number of research facilities have moved to China too. It only makes sense to innovate in the same place you manufacture.

What's left? If it wasn't for the defense industry, aerospace and industrial machines there wouldn't be much left for high end, high quality manufacturing in the United States. It's true that there's a lot of manufacturing still taking place in the U.S. but the trajectory is heading in the wrong direction and the current national government is of no help at all. The gutting of the defense sector will have a domino effect on good paying jobs across the country. The animus between the current regime in Washington and our last great aerospace company Boeing makes you wonder to what depths will they sink to destroy what's left of our high end manufacturing industries.

There is hope that cheaper and more reliable energy will be the difference maker for the U.S. but again the current government despite all their claims to have presided over an incredible energy boon has done nothing but stand in the way. The Keystone Pipeline being one huge case in point, of course. Additionally they are on the record with a desire to kill the coal industry. They continue to deny any access to government lands for advanced oil and gas extraction. They are not so quietly turning "fracking" into a dirty word. They spread enough disinformation about potential environmental catastrophes to get the public to put the brakes on further domestic energy development. Will America snatch defeat from the jaws of victory? Yes, if the current leadership gets it's way.

All this will result in China's continued ascent and continued job losses in middle America. China's ghost towns are shiny and spectacular, America's ghost towns are sad remnants of a once great nation sold down the river for reasons a once great people don't really understand.

Will the world be better off with China holding the leadership mantle?