Is China Headed for a Breakup Just Like The Soviet Union’s?

The Wall Street Journal article “The Coming Chinese Crackup” by Dr. David Shambaugh, a leading expert on China, forecasts that China may be heading towards the same political breakup the Soviet Union experienced in 1991 under Mikhail Gorbachev.

“China-watchers have been on high alert for telltale signs of regime decay and decline ever since the regime’s near-death experience in Tiananmen Square in 1989. Since then, several seasoned Sinologists have risked their professional reputations by asserting that the collapse of CCP (Chinese Communist Party) rule was inevitable.”

Dr. Shambaugh suggests:

“Consider five telling indications of the regime’s vulnerability and the party’s systemic weaknesses.”:

1. Many of the richest and most powerful citizens are making plans to leave China permanently. Some have already left the country. A large number have already transferred their wealth to safe havens.

2. Since becoming China’s leader, Mr. Xi Jinping, has arbitrarily increased political repression. The crackdown is severe compared to the tactics of prior leaders. One signal that he is not popular are reports that he recently changed his security detail.

3. A number of CCP’s leaders have signaled that they are not happy.

4. The extensive corruption continues which is corroding support for the CCP and Mr. Xi’s policies and actions.

“Moreover, Mr. Xi’s campaign is turning out to be at least as much a selective purge as an antigraft campaign. Many of its targets to date have been political clients and allies of former Chinese leader Jiang Zemin.”

5. The economy is not an unstoppable and powerful force. There are problems which are not easily fixed. “…economy that has slowed to its lowest pace in two decades.” My question: Will China experience the economic malaise Japan experienced?

Dr. Shambaugh’s conclusion:

“These five increasingly evident cracks in the regime’s control can be fixed only through political reform. Until and unless China relaxes its draconian political controls, it will never become an innovative society and a “knowledge economy”— a main goal of the Third Plenum reforms. The political system has become the primary impediment to China’s needed social and economic reforms. If Mr. Xi and party leaders don’t relax their grip, they may be summoning precisely the fate they hope to avoid.“

Based on my experiences managing a business in China, I see Dr. Shambaugh’s treatise as reasonable. I suggest adding the following intractable problems to the Sinologist’s lists of telltale signs of that may result in decay and decline:

• Servicing the massive debt China has incurred to support economic growth.

• Its hazardous environmental conditions.

• A number of its manufacturing operations are inefficient with knowledge, processes and productivity comparable to the USA in the 1970s.

Dr. Shambaugh is a professor of international affairs and the director of the China Policy Program at George Washington University and a nonresident senior fellow at the Brookings Institution. His books include “China’s Communist Party: Atrophy and Adaptation” and, most recently, “China Goes Global: The Partial Power.”

Follow-up articles:

BBC May 10, 2015 “China Cuts Interest Rates to 5.1%” – to stimulate economic growth

Bloomberg April 28, 2015 “China Is Set to Lose Manufacturing Crown”

Reuters’ April 15, 2015 “China growth slowest in six years, more stimulus expected soon”

Is China Facing a Growth and Debt Crisis?

"Will China Shake the World Again?” is a recent article written by Robert Preston. Preston is the Business Editor for the BBC. The piece discusses China’s ability to sustain its growth, manage its heavy debt positions and avoid a disaster equal to or greater than the 2007-2008 financial crisis

Preston believes China has an "unbalanced economy whose recent sources of growth are not sustainable.”

In 2007-2008 “…the Chinese government unleashed a stimulus programme of mammoth scale: £400bn…growth accelerated... But the sources of growth…have a limited life.” “…China's growth rate…really looking at 4%."

 “But what makes much of the spending and investment toxic is the way it was financed: there has been an explosion of lending. China's debts…have increased since 2008 from 125% of GDP to 200%.”

“…investing at that pace…it is a…certainty that much of it will never generate an economic return…debtors unable to meet their obligations…large losses for creditors; the question is not whether this will happen but when, and on what scale.”

Based on my experience working with operating companies in Shanghai and Guangdong, I have to agree. My expectation for China’s future is negative, as their potential for serious growth and continued competitiveness will prove to be very difficult.

Having inspected a number of Chinese owned manufacturing companies in mainland China, it becomes apparent manufacturing knowledge, processes, and systems are woefully behind the times. Contemporary manufacturing in China corresponds to the USA’s 1970 manufacturing capabilities.

Therefore, cost increases from higher wages and inefficient operations are to be expected. Also, unfavorable changes in currency valuation will be a factor. This will result in lower growth, employment and capital availability. This will make it far more difficult to service its debts and fund necessary initiatives.

Judging from my visits, the young and educated Chinese appear much more independent, aggressive and spontaneous. It may make its citizens more difficult to control. Social unrest could be a major issue affecting China's economic development as well.

Click on this link to read Mr. Preston’s article.

Here are some other posts on China:

Is China’s decline permanent?

China to surpass USA as World Leader in manufacturing?

Can Manufacturing Return to the USA?

4 Gloomy Scenarios

The US Economy continues to be unhealthy.  A review of various forecasts, suggests either a painfully slow recovery or future declines should be expected. One can never trust various predictions to be accurate, but there were four experienced voices who provided sincere concern.

Here is the first:

"The Hindenburg Omen reared its ugly head late last week, signaling more doom and gloom as stocks plod along amid the dog days of summer."

“Yes Folks, Hindenburg Omen Tripped Again” - Mr. Steven Russolillo

The second:

"The Dow Jones Industrial Average will lose about half of its value over the next couple of years as it follows a Nikkei-like pattern of several sharp rallies in an overall decline, according to Charles Nenner, founder and president of Charles Nenner research."

“Dow Faces Bouncy Ride to 5,000: Strategist” - CNBC.com

The third:

Some have predicted this continued deterioration of the economic climate.  Mr. David Farr, the Chief Executive Officer of the Emerson Electric Co., referenced a number of the circumstances contributing to this poor economy in an opinion piece from 2009.

Mr. Farr's Op-Ed is referenced here:
"An Op-Ed on Federal Spending and Legislation"

And finally the fourth:

Neuberger Berman’s MLB Group's 2nd quarter 2010 Economic Outlook is very thorough and well conceived.  It contributes positively with global investment opportunities as well as a potential Achilles' heel to the recovery. 

In these challenging economic times, it is worth a reading and can be accessed here:
"The World Is Still Upside Down"

Lenders Change their Treatment of Troubled Loans

An interesting recent Reuters article, titled 'Lenders More Willing To Own Bankrupt Firms', documents a fairly significant change in the distressed and bankrupt marketplace. Lenders, it reports, are no longer selling their delinquent and troubled loans. They are not selling the loans at steep discounts. They are converting loans to equity ownership and managing the companies themselves.

Reportedly lenders are “kicking the proverbial can down the street" by granting waivers. They are no longer forcing companies to default, or marking loans to market. This is quite unusual, as compared to prior practice.

Will this continue? Once the economy improves, will lenders focus on lending money? Or will lenders continue to be owners and manage the operating companies? Or will they return to selling troubled loans?

Bankruptcy and the Financial Crisis

On June 30, 2009 New York University held an excellent seminar on “Bankruptcy and the Financial Crisis".

The link to view NYU's webcast of the seminar is included below.

The subjects discussed included:

1. Federal government policy on large financial institutions and managing too-big-to-fail firms.

2. Creditor’s rights particularly reconciling Chapter 11 filings with section 363 of the federal bankruptcy code. Has anything changed in the distressed trading markets based on the handling of the Chrysler and General Motors bankruptcies?

3. Will a large bank fail? Actions the federal government will take if there are failures. Is capitalism affected and sacrificed to expediency?

4. Bankruptcy trends and risks – increase in distressed businesses.

The “Creditor’s Rights” panel:

• Moderator: Thomas Cooley, Dean, NYU Stern School of Business
• Barry Adler, Professor, NYU School of Law
• Edward Altman, Professor, NYU Stern School of Business
• Gerald Rosenfeld, Deputy Chairman, Rothschild North America

The keynote speaker: Thomas M. Hoenig, President, Federal Reserve Bank of Kansas City:

1. Mr. Hoenig rejected the notion that some firms are too-big-to-fail. He laid out a three-step plan to address troubled, large institutions and the need to avoid ad-hoc approaches.

2. He suggested that large firms be held accountable including replacing management.

The “What if a Large Bank is Failing?” panel:

• Moderator: Matthew Richardson, Professor, NYU Stern School of Business
• William Ackman, Pershing Square Capital Management LP
• Edward Altman, Professor, NYU Stern School of Business
• Micheal Krimminger, Special Advisor, Federal Deposit Insurance Corporation
• Nouriel Roubini, Professor, NYU Stern School of Business
• Myron Scholes, Chairman, Platinum Grove Asset Management

Click here to access the webcast link to NYU’s seminar.

2nd Follow-up to the Analysis of the Financial Crisis

Mr. Komal Sri-Kumar analyzed the Financial Crisis on October 31. It is his fourth webcast since October 3. Mr. Sri-Kumar is TCW Group’s Chief Global Strategist.

It is a meaningful, worthwhile analysis.

A summary of Mr. Sri-Kumar's views and forecasts:

1. The 4th quarter of 2008 will be the worst quarter with a 4% drop in GDP.

2. Is relatively optimistic in expecting the USA recession to end in the middle of 2009 because: “…the economy and stock market went down very fast…for the same reason the upturn will be equally rapid”.

The significant decline in consumer sentiment suggests a deep consumer recession. Does not see a depression risk. Expects unemployment to hit 8% or higher.

3. Federal Reserve should not have cut the interest rate by 50 basis points. It gave little stimulus to the economy. It was not the reason for the stock market increase. The stock market surged because the TED risk spreads have come down. The principal negative issue is the “liquidity trap” in that lenders are not willing to lend.

He suggests that direct to consumer stimulus is more important than interest rate reductions.

Does not see an inflation risk – including copper and oil. But he advises that the Federal Reserve will need to increase the interest rate in six months to avoid inflation.

Federal Reserve has ignored older people who largely rely on interest income for living expenses. An important factor to the economy.

4. As this webcast was prior to the Presidential election, he commented on both candidates and said the new President will not have much flexibility. Senator McCain cannot reduce taxes because of the sizeable budget deficit. President-elect Obama will not be able to increase taxes – particularly dividend and capital gains tax rates – because of the negative impact on economic growth.

5. Forecasts a $1 trillion budget deficit in 2009 which at 7% of GDP he views as manageable.

6. Continues to be bullish on equities. Is negative on Europe’s prospects. Expects equities to yield 9%-10% over the next 3 to 5 years. Forecasted 3% GDP growth and 2% inflation. Considers leverage dead.

7. Surge in the dollar has ended.

8. “What worries him most?” Policy maker errors. Not the economy. Not consumers. In September 2007 he predicted a recession. Federal Reserve and Treasury policy makers ignored the signs. “…will need to depend too much on policy makers”.

Click on this link for access Mr. Sri-Kumar’s October 31, 2008 webcast, approximate duration 60 minutes, expires January 31, 2009:

On October 15, 2008 a panel of economists at New York University gave a decidedly bleaker analysis of the financial crisis compared to the analyses Mr. Sri-Kumar has given.

Click on this link for a summary and access to NYU’s October 15 webcast:

Follow-up to Analysis of the Financial Crisis

Two weeks ago, I posted about Mr. Komal Sri-Kumar’s near calming treatise of the financial crisis provided on October 3rd. He is TCW Group’s Chief Global Strategist.

Mr. Sri-Kumar expects a 6 to 9 month Recession, with the stock market starting it's recovery in April 2009. He is rather bullish on equities, and does not believe we are heading into a Depression. Bearish on oil and bullish on the dollar: Oil $75, Euro $1.25, Gold $700.

However, last week I attended New York University’s financial crisis seminar. This Panel’s views and forecasts were decidedly bleaker than Mr. Sri-Kumar’s.

NYU Panelists:

• Dennis Berman, Deputy Bureau Chief, Wall Street Journal’s Money & Investing
• Mark Patterson, Chairman, MatlinPatterson Global Advisors LLC
• Nouriel Roubini, Professor of Economics, NYU Stern School of Business
• Lawrence White, Deputy Chairman & Professor of Economics, NYU Stern School of Business
• Moderator: Thomas Cooley, Dean, NYU Stern School of Business

The NYU Panel’s views:

1. Predicted that the worse is yet ahead.

2. The recession would last 18 to 24 months. The question is whether the recession will be V, U or L shaped. While the word “depression” was not used, the Panel described the economic recession as one of the worst since the Great Depression years.

3. Equities will decline further from current levels and will not have a meaningful recovery for perhaps two years.

4. Housing prices expected to decline further. Housing prices will not recover quickly and will reduce the net worth of consumers to such an extent that it will affect spending.

5. Expect consumer loan defaults and hedge fund failures to add to the financial crisis.

6. The bond default rate is currently at 3%. Its historical average is 4%. The Panel expects it to rise to 10% or higher with the possibility it could reach 25%. The covenant light and toggle loans will delay defaults and bankruptcies.

7. China’s funding the USA trade deficit will become problematic and may require higher interest rates and perhaps a political “quid pro quo” such as Taiwan.

Mr. Sri-Kumar and the NYU Panel are in agreement that:

1.The Financial Rescue Plan was not developed and implemented effectively. The solutions have come late to a problem that was obvious in 2007. The handling of the Crisis by officials world-wide undermined their credibility and the predictability of the Crisis which has exasperated it.

2. “Inter-bank lending” is a key variable.

Click here to access the NYU Panel’s webcast link. Seminar held October 15, 2008. Duration: 97 minutes.

Click on this link for a summary and to access Mr. Sri-Kumar’ October 3, 2008 teleconference call.

Analysis of the Financial Crisis

Mr. Komal Sri-Kumar, TCW Group’s Chief Global Strategist, gives a thorough, almost calming, treatise of the financial crisis in his October 3rd teleconference call.

It is worthy of review.

A summary of Mr. Sri-Kumar's content and conclusions:

Believes the two major reasons crisis came about:
1. Low interest rates in force for a longer time than necessary which encouraged borrowing regardless of qualifications or the ability to repay the loan.
2. Ineffective regulation.

Not heading into a depression. Disinflation is major threat, not inflation.

His expectations include being bearish on oil and bullish on the dollar: oil $75, Euro $1.25, Gold $700. USA recession starts 4th quarter 2008, 1st quarter 2009 and ends March April 2009 with the stock market starting its recovery. Recession will be worldwide. Bullish on USA equities. The $700 billion rescue plan may result in a profit for the Federal government.

Europe will continue to decline and will decline much steeper than other areas. Particularly affected will be the United Kingdom since 20% of its economy relies on the financial sector versus the USA’s 5%.

China’s GDP growth will be reduced perhaps to 7%-8% in 2009 compared to 2008's expected 11% with the complication that China has stopped trying to curb inflation and is striving for growth.

His presentation explores: When will this crisis end? Are foreign investments safer than investing in the United States? What areas of the world offer attractive investment opportunities now? The origins of the ongoing financial crisis. An explanation of what the rescue plan is intended to achieve.

The recording of Mr. Sri- Kumar's Conference Call is available for free to the public domain.

For the Digital Playback call:
Primary Playback Number: (888) 843-8996
International Playback Number: (630) 652-3044
Passcode: 22866500
Call available: October 3, 2008 - November 3, 2008
Broadcast on October 3, 2008 – duration 45 minutes.

Click here to get a copy of the PDF of his presentation.
(* It is not necessary to register on the web site to listen to the conference call, just call the 888#).