This is a continuation of the discussion of our housing bubble, the debt crisis and global developments as they change the long-term direction of our economy. The column is by David B. Prilliman, who is a principal with Professional Investment Counsel Inc. in El Paso.
During the G20 meeting in Japan last month, President Trump sat down with Chinese President Xi Jinping to discuss the trade dispute between the U.S. and China.
Both sides agreed to a temporary truce in the trade dispute and to restart negotiations.
The U.S. agreed to not impose an additional 10% tariff on $325 billion of Chinese imports, and the Chinese supposedly agreed to buy more U.S. agricultural products. The Chinese have not publicly confirmed this assertion, and while U.S. politicians have been claiming a victory for American farmers, the Chinese have kept quiet.
This is a common tactic used by the Chinese – promising something behind closed doors, and then refusing to publicly confirm the promised agreement in order to save face or possibly with the intent of reneging on that promise in the future.
So is this restart in the trade negotiations cause for celebration or is it just déjà vu all over again?
We have been down this road before where politicians and diplomats declare optimism concerning the trade negotiations and then are rebuffed with disappointment and setbacks.
The latest extreme example of this phenomenon occurred during the week of April 22 when politicians from the U.S. and China expressed optimism that a trade deal would be finalized in May or June of this year.
And then it became clear on May 5 that the Chinese were reneging on their promises and previously negotiated agreements. This essentially destroyed months of negotiations even though politicians were trying to downplay the overall impact.
The U.S. responded on May 10 by raising tariffs on $200 billion worth of Chinese imports from 10% to 25%. Naturally the Chinese responded on June 1 by raising tariffs on $60 billion of U.S. imports from 5% and 10%, to 10%, 20% or 25%.
Even though the U.S. and China have reached a truce after two months of uncertainty, there is no reason to believe the Chinese will act in good faith or that this truce is any different from previous ones.
To understand the Chinese position in the trade talks, one must first understand their future ambitions, which includes two primary goals:
• They want to transform their economy away from one that is driven by exports towards an economy that is “consumer-driven” where consumer consumption makes up a greater proportion of GDP.
• They want to become a global economic, political and military power going forward that rivals the U.S.
China will not budge on issues that directly impact these future ambitions, including forced technology transfer, the theft of intellectual property from U.S. companies and protectionist policies that favor Chinese state-owned enterprises at the expense of U.S. companies.
It is also the Chinese president’s desire to save face in front of the Chinese people and the world.
The giant hurdle standing in front of Beijing these days regarding both the trade negotiations and their future goals is the loss of momentum in their economy, which is growing at its slowest pace in 30 years.
While it is easy to assume this slowdown is due to the tariffs and a decline in exports, the primary cause is much deeper.
Basically, the Chinese economy is drowning in overwhelming levels of non-productive debt in the private sector, in state-owned enterprises and in local governments. Their banking system is also very fragile after years of poor lending practices and bad management.
Overall debt in China has quadrupled over the past 10 years. Initially, this extreme debt expansion was in response to the financial crisis in 2009 to provide a cushion and stimulate growth. The plan worked and China avoided the financial morass experienced by the rest of the world.
However, debt levels continued to expand in the ensuing years as the result of Beijing’s erratic management of the economy and the unrealistic expectations of investors, developers and local governments.
The ramifications of China’s excessive debt are beginning to show as bills come due and debtors are unable to pay.
For example, company bankruptcies doubled in 2018 over the previous year, setting a record. Corporate bond defaults hit a new record in 2018 – a rate that is five times the number of defaults in 2015. Defaults are growing at an even faster pace in 2019.
And then there are the developers and local governments that racked up trillions of dollars in debt to build their way to prosperity with lavish and unnecessary projects. Now many of these entities find themselves in a clutch since their grandiose projects failed to produce enough revenue to service the debt.
Examples of this excess can be found throughout China in the form of ghost cities and abandoned projects. Huge developments were built, but no one showed up.
It remains to be seen if the latest restart in trade negotiations with China will result in a fruitful conclusion. Based on China’s history of broken promises any new promises made should be considered suspect and taken with a grain of salt.
However, the slowing Chinese economy and the great wall of debt they face might alter their negotiation stance and force them to act in good faith. Only time will tell.
Email questions or comments to David B. Prilliman at firstname.lastname@example.org.