China's Collapse Is Here - And It Will Be Brutal!

Japan’s Still Not Back To 1989!

Japan’s primary stock market index (the Nikkei 225) peaked in late 1989 at almost 39,000. 30 years later, the closest the Nikkei has come to that level was 33,772 in July of this year. Please let that sink in. Investors from 1989 have not even come close to recouping their initial investment – after 30 years!

I bring that up because everyone was terrified of Japan overtaking the U.S. in the 1980s, touting their growth, industrial prowess, intellectual property theft, domination of export markets, low interest rates & cost of capital, and their government-directed industrial policy.

If that sounds familiar, it should – because we have been hearing the exact same things about China for the last 10 years.

Japan’s issues stem largely from bad investments that resulted from its industrial policy (investments in soon-to-be-obsolete industries like DRAM chips and shipbuilding), and its excessively low rates (that created a real estate bubble among other things).

China Is Much More Precarious Than Japan Ever Was!

China’s problems dwarf Japan’s, and here are just a few.

  1. DEMOGRAPHICS. Peter Zeihan reminds us often that China has the fastest aging population in world history, largely as a result of its “one child” policy that prevented the births of 400 million people. This is extremely serious because there will not be enough new workers to support the vast number of future retirees, and there will not be enough workers to supply the labor for the economy in general.
  2. LACK OF INNOVATION. China’s industrial policy focuses on scale, cheap labor, and intellectual property “borrowing” as opposed to development. As a result, they are falling farther and farther behind in a world where innovation is everything.
  3. WAY TOO MUCH BAD DEBT. China’s total debt (consumer, corporate, and government) to GDP ratio is 300% – one of the highest levels in the entire world. Worst of all though is that much of that debt is tied to massive real estate Ponzi schemes that encouraged hundreds of millions to pour their life savings into “ghost city” developments that will never be filled. Enormous property developers are again missing debt payments, sending shock waves through the world’s financial markets. There are likely TRILLIONS of dollars of bad loans held by Chinese banks.
  4. OUTDATED MILITARY. China has a 2 million-man army – which is formidable. BUT – as we are seeing in Ukraine, technology is now the driver of victory and China is way behind on the tech front for the reasons described in Item #2 above. In addition, China lacks a large “blue water navy,” (large ships and aircraft carriers capable of patrolling anywhere) so it can’t hold open its trade routes or defend itself on open seas.
  5. DICTATORSHIP. This is something Peter Zeihan points out often too. China’s one-man/one-party control stifles freedom, innovation, and effective decision-making at every level – which always destroys economies (see North Korea, Venezuela, Cuba, Soviet Union).
  6. BROKE/NO RESERVE CURRENCY. China is currently broke and its currency is crashing. In addition, it does not have the ability of the U.S. to borrow because it does not have a reserve currency like we do and investors do not trust China either.
  7. YOUTH UNEMPLOYMENT. China’s economy is slowing down so much right now that its youth unemployment numbers are skyrocketing. And few things destabilize a society more than large groups of wayward young people without jobs.
  8. ECONOMIC WEAKNESS. The numbers coming out of China right now are abysmal. This is something macro analysts of all stripes are focusing on now and it is why I am blogging about China in general. I blogged about China as recently as May (Is China’s Collapse Imminent?) but am hitting it again because the collapse clearly seems to be starting. Exports and imports are way down, and China’s entire manufacturing sector is on the ropes. Jeff Snider has been all over this, as have many others.

William Galston published this op-ed today in the WSJ, expressing similar concerns: Is China Past Its Peak?

China’s Collapse Will Result In Lower Rates – But Be Careful What You Wish For!

China’s collapse will likely result in much lower interest rates – which could be a boon for those of us in the mortgage and real estate industries, as I point out often. But all will not be good.

  1. Less demand for real estate. This is probably the least of our concerns, but if massive Chinese demand for North American real estate dries up, prices could fall.
  2. Far weaker world economy. The world benefits tremendously from China’s economy, despite its threat to American jobs and much else. One of the primary causes of the 1930s depression was a huge “tariff bill” that pretty much halted world trade. Seeing China pull out of the world economy will have similar adverse effects.
  3. More expensive goods. The prices of goods in general have plummeted over the last 30 years primarily because of China’s rise. Without China’s scale and cheap labor, we will see prices rise.
  4. Saber rattling. This is the most terrifying aspect of this, and something Kyle Bass is sounding the alarm over again and again. When countries face severe economic hardships, their leaders often threaten or start wars to prevent their citizens from noticing their economic problems. Examples include Japan and Germany in the 1930s, North Korea … always, Argentina in the 1980s, and Russia recently with Ukraine.

I suspect the U.S. might be doing more than we realize to help China, despite our enmity, because so many major investors (BlackRock, Vanguard, Tesla, Apple, Ray Dalio, etc.) are tied so closely to China. But – many analysts can’t see how China will climb out of its mess no matter what we or China do.

In any case, this is just one more reason why I expect rates to fall and why I don’t think a “soft landing” is in the cards.

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