Did the Dragon Get its Timing Horribly Wrong

by July 14, 2020 0 comments

Even before the Covid 19 catastrophe, the USA was doing everything economically possible to lose its multiple battles to the Chinese. Its dollar hegemony was getting steadily eroded as segments of trade were steadily moving out to multiple other currencies. President Trump was succeeding in antagonizing most global leaders, he was under attack at home, his trade war with China had hurt economic growth for most economies, and his domestic ratings were dropping. What made emperor Xi Jinping decide that 2020 was the year that he dethroned the USA and establish the RMB as the new reserve currency is the world?

Let’s see if some forecasts of economic parameters for 2019 and 2030 by a few American think-tanks make sense. They projected that in Purchasing Power parity terms, in 2019 the Chinese GDP was already larger than the USA’s GDP and by 2030 it could be up-to 70% larger. As a share of Global output China would grow to 32% from 20% currently, as opposed to the USA declining from 16% to 10%. In terms of Global Market Capitalisation the Chinese would grow to 25% from 5% in 2019, whilst the USA would decline from 40% to 18%. China’s share of global exports would rise to 18% from 12% whilst the USA would be static at 8%. The above forecasts were supported by massive Chinese investments in Education in the fields of Mathematics, Science, Technology, Medicine and rapidly improving the quality of education. The number of STEM students would outnumber the USA by a factor of five times. Chinese ranking in Fintech is number 1, Wearables , Virtual Reality, Education Tech, Autonomous Driving is 2, and in Artificial Intelligence they are a close third behind the USA and UK. 34% of the world’s unicorns are Chinese as opposed to 47% for the USA, but in terms of market capitalization they were on par.

Starting with the 1980’s the Chinese had successfully got the world’s manufacturing supply chain to relocate to China, and were truly the “factory of the world”. From a pure labour arbitrage offering, they created world class infrastructure (Cities, Roads, Ports, Airports) to support it. The top 2500 corporates outside China all had a business presence in China. This aggressive export led growth model allowed the Chinese to radically improve per capita income, and in the process also create a massive domestic consumption engine. A 40% domestic savings rate supported the huge developments that happened on their Eastern Seaboard. Till 2012 the Chinese government was sitting on Foreign Exchange Reserves of close to $5 Trillion. Over time Chinese labour had become a very skilled workforce, moved up the value chain and was no longer cheap. China now imported/consumed 45-50% of virtually every commodity in the world even though more than half of it was re-exported.

Chinese leaders till 2012 had made the country keep a low profile , hiding their strengths, whilst they relentlessly gained market share from the world. Asian growth engines Japan and South Korea had also felt compelled to move/make tangible manufacturing investments in China. The Chinese had mastered the skill of acquiring the world’s IPR ‘s by any means-true implementers of Chanakya-Niti(sama, dama, danda, bheda). Their Chinese Communist Party(CCP) command and control structure had also silently expanded their Foreign Ministry with requisite resources to create a Public Relations repository in every major country, to manage the national discourse on any prickly subject in their favour. This three decade profile started changing with Xi Jinping’s ascension to Chairmanship in 2012.

The Chinese strategists now started believing that the Middle Kingdom deserved to rule the world. They changed the nomenclature of the 21 st. century being an Asian century to a Chinese century. They mapped that post 2008 Global Financial Institutions were weakened, substantially dysfunctional and lacking leadership. They unleashed a project of achieving complete Chinese dominance in the manpower of every multilateral agency and United Nations body in the world. Chinese students were encouraged to study overseas and many persuaded to join these organizations, and as so many FBI investigations are now showing made instruments of Government policy.

The collapse of the USSR in the 1990’s and the profligacy of the US financial sector in 2008 had left a leadership vacuum in many areas. Xi Jinping moved rapidly to occupy the vacancies. China needed to secure its supply chain as it neither produced adequate food for its population, nor was endowed with  manufacturing or energy raw materials. Chinese leadership wanted to avoid supply side shocks and created strategies to acquire assets surreptitiously. They moved rapidly to fund every country and project that the World Bank or rest of the world would not find viable. The Chinese wanted to eventually acquire the underlying asset and default was hence a preferred option for them. This juggernaut covered 150 countries and nearly $5 Trillion in loans/investments. The new Chairman had successfully
over-invested the Chinese USD reserves, and left his country very vulnerable. They desperately needed their Dollar engine( Foreign Direct Investment, Foreign Portfolio Investment, and Foreign Currency Loans) to keep firing quickly to recoup their position, or alternately fast track their long term vision to get global trade out of the dollar and into the RMB.

Unluckily for the Chinese two things changed the landscape in 2017. President Trump had won the US election and was a wildcard that the Chinese read wrongly. Secondly the world economy started topping out, and growth started stalling. The Chinese engine was not designed to handle economic contraction. Fault-lines in the domestic economy led by huge non performing loans in domestic State Owned Enterprises. Ghost cities started appearing, as domestic demand stalled, whilst domestic real estate started going belly-up. The country was overbuilt and no more infrastructure spending was needed. Trump started the trade war and insisted that the Chinese reduce the Trade surpluses. President Xi erred massively in not giving Trump a cheap victory, and getting the Americans riled.

American strategists had clearly war-games that the days of the USD hegemony were numbered, and if their political dominance was to be extended, a war with China was not an option, the only question was timing. By a strange coincidence the two technology hardware giants USA and China were tangibly dependent on Taiwan for their Semiconductor underbelly. Taiwan has a dominant share in the Semiconductor foundries globally, and both the USA and China are dependent on them. The Americans had anticipated this and a JV with the Taiwanese would go operational in Arizona in 2023. Till then any military threat to Taiwan would be an attack on their technology dominance, an intolerable thought for them. Democrat Presidents had soft-pedaled on the One China policy, and the Chinese had succeeded in getting away with their wish-lists. The Americans had celebrated access to a large consumption market, but landed up creating a rival.

The Chinese People’s Liberation Army(PLA) in manpower terms is the largest standing armed force on the globe. The PLA and CCP moved fast to upgrade weapon systems, stealing blueprints and buying where they could not .Theoretically they are a lethal strike force. However the navy is their Achilles heel, and they lack best in class aircraft carriers and submarines. This limits their ability to protect their interests spanning 150 countries.75% of Chinese oil still moves in tankers through the narrow Malacca Straits. To reach the Arabian sea by land they invested in a bankrupt Pakistan by constructing the CPEC which links Xinjiang to Gwadar Port and is a dedicated economic corridor. They also engaged east European and European countries to construct the Belt and Road Initiative (BRI) for creating dedicated freight corridors to 50 European cities. In the process they have de-risked their trade supply routes, but their oil buy routes lie exposed.

The nightmare for China achieving dominance is that Indian land illegally occupied by Pakistan is being used by CPEC and India reacquiring POK by use of military power could render their $66 Billion investment in Pakistan useless, blocking oil supply. The Chinese realized that economic sanctions against Iran had crippled the proud country, that it had 15% of the world’s oil, needed investments, and so decided to bust sanctions on Iran imposed by the United Nations (they were party to imposing them). China and Iran signed a 25 year Trade and Military alliance in June 2020. China has bet on the USA exiting Afghanistan in 2020, and by using the Pakistani’s to install a puppet regime in Afghanistan, they could take a pipeline from Iran to Xinjiang. In turn the Chinese have to pump in the equivalent of $400 Billion into Iran’s development, which they can crank their RMB economy to deliver. Where does that leave the Pakistani’s?

In the interim President Xi got the CCP to appoint him as the leader for life and emerged as an emperor. The CCP decided that by its 100th anniversary in 2021, they would stamp themselves as “numero uno” in the world. A few pinpricks remained. Taiwan and Hong-kong as independent democracies were an eyesore, and raised aspirations of good life in mainland Chinese youth. They had to be acquired by coercion or force at the earliest. The South China sea had $4 Trillion of supply chain that transited the route. China laid claims to territories/islands of all its neighbours and started constructing artificial islands as missile bases. They started bullying and humiliating Australia since 70% of Australian mining exports were bought by China. Singularly none of the Asian countries could take on China, but many could exact a heavy toll if it came to conflict. The Chinese flirted with conflict with all their neighbours using “wearing down” tactics.

The success of this gambit hinged on the continuity of their trade with the USA, heavily skewed in their favour. President Trump not getting an early trade war win, upped the ante, imposing a $250 Billion annual hit on China. Chinese perhaps felt that US corporations would not listen to their government and continue business as usual. They floated a trial balloon by abrogating the agreement with Hong Kong which would have lapsed in 2047, and suppressing protests with brute force. Then they ostensibly colluded/ manipulated the WHO and unleashed the Covid 19 pandemic on the world infecting every country on the planet. This collapsed world economies and has created a very strong anti-China sentiment.

It has resulted in fast tracking the creation of the Quad, an alliance of the USA, Japan, Australia and India to take on the Chinese. UK, France and Israel are openly in support of the Quad, whilst Vietnam, Myanmar, Philippines, Indonesia ,Taiwan and South Korea have alerted their armed forces for battle readiness. In the Chinese camp are North Korea, Pakistan, Iran and Turkey with anti-India squeaks emerging from Nepal, Bangladesh and SriLanka.

With China designated as world enemy number 1, even Joe Biden has ratcheted up the anti-China rhetoric, lest President Trump steal the thunder and a potentially lost election by a war with China before November this year. The Indian and Chinese armies are facing off across 3400 Km. border, and a tense peace prevails currently. The Middle East has so far stayed quiet, but by default will have to choose sides as a Shia Iran and a Sunni Pakistan and Turkey side with the Chinese. It is an uneasy time for the Saudi’s and the UAE. It is ironic that the OIC and its 54 member countries including the” Turkish caliphate” maintain a studied silence on China incarcerating nearly 3 million Uyghur muslims in Xinjiang, and possibly Chinese money silences their conscience when no Uyghur child can have the name Mohammed(as per media reports).

The Koreans however had seen this coming two years earlier and Samsung had moved an $18 Billion annual capacity out of China to Vietnam. Japan has incentivized its corporations to exit China totally. India has banned Chinese Telecom equipment and Apps with immediate effect. There is a very strong anti-Chinese imports movement starting in India, and may set an example for the world to follow. China’s partners in BRI and in Africa are resenting the usurious conditions in their loan agreements. The Americans are shutting off access to their Capital markets to the Chinese, and cancellation of the Hong Kong treaty will kill the USD supply route to China. The Chinese Balance of payments is negative for the last few months, and days of surpluses are now a memory. They still need to buy food and oil and commodities.

Even nature seems to have conspired to ruin Emperor Xi’s timing. China is being ravaged by the worst ever floods in the last 100 years with 29 of its provinces impacted, and the survival of the showpiece Three Gorges Dam under threat from heavy rain which could affect nearly 400 Million people as downstream cities including Shanghai could be impacted. Scams like fake Gold collateral has shaken China’s $5 Trillion Shadow banking industry as the Kingold default is by a powerful former CCP member. It also puts a question mark on the credibility of China’s domestic gold production which is part of its National Reserves, as to how much of it is gold plated copper. Will anyone in the world now ever trust a Chinese certification of gold. This scandal has seriously damaged China’s plans of having a partial gold backed alternate currency to replace the dollar.

The silent spectator in the entire game is Russia. They are happy selling their weapon systems to China, India and Turkey. In the EU, the Germans have broken ranks with France and chosen to placate the Chinese. They have removed Taiwan’s flag from their website and refused to criticize Chinese action in Hong Kong, leaving a non-state flag of Palestine intact .It is ironic that this once proud industrial giant is now subservient to a regime with ambitions very similar to Hitler. Early days but it signals the cracks in the EU, and are its days as a common market nearing a close?

The world now sits on a powder keg in the midst of the Covid crisis. Funnily it is China’s 150 debtor countries (especially Pakistan) that must be praying for a fall and dismemberment of their Lender, for them to escape losing their sovereignty which they have so negligently mortgaged. President Trump and Emperor Xi now have gone too far for either of them to back-down without losing their crowns. For Trump it’s just an election, but the world knows what happens to deposed Chinese dictators. The South Asian countries all want Tibet to regain its independence after being annexed by the Chinese in 1950 so that they all get their fresh water security back.

The Chinese till the last four years maintained an inscrutable long term game plan in every sphere and slowly and steadily acquired a position of dominance. It is inexplicable that with chips falling in their favour by default, why did they have to speed up the time table. The USA was busy scoring self goals, and vacating its global presence, and in five years would have handed the Chinese global dominance on a platter. Thus the trigger to the timeline was not a global prod, but very compelling domestic reasons. China’s banking regulator has advised domestic banks to be prepared for sharp rises in bad loans once the Covid moratorium period is over. It has guided banks to conserve capital by not paying dividends and bonuses. Three Chinese banks have collapsed in the last three years, and 15% of the Financial sector is supposedly past a high risk stage. Tax revenues have grown under 5%, and budget deficits exceed 11%. In the Hebei province (population 70 Million) bank depositors cannot withdraw their own money
without genuine reasons to prevent a run on the banks. The season of discontent for 1.4 Billion Chinese has arrived.

China created the BRI to use the surplus capacity in its construction materials and equipment sector, and to keep Chinese labour occupied. Experts estimate that this project needs another $ 5Trillion over the next five years to complete it. The money given to 150 countries cannot be recalled. The Hong Kong door may be closed by the Americans if push comes to shove. The FDI and FPI flows post Covid may flow outwards. China’s $10 Trillion foreign debt is realistically supported by $2 Trillion of reserves. With Balance of Trade going negative, even diehard Chinese supporters are a highly nervous lot. If China’s trading partners do not agree to settlements denominated in the RMB, a run on the currency is highly possible.

The dilemma for the Xi led CCP is what do they tell their domestic audience. In the age of the internet, you can censor but not hide. News spreads like wildfire with every citizen carrying smart-phones. Do the Chinese need to beat the war-drums to transfer the blame for their miscalculations. The world scenario is evolving every week, and 2020 threatened to be a very long year indeed.

Sanjit Paul Singh (Managing Partner S&S associates)

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