Publications

The Coming Chinese Financial Collapse

It is almost 85 years since the start of the Great Depression. That maelstrom is generally accepted to have been the worst worldwide economic crisis of modern times. Economic activity declined, national finances suffered, whilst millions of people became unemployed.

Macro-economics are rather better understood in 2014 than they were in 1929. Yet despite the best efforts of economists and governments, recessions cannot always be avoided even today. The Global Financial Crisis (GFC) from 2008, otherwise known as the Great Recession, demonstrates this. The world has still not recovered fully from that recession.

The GFC resulted from a number of factors, but the main precipitating causes were the collapse of the American house price bubble, the failure of related bonds (euphemistically known as “sub-prime mortgages” (SPM’s)) and the resulting loss of bank confidence and liquidity.

Before the GFC, American houses had been overvalued by some 30%. The Government had allowed essentially unregulated lending and property speculation. A collapse of the property bubble was inevitable.

When the bubble burst there was a swift decline in both house prices and demand for property. This depressed the US economy, causing further declines in spending, savings and house purchases. Newly unemployed people were unable to meet their mortgage payments, and lenders foreclosed on record numbers of properties, further depressing prices.

However, five years after the recession began house prices are well on their way to reaching pre-recession levels, and economic confidence has been largely restored in the USA.

The depth and duration of any recession depends on a number of factors, one of the most significant being pre-existing economic imbalances in the countries affected.

In the GFC, the American people and economy suffered primarily due to the collapse of the property bubble. In parts of Europe over-exposure to American financial instruments – themselves linked through SPM investments to the American property bubble – was often the major problem. In other counties high levels of pre-crisis debt was the major factor in deepening and lengthening the crisis. Heavily indebted countries could not afford additional spending to stimulate their economies when the recession hit.

As bad as the GFC was, a far worse world financial crisis is imminent. Unlike the Great Depression and the Great Recession, both of which were caused by American economic mismanagement, this one will emanate from Communist China.

China has had a burgeoning economy ever since the Communist regime began tentative liberalisation in the early 1980’s.

Free enterprise has expanded from being almost non-existent to dominating the economy. China now produces much of the world’s consumer goods. This has generated unprecedented personal wealth. The Chinese people have become for the first time consumers of luxury goods and have surplus funds to invest.

Communist China is in many ways not a good place to invest, for either locals or foreigners. Corruption is ubiquitous, the regime is tyrannical and mercurial. Bank interest rates are very low, investing in business is bureaucratic and difficult. For many people investment in real estate is the only realistic option. Accordingly since the 1990’s many Chinese have invested in property.

Despite reforms, China’s economy is centrally planned and remains structurally weak. Political imperatives and corruption influence, and often undermine, prudent economic management. Regional and local Communist Party bosses are required to report sustained economic growth and progress. Authorities are under pressure to show impressive economic growth in their regions. This is most readily achieved through the authorities undertaking building projects, using borrowed funds. A booming property market, fuelled by individual Chinese investing their surplus funds, further encouraged local authorities to invest in massive building projects.

Consequently much of the impressive economic growth occurring in China since the 1990’s has been in building and construction. For a number of years 50% of all building work carried out worldwide has occurred in Mainland China. China consumes more than half of the work’s steel, coal and concrete production, 45% of the world’s iron, 25% of the refined copper and aluminium, and 16% of the world’s nickel. These statistics are often reported as if they are desirable. They are not.

The construction boom was not caused by demand from occupiers of apartments, shops and offices, but by demand by investors and political imperatives. This demand has led to the building of virtual Potemkin cities. There are vast numbers of poor quality apartments being built that will never be occupied.

Although a phenomenal 50% of home owners in many Chinese cities own an investment property in addition to their own apartment, only a small percentage of these “investment” properties are actually occupied.

There are now some 65 million empty apartments in China, enough to house 200 million Chinese.

Yet millions of urban Chinese remain living in slums. Nearly half of all migrant workers still live in dormitories or on worksites. They cannot afford to purchase or rent the new apartments. Although China remains largely a third world country, apartment prices for sale and rent are set at first world levels. The apartment owners cannot reduce the rents they are asking, as this would reduce the “value” of the apartment to a more realistic level. They prefer to leave them empty and cling to the illusion that they own a valuable asset.

From one-quarter to one-third of all apartments in the average Chinese city are empty and will never be occupied. Many cities have built new suburbs that are almost entirely empty. According to Citigroup, 12 provincial capitals are building an average of nearly 15 “new towns” each. There will be very few inhabitants for any of these massive and costly projects.

Most notorious of the many newly built ghost towns is the city of Ordos, in China’s Inner Mongolia. This white elephant was built at a cost of US$161 billion. Intended to ultimately house one million people, it now has housing completed for 300,000. Yet it has only 20,000 to 30,000 permanent residents. It will never be more fully occupied, being far from places of work. Soon it will be abandoned and reclaimed by the surrounding desert.

Other local authorities have built thousands of commercial and office buildings, many of which remain empty. The largest shopping mall in the world, the New South China Mall, is 99% empty, ten years after opening.

Unfortunately the unfettered and pointless construction boom continues. More and more unneeded apartments are built every year, despite the absence of tenants, and the near impossibility of on-selling to owner-occupiers.

An unprecedented building bubble has occurred in China. It is very largely artificial, and enormously wasteful.

This construction boom is the largest waste of wealth and resources that the modern world has ever seen. But the results are not simply the squandering of financial and material resources, and the destruction of the environment.

Even in a centrally-controlled dictatorship, there will be a day of reckoning. The economic fundamentals are too wrong. There will inevitably be a major adjustment.

Unfortunately the consequences of this illogical economic policy are dire. The correction will be painful. The American property crash, which caused a five year international recession, was nothing compared to what the Chinese crash will be like. Apartment prices will not fall 30%, and then recover, as they did in America. They will drop by 75% or more, and remain low permanently.

The loss of this nominal “wealth” will be massive. There are 50 billion square metres of apartments in China. The average price of an apartment is US$1,700 per square metre. A 75% decline in apartment values will result in a reduction in household wealth by some US$60 trillion.

The 80% of urban Chinese who own their own apartments will see a massive decline in their equity. Half of the population of many cities will see both their own apartments and their “investment” apartments drop in value, wiping out their illusory wealth. They will be forced to lower rents to market level to attract real tenants. Many of the presently empty apartments may be occupied, but rents can only be a fraction of rentals asked until now.

The decline in residential property values will be matched in the commercial and industrial sector.

The coming property market crash will cause a major drying up of both domestic spending and investment. There will probably be a complete cessation of overseas investment. China’s economy will immediately fall into a deep recession.

China will be lucky to avoid a much worse recession than that of the 1930’s.

There will probably be social unrest on a scale unmatched even during the Cultural Revolution of the 1960’s and early 1970’s. The Tiananmen Square protests of 1989 will be nothing as to what may be seen.

The Communist regime will quite possibly fall, and as it falls there will be further chaos, and possibly war.

Many crumbling dictatorships start a war to try to bolster their position. In this case Beijing would probably choose to invade the Republic of China in its dying days. That risks war with the United States.

Meanwhile, the sudden collapse of the Chinese economy will have major repercussions for the rest of us. To a significant extent China is now the factory of the world. When that factory’s lights go out, the world economy will suffer a major blow. It will be plunged into another global recession, probably much deeper than the GFC. As bad as the last five years were, the next recession could be much worse.

The only glimmer of hope is that other countries will benefit from the enforced introduction of import substitution, replacing cheap Chinese imports. Those countries whose manufacturing base has not yet been lost to China will be the least affected.

This coming crisis was entirely preventable. A competent government would not have fostered a wasteful speculative boom. The Communist regime is the source of its own misfortune. Unfortunately many millions of innocent people worldwide will suffer the consequences of their mismanagement and folly.

By John Cox

Text copyright Paratus Defence Analysts and Consultants Limited 2014

 

Sources:

“Building Rome in a day. The sustainability of China’s housing boom”; A report from the Economist Intelligence Unit’s Access China service; 2011; http://www.excellentfuture.ca/sites/default/files/Building%20Rome%20in%20a%20Day_0.pdf

“The Fallout From China’s Property Downturn”; Sara Hsu, The Diplomat; 9 May 2014; http://thediplomat.com/2014/05/the-fallout-from-chinas-property-downturn/

The emperor’s new clothes?; HSBC, Week in China; 25 Apr 2014; http://www.hsbcnet.com/gbm/global-insights/week-in-china/2014/the-emperors-new-clothes.html

“Ordos: The biggest ghost town in China”; Peter Day; BBC; 17 March 2012; http://www.bbc.com/news/magazine-17390729

“Great Leap Backward. Here’s why a China housing crash would crush the middle class—and why that matters”; Gwynn Guilford; 4 April 2014; http://qz.com/195574/heres-why-a-china-housing-crash-would-crush-the-middle-class-and-why-that-matters/

Housing Trouble Grows in China. Overbuilding by Real-Estate Developers Leaves Smaller Cities With Glut of Apartments; Bob Davis and Esther Fung; 14 April 2014; http://online.wsj.com/news/articles/SB10001424052702303456104579487790125203828

“Double bubble trouble. China’s property prices appear to be falling again”; 22 March 2014; the Economist; http://www.economist.com/news/china/21599395-chinas-property-prices-appear-be-falling-again-double-bubble-trouble

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Publications, Ukraine

Russia Confirms Invasion of Crimea

Paratus Monograph 33: Russia’s Campaign Medal Confirms Invasion of Crimea

 

Russia has acknowledged invading Crimea.

Russia’s Vladimir Putin had consistently denied that his country had invaded the Ukrainian Autonomous Republic of Crimea. His official position has been that the people of Crimea had revolted against a fascist regime in Ukraine, and requested annexation by Russia. Russia had no responsibility for the events in the republic.

The facts do not support that denial.

Under the terms of agreements between Russia and Ukraine, Russia was permitted access to Sevastopol, and the right to maintain naval forces there, until 2045. The agreements provided that Russian military forces in Crimea would respect “the sovereignty of Ukraine, observing its laws and permitting no interference in the internal affairs of Ukraine”.

The 1994 Budapest Memorandum was the international agreement which underpinned the elimination of Ukraine’s nuclear arsenal. In return for giving up its nuclear weapons, Ukraine received security assurances from the USA, UK and Russia to protect Ukraine’s sovereignty and territorial integrity. The parties agreed not to use economic or other coercion or aggression against Ukraine, and agreed to assist the country in the event of outside aggression.

For several years Russia has been using economic coercion against Ukraine, in direct violation of the Budapest Memorandum.

On 21 February 2014 the corrupt president of Ukraine, Viktor Yanukovych, fled the country. This was welcomed by the majority of the people of Ukraine.  Even members of Yanukovych’s own party voted to disown him. The Ukrainian parliament, the Verkhovna Rada, voted 338:0 (out of 447 deputies) on 22 February to set new presidential elections for 25 May. Parliament did not purport to remove Yanukovych, as is widely but incorrectly reported. It did pass a resolution that declared that Yanukovych “withdrew from his duties in an unconstitutional manner“, which he clearly had done, and voted to elect Oleksandr Turchynov as Chairman of the Verkhovna Rada and acting President and Prime Minister of Ukraine.

Shortly afterwards an extensive and well-organised Russian propaganda campaign began. The change of leadership in Ukraine was represented as a violent fascist coup by anti-Russian extremists. It was falsely suggested that Russian speaking residents of Crimea, and eastern Ukraine, were in danger.

In early March euphemistically described “pro-Russian militants” seized the Crimean parliament (the Supreme Council of Crimea), and other government and police buildings, set up roadblocks and besieged Ukrainian military and naval bases in Crimea. A leader of a tiny pro-Russian neo-Nazi group, Sergey Aksyonov, was “elected” prime minister of Ukraine by members of the Autonomous Republic’s parliament who were being held at gunpoint by the “militants”. It was widely believed, but never proven, that many of the ”militants” were actually Russian special forces.

Simultaneously Russian naval vessels prevented Ukrainian ships from leaving or entering port; and Russian marines and special forces assisted the pro-Russian militants to secure government installations. Large numbers of additional Russian troops entered Crimea. Whilst Russia claimed that these troop movements were consistent with theBbases Agreements, they were not. Not only did the incursion of additional troops violate the provisions relating to the numbers and movement of troops, but the purpose of their operations violated the fundamental commitment not to interfere in the internal affairs of Ukraine.

A referendum on annexation by Russia was hastily organised by the de facto government of Sergey Aksyonov. This resulted in an overwhelming vote for annexation. This result was not a surprise, due to a boycott by almost all opponents of independence, strident official pro-Russian propaganda, and vote-rigging by the new regime in Crimea.  Following the vote, Russia almost immediately annexed the Autonomous Republic of Crimea.

It is clear that Russia had orchestrated the disorder and takeover in Crimea, and was directly responsible for the events leading up to the referendum. It had violated its commitments under the Budapest Memorandum, the Bases Agreements, and at international law to protect the sovereignty and territorial integrity of Ukraine, and not to interfere in the internal affairs of another country.

Ironically even if Russia had not been responsible for these events, it was still breaching its international commitments by annexing Crimea.

In a scene eerily reminiscent of Adolf Hitler visiting Sudetenland in September 1938, Vladimir Putin visited Crimea in May 2014. At a military parade in Simferopol World War Two veterans were joined by veterans of the “Liberation of Crimea“.  The new veterans sported a fresh medal, issued by the Russian Federation’s Ministry of Defence. This is inscribed “For the return of Crimea 20.02.14 – 03.18.14.”

If Russia was not directly involved in the seizure of Crimea, why was a campaign medal issued?  The issue of this medal by the Russian Ministry of Defence confirms Russia’s involvement in the annexation of Crimea, and that this was an official military operation.

More important is the dates on the medal. 20 February 2014 was the day before Viktor Yanukovych fled Ukraine, and before the Verkhovna Rada voted to appoint an acting president.

The issue of an official campaign medal has undermined Russia’s claim that it did not invade Crimea. Not only does the medal official effectively recognise that an invasion occurred, but it supports the supposition that the planning for that invasion began even before Russia’s corrupt ally Viktor Yanukovych fled Ukraine.

 

Text copyright Paratus Defence Analysts and Consultants Limited May 2014

 

Sources:

The Online Debate Over A Mysterious Russian ‘Medal’; Radio Free Europe Radio Liberty; 24 April 2014; http://www.rferl.org/content/the-online-debate-over-a-mysterious-russian-medal/25361367.html

Putin’s Crimean Medal of Honor, Forged Before the War Even Began, Will Cathcart, The Daily Beast, 25 April 2014; htttp://www.thedailybeast.com/articles/2014/04/25/putin-s-crimean-medal-of-honor-forged-before-the-war-even-began.html

Kyiv Post; 26 April 2014; http://www.kyivpost.com/content/ukraine-abroad/the-daily-beast-putins-crimean-medal-of-honor-forged-before-the-war-even-began-345284.html

Vladimir Putin makes triumphant visit to Crimea as “20 separatists killed’’ The Telegraph; 9 May 2014; http://www.telegraph.co.uk/news/worldnews/europe/ukraine/10820873/Vladimir-Putin-makes-triumphant-visit-to-Crimea-as-20-separatists-killed.html

Parade Ignores Carnage; New Zealand Herald, 11 May 2014; http://www.nzherald.co.nz/world/news/article.cfm?c_id=2&objectid=11253015

 

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