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Babies and the China Bubble

By Jonathan V. Last
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Walter Russell Mead has a typically incisive post about the economic problems rippling outward from China. He points out there are actually two issues here—China and the China Bubble:

China is a middle-income developing country bumping up against the limits of a growth model built on massive exports of manufactured goods. There are lots of bubbles inside China, largely because both national and local governments have pursued a mix of stimulative policies even as the health of the underlying growth model deteriorated. Massive over-investment in real estate, infrastructure and manufacturing capacity, overvalued stock prices and poorly priced financial assets have created an increasingly toxic and dangerous economic situation inside China, and a rattled government is doing its best to keep the system from imploding. The government is hoping to achieve a “soft landing” as China switches away from growth led by manufacturing for export to growth led by services and internal consumption. We shall see; China’s regulators and managers are skilled and have a lot of ammunition. But this is a difficult maneuver to execute and as Chinese society and the Chinese economy both become more complex, the task of running the country keeps getting harder. The China Bubble on the other hand is an international phenomenon. All over the world, the producers of commodities and manufactured goods have bought into the idea that Chinese demand is a perpetual growth machine. Producers of everything from cotton to copper to soybeans to silicon chips have assumed that double digit growth in China’s appetite for the components of its industrial machine will continue indefinitely—and they have invested to create the capacity to match this inexorably growing demand. From the jungles of Africa and the backwoods of Brazil to the rice paddies of Thailand and the Australian Outback there have been massive investments in mining, agriculture, energy production and infrastructure that assume continuing and even accelerating growth in Chinese demand. These investments, the excess capacity they represent, and the stocks and bonds dependent on these investments (both inside and outside China) are what the China Bubble is about.

Mead’s point is that these two problems are somewhat intertwined, but are more separable than you might think: Even if Chinese economists figure out how to transition out of fast-growth into a soft landing, everything downstream from the commodities bust will still be swamped. “The earthquake has happened,” he writes, “we are now watching the tsunami surge around the world. From Germany’s high tech capital goods export sector to the copper pits of Zimbabwe…”

There’s a lot going on here, from labor supply to commodities demand to currency manipulation. But underlying everything is China’s demographic reality: As demographers such as Nick Eberstadt have been warning for years, China’s One-Child policy has set rolling “a slow-motion humanitarian tragedy.” Because at the foundational level they’ve inverted the balance of their human capital. By enforcing a fertility rate far below replacement, China has ensured that by 2050 their population will be falling by 20 million people every five years or so and—more importantly—one out of every four Chinese citizens will be over the age of 65.

This means that both production and consumption in China will fall, exacerbating the China Bubble problems Mead discusses. But it also sets the stage for internal instability. China didn’t set up a pension system until 2000. It covers only 365 million people and even so, is underfunded by about 150 percent of the country’s GDP. Because of One-Child, very few Chinese have extended families. So who is going to take care of the China’s old people?

In What to Expect When No One’s Expecting I argued that because of China’s demographic problems, “Far from worrying about the Chinese economy overtaking America’s, or China becoming a regional hegemon, we should be preparing to manage a suddenly weakened and unstable China . . . a declining superpower with a rapidly contracting economic base and an unstable political structure.”

Since I wrote that, China has dismantled One-Child in a desperate attempt to come to terms with its demographic challenges. If they don’t succeed, then no amount of economic soft-landing management will matter much in the long haul.

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