China contagion. Exporting crisis and why they won’t recover for years

Part 1. China’s governance system

China’s People Operating System is regionally decentralized, the relationship between the people and the government is a “principal-agency” model.  It is organized as a unitary form in a three-tier hierarchy:

1. Central government

  • Controls major decision making and authorizes appointments, advancement within the China Communist Party, etc.
  • Since the economic reforms, China adopted policies to “loosen and stimulate the economy” and implemented fiscal revenue sharing
  • Provincial governments enter into contracts with the central government on the total amount or share of taxes and profits revenue to be remitted, provincial governments will keep the rest

2. Local governments

Execute resolutions and decisions of the People’s Congress and the Standing Committee of the People’s Congress at the local level, as well as decisions and orders from the upper-tier government. 

  • Local governments are residual claimants to local revenue and have incentives to maximize local revenues by protecting local enterprises. It is a tournament.
  • It is (very) difficult to find the truth. The process of transferring information from the bottom up the decision-making pyramid is complex and requires reporting at each level with compounding points of failure. 

3. Citizens 

Have no effective monitoring system by which the public can supervise the behavior of local governments.

  • They must endure territorialism, departmentalism, and the fragmentation of authoritarianism.
  • High economic inequality has weakened its immune system, it is unstable

Part 2: Effects of crises on citizens 

China’s rush for economic growth, its lack of accountability and propensity for corruption have allowed disasters to become crises. 

When in crisis, the regular completion of rituals is imperative and it is utilized to transmit a perception of compassion, stability and optimism, the continuance of governing and determination in the face of uncertainty.

  • In a liberal democracy, a crisis has the potential to remove the incumbent regime or its leaders, however, there are other politicians or parties that can take their place.
  • In China, a crisis threaten the entire one party regime. A loss of legitimacy can have a cascading effect, leading to spillover in all areas the Chinese Communist Party is involved in.

Part 3. Industrial Accidents and Weather

2008 Sichuan earthquake

  • 87,000 people dead or missing
  • 370,000 injured
  • 5 million left homeless

Journalists and forensics accountants looked at the financials of the earthquake response…

  • Over $12b dollars in goods and services were donated to quake victims in the year after the 2008 Sichuan quake.
  • In 2009, researchers at Tsinghua University revealed that 80% of charitable donations after 2008’s Sichuan earthquake were funneled into Chinese government coffers as “extra revenue“.

2017 Guandong Waterways. 470,000 tons of untreated sewage was intentionally discharged into rivers in the provincial capital of Guangzhou, China’s third-largest city, with a population of over 14 million.

2005 Songhua River benzene spillBenzene is a chemical used as a solvent and cleaning agent. 100 tons was released into the Songhua River after explosions at a petrochemical plant and reached Harbin’s water supply, a city of 4 million.

2015 Tianjin warehouse explosions700 tons of sodium cyanide were released. 115 firefighters and police officers died.

2008 winter storms: 78 million people, 14 provinces, autonomous regions and municipalities had been totally blanketed

2016 June and July floods147,200 houses destroyed. 21,000 square miles of farmland went under water, a size equivalent of Massachusetts and Vermont combined.

Part 4: Coronavirus

January 2020 Coronavirus epidemic emerged and spread quickly from China’s Wuhan City, in the Hubei Province

February 7 the coronavirus became a crisis within China. The approach to relief was shifted, adopting a system called Counterpart Assistance:

  • FROM aid dispersal from top-down command by the central government
  • TO counterpart assistance in which the authority for resource allocation is delegated from the central government to local governments

Part 5: Counterpart Assistance

The level of economic development and resources are unbalanced in China, it is a defining feature of “two overall situations”.

Counterpart Assistance was incorporated into the Chinese system in the 1970s as policies in which designated developed regions use their fiscal revenue, agricultural resources, human capital, technology, etc., to provide support to lesser developed, resource poorer recipient regions.

Counterpart Assistance is an administrative downtime that bypasses institutional barriers. It is easy to initiate, but inferior to a centralized system in solving for externalities such as corruption among local contractors, etc.,

Part 5: What happens next to their economy?

Let’s also skip lively away from precision, discussions of trade and product families, supply routes, pharmaceuticals, shipping, logistics, diversions, knockdowns to Vietnam, and such. I’ve written about it elsewhere and your patience is not inexhaustible, neither is mine.

China’s stores and factories may shut down, but the clock still ticks. Businesses must still pay debts, with nothing coming in. They have to pay wages — otherwise, what will people do to buy food? People have to make mortgage payments and rent, likely with no income coming in. Left alone, there could be a huge wave of bankruptcies, insolvencies, or just plan inability to pay the bills. A modestly long economic shutdown, left alone, could be a financial catastrophe.

China has no pandemic financial crisis plan that can forestall bankruptcies that were already being forestalled, without causing a new massive downstream crises. There is no mechanism that floods China with morally hazardous money in the right spots but not in the wrong spots of  dastardly corrupt provinces. 

Some additional 2nd to 100 degree orders that will radiate outward, and inward. Monetary policy is about 10th order and the level of overnight rates about 100th order.

1. Dutch disease occurs when a large number of external resources flow into an area. 

  • The influx of Counterpart Assistance will draw human and material resources to the non-tradable sector related to the resource, causing wages to increase.
  • Because they operate within a competitive global market, the tradable sectors (such as textile factories) cannot adjust quickly to product prices and workers’ wages through market supply and demand.
  • As a result, workers shift to the non-tradable sector, causing the tradeable sector to lose export competitiveness in the market.

For example the building materials such as for hospitals are bricks, cement. To service this industry are restaurants, barber shops, and other non-tradeable sectors.

2. Yuan devalue China has to initiate a liquidity and stimulus package in the next few weeks in March and April. This will be a pain that lingers on the exchange rate.

Lets go back in time to August 2019 when China’s central bank coerced its currency, the renminbi (RMB) to weaken to 7 RMB (to the U.S. dollar) offsetting the effects of US tariffs,  the lowest its traded since 2008

  • As a result of the band-aid, the pricing power of Chinese firms in export intensive industries suffer negative price growth and even more so by lowering wholesale prices to counteract U.S continuing tariffs.
  • As pricing power weakens, they still need to pay interest on debt and also increasing wages due to internal inflation/food prices
  • The devaluation increases the credit risk of Chinese corporate debtors who have cash flows and collateral mainly denominated in RMB but have borrowed from foreign lenders and counterparties in US dollar-denominated debt. $650b of this matures +/- 2020
  • The faster devaluation occurs, the more debtors will seek to convert their RMB into dollars in an attempt to limit their losses = a rapid drainage in China’s foreign exchange reserve

3. Local provinces will bleed out as they are caught between fiscal stimulus and their own budget deficits. Revenues in 11 provinces contracted year-on-year in the first half of 2019 and revenue growth deceleration in 12 other

4. Shadow banking risk inventory. Long story short, it’s massive and I’m tired. 

5. China’s Exim Bank has a cash crunch and can’t meet its obligations. As it’s a bit complex, this post is helpful Beware the China Exim Bank – 8 countries with bilateral relationships with China along Belt and Road path

6. Belt and Road clients such as Pakistan experience road blocks. This post about Pakistan: China Pakistan Economic Corridor (CPEC) debt and you. Explained

7. Social instability abroad comes home from China’s extraction economy all over the world. This earlier post is about China’s digestion of Bolivia 

8. Social instability internally. A type of co-morbidity, this point will explain China’s Social Credit System and this one explains that Hong Kong is contagious. Hong Kong. An update with questions answered

My work here is done.

The end?