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U.S. House Prices Analysis and Trend Forecast 2019 to 2021

China Part 2: Path To Regaining Face, Reclaiming Middle Kingdom Status

Politics / China Jul 09, 2016 - 01:43 PM GMT

By: Raymond_Matison

Politics

Potential War as Agent of Change

Geopolitics in the late 1960s and early 1970s were dominated by considerations of the Cold War.  The Soviet Union and The Peoples Republic of China were staunchly communist in their conviction and actions.  The United States understood that these two powers when united represented a formidable enemy.  Utilizing a brief period of policy difference between Russia and China, President Nixon sought an opportunity to split the interests of these two communist countries, and managed in secret to arrange a meeting with Mao Zedong in 1972, which ultimately led to China’s leaning to the West.  , That action was purely based on geopolitical considerations, and no design or underlying concept of trade between the two countries was evident at that time. 


Potential for war between capitalists promoting democracy, and communists with its central planning totalitarianism was ever present.  China’s early history of conflict attests to the fact that they fully understood the strategies, intricacies and nuances of war.  Wikipedia notes that Sun Tzu, a Chinese general and military strategist, who lived in the same time period and Confucius, had written a book “The Art of War” that covers all the aspects of conducting successful warfare. This timeless book has been also guidance and inspiration to some modern generals including General MacArthur.

Henry Kissinger in his book “On China” quotes a paragraph from the Art of War where it states: “The skillful strategist defeats the enemy without doing battle, capture the city without laying siege, overthrows the enemy state without protracted war.”  In other words, one part of Sun Tzu’s war strategy is to achieve a position of such strength or dominance that the adversary recognizes futility in conflict and the winner essentially avoids war completely.  As China grows in economic and military strength and “regains face” from its “century of humiliation”, this concept is necessary to keep in mind.  It is very likely that Sun Tzu’s military principles will be practiced by China in the not too distant future with the United States as the U.S. tries to maintain world hegemony.

Diversion from Communist Central Planning

Reversing Mao Zedong’s policies, Deng Xiaoping, a leader brought back after Mao’s death, rejected Mao’s economic policies and emphasized what seemed to be working.  In Martin Jacques book “When China Rules the World”, the author notes: “They were painstakingly meticulous in the ways that they sought to introduce reforms by a gradual process of constant testing and trial and error. The state, in the time-honored Chinese fashion remained at the heart of this process of reform, even though the latter was to involve a major contraction in its economic role, with the share of government revenues decreasing.”

To stave off starvation, in the early 1960’s an experiment allowed individuals to have what were called “responsibility fields” - which permitted farmers to control planting, growing, and harvesting of produce on small individual plots of land.  This program became so successful that over the next decade it was instituted nationwide. The communist leadership was learning as to what worked, and they were ever so slowly willing to make changes to their communist dogma.  We need to remember that after the closing of universities and discrediting of professionals, experts and intellectuals in the 1960s, China was ruled by essentially uneducated and inexperienced dogmatists of the communist order.

Historically and culturally the people of China were used to one party rule and likely were accepting of any form of government as long as it improved their lives. John Bryan Starr states:  “The Chinese Communist Party has as little political credibility today as it has ever had since its founding in 1921. It came to power in 1949 with a tremendous reservoir of popular support.  It added to that reservoir with reforms it undertook in the early 1950’s that soon lost credibility with a series of misguided movements undertaken at Mao’s insistence that had disastrous consequences for the Chinese people.”

Henry Kissinger in his book “On China” quotes Deng Xiaoping:”The people, he said, needed to be given a stake in what they produced.  Consumer goods had to have priority over heavy industry, the ingenuity of Chinese farmers had to be liberated, the Communist Party needed to become less intrusive, and government would have to be decentralized.”

Perhaps in his most memorable phase Deng Xiaoping had said that “it does not matter whether the cat is black or white as long as it catches mice”.  He understood that China needed higher education, technology, investment, production and a connection with the outside world from which China had been shut off under Mao’s leadership.  Xiaoping had proclaimed that “poverty is not socialism”, and started a “revolutionary” program that he called “Socialism with Chinese characteristics”, which supported individual initiative, opened free markets and allowed foreign investment.  By 1987 another leader, Zhao Ziyang emphasized that “China was on a complicated and very long course of meshing capitalism with socialism”.  Some years later western economists were referring to this economic system as “state capitalism”.

Early Economic and Political Consequences

Such dramatic economic reforms for a communist-led country seem incredulous, and understandably fostered hope for diminishing centrally planned control in the political arena as well.  This ultimately led to demonstrations at Tiananmen Square in Beijing, which likely were a result of both a small minority of Chinese people’s popular demands for political reform, and covert U.S. efforts to democratize the country.  Robyn Meredith in her book “The Elephant and the Dragon” notes:  “China’s tiptoeing away from communism was as momentous as any revolution.  In 1989, China stunned its own people, and the world, when it violently repressed the peaceful protest.  As China crushed a political revolution in the public square, Deng and his cadres pressed their economic revolution forward. Democracy remained out of the question, but for Deng and other Communist Party leaders, it was worth killing thousands of Chinese in order to continue the nation’s march toward capitalism.”

Subsequent to Nixon’s meeting with Mao there were numerous high level State Department members, notably Nixon’s Secretary of State Henry Kissinger, who in seeking areas of common interest led to trade, education, and investment programs - which eventually exceeded anyone’s expectations in coming years.  Robyn Meredith writes: “…between 1978 and 1984, rural Chinese saw their incomes rise by 15% per year on average.  They still lived on less than a dollar a day, but it was a vast improvement over the four cents a day they had somehow scrapped by on before.”  By 2010 Chinese per capita income had risen above $4,000 per year.

China assiduously followed all strictures to qualify for membership in the IMF and World Bank.  When it was accepted as a member in 1980, loans and investments started to flow into China.  While Hong Kong provided more than one third of such investment, Taiwan did not hesitate to invest as they saw China embrace free trade in earnest.  Currently total foreign investment approximates $2 trillion, with more than half of China’s goods produced through firms representing foreign investment of multinational firms.  Accordingly, foreign nationals dominate the country’s exports, while perhaps nearly a quarter of China’s banks is said to be owned by foreign investors.

Effects of China’s Trade and Economic Development

Over the next two decades, as trade mushroomed between China, U.S. and the rest of the world, its low cost labor force produced goods which depressed price inflation in advanced nations, created millions of jobs for untrained Chinese labor, and also produced a huge annual trade surplus for China that was largely reinvested in U.S. Treasury securities.  In effect China, by purchasing U.S. Treasury securities, was financing and facilitating America’s pernicious slide into overwhelming debt.  Another way to look at it was to understand that our “quantitative easing” stimulus program in reality was simply printing money to pay for the goods that China’s people and factories produced, and supported America’s own welfare  and entitlement programs. 

Understandably, now there are negotiations between the U.S. and China, as manifested by China’s inclusion into the International Monetary Fund’s reserve currency, as a means for China to maintain value of its $1 trillion plus hoard of dollar currency assets. Overall, China had to find ways to protect its total over $3 trillion accumulated trade surplus of various currencies.  With all currencies declining in value purchase or investment in foreign resources became the reasonable solution.

Taking into account its decades-long evolution in economic, financial and political spheres, China is regaining its historical status as a leading civilization/country. It is also re-embracing its historical Confucian philosophy, now adding to it the anti-colonialist pillar of military strength.  Henry Kissinger’s observations on China’s reversion to its philosophical and cultural roots provide cogent future policy guidance: “Still with all its achievements, Mao’s insistence of turning the ancient system upside down could not escape the eternal rhythm of China’s life.  Forty years after his death, after a journey violent, dramatic, and searing, his successors again described their now increasingly well-off society as Confucian.  In 2011, a statue of Confucius was placed in Tiananmen Square within sight of Mao’s mausoleum- the only other personality so honored.” 

Given China’s growth of its economic, scientific and military capabilities, it is no surprise that China is creating a new and significantly different world order than that since 1990, when the collapse of the Soviet Union left the United States as the world’s single super power.  That world will reflect Chinese and interests, priorities, and cultural values.

Modern Infrastructure, Military, and Financial Institutions

The Chinese had learned in the 19th century that they were militarily inferior to industrialized nations of Europe.  This lesson was learned by Mao, and he built up their military; but this lesson has not been forgotten by its subsequent leaders.  China will aspire to build its military strength to the level of its perceived cultural superiority and its increased economic means.  Its manufacturing trade is paying for its vast internal infrastructure buildup which includes railways, roads, shipping ports, airports and entire presently nearly empty cities. Notably, until rates declined to near zero territory, interest on their US held Treasury debt provided more than enough income to completely pay for China’s annual military program.

Last year, the BRICS nations comprised of Brazil, Russia, India, China, and South Africa, confirming that imitation is the sincerest form of flattery, launched a competing set of institutions to the International Monetary Fund, and the World Bank. Apparently they felt this was necessary because they had little policy influence or voting representation with these U.S. controlled institutions.  Their Asian Infrastructure and Investment Bank (AIIB) and the New Development Bank (NDB) are rapidly gaining members and are likely to become a favorite for non-western world countries.  They are also likely to get as members that long list of countries which have suffered under previous loan renegotiations with the IMF or World Bank. 

Over the last several years, China has also been investing its substantial trade surplus in foreign resource, energy, and manufacturing opportunities. It has made notable investments in Africa, Iran, Brazil, Venezuela, Ecuador, and Peru.  With Iran and several South American countries applying for status in the AIIB, it appears that the familiar BRICS acronym should be renamed CRISIS (China, Iran, South America, India, South Africa).

Adding to China’s rapid buildup of financial institutions is their China International Payments System (CIPS) which will not only allow settlement of trade among member countries avoiding dollar use, but will also make sanctions related to exclusion from the western SWIFT settlement system mostly irrelevant.  This solves member countries trade settlement issues, without needing to make the renminbi fully convertible.  This sage strategy deprives unscrupulous countries or international currency speculators the ability to commit raids on their currency.  Arguably when their currency does become fully tradable, it will be at a time when China feels comfortable in defending their currency, or it might be because it may be linked or backed by gold.

In ongoing developments, China and many East Asian countries have formed and expanded their trade organization ASEAN to include Japan, India, Australia, and New Zealand.  China is being increasingly accepted as a constructive, supportive and fair trading partner in a combined grouping that exceeds 3 billion people.  Noteworthy is the fact that these countries have excluded the United States from its membership.  Accordingly, the U.S. is promoting the Trans-Pacific Partnership as a means to increase its formal participation in trade with Asian or East Asian countries.  This program is meeting increasing resistance in the U.S., as citizens rightly worry about losing U.S. sovereignty due to its globalist trade agreement terms.

England’s galleons of prior centuries provided the means of conducting trade and delivering goods. Long land routes were difficult, or impossible and highly insecure. China is now developing that secure delivery means over land by building its Silk Road “One Belt, One Road” project which envisions a modern land railway and road route between China and Europe.  In that process China will also expand regional cooperation with the Eurasian Economic Union.  Containership sea routes will still be important, but this project will bring trade to places heretofore inaccessible to efficient transport.

Since such deep and dramatic institutional changes take years to plan and implement, some must have been envisioned decades ago.  Still Henry Kissinger in 2011, when his book “On China” was published felt comfortable in stating at that time: “American export controls are now essentially irrelevant because China already possesses most of the technology it needs to become a comprehensively industrialized power and will soon have an agricultural, industrial, and “post-industrial” economic base of its own – in other words, it will no longer be reliant of the products or the goodwill of other nations.”  However, it is with the elevation of Xi Jinping as China’s leader in 2013, who has engaged more leaders of foreign countries than any of his predecessors that China’s programs have accelerated and moved rapidly toward achievement.

Credit Based Growth of Collapse?

The very near meltdown of the Western financial system in 2008 gave warning to the world that neither the U.S. nor Europe is immune to its own, seminal financial crash.  Now with England’s vote to exit the European Union decided, signaling instability and possible disintegration of the EU, investors will have good reason to focus greater attention to the rise of China, Russia, and the East Asia axis.

Many of the world’s countries, or some groupings, haves been in competition to devalue, or to follow the United States example of QE (quantitative easing) which expands money supply.  The United States has used its credit and money expansion largely to pay for entitlement or social programs.  China has used its credit and money expansion to build infrastructure and manufacturing facilities. 

U.S. credit and dollar currency expansion has produced many undesirable consequences for the rest of the world.  An abundance of dollars found them being used for speculation in derivative and currency markets, which severely damage currencies of other nations with equally devastating effects on their economies. It has also prompted or required other countries to print and expand their own currency base, which has resulted in counterproductive inflation in their economies.  Unconstrained sovereign credit has created too much debt and currency in almost all countries, which unfortunately not only has been used also as a weapon disrupting many parts of the world, but is itself in abundance destabilizing.

Market pundits have pronounced that China’s huge credit expansion of the last decade and its coming contraction from massive loan defaults will cause a severe economic crisis with an attendant market crash.  Other pundits note that China’s double digit growth over the last thirty years will continue even if with a somewhat slower rate, and that its market will be heading higher.  The pundits are right!  Yes, actually both are likely to happen. 

First, no economic or social activity grows in a straight line. Second, pundits expecting high single or low double digit growth rates for China to continue in the future obviously have no understanding of the power of compound interest over a long period of years. One should not expect to see high rates of economic growth rates for China to continue.  Lower rates of growth, yet higher than elsewhere, will suffice to make their economy admired and investment market attractive over the long term.

It is not China’s financial system that may implode, it is the global system.  That implosion may start in Europe, China, U.S., with the banking system, or elsewhere.  It has been clear for many years that such an implosion based on unsustainable global credit expansion and currency wars will take place, and that China, in addition to every other country in this interconnected world will, at first freeze up or collapse. The recovery will require that countries once more earn their national incomes from manufacturing, agriculture, and trade paid with new sound money.  Infrastructure, business regulation, population growth, emphasis on education, welfare expenditures, and precious metal backing of money are the most likely and important determinants of future prosperity.  In this regard, the mature developed countries no longer appear to have any advantage over China.

Despite China being a complex combination of socialism and capitalism, while ruled by the Communist Party, still has no official national wealth redistribution – pension or health programs, except for government workers.  Americans earn ten of more times per hour than the hard-working Chinese; if the world has become interconnected, America worker wages are at greater risk to decline.  The Chinese people are used to hardship, Americans no longer.  Despite its authoritarian one party rule it is developing infrastructure and institutions which enhance the well-being of its people. By contrast America has produced prolix regulation with high tax rates which stifles business and initiative.  So it will be interesting to see how Europe, China, and the United States compare in the recovery of the coming global economic and currency crash.

Regained Face, Center of the World

In the last several months news media has announced a number of interesting Chinese  milestones and projects: 1) China announced Sunway TaihuLight as the world’s fastest computer which was build entirely with Chinese components, after the U.S. denied it Intel’s fastest microprocessors.  Its theoretical peak performance is 124.5 petaflops, compares to America’s fastest computer, Titan whose performance peaks at 27 petaflops,  2) The Chinese government orders 1000 heavy transport aircraft, the Xian Y-20, that can deliver 66 tons of arms or soldiers at a range of 3,230 miles, 3) China is developing the DR-ZF hypersonic missile that can travel at speeds exceeding Mach 5, which can carry nuclear weapons, and seems almost unstoppable,  4) It has announced a stated goal of sending a mission to Mars within the next five years, 5) It has listed and sold through London Stock Exchange a 3 billion yuan ($458 million) three year bond issue in renminbi in global markets.

China by its economic, scientific, educational, financial, infrastructure and military build- up has already announced, without a formal press release, that China has recovered face, and terminated its century of humiliation.  China has regained its long ago held advanced civilization status.  China would not back down to both Russia and the United States decades ago when it was economically and militarily weak.  In 1991 Chinese leader Jiang had insisted to Henry Kissinger “We never submit to pressure.  This is very important.  It is a philosophical principle.” Jiang elaborated with defiance revealing a latent disquiet: “The great People’ Republic of China will never be bullied, the great Chinese nation will never be humiliated, and the great Chinese people will never be conquered.”  Given China’s development in all spheres since those statements were made twenty five years ago, it really does not require genius to figure out that China will decide its own, future independent path that it will take – without ever again being intimidated by other powers. No more loss of face or humiliation.

With China’s re-embracing its Confucian principles of virtue, unity, and enlightened governance, it will not be a source of war with America or the rest of the world.  More likely, it will use its characteristic infinite patience and Sun Tzu’s war principles to continue to build its economic, scientific, and military strength whereby they will be able to reassert their dominant civilization status without reverting to physical war.  There is little doubt that China will dominate its portion, and have a great influence on the rest of the world in the future.

China now has a historic opportunity to share its Confucian cultural wisdom with the rest of the world.  At a time when the developed world is increasingly embracing socialism and taking from workers to redistribute income to those who would not or cannot work, China is distancing itself from communism and encouraging a form of socialism whereby individual entrepreneurship is rewarded. 
As of 2016, China is ruled by its Communist Party, traditional authoritarian one party government, which has made individual, troublesome bankers and booksellers disappear.  So there is some disparity between the idealist version and realist experience of present government tolerance or enlightenment.  In its idealist version of virtue, unity and enlightened governance it can be an inspiration to the rest of the world, which in recent decades has experienced a deficit of these traits.  The reality version of paternal Chinese government still leaves room for it to practice a greater level of Confucius inspired compassion.  But with patience and time, this too may come.  Nonetheless, China’s amazing political and economic reform over the last few decades and overall achievements should provide inspiration and lessons for the rest of the world. The loss of face is recovered, and humiliation turned to pride.

Raymond Matison

Mr. Matison is a U.S. patriot who immigrated to this country in 1949. With a B.S. in engineering physics, an M.S. in Actuarial Science, work in the actuarial field, and as a financial analyst at Legg, Mason Inc., Lehman Brothers, and investment banking at Kidder Peabody, and Merrill Lynch provides a diverse background for experience.  First-hand exposure to fascism, socialism, and communism as well as the completion of a U.S. Army military intelligence course in the 1960’s have inspired a continuing interest in selected topics in science, military, and economics.  He can be e-mailed at rmatison@msn.com
Copyright © 2006 Raymond Matison - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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