What will happen in the next five years? China growth’s evening and the continuation of American century

Time flies!

Almost eight years ago, I made the following predictions for the five years after that time:

http://xlpartners.blogspot.com/2011/09/on-money-so-far-and-longer-term-5-year.html

http://xlpartners.blogspot.com/2012/01/review-and-preview.html

n. China will face sharp slowdown in growth in five years (say from 10% to 3%) for many years to come

n  Related emerging markets and commodity producers will suffer as well.

n  HK’s housing price will drop substantially

n  Chinese people may not suffer in their satisfaction

n  The world will not come to an end with the slowdown in China’s growth

n  Eurozone will not survive in the current form

n  The U.S. will become stronger in relative terms if it can get the political act together

I have explained the reasons why I predicted a sharp China growth slowdown from 2011 in my blog (http://xlpartners.blogspot.com/2014/11/3.html Chinese version; http://xlpartners.blogspot.com/2014/11/why-did-i-predict-chinese-economy-to.html English version). Before these posting, I have presented these reasons in many executive and MBA classes and practitioner meetings.

The predictions are almost all correct during this horizon with almost perfect timing. Before 2011, I have never predicted a turning point of slowdown in Chinese growth. As I predicted in 2011, there has been a significant return wedge between the U.S. equity markets and emerging markets and commodities.

From early 2016, there has been a bull run in all the markets around the world until January 2018. But other than the U.S. equity, pretty much all the risky assets of equity and commodity markets have faltered since then, with some dropping close to the low levels reached in early 2016. So what are likely to happen in the next five years?

In June 2018, I made most of the following predictions on my WeChat blog about the five years going forward from then. What will happen in the next five years is likely to be a continuation of what have happened from 2011 to 2016, especially the next year or two. The trend of slowing Chinese growth has not finished. The U.S. growth will not be significantly affected from now but the risky assets in the U.S. and the world may drop significantly.

I will also refute many common misconceptions of both Chinese and Western elite (not mentioning the laymen), including the many so called academic and professional MACROECONOMISTS. In the last decade or so, the dominant majority of them had little idea about the direction of the world or Chinese economy as seen in their own records. However, even if they are right, in reality they have little influence on the course of the Chinese economy, given the political and economic system and reality in China. In China, the entrenched interest just do what they prefer.

So here are the predictions:

·       The world still underestimates the extent of coming China slowdown. The slowdown is real however the Chinese government manipulate the statistics, and this trend will enhance and eventually conclude itself. China’s future is at best Japan, as I have always predicted since 2011. China will become a much smaller portion of world economy in the coming decades.

·       The Chinese housing bubble are finally reaching its peak given that some demographic experts that I believe have updated estimate their predicted peak population has come earlier in 2018-2019 instead of 2022-2023.

·       The world still underestimates the long term strength of the United States after a long ten year bull run in both USD and U.S. assets. This is despite the fact that the coming U.S. economic recession, if any, will probably not be very deep. In the foreseeable future and the whole 21^st century, the U.S. will still be the largest economy and sole superpower in the world. But this probably won’t spare the U.S. equity markets from a deep drop.

·       Most risky assets of equity and commodities will drop to at least around the low point reached in early 2016 before the bear markets are over, including the U.S. equity markets. Shanghai index will drop to at least 2000, and the small and medium companies will drop a lot more. Chinese Enterprise index could drop to 700s. S&P could drop from 2900s to 2000s or even 1600s. Emerging markets will lead in the bottoming process.

·       China’s slowdown is not a cyclical story as many believe. It is a one way street. The growth will not reach the current levels again and will be much lower and reach 0% in the very long term. This is the key to debate about the asset prices of emerging markets and commodities and about how world will look like in this century.

·       How strong and how soon the bull market in emerging markets and commodities afterwards depend on how complete the Chinese economy has finished its adjustment to a much slower growth level and whether there are some large emerging markets experiencing fast growth.

·       The Sino-American military conflicts that I was concerned is unlikely. Being behind the U.S. militarily by decades, and becoming relatively weaker and older, China won’t pose military threat to the U.S. even in Asia. But the Sino-American conflicts will be long lasting.

I will explain the reasons for these predictions below. I also clarify many wrong believes of the Chinese and Western elites.

The fate of Chinese economic growth slowdown is already written on the wall in 2011, and even after early 2016 when the Chinese government tried another round of huge increase in leverage and housing price. The Chinese government should have used some mild stimulus to smooth the inevitable drop in economic growth. As I mentioned in 2011 and afterwards, the earlier they slowed the economic growth, the better off the country would be in the long run, and there will be more resources to help households enjoy a better life. The huge stimulus and housing price increase in 2016 and 2017 result in a sharp bounce in all risky assets such as equity all over the world and commodities. This also made many believe that universal economic rules do not apply in China. The drop in risky assets from early 2018 is just a continuation of the initial drop between 2011 and 2015 after the huge intervention by the Chinese government from early 2016.

The Chinese government has engaged wasteful investment to secure a targeted GDP growth rate for so long that it does not have the resources to achieve the target any more given how big the Chinese economy and particularly the investment scale have become and how low the return the investment have. It has to resort to faking numbers to reach the targeted GDP growth rate.

Many people in China blame the current administration in China or the trade war by Trump about many economic ills. This is wrong and unfair. The slowdown is inevitable for a country with the institutions and growth model of China or for most every country that have grown to the current stage of income level. The long delay just made it even worse. At the same time, the trade war has already started long ago during Obama administration, and it is inevitable given China’s trade practice. However bad, such practice is rational for China.  

Many people in the West start to worry about China’s rise in the last decade, and the concern intensified and reached more people a couple years ago. I have long predicted and observed this inevitable conflict and have advised all people I met to come to America for the longer term if possible due to the inevitable economic slowdown and the inevitable conflicts between China and the U.S. Trump is not and probably cannot do much more to China than Obama. As I have said a long time ago, Obama was uniting the world to exclude China from the rest of the world supply chain through TPP and TTIP. Trump gives up all the progress that Obama made and tries to fight the world, in particular China. The U.S. elite have already recognized the economic and political issues of trade with China a long time ago before Trump came to power. Trump just yelled with a big mouth, as he always does, which may be stupid from a strategic point of view. And China’s slowdown and relative weakening are mostly due to its own failing, not due to the trade war.

Whatever the outcomes, one thing is clear. The U.S. will try every means to force global supply chains out of China. As long as the U.S. has the market and consumers compared to China, this dramatic change in supply chain will happen. Although no one single other country may replace China but a group of smaller countries can certainly take over. Vietnam is just the start. The trend was in motion for a while already given the increased cost in China, but now it probably will become irreversible. With the slower growth and being somewhat taken out of the global supply chain, China’s economic weight in the world will shrink. In addition, the bigger concern of Sino-U.S. military conflicts may fade as China slows down and get old dramatically.

Many, including Yifu Lin, suggest that focusing on manufacturing upgrade help stabilize the economic growth at the current high levels for a long time. This is impossible. At the current economic development stage of China and given how large a glut of supplies China’s manufacturing has already created in the world, China cannot reply on manufacturing to grow its economy any more. Growing through service is the only way forward and it also entails much slower growth.

The common perception held by so many that the younger generations in China are less ambitious and lazier, which leads to slower growth, is wrong. There was much more room to grow at the beginning of the reform so success was easier. People don’t even have enough to eat so they have to work hard. After they have a decent living standard, the Chinese government still use the growth model of sucking up households with reduced social safety net, which forces households to work harder. By now, many Chinese households have much more wealth and income than before and they also devote much of that to their kids. There is no need for their kids to work as hard and there are many important things other than ambition and wealth in life. Of course in return, if you marry their kids, you marry the parents and siblings, and possibly the whole extended family, because kids are also treated as an investment for retirement as the developed countries before they had their social safety net.

Is it still possible for China to become the largest economy? Yes. They are relatively close to that goal. The reasons of the failing that are mostly self inflicted. If the Chinese government can change the growth model of sucking up households through all the channels I have mentioned since 2011 and transfer wealth to households, there is some hope of China becoming a developed country and the largest economy. But it is almost impossible anywhere for the entrenched interest to give up what they have voluntarily. There is a low likelihood of peaceful rebalance of the interests of different classes in a system as in China. Without a healthy and growing domestic market, along with the deteriorating demographics, China’s growth potential will be constrained significantly and China won’t have enough clout of the domestic market and consumers over the other countries to become a superpower to compete with the U.S. Of course, there is always an alternative in China. The National Bureau of Statistics can always report whatever growth so that China has the largest economy if the Chinese government insists. But how many would believe it.

Will China become such a miserable place with the much slower economic growth? Not necessarily. Even without fast growth, it is possible that China will become a more livable place with some conveniences afforded by its big cities that the West does not have for now. Of course most of the convenience means that you have to give up privacy completely. But that is a Faustian bargain that many people would make. That would mean a very strong autocratic country, especially regarding to their own citizens, and make the Sino-American conflicts lasting for a long time.

Will China become an economic wasteland overall? Unlikely. Many industrial areas will fade into history and disappears as population shrinks. The same happened to many developed countries. However, with the help of America and Pax American system protected by America, China has already become an industrialized nation. That is the most important giant step for a nation in economic growth, just like Industrial Revolution is much more important than any technology revolutions afterwards. Unless China screws up internally big time, which happened almost every time when dynasties switch and the population could shrink up to 90%, there is no turning back in the economic development level.

Would I like to see China losing the potential to become the largest economy? Absolutely not. China’s rise certainly helps reduce the racial discrimination that Chinese Americans face in the U.S., and many corners of America are still a very racially hostile to minorities. A China with reasonably economic growth is beneficial for the world economy. I have tried to presented my predictions, and the remedies for Chines economy since 2011 to many professional meetings and work on macroeconomic academic papers on Chinese economy. But the existing system will not listen as I found out many times. This is not surprising because most of time you could not even persuade your parents, spouse, and kids to do something that is good for their health and wealth.

It is probably that the U.S. will become an even smaller share of the world economy in the coming decade. But that is not a sure thing, as China slows down and few other developing countries can muster the power and luck to industrialize. Even if it becomes a smaller share, its status as the largest economy and sole superpower does not see any challenger in any foreseeable future. America has many serious ills, but it still has the best system which is much better than any other system, just like democracy is the least ugly political system. Although the correlation between effort and outcome may be only 20% in the U.S., it may be 10% in China, as I told people soon after I came to the U.S. That is double what’s in China as anyone in solar industry can attest to. Even if the best solar panel can only transfer about 20% of sunlight to electricity, it doubles that of panels of 10% efficiency. The top global talent will still prefer the U.S. as in the post-WWII era.

U.S. equity markets could drop by close to half, i.e., from 2900s to 2000s and even 1600s. The drop will likely go through at least three or even four stages, with sharp bouncing backs followed by another drop, and will take at least a couple years from last October. This is because few people believe we will have a recession in the U.S. any time soon, and because any recession, if realized, will be relatively shallow. However, they underestimate the danger from abroad and some of the vulnerabilities accumulated in the last decade of growth era, including Trump and the Republicans.

The U.S. housing market may be a relatively good place to be. Given the relatively shallow recession, personal income won’t be affected that much. The recession will lead to interest rate cuts from the Fed, which helps cushion the housing market.

After the bottoming of all markets, which will be at least early 2019 and probably later, we could still have a long bull market in emerging markets and commodities if some other country, or countries, such as India, could start to create the demand for commodities again. China will continue a bottoming process of large ups and downs but once that is finished, even China can have another very long term bull market. The markets leading out of the bottoming process are likely to be emerging markets.