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The China Problem - Wealth, Corruption and Debt

October, 2016 -- Before we begin, I think it is important to explain that although I am a white Anglo-Saxon male, this is not some xenophobic rant. Many of my friends are Asians, including my ex-wife of some 17 years, and thus half the blood of my much-loved son. In fact what I really want most of all is a better life for over one billion people in mainland China who are of my race, "The HUMAN RACE". But to get a better world, you must first see the problem.

Again it could also be argued that I have not stepped foot on Chinese soil since the days when Hong Kong was under British rule, thus I have no right to comment. However, men write about the outer solar system without visiting these places and most of my research is from quotes of some of the foremost authorities, many of which were born and live in China today.  Besides, this post is about my thoughts on subjects and these are my opinions, I never said they were anything more than that.

The urge to write this article comes from the fact that I spend so much time at social functions discussing two core issues: the wealth of the Chinese and the problem that creates and also the new role of Real Estate as a tool to hide dirty money.  The two topics are interrelated and the intent is to write two articles to cover the subject.

Before we begin we should digress for a moment and explain my belief that the only systems that are long term stable are the ones that are self-correcting through feedback loops. In other words you just can’t command an economy to be productive, it must find its own way and this is often painful. In fact pain is a perfect example of feedback, your body is telling you to avoid or to fix something when you are in pain.

The core of the problem in China is that the economy is dictated, not by organic growth but from a command and control structure. In this case that is the communist party. That alone is enough to tell me the system is unstable. If you’re going to understand my ideas on China, I highly recommend reading my article called Command and Control vs. Nature and Feedback.

It is hard to live in Vancouver and not marvel at the wealth of the millionaires and billionaires of China who have adopted Vancouver as a second home. There are almost daily reminders, as quarter-million dollar Lamborghinis go by on tow trucks due to one of many high speed crashes and I have seen at least two of them on the hook. One famous high speed-racing incident involved a group of wealthy children of the leaders in China who go to school in the best universities in the world or just generally spend their days partying and shopping.

Read more about Super cars racing in BC on CTV.

It has become such a cliche that even reality TV shows have sprung up to mock the aimless lives of these wealthy Asian youth of Vancouver who days are spent aimlessly shopping and taking making selfies.  I have no idea who can sit through a whole episode of this self-indulgent farce, but I include to make a point. See the video below the series is simply called, Ultra Rich Asian Girls:

It’s unclear how much heed misbehaving Chinese youth will pay to mentors from the Communist Party. Still, there’s no question that the image of China’s fuerdai, or “second-generation rich,” needs an upgrade. As China’s income inequality has widened, their shenanigans — perhaps excused as youthful brio in other societies — have catalyzed widespread disgust.

There is also an even more connected set of children who are directly related to the real power in China. These so called “Princelings” are in great demand as firms hire them to gain access to heavyweights without appearing to bribe anyone.

Read about Princlings in the Financial Times.

And so is it any wonder as we read of these new super rich and their crazy lifestyles that we begin to question why the Chinese are so wealthy. But are they? Well, for a fact, the Chinese are not wealthy. No mater how poor a nation is, someone will always be powerful, a few who make a fortune. There are an elite few in Kenya and Mexico, in Ecuador and in Thailand. Even though the common man in these nations do not have a high standard of living, a very few elite do. So it is in China too.

If you take the total economic output of a nation, you get its Gross Domestic Product. If you divide that by the number of people that live there you get the Per capita GDP. You can think of this number as “what the average man makes” in a country. Here are a few countries to consider based on World Bank figures in 2016:


Kenya $1,300
China $7,924
Mexico $9,009
Turkey $9,100
Poland $12,400
Greece $18,335
Spain $25,831
Canada $43,248
United States $55,836
Norway $74,734
Switzerland $80,214
Luxembourg $101,450

When you think of the Chinese as earning a similar income to Mexicans, or half of Greeks, you begin to understand why the idea that Chinese consumers can pull up the Chinese economy is a stretch. That said, to give credit where credit is due, the current financial evolution in China has propelled these people a long way. In the days when Ronald Regan was president the Per capita GDP of China was under $600. 

In 2006, China’s Nominal GDP was $2.7 trillion. It is now almost ten years down the line and they are heading close to $11 trillion. Considering that their economy last year alone grew by more than the total economy of a country like Sweden, it means that their economy is still growing fast.

Read more in Forbes Magazine.

However there are a lot of questions of how these numbers came to be, and many leaders outright say the numbers are a fiction.

Read more in the Washington Post.

However if even half that number is real, it is impressive, but there is a bigger concern. As you will see, and China’s leadership is learning, GDP when it is dictated, is not like GDP when it is a result of market demand. China’s leaders have set growth targets, and regions and municipalities have hit those numbers year after year. The targets were hit one of two ways:
1)    often through over-expansion and creation of assets that are unused, the so called White Elephant projects. Sprawling subways, uninhabited apartments even so called Ghost Cities and massive freeways to nowhere.
2)    A endless series of upward revision fudges in numbers as the report flow up to higher and higher levels of bureaucracy.

Read More about White Elephant projects on the NPR web site.

Read a civilized account of Chin’s fake GDP in the UK independent:

Read a very academic review of the pressure to inflate numbers from the U.S. government:

Read a less civil account of Fake GDP numbers in China in the Huffington Post.

If China can pull itself out of extreme poverty in 20 years, perhaps the same magic can be applied to other developing nations. But how was it achieved? The answer is just three simple concepts; Sacrifice, Corruption and Debt. As you will see, these all have far reaching consequences.

Section 1: Sacrifice
It is no secret that the Chinese people are industrious, visit any elite technical university such as MIT or Berkley and you will find a disproportionate number of Asian students and in particular Chinese born students.

One woman I met with a very narrow view of the world and a large ego, did mention one concept I found profound. She mentioned, in Chinese communities it is very rare to find youth begging. Her assertion was the elders would not allow it, in effect telling them to “go get a job”. I have no reason to doubt it and in fact I have never seen any Asian street beggars in Vancouver, a city with both a large Asian population and many young street people looking for handouts.

There is another form of sacrifice in China, unpaid and underpaid labour. Many of China’s companies are in tight financial problems as they fight over competition, a host of changing rules and plans, and also a viciously over competitive environment. The simple reality is that the bank account is often empty, and the result is months without pay, as workers must stay because of no travel permits and no alternate employers in the area.

Read more from Reuters.

The over competitive market is caused by an endless series of factories being built to produce goods that there is no demand for. If you want a nightmare, think of owning a clothing factory making plain men black socks, now go to Wal-Mart and convince them your black socks are anything but a low price commodity that should go to the lowest bidder. I would not be surprised to find purchasing agents have over 500 sources for black socks. The world is awash in everything from cell phone models to cars. Just think of all the firms that can sell you a white four-door SUV in any major city, such a product is available from at least 15 manufacturers. Also, these models are very similar it is very hard to tell if you are test-driving a product from KIA, Ford or Porsche if you look at them quickly. It’s not just big-ticket items, the deli section wows us with 100 types of cheese. The shoe stores offer women every color of shoe to match that dress perfectly. The neighborhood pub now boasts 11 taps of draft from around the world. There are over 20 leading brands of laundry soap and Android phones are now made in over 30 different brands and are essentially the same.  The issue has become so commonplace that there are advice articles written to help people cope with choice.

Read about choice in The Economist

At the heart of this oversupply are unprofitable factories in China, churning out both consumer products and sub-assemblies for the name brand firms, so that more choices and possibilities are available to bombard the spoiled and bewildered western consumer.

Still, further sacrifices abound in Chinese living standards and pollution.

Despite the rapid growth of the Chinese economy in the last decade, more than 482 million people in China – 36% of the population – live on less than $2 a day. In total 85% of China’s poor live in rural areas and extreme poverty forces many of them to leave the countryside in search of employment in urban areas. Often referred to as the factory of the world, China’s industry-oriented economy relies on these migrant workers who make up the majority of the workforce. There are approximately 150 million internal migrant workers in China who because of their status, do not receive any state benefits or protection. They have to endure poor working conditions such as excessive and forced overtime, denial of social security rights, failure to provide employment contracts, as well as severe health risks.

Living conditions are poor with up to six people sharing small cramped dormitories. Women migrant workers, who are primarily employed in factories, rarely get maternity leave, and with no childcare facilities and working weeks of more than 70 hours many are forced to send their children to live with family in the countryside.

There is no freedom of association to form trade unions and non-governmental labour organisations are closely monitored by the Government who carry out regular crackdowns.

Read more about China Labour Unions in the New York Times:

Multinational corporations and national factory owners take advantage of the anti-union climate, the workers’ lack of awareness of their own rights and the Chinese government’s unwillingness to address the abuse of migrant workers’ rights often because ultimately those officials profit from the factories.

In addition, the level of occupational disease and injuries is alarmingly high. In 2009 alone, approximately one million workers were injured at work and about 20,000 suffered from diseases due to their occupation.

One particularly disturbing idea from the “Yes Men” protest group is that modern remote labour is worse than slavery.

Consider if slavery had not been abolished in the United States, it is likely that by now, laws would have evolved protecting slaves requiring them to be fed and clothed at least as well as U.S. children. An American child costs at least $2,000 per year to feed and cloth, yet in china “slaves” are available at far less cost than $500 a year. Under this idea, if slavery was NOT abolished in the USA, Nike could not clothe and feed their U.S. based slaves, as cheap as it is to get labour in the third world.

In other words in Asia and Africa we have a new kind of super low cost slavery where the slaves are not rounded up, moved and sold, the work goes to them. Today these slaves even must feed, clothe and house themselves. It could be argued that bottom tier labourers in China are worse off than pre-civil-war American slaves.

Pollution is another area of sacrifice in China. The severity of the problem was not understood outside China until the Beijing Olympics of 2008. The 2008 Olympics were declared the most polluted games ever with athletes and spectators exposed to dangerous level of smog. The press were quick to publish pictures of the permanent haze of Beijing. This is despite a partial ban on private automobiles and manufacturing during the games. The World Health Organization, WHO discovered that exceeding of the limits were "excessive" while scientists found levels were one-third higher than Chinese government experts claimed. The findings were revealed as scientists from Oregon State University in the United States of American and their Chinese counterparts from Peking University published the conclusions of the research in the professional journal; Environmental Science and Technology.

Many residents of different cities in China especially Beijing, have to find ways of keeping themselves safe from the harmful polluted air. They need to carry gas masks when they leave their home while some need to keep a number of air filter systems in their homes for them to get fresh air. According to a research done by Greenpeace, China loses up to 1.6 million people every year due to the toxic air they breathe.

Read more on CNBC:

In 1997, the World Bank issued a report targeting China's policy towards industrial pollution. The report stated "hundreds of thousands of premature deaths and incidents of serious respiratory illness [have been] caused by exposure to industrial air pollution. Seriously contaminated by industrial discharges, many of China's waterways are largely unfit for direct human use”.

Sixteen of the world’s 20 most polluted cities are in China. The air in some of these cities is so bad that at times, visibility drops to 30 feet, traffic slows to a crawl, and nearly everyone wears masks over their noses and mouths. In Harbin, a city of 11 million people, government officials recently shut down roads, schools, and the airport when air pollution levels hit 40 times the safe limit set by the World Health Organization (WHO). During the “airpocalypse” in Beijing earlier this year, the density of small, lung-penetrating particles reached 993 micrograms per cubic meter — a concentration normally not seen outside of forest fires. The U.S. Environmental Protection Agency (EPA) considers anything above 300 dangerous, and maxes out its scale at 500. The smog was so thick in Beijing — which English-speaking residents call “Greyjing” — that a factory building burned for three hours before anyone even noticed that it was in flames.

More than 1.6 million people per year die in China from breathing toxic air. Air pollution is clearly very costly though to its $11-trillion-plus economy. It dings China's GDP about 6.5 percent annually, according to RAND Corp. estimates. Those costs are mainly driven by lost productivity, since factories are shut down on bad air days to avoid the dangerous health effects of breathing the dense, toxic air.

"Sick days and hospital visits all take a toll on the urban economy," said Anders Hove, associate director of research at the Paulson Institute. High levels of pollution are linked to serious chronic illnesses, like heart disease and lung cancer, which are costly to treat. And air pollution also affects tourism and outdoor recreation, he added.

Read more on CNBC:

Again this is symptomatic of a nation coming of age. In my childhood the issue of pollution in the United States was front-page news as old-school industries dumped carcinogens, toxic waste and just plain old slime into rivers and leached from pools into ground water. Acid rain and the smog of Los Angles were front-page news. Tom Lehrer, a comedian, wrote a hit song urging tourists to be wary visiting America because you “can’t drink the water or breath the air”.

The out cry over the environment prompted Richard Nixon to push in 1970 for the creation of the American Environmental Protection Agency – EPA, an agency with board powers to fine and police industrial companies. 

The U.S environmental laws have been a huge success, clearing the skies over major cities, eliminating acid rain and generally protecting most waterways. However in an age when the consumer demands $4 t-shirts and $60 cell phones these laws are prompting companies to use their global reach to outsource production to places where the laws are not so stringent. China has created a zone free from costly environmental protection, in effect poisoning their own people to encourage trade.

The communist party of China has one overriding goal, to survive. To achieve this is a delicate balancing act, they must appear to protect the environment and still maintain full employment; busy workers have no time for revolution. Time and again the party has picked GDP over environmental issues. This is a great disadvantage when the “planned” economy is controlled by the watchdog to protect the people. However the elite now have a new issue, as their own children are suffering from asthma and major breathing disorders the issues become more real. When they visit lakes and rivers of their childhood and see they are now unusable for recreation, again the issue becomes more pressing.

Read more in Fortune Magazine.

Certainly today there are some attempts to deal with the pollution and some are quite innovative. Some big, polluted cities, like Guigang, are using mist cannons, which shoot into the air a spray that disperses smog particles. China has launched a $7.6 billion fund to combat air pollution. IBM has been testing a system called Green Horizons, which uses artificial intelligence that can predict how bad pollution will be in Beijing 10 days in advance. It crunches large amounts of varied data based on pollution drivers, like traffic, weather, industrial production and the like.

On the other hand some attempts to deal with pollution are classic ham-handed bureaucratic decision that bear all the hallmarks of “committee-think”. China built its first nuclear power generating plant in 1994, today over 36 reactors are on-line and a further 20 are in construction. There are over a dozen more in the planning stages. Contrast this with the USA that has completed only 1 plant in 20 years. At 750 Kilowatts a year, China already produces more nuclear power than the USA. By 2030, China expects 9% of its power to be atomic. But Chinese engineering is decades behind the west and the nation has a long history of poor safety standards and corruption. Britain, Canada, France, the USA, the former USSR, Japan and Germany all have had major accidents with nuclear reactors.  click here for a list.  I think it will probably be worse in China where again, the government is far from a watchdog and more the prime mover toward building reactors at any cost.

Like all Nuclear power, the problem is the waste. Super toxic radioactive materials that can be dangerous for centuries. When fuel rods in a nuclear reactor are “spent,” or no longer usable, they are removed from the reactor core and replaced with fresh fuel rods. The spent fuel rods are still highly radioactive and  continue to generate significant heat for decades. The fuel assemblies, which consist of dozens to hundreds of fuel rods each, are moved to pools of water to cool. They are kept on racks in the pool, submerged in more than twenty feet of water, and water is continuously circulated to draw heat away from the rods and keep them at a safe temperature. Because no permanent repository for spent fuel exists in China, power plants have kept spent fuel at the reactor sites. As the amount of spent fuel has increased, many power plants have increased the amount in their storage pools to as much as five times what they were designed to hold. This is not a sustainable or permanent solution and there is no plan to create one.

For all the show, low costs and lax environmental laws are at the heart of why production moves to China. The communist party wants a high standard of living and a strong middle class. However, as real wages in China edge up, leaders are in a dilemma. They know if they increase the cost of doing business, through better wages and at the same time permitting tougher environmental laws, other nations will step up. Already the Philippines , Poland or even Ethiopia, are offering equally cheap labour and even more half-hearted environmental laws than China, creating more compelling competitors.

Read More about Ethiopia here:

In a 2007 article about China's pollution problem, the New York Times stated that "Environmental degradation is now so severe, with such stark domestic and international repercussions, that pollution poses not only a major long-term burden on the Chinese public but also an acute political challenge to the ruling Communist Party." That alone should ensure steps will be taken.

Section 2: Corruption
Key to understanding the powerful elite of China is the type of soft corruption that pervades the society.

Behind every great fortune lies a great crime.
- Honore de Balzac

As is often the case, those at the heart of the problem, probably do not understand that what they are doing is in fact a crime. They see no difference from their system and legitimate western style business.

According to the China Business review, conflicts of interest are everywhere in China:  The concept of “conflict of interest” is not widely understood in China. As a result, embezzlement, kickbacks, and other forms of fraud and corruption are widespread. Corruption is not limited to government officials; it is equally pervasive in the private sector. In a 2005 Transparency International study that measures the perceptions of international business people on global corruption, China scored 3.2 on a scale of 0-10, where zero is “highly corrupt” and 10 is “highly clean.”

Here is a key point: Probably the biggest tell that corruption flows right from the top is a simple statistic. The Chinese equivalent of the U.S. congress is the National Peoples Congress, or NPC. Although the U.S. congress has ZERO billionaires the Chinese NPC has 83!

Read more about Billionaires here at CNBC:

More than that there are also many multi-millionaires in the NPC, as well as many enriched hangers-on in many levels of local officials such as the equivalent of governors and mayors.

Obviously these 83 billionaires and many near billionaires are setting policies that are benefiting them. In the west this would be called a conflict of interest, but the idea is not common in China, where this is just considered “doing business”.

Let’s look at a theoretical example of how this works. First, let’s meet our cast of characters

Mr. Big Shot – A 30-year party member, former high-ranking Red Army officer, 12 years a sitting member of the NPC.
Mr. Banker – A poorly educated cog in the China Commercial Bank, 10 years as a party member and 5 years from retirement.
Mr. Mayor – A likable but poorly educated middle aged official with a good record of party obedience. Recently given control of a midsize industrial area.
Mr. Stooge – A young man with good family connections, freshly back from studying business in a lower tier U.S. business school in southern California.
Mr. Migrant – A poor farmer who lost everything and is trying to find work by traveling to an industrial area so he can feed his family.

Now here is how it works. Mr. Mayor hopes to gain favour with Mr. Big Shot. In a meeting over good wine and scotch, it is decided that Mr. Big Shot will buy 80 acres of land in Mr. Mayor’s area. This land was appropriated by the regional government from locals at no cost and is sold to Mr. Big Shot for $100,000. Mr. Banker hoping to gain favour issues a loan for the $100,000 to Mr. Big Shot and no word is discussed about payments. Mr. Mayor is given 8 acres for arranging the deal.

Mr. Mayor then convinces Mr. Stooge to sign a stack of papers creating the “the Happy Sunshine Bottle company” and after a call to Mr. Banker from Mr. Big Shot there is (inexplicably) great interest from Mr. Banker in creating a loan to the new firm. The new company wants to build a plastic bottle factory and decides to buy Mr. Big Shot’s land, also an office should be built on Mr. Mayor’s land that is also purchased. The land is now valued at $30 million dollars. A mortgage and a line of credit for $80 million dollars is issued to the new firm and the factory is built.

The $30,000 million dollars is transferred to Mr. Big Shot’s special unlimited credit cards. In Hong Kong, fleets of staff may swipe these cards for many hours, to avoid card limits per transaction.

Click to read in Bloomberg about Credit Cards in China, used to launder money.

These cards are used to buy insurance policies in Hong Kong, from the Canadian firm Manufactures Life Insurance. The policies are flown to Vancouver and surrendered for a small penalty of 10%, so $27 million dollars remains, transferred to Canadian banks, such as HSBC Canada.

Click here to read more about Insurance as a way to transfer stolen wealth.

The money is then given in trust to a Vancouver law firm, who using a series of shell companies hides the identity of the owner, and the money is used to buy 60 condominiums on Alberni street in Vancouver. Each unit is furnished, draped and ready to occupy, but the last thing Mr. Big Shot wants is tenants asking questions, so the units sit vacant and Mr. Big Shot has millions of dollars in assets in safe stable Canada.

As the bottling factory is completed it occurs to Mr. Stooge to make some sales calls, he finds willing buyers but that the market for plastic bottles has gotten tighter than anticipated, however he knows that if he is to stay out of jail, he must deliver product. Mr. Stooge signs a series of deals, but unfortunately below his cost of production, still the important thing is the lights are on and Mr. Stooge is getting a handsome salary from borrowed bank money.

Mr. Migrant arrives from the countryside spending his meager savings on train tickets, to get a job at the new bottling plant. He soon finds he is working at near slave wages with great promises of future riches when the plant becomes a major success. He works long hours and is exposed to a host of dangerous chemicals and fumes.

Despite having slow sales and no profit, the plant remains in business by calling on Mr. Mayor, who demands still more credit from Mr. Banker. At some point the loan becomes unserviceable. Regulations require the bank to write off the loan, but this is impossible since the bank would soon not meet reserve requirements.

Bad loans are made to “disappear” two ways, either risky loans are shifted to the lightly regulated shadow banking institutions - mainly trust companies, brokerages and insurance companies, this is called “Off Balance Sheet Financing” and the firms are know as “shadow banks”, (same trick Enron used) or sent to another sister bank.

Fitch is rating agency that rates debt. Read more about their problems with China’s bank’s hidden bad loans.

Ratings agency S&P estimates that outstanding Chinese shadow banking credit totaled $3.7 trillion by the end of 2012, equal to 34 percent of on-balance-sheet loans and a whopping 44 percent of GDP.

Read more about the problem in The Economist.

You might wonder where the Trust companies get their funding, well a lot of it is from leveraging up (more borrowing), based on a small layer of private money from investors buying so called “wealth management products (WMP)”. These funds are raised so they can purchase loans that banks want off their books. WMPs are then marketed through bank branches to very naive investors, as a higher-yielding alternative to traditional bank deposits. Since the government owns the banks the investors assume they are also guaranteeing the loans.

"The entire push behind shadow banking is deeply rooted in the government's desire for growth," wrote Dong Tao, China economist at Credit Suisse, in a recent note. "Shadow banking activities have increased because China needs growth, and the banking sector has, to a significant degree, failed in its role of financial intermediary."

The other method used to bury bad loans is a quid-pro-quo exchange system where bad loans are recycled as new loans. The process requires a “sister” bank, where this other bank is called in to refinance the whole mess with a new loan, in return the first bank bails out an equally bad loan. The same toxic waste loans are still under-performing but the banks have laundered them to appear to be performing fresh new loans.

So in our story, Mr. Banker trades the bad bottling plant mortgage and returns the favour by taking on an equally bad loan from the sister bank. At some point the lending stops, generally when the political pressure disappears.  As loan dry up so do Mr. Migrant’s paychecks. He stays on because there is no alternative. Lies and promises go on to the employees for months, until Mr. Migrant cannot even feed himself let alone his family.

Cases of corruption in china do not end with phony land deals. Many more influential individuals and sometimes, Chinese fugitives have been found to be guilty of significant corruption cases. For example there is a report of a top anti-corruption agency of the communist party issuing a disciplinary warning to a top official in the People’s Bank of China. The official is believed to have used public funds in paying for holiday expenses and banquets two years ago. The misconduct details of Yang Ziqiang who is one of the assistant governors in the people’s bank of china, were announced by the central commission of discipline inspection. Such a case is a clear indication of how public funds are being used for personal gains by the few Chinese who are in power.

Click here to read more about Yang Ziqiang.

Corruption is found throughout the system, especially in the military. General Guo Boxiong, the retired military chief of the People’s Liberation Army, had been under investigation for corruption and was expelled from the Communist Party after being given a life sentence.  A senior military general was also linked to issues of corruption. Wan Jianping 62 years old who is also believed to be a close ally of Zhou Yongkang, was arrested while on duty due to beliefs that he was involved in corrupt activities. He is one of the top generals who have been arrested while still in office due to corruption. It is an indication that those who are expected to work with the government in dealing with and eliminating corruption are the same individuals who are engaging in many corrupt activities.

Click here to read more about Zhou.

The other form of corruption is subtler and involves a kind of “routine” that gets things done, this is more like the kind of bribes that are common in many places in the world.

The common practice of guanxi is a custom for building connections and relationships based on gifts, banqueting, or small favours. Guanxi related gifts can be considered bribery by foreign companies and by national and international anti-corruption laws. Particularly prized are trips taken each year by many mid-level officials who frequent the gambling Mecca of Macau. These so called VIP junkets are common and have become a great source of revenue for Chinas gangs and mobsters. Luxury suites, top-shelf drinks and prostitutes are the heart of the “entertainment”

Read more about crime and Macau in the Guardian newspaper.

Companies report the exchange of irregular payments and bribes and consider government regulations to be burdensome and at times inefficient. Anecdotal information indicates that public officials actively slow down approval of foreign investment projects in order not to arouse corruption suspicions.

Corruption was even involved in a major industrial fire. As reported in the New York Times in Aug 2015, the Tianjin explosion was investigated as licences had seemingly been obtained through the principle of guanxi and collusion with government officials.

Read more in the New York Times by clicking here.

There is an art to the political game of turning an ugly truth in to careful massaged and disguised words. Former Goldman Sacks President Hank Paulson had to address the issue of corruption very delicately in his book “Dealing with China”. Both to protect the butt of his investment bank and to not offend the Chinese whom he still holds close ties with. The best he could do was to put it this way: It was then and it remains to a greater extent today that China is governed by men and not by laws

The Crack Down
Two days after taking control of the world’s most powerful political party in November 2012, Xi Jinping warned his fellow Chinese Communist Party members that their six decades of rule was in jeopardy because of what he saw as endemic corruption eating away at the party’s authority and effectiveness. Xi Jinping seeing the danger of corruption to the long-term health of the Communist Party implemented an anti-corruption campaign called “Tigers and Flies”.   The intent was to hit hard at both the big shots (Tigers) and the small time officials (Flies). Critics of the program point out that many of the president’s loyal friends were never investigated, still the project is staggering in its size and scope.

Among the so-called tigers felled by the campaign were Zhou Yongkang, the former security chief who was sentenced to life in prison last June; Ling Jihua, former top aide of Xi’s predecessor; and two former deputy commanders-in-chief of the People’s Liberation Army, Xu Caihou and Guo Boxiong. Last year 26 "tigers", meaning officials at the vice-ministerial level or above, were put under investigation for alleged corruption according to Xinhua. The CCDI, the Communist Party’s top disciplinary body has said there are three phases in its fight against graft: the first stage is to ensure officials don’t dare to be corrupt, then institutionalizing the drive and perfecting the legal framework so officials aren’t able to be corrupt, and lastly, instilling ethics and morality so that officials won’t want to be corrupt.

In the overseas hunt for corruption suspects, an initiative dubbed "Skynet" that was launched in April of last year, more than 1,000 economic fugitives residing in 68 countries have been brought back to China, Xinhua said. A new round of Skynet will be launched in 2016 that will rely on increased judicial cooperation with other countries, according to the CCDI.

The online site China File tracks the current state of the Tigers and Flies Purge in a visual database, click here to see it.

Like a page out of the Stalin play book the tigers and flies crack-down has been rolling out all across China. It has been breathtaking in its size and scope -- over 1,800 convictions so far, many for ten-year terms. Also there were at least 10 life sentences and 10 death penalty convictions.  Like the Jews fleeing Nazi Germany’s occupation, the current preoccupation in China’s higher levels has been “take the money and run”.   Run they did, in 2015 over 1 trillion dollars left China. A new trillion dollars every nine months, is expected to exit for many years to come.

Read more about the exodus on Bloomberg.

It is hard to imagine how much money 1 trillion is, but this youTube Video might help envision it.

As far as china is concerned, a trillion is a lot and will not be repaid soon.  A trillion was more money than the United States required to stem the 2008 financial crisis and bail out every major bank. That trillion dollars every year leaving China, is backed by loans that will never be paid. Since there is no real difference between China’s banks and China’s government the loans are the legacy that will be paid by taxpayers for many decades. Remember those taxpayers earn about what Mexicans do. So the reaction to China’s corruption could hasten the inevitable financial collapse. The president Xi Jinping’s “cure” could be worse than the original problem; at least that problem was somewhat deniable. The potential for violent social unrest is obvious.

Section 3: Debt
Before we begin on this section it is important to understand the scope of the problem. This excellent Video produced for the BBC, titled "How China Fooled the World". It details the scope of the issue and if you have not watched it before, I urge you to see what I think is the best 40 mins you can invest.

Click here to watch on Daily Motion.

The Video use the very British saying “tears before bedtime”, but what it means is that this is not going to end well. This fact of economic life was apparent to me in 2007, and it is still true.

Back in 2009-2010, to mitigate the effects of the global crisis, Beijing officials encouraged banks to lend money to local governments and real estate developers to fund make-work projects that were either unnecessary or not yet needed, leading to a pileup of municipal debts. The command to the bankers was to “open your wallets wide”, and wow did they. Schemes such as replica of Manhattan in a city near Beijing and this huge theme park in Tibet became commonplace. The credit boom also encouraged developers to build too many un-affordable empty apartment complexes and vast vacant shopping malls.

According to Chinese media reports, Shang Fulin, the chairman of the Chinese Banking Regulatory Commission, raised concerns at a mid-January 2016 meeting that over half of the 67 trillion yuan of loans held by Chinese financing institutions have been made to risky borrowers such as local government financing vehicles, property developers and industries with overcapacity. Shang added that such loans need to be “heavily fortified” and require “classified policies.”

Read about the Bank crisis in The Telegraph Newspaper.

The article above states the current debt of China is some 28 trillion. In the fall of 2016 the People’s Bank of China released a report claiming China's total debt is now 3 times its GDP, which is way more in debt than Greece. It is also more than the USA and Japan combined.

But there is a big difference; the debts of Japan and the United States are backed by solvent taxpayers who have high incomes, not so for China. Also the debts in Japan and the United States were used for prudent projects, with good collateral, but China has spent on building unused cities, vacant shopping malls and overly ambitious public works projects. The ugly truth is that a lot of the money is no longer even in China, now simply hidden in empty condominiums and stashes of gold all over the world

I mentioned Hank Paulson earlier. He became best know during his term as Secretary of the Treasury during the 2008 financial crisis, but long before that he was President of Goldman Sacks. He detailed his time in this job in a book titled “Dealing with China”. Although far from a tell-all book, it hints at the importance Goldman put on getting connected at the highest levels of Chinese power. The tool they brought to the table was the same one Paulson and Ben Bernanke would use years later to rescue the major US banks, that tool being government debts, mountains of debt.   

Chinese banks were taught by Goldman Sachs, J.P. Morgan, Morgan Stanley and other U.S. investment banks, how to pass liquidity tests and to appear solvent. With carefully cooked books, the world’s big funds buy their bonds and lend freely. In other cases the government just issue paper backed by marginal assets such as inefficient state run enterprises. The state run enterprises had trouble meeting profit targets and so much excess access to capital, that one of the business they entered into was private lending money to smaller firms. The shaky state-controlled borrower becomes a bank for the even shakier.

Read more form the Brookings Institute.

This underground lending is not transparent and there is no way to really understand the scope of the debt in China, but even using official figures China’s ratio of what it owes, to the size of its economy is an off-the-chart number. The figure is the Debt/GDP ratio. In 2016 this the Bank for international Settlements pegged at over 30:1

Read more about those Numbers in The Telegraph Newspaper.

Compare that with faltering Greece, at less than 2:1. In fact China’s known corporate debt is higher on a GDP ratio than Greece not to mention the public debt.

Read more in the Financial Times.

The current challenge regarding China’s debt can be compared to a large heap of dry leaves piled up dangerously close to an open flame. Traditional non-performing loans are on the rise, while opaque, retail-exposed, structured product defaults threaten systemic stability. The danger that looms in China’s economy resulted from fraudulent actions of national financial institution, ranging from illegal borrowing to unaccounted loans and boycotted interest.

According to Francis Cheung, head of CLSA’s China and Hong Kong strategy, the country’s bad loans are actually around 15% to 19%, significantly more than the 1.6% announced by the government recently. At that rate, it will require at least $1 trillion, equivalent to 10% of the economy, to clean up the banking sector. That is in line with a study from the International Monetary Fund last month that indicated that loans at risk account for about 15.5% of total bank loans, or $1.3 trillion.

“The share of commercial banks’ loans to corporates that could potentially be at risk has been rising fast and although currently at a manageable level, needs to be addressed with urgency in order to avoid serious problems down the road.”

In another dimension, it’s best to reason along the architects and culprits found wanting here, it can be said that half of China’s debt is owed by companies, and most of that, in turn, is owed by state-owned enterprises and property developers. As the economy slows and housing prices fall, many of these loans will prove unpayable. Banks report that bad loans are just 1% of their assets and their auditors insist that the banks are not lying, however, if you look to investors and how they price bank shares in China, it is as if the true level is closer to 10%. Given a choice between an auditor and a shrewd investor, my bet is on the market value from the people playing with their own money.

Even if a huge swathe of loans go bad, the consequence is unlikely to be a Lehman-style financial collapse. For that, thank the Chinese regime’s vice-like grip on its financial system. Most lending is by state-controlled banks, much of it to state-owned companies. If it faced an economy-wide credit crunch, the government would (as it has in the past) simply order banks to lend more. At the same time the country’s vast foreign-exchange reserves mean China need not worry about a sudden drying up of foreign capital, the main cause of many other emerging-economy crises. This combination of control and buffers gives China the time and headroom needed to tackle its debt problem. Unfortunately, it has also bred complacency. After all, officials began to talk about tackling debt in 2010. They have taken a few baby steps towards cleaning things up: a new budget law taking effect next year, gives central authorities more power to oversee local governments borrowings. But in practice, too many officials are content to see bad loans rolled over; too many prefer bailouts to defaults. Earlier this year, amid much hoopla, Chaori Solar was the first Chinese company to default on a bond and many more, so you see where the problem emanates.

Many are quick to point out that China’s debt is almost entirely denominated in local currency and owned by domestic institutions. This situation it is thought, shields the economy against government debt crises. True, a default may not destroy international creditors like the 2008 crisis in the U.S.A. but if the government secures the bad debts, who bails out the government? Well the answer is either economic Armageddon through money printing, like the lesson learned in Germany pre-world war two or massive tax bills for generations to come.

Read about hyper inflation from money printing here.

Warning signs of a people an economy on the brink abound, even within China, read here in the Wall Street Journal about internal warnings in the latest Chinese beige book.

Section 4: Conclusion

China may look unstoppable now, but currently on the horizon there are dark economic clouds foreshadowing slower growth. Don't forget 30 years ago, few foresaw the decline of Japan, either. In those days as Japan grew to be the worlds second largest economy, as the pundits predict the end of America. Japan overtook the US auto industry in quality and value, innovation in electronics primary came from Japan and American iconic landmarks like the Pebble Beach golf course were gobbled up by Japanese investors.

But ultimately what destroyed the Japanese miracle was the same two forces at work in China now.

First meddling from a central bureaucracy. With tight ties among finance, business, and government misallocated capital that leads to wasteful investments. In China, the government-business-banking commingling has led to excess steel mills, unused infrastructure projects, and apartment blocks on a staggering scale. Beijing’s policymakers have responded to overbuilding with a massive influx of easy cash to keep the old, sputtering growth engines spinning. The flood of yuan has fueled unstable spikes in asset prices, as it did in Japan.

Secondly and perhaps more dangerously, China’s loose money has also pumped up a mammoth increase in debt—like Japan’s in the 1980s a debt fueled expansion that at it s core was a giant real estate bubble.

Japan also proved that massive currency and trade balance is not fool proof protection. It, too, was a creditor nation with large trade surpluses and ample savings in the early 1990s, but that didn’t prevent a financial crisis. If anything, Japan is proof that a bubble-prone, debt-obsessed economy is susceptible to failure, no matter the circumstances. In the case of Japan the aftermath was two "lost decades" of stagnant economy.

The news is not all bad, thousands of Chinese people are seeing real hope, hope they never had under strict Mao communism. Healthcare has improved, real wages are on the rise, and fledgling unions are gaining some real protection and rights for some workers. People eat better and millions have access to better food, education, and water.

Also there is no putting the genie back in the bottle, the Chinese communist party must evolve to better serve the people. Despite restrictions, students learning abroad come home with new views and ideas; snippets of the Internet delivered messages that can’t be stopped. The modern youth of China are very cynical about the endless happy stories out of the state-controlled propaganda machine. Many Chinese tourists leave China each year and they see the western newspapers, they engage in conversations and they see a different world than the one the party describes. The communist party has on-going trouble controlling the messages, as the channels of communication evolve far and wide.

The party also will change out of its own human desire. Even at the highest levels, they can see the smog of Beijing and they do want better for their own children. Ultimately they also want a China that is globally respected, where a Chinese Yuan is traded with the same respect as a Euro, Pound or Dollar. These goals are not compatible with human rights abuses and corruption as the world points out to the leaders at every chance it gets.

Watch Mike Wallace speak with Jiang Zemin:

Although pre-coached by the spin-doctors, the leader clearly is not used to a probing press that can’t be leashed, yet, clearly the leaders want to master such interviews. The writing is on the wall, a freer press is coming to China.

The cronies and the corruption become less tolerable as the people see the reality. The current Wild West economy is just that, very similar to America pre 1900, literally the Wild West.  This is not the end for China, nor even a turning point, one billion people will see better conditions as they eventually join the global economy as equals.

For the coming few years, the tragic endless loop is future enslavement for China’s common man, to pay debts that were used to enrich party officials and consequently drive up real estate prices all over the world.

As China evolves, it must find its own way to be a powerful and respected nation. Key to that journey are steps to offer more “value add” than what it currently offers. China must grow beyond simple slave labour, lax environment and safety rules, total disregard for intellectual property and the ability to sell below cost financed by a mountain of debt.

China also needs a system with better checks and balances than the current all-powerful one party system.

There is a perverse side to Chinese “communism” in that it is originally based on the ideas of Karl Marx and Friedrich Engels. These utopian dreamers sought to build a world of workers as equals -- a classless society. China’s communist party has been singing this song of a perfect society of workers all equal, with the spoils of collective production being divided to the people based on need. This protection of the masses is the heart of the ruling parties divine right to govern the people. Yet what they have built could not be more the opposite. A designer clothing covered leadership sipping fine cognac and stealing billions. A cold machine that pollutes the very air and water the people need. The “peoples party” has built an economic engine that is burring the nation in debts and to what end? Mostly to make billionaires of some 200 men and millionaires of 50,000 more, all on the backs of one billion impoverished, overworked, poisoned and enslaved citizens.

As for this corrupt elite, you might say this time is really no different than the Morgans, Vanderbilts, Asters and Rockefellers of the American era. However, these were private businessmen and their fortunes came with great risks. For example the government of the United States tore apart Rockefeller's standard oil. In contrast China’s party elite are handed sure things and achieve their wealth on misuse of public funds.  Sadly, the money that could have helped a billion people have a brighter future has been used on pampering the party elite, it was squandered on top tier pep schools, private jets, vast wardrobes, private yachts, and Super cars. Worse much languish in underground vaults of gold and in empty flats in London.

Ultimately I fear, just like the brutal economic pullbacks in America before the Great Depression, China is facing a period of great economic disruption that will affect the whole world. Banks might collapse, and industry maybe cut off from funding.  Millions may go hungry and even die, vast social upheaval could ensue, and this could be everything from leadership changing revolution to massive and protracted civil war.  China’s coming great depression has some never before seen attributes. As a nuclear power with a paranoid ruthless party in firm control -- China’s problems are uniquely theirs. They control a vast area of the earth and it people and they do it with increasing less effective tools of misinformation and party loyalty. As THE key supplier to the global economy, this is not something the world can ignore.

In other ways this is an old song. History is clear, as it was for the adolescent economies of the early United States, France and Rome on the road to economic stability, so too must the newly awakened China face its own monumental tests by economic fire.


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