China must tackle its unreported internal problems

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Chinese President Xi Jinping’s government has numerous serious issues that need to be dealt with before the upcoming 19th National Congress of the Communist Party of China (CPC), where he will attempt to consolidate his power. This will make him a Mao-like figure in total control of an economic dynamo.

This will be a power that subdues his citizens into complacency, but continues to deliver false economic growth that will hinder world growth and eventually put China on the path to further foreign adventures (such as the India-China border dispute) outside the South China Sea.

China continues to put forward a good face for the world community, particularly the environmental movement, by touting its commitment to clean energy. But it is doing the exact opposite of upholding the Paris Climate Agreement or pushing away from fossil fuels by building more coal-fired power plants, importing copious amounts of oil and not taking aggressive action to clean up its dirty cities, waterways and air.

This could be the greatest year for the Chinese in recent memory if they deal with their problems of overseas investments versus domestic consumption, the management of their debt-ridden economy by their central bank and the quizzical nature of Chinese bond defaults on the rise.

Further, their real-estate boom has all the makings of the type of crash that still haunts the US economy and real-estate markets. Additionally the falling birth rates for China (in fairness, also a massive Western-led problem) and the entire East Asian region could overtake the biggest problem of all, North Korea, China’s proxy – which so far Xi is allowing to flourish, instead of reining in.

Worldwide investments have allowed China to project soft power and have economic influence unheard of in the Hermit Kingdom a generation ago. However, Beijing made the unprecedented step of asking Anbang, a Chinese holding company that owns the Waldorf Astoria in New York City, to begin selling assets abroad, and bring the resulting billions of dollars home. This will further move the Chinese economy from an export-based system to a domestic growth model. The downside will be that real estate and financial services purchased by Chinese firms across the world that have firmed up soft power and influence will wane if firms start unloading assets at fire-sale prices.

How the People’s Bank of China handles deleveraging by forcing financial institutions “to cut debt but ensure the process is smooth and orderly to limit its impact on market liquidity” was the main point made recently by assistant PBC governor Zhang Xiaohui. With the five-year leadership transition to take place at the 19th Congress, this will be Xi’s biggest risk to economic stability – this smooth process occurring – with a debt-to-GDP ratio of 250%, among the highest in the industrialized world. Xi will also want to maintain an appropriate and prudent money supply and credit growth to keep liquidity steady if he wants total control within his government.

With poor disclosure practices, graft and corruption the norm along with a shaky legal foundation, bond buyers are seeing record number of bond defaults taking place. Only an open society, an unobstructed Internet and outside transparency can save China’s bond market from further defaults.

Zombie firms in China could be paving the way for a real-estate bust that will be larger than the one in the US that caused the 2008 recession. Small Chinese cities are seeing a boom in construction, but supply is greater than demand. This surge in construction has CPC  leaders and Xi worried ahead of the Congress, since real-estate market stability is a hallmark of his regime.

Two variables risk stability: First, increased construction leaves large swaths of inventory untouched, and second, small cities such as Bengbu in Anhui province that already have surplus inventory from the housing downturn three years ago will have further housing headaches ahead for local policymakers to solve.

US President Donald Trump continues pressing China about North Korea, but it seems there is a bigger threat that has just been put into the North Korea-US-China equation: South Korea’s quest for nuclear weapons to counter the China/North Korean menace.

If South Korea acquires a nuclear arsenal or triad, then Japan and the remainder of Asia will also want a deterrent nuclear ability. China has reasons to be concerned about the THAAD (Terminal High Altitude Area Defense) missile system in South Korea, but if it doesn’t stop worrying about World War II-era grievances and address the instability of its North Korean proxy, then a nuclear arms race could be unleashed in the most important geopolitical region in the world.

The US made four moves in July letting China, North Korea and, I would contend, Russia know it is serious about solving the North Korean nuclear-weapons threat that the previous administrations of Bill Clinton, George W Bush and Barack Obama wouldn’t counter.

First, the US fired a barrage of missiles off South Korea’s coast under the guise of an exercise. Second, THAAD testing persists, which  continues rattling China’s sovereignty. Third, B-1 bombers flew over South Korea in a show of defiance aimed at China and North Korea. And finally, Trump fired his political chief of staff, Reince Preibus, in favor of 4-star General John Kelly, who understands and can fully execute service to a wartime president if the US, China and North Korea clash in the near future.

Leading realist foreign-policy magazine Foreign Affairs, the publication of the Council on Foreign Relations, advocates a “good cop, bad cop” scenario playing out with Pyongyang and even Beijing. Realistically, Xi and China have options they should consider immediately, from complete economic isolation of North Korea to working with the United Nations to implement crippling sanctions.

But China’s domestic problems – especially the debt-to-GDP issues – will severely hamper Beijing and prove problematic for world gross domestic product unless steps are taken before the 19th Congress this autumn.

While North Korea garners the majority of news coverage, the domestic issues also need to be reported on, which could cause China to make structural reform and attempt policy solutions. To counter the falling birth rates, China wisely disbanded its one-child policy. This example illustrates that China can make necessary changes when pressed.

Analyzing China’s history and behavior in the South China Sea, Xi will use foreign meddling and military adventures to paper over domestic problems, ensuring his reign isn’t shut down by the Politburo or other powerful CPC bosses. The time for China to act is now.

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