China's Debt Profile: A Mixed Picture

Hello, and welcome to Liberty Law Talk. I’m Richard Reinsch. Today we’re talking with David Goldman about his new book, You Will Be Assimilated: China’s Plan to Sino-form the World. David Goldman is the author of the widely read Spengler column for the Asia Times. He’s an award-winning Wall Street strategist. He’s worked for Credit Suisse. He was the head of global trading research for Bank of America. And he was an investment banker for a Hong Kong boutique called Reorient, which was purchased by Jack Ma, founder of Alibaba. He also is widely read and published in foreign policy and national security. He’s advised the US National Security Council, the Department of Defense, and institutional investors globally. He’s the author of a number books, including most recently, How Civilizations Die. David Goldman, welcome to Liberty Law Talk.

David Goldman:

Thank you so much for inviting me, Richard.

Richard Reinsch:

David, on your book, two items from China everyone is discussing, and I know that they in some way feature into what you’ve written. First, China’s move to encroach upon, if not eliminate, the semi-autonomous zone of freedom given to Hong Kong. Recently, the British government has offered to every Hong Kong citizen, I’ve read, a passport or some sort of regularized status in the United Kingdom. Your thoughts on what China is doing there?

David Goldman:

Hong Kong has never been a Chinese city. It was a British city. It was founded by the British at the beginning of the opium trade. The majority of its population never wanted to be Chinese. So I think the biggest mistake Margaret Thatcher made in her glorious career was to cede Hong Kong and Kowloon to China when she didn’t have to. Most of the Chinese population hasn’t liked this. There is a significant independence movement in Hong Kong. From the Chinese standpoint, China’s like a Roach Motel. Once you go in, you don’t get out. The Chinese are always terrified that if one rebel province can secede, they’ll all secede. So they will use whatever measures they need to prevent that. Their solution to this long term is going to be a population tragedy. A lot of the Hong Kongers who don’t like living under Chinese rule will leave. They’ll go to Taiwan, Britain, Canada, some to the United States. More and more people will migrate to Hong Kong from the mainland, and eventually it will become a Chinese city.

Richard Reinsch:

So your thinking there, what China stands to gain is really consolidation. They’re worried about the sinner pulling away from the country in some way, or people seeing Hong Kong be successful, operate on its own, without Chinese authority or control.

David Goldman:

Well, it’s worried about secession. There is a significant secession movement. And the most important thing that’s happened with the new national security law is that it has become illegal, seditious to talk about secession. So a lot of the pro-Taiwan, anti-Beijing protestors have simply left the island and will never come back. Remember, China is not a country. We tend to think of it as a country. It is a heterogeneous empire with 200 languages spoken in 90 major ethnic groups, and always at risk of falling apart. The Chinese Empire, whoever runs it, whether it’s called an Imperial Dynasty or a Communist Party, lives in terror of a rebel province that will encourage other rebel provinces. So that’s why China will go to war over Taiwan. It will never allow Taiwan independence without a real fight. It has a good deal to do with why China is being so aggressive in the South China Sea.

Xi Jinping told this to Barack Obama during the APEC summit in 2015. There’s an old Chinese proverb: kill the chicken while the monkey watches. Well, the South China Sea is the chicken, and Taiwan is the monkey here. China is saying, “We’re willing to go to war over a bunch of empty atolls based on some glorious old map. Think of what we’ll do with Taiwan. Think of what we’ll do with Hong Kong.” So that’s China’s method of governance going back thousands of years. Sadly, there’s a continuity between what was always a very heterogeneous set of men who has a very cruel empire and what the Chinese are doing today. This is based on traditional Chinese governance. It’s not per se a function of Marxist-Leninist ideology.

The West has underestimated Asians for the past century and change. The Russians underestimated the Japanese during the 1905 war. The British underestimated the Japanese at Singapore. The French underestimated the Vietnamese at Dien Bien Phu. And I think we can say fairly that the American military in the ’60s underestimated the North Vietnamese Army. We simply have difficulty believing that a culture so different from ours, and one that was so impoverished and humiliated for such a long period of time could come back so quickly. 

Richard Reinsch:

On another front, something else people are discussing widely right now is a video purporting to show Uighur Muslims, who have been persecuted by the Chinese government for years, being loaded onto train cars to be sent to concentration camps. That’s widely believed. There was a fascinating segment the other night on BBC, where the BBC commentator presented this video to the Chinese Ambassador to the United Kingdom, who was literally speechless and had nothing to say. I mean, it was sort of a fascinating interview. What’s going on here from the Chinese standpoint, and what they’re doing to this population?

David Goldman:

Every Chinese I’ve talked to, ranging from senior officials of the Foreign Ministry to taxi drivers, when asked, “What are you going to do about the Uighur problem,” has said, “We’re going to kill them all.” China has had a policy of exterminating what it considers unruly barbarians on its borders for a very long time. Their attitude towards the Uighurs is that they don’t want to assimilate into China. You get the traditional Chinese choice, which is column A, you become Chinese, column B, we kill you all, and there isn’t anything on the menu. I don’t have detailed information about what’s happening in Xinjiang Province to the Uighurs. It’s impossible to get reporters in. The Asia Times is not able to send correspondents in like the rest of the world press. However, the suppression of the Uighurs through forced sterilization, forced use of birth control, cultural suppression amounts to a slow motion ethnocide. In other words, an attempt to extirpate this culture entirely. So putting Uighurs in concentration camps would not surprise me. They’ve already put between one and two million Uighurs through reeducation camps. From a Western standpoint, this is repugnant and brutal. From the standpoint of the vast majority of Chinese, it’s business as usual.

Richard Reinsch:

That’s incredible. You write about the transformation, the economic transformation that has happened in China. I welcome you to talk more about that. The way they’ve brought hundreds of millions of people from the rural countryside into their cities, the tremendous growth of Chinese cities, and their economy, their technological transformation. Why did American policymakers for so long underestimate China?

David Goldman:

The West has underestimated Asians for the past century and change. The Russians underestimated the Japanese during the 1905 war. The British underestimated the Japanese at Singapore. The French underestimated the Vietnamese at Dien Bien Phu. And I think we can say fairly that the American military in the ’60s underestimated the North Vietnamese Army. We simply have difficulty believing that a culture so different from ours, and one that was so impoverished and humiliated for such a long period of time could come back so quickly. But you look at the economic miracle of South Korea, you look at the transformation of Japan from a rural society in the 1860s to a major industrial power by the beginning of the 20th century. China’s rise is not at all without precedent. We saw the same kind of thing in Japan and Korea before.

The difference is that China has 1.4 billion people. As you mentioned, they’ve moved in the past 35 years nearly 600 million people from countryside to city. That’s the equivalent of the whole of Europe from the Ural Mountains to the Atlantic Ocean. Imagine building a new Glasgow, a new Rome, a new Lisbon, a new Helsinki. Build every city in Europe to accommodate that many people. That’s the biggest economic transformation in history. I don’t know if it’s the fastest. But I calculate that per capita household consumption in China has risen nine times, 900% in the past 30 years. That’s one generation. When you talk to Chinese, they’ll tell you, “Well, I grew up with a dirt floor and an outhouse and an outside pump. Now, my kids have indoor plumbing and central heating and a car.” It’s a completely different kind of world. So however brutal and repugnant the Communist Party of China has been, the economic accomplishments of China are real. Walk around Chinese cities. I urge people to just go onto YouTube and look at tours of Chinese cities that you’ve never heard of: Chengdu, Chongqing, Hefei. Names that you don’t know. These are cities of 30 million people that look like science fiction movie sets that were third-world backwaters just 20 years ago. This is an incredible transformation, and the energy and intelligence of the Chinese people is impressive. I am not a panda hugger. I’m not a Sinophile. I don’t like Chinese culture. I find it brutal, and from a Western standpoint, in many ways repugnant. But it’s nonetheless impressive, and underestimating it would be a terrible error.

Richard Reinsch:

Yeah. So if we think about the standard post-Cold War view of our elites, bipartisan, that has this middle class forum which you’ve just described, as the wealth grew, there would be this just natural desire for democracy or some sort of civil society rule of law to form. That hasn’t formed. It’s evident, as you know, that we’re moving from that post-Cold War view. Help us think more about … Help us understand China. Help us understand maybe their thinking about who the human person is. Because that seems to me interesting alone in how this has not produced any sort of desire for more freedom.

So the Chinese have no experience of self-governance. In place of democratic governance, you have a selection of supposedly the smartest people, or at least the best exam takers in the country. Imagine if the United States were ruled by a committee of National Merit Scholars, that was a self-perpetuating elite run by exams.

David Goldman:

Well, there are three things to understand about China, what makes China China, that go back literally 5,000 years. One is its enormous wealth and population are based on fertilized river valleys which could produce eight times the caloric content per acre with rice that Western European or Middle Eastern cultures could produce with wheat. So enormous wealth, but also enormous susceptibility to flooding and famine. So massive infrastructure to control floods has been the foundation of the Chinese Empire. When we look at things like the $2 trillion Belt and Road Initiative where China proposed to build infrastructure all across the Eurasian continent and basically lock it in to the Chinese Empire, that is the old Chinese imperial model extended into an external policy.

The second thing to understand about China is imperial bureaucracy. For thousands of years, the smartest kids in the provinces that sat and taken an examination to become government officials, used to be called the mandarin system. You can see pictures from over 2,000 years ago of young Chinese sitting in an examination hold taking the mandarin exam. This is now the university entrance exam, the Gaokao, which is taken by nearly 10 million Chinese every year. About six out of 10 of whom get to go to university. If you look at the math questions on that, I doubt one in 500 American high school seniors could answer them. I know a little math, and they made me sweat.

The third thing to understand is family. Chinese society is based on the extended family. It’s hierarchical. The emperor is like the big pater familias of the nation, and he has smaller pater familiases under him. The foundation of the Chinese economy has always been an extended family farm led by one pater familias. So you’ve never had a civil society where people have peers. No Chinese has ever sat on a school board or a little league committee. Everything’s always come top down. There’s no sense of rights and obligations as we have under Roman law, no sense of the divine spark of the individual as we have under ancient Hebrew law. What you have is a set of loyalties to hierarchy. That, in a thumbnail, is what Confucianism is about.

So the Chinese have no experience of self-governance. In place of democratic governance, you have a selection of supposedly the smartest people, or at least the best exam takers in the country. Imagine if the United States were ruled by a committee of National Merit Scholars, that was a self-perpetuating elite run by exams. They’re awfully smart. The system is in many ways awfully inefficient. But they’re not stupid, and they’re incredibly ambitious. They’ve never liked their emperor. The emperor in China is just the capo di tutti i capi. He’s the guy who’s there to prevent the underbosses from killing each other. That’s exactly what they do when there isn’t a strong emperor. So the Chinese tend to like having a strong emperor because in their experience, when you don’t have one you have civil war, war widows, and you lose 10 or 20% of the population.

Richard Reinsch:

You said something in the book that stuck with me, and I wonder if you can elaborate on it. You’re touching on it here. The Chinese don’t have friends.

David Goldman:

Well, they don’t have friends in Aristotle’s sense of political friendship where you have a peer group that governs a city, and you have to form friendships in order to solve governance problems and advance policies. Everything in China comes from the top, so the Chinese tend to kiss up and kick down. You don’t question the order that comes down from the top because it’s bad for your health. You could become a kidney donor real fast. And the people below you, you simply tell them what to do. You’re the pater familias. They owe you loyalty. You’re supposed to be benevolent under Confucian philosophy. But in fact, you have absolute control. As I’ve said, there is no subsidiarity. There is no civil society structure. Everything is up and down as opposed to parallel. So the Western concept of political friendship, which was first enunciated by Aristotle, is something which the Chinese simply have never experienced. It’s also a winner-take-all system. There are only a certain number of places. So you have to look to your left and right when you’re in second grade, and decide who you’re going to step over to get ahead.

Richard Reinsch:

So listening to you describe China, it’s almost as if our foreign policy consensus in the post-Cold War period was at odds with reality, at odds with their cultural, economic, political reality. I mean, it sounds absurd that we thought this.

David Goldman:

Richard, I agree with you. The whole idea that China was going to evolve into a Western style democracy simply because they got more prosperous ignores the fact that this is a culture that’s been around for 5,000 years, which operated radically differently from Judeo-Christian cultures. This is the purest form of paganism.

Richard Reinsch:

Yeah, it’s incredible.

David Goldman:

It is. Well, the Chinese are probably the least spiritual people in the world. They believe in fate and themselves. When you say, “Well, what’s Chinese religion?” Well, you can say that there’s Buddhism, there’s some Daoism, there’s some household gods. But the Chinese really are down-to-earth pragmatic. How do I advance my family? How do I get rich?

Richard Reinsch:

On this point, in the book you say China has no desire for war or military confrontation with America. It does desire global economic domination in many respects, and I want to talk about that specifically. One point you make is their technological prowess matches ours, if not surpassing us in quantum computing now. Their ability to deploy the coming generation of 5G technology surpasses America’s, or anything a Western corporation could offer. How did that tech superiority or equality emerge so fast?

David Goldman:

Well, we got very complacent after we won the Cold War. We decided we were so powerful that we could rest on laurels and coast. We could, under the Clinton administration, turn NATO into a responsibility to protect kind of social work organization. Or the George W. Bush, we could go out to support democracy to the world. I think that was a big mistake. I very much agree with President Trump in his criticism of that kind of policy. With the Chinese, they watched what happened to the Soviet Union in the 1980s. They saw the United States created technological miracles that no one could have imagined. We created the digital age, the fast microchip, optical networks, plasma displays, the internet, graphic user interface. Everything that goes into modern economy came from America’s commitment for superiority over the Soviet Union, Defense Department funding of public-private partnerships with US corporations. Chinese watched this, and they learned. So China is attempting to emulate what the United States did in the 70s and 80s as it won the Cold War. It has a vast budget for public support for advanced technologies. China’s idea is that there’s going to be a fourth industrial revolution. That industrial revolution is going to be based on artificial intelligence. And whoever controls the porting and storage and processing of data is going to run the world, because that’s going to allow you to have industrial robots talk to each other and automatically program themselves in flexible manufacturing. It’s going to allow artificial applications to medical diagnoses based on analysis of billions of people’s digitized medical records, DNA, and daily upload of vital signs into the computer cloud. It’ll be based on autonomous driving vehicles, detailed analysis of consumer behavior. And 5G internet is kind of like the railroad in the 19th century, which was the carrier for all these other technologies that made them possible. They want to dominate that, and they want to dominate the industrial applications. They saw the United States dominate the third industrial revolution, the computation revolution. They want to dominate the artificial intelligence revolution.

Richard Reinsch:

The Chinese government invested a lot of money in this technology itself with the idea that the spinoffs, the entrepreneurial creativity and how those would be deployed in various ways would come, but they wanted to beat us in this technology front. You argue they’ve largely succeeded.

David Goldman:

The Chinese People’s Congress, at the end of May, just approved a $2.2 trillion five-year technology budget for any number of things. I mean, 5G itself, the Chinese are spending, according to a study by Deloitte, three times what we spend per capita on 5G. They’ll have the fastest rollout. They also are the biggest market for robotics in the world. The last I saw, their robotic purchases have gone up 25% year on year. And the chief technology officer of Huawei, whom I interview in the book You Will Be Assimilated, explained to me that with 5G and artificial intelligence, you can get a bunch of industrial robots in a factory floor, give them an assignment, and they will work out autonomously a production process that human engineers wouldn’t come up with, in a tiny fraction of the time. So the implications for manufacturing productivity are just staggering. You add that to medical diagnosis. I mean, let’s say you’ve got hundreds of millions of digitized medical records and DNA, and you have a smart phone that takes your blood oxygen content, your temperature, your blood pressure, and so forth with attachments. And with these hundreds of millions of people, in real time, uploading their vital signs into artificial intelligence services run by servers run by Huawei. What’s already happening, Richard, is that every pharmaceutical company in the world is setting up shop in China because the data the Chinese have is a vast mine for researching new drugs, interactions, genetic defects, and so forth. The Chinese computer scientists aren’t any smarter than Google. I think Google’s probably the best computation company in the world. But if you think of artificial intelligence as the engine, data is the fuel. And China, where there’s no guarantee of personal data protection, has the biggest trove of data for medical research in the world.

Richard Reinsch:

On the question of Huawei, which you write about compellingly in the book, and in this interview you’ve mentioned. Their position versus, say, Silicon Valley. Because we always think Silicon Valley has the best technology, the best creativity. Capital is flowing to the best opportunities, those with the best ideas. And there’s Huawei out here which seems to be in position to supply all of Europe with 5G, if not many other countries around the world. Where are we on this? I take it we have the technology. It’s just what? The ability to deploy it or implement it?

David Goldman:

Well, starting about 20 years ago, American technology companies decided that they were much better off in terms of share price by letting the Asians do the manufacturing. Not just China, but also Korea and Japan and Taiwan. Now, to some extent, Vietnam. Let the Asians do the dirty work, and we do the software. Software, if you’re successful, has incredibly high return on equity, because the marginal cost of adding a customer is zero. They just download the software from the internet and pay you. So a company like Cisco, which used to dominate the hardware for internet routers has basically gotten out of the manufacturing business entirely. There was a report in The Wall Street Journal a couple of weeks ago. It mentioned that the US government, specifically Larry Kudlow, the head of the President’s Economic Council, had gone to Chuck Robbins, the CEO of Cisco, and said, “Well, why don’t you go and buy another big telecommunications equipment manufacturer? Go buy Ericsson so we would have a national champion to compete with Huawei.” And Robbins told him, “Cisco’s not in the business of buying low-margin companies.” In fact, Ericsson’s return on equity is a fraction of that of Cisco. So if they did that, Cisco’s stock price might go down. The problem is not so much that we don’t have smart people. It’s that the US tech sector made a conscious decision to become dependent on China for the production of hardware. And of course, the Chinese, who excluded Google and other US companies from the Chinese market, has spent vast amounts of money developing their own software, their own computation, and are now in position to compete with us in the software field, as well. I think this was terribly short-sighted. But I don’t want to entirely put the blame on the tech companies because in Asia, capital-intensive businesses are subsidized the way we subsidize sports stadiums. We don’t have that kind of subsidy in the United States. So to some extent, we are running according to an industrial policy which steers people into that kind of choice. The problems is it’s not our policy. It’s China’s industrial policy which is guiding our investment decisions.

Richard Reinsch:

So just thinking about that, I mean, you and I are both students of free market economics, understand those arguments well. Let’s just play this out, though. Is it not the case though, that in subsidizing these things and having incredible government directed investment, that the technology over time is deficient? Or that resources themselves aren’t being well-utilized and, say, the Silicon Valley sector should over time find the highest and best uses, not only for capital but technology itself?

David Goldman:

I think China’s system is extremely vulnerable because any kind of top-down system tends to make very bad choices, but there are certain kinds of subsidies which stood us in good stead in the past. I think the right division of labor is the key. For example, under Reagan we spent about 1-1/4% of our gross domestic product on federal support for R&D. What that meant is that RCA Labs and GE Labs and IBM Labs would get a research grant from DARPA, and they’d do basic research. Bell Labs, their people won Nobel Prizes doing things there. That produced things like the semiconductor laser, which made optical networks like cable television possible. Produced fast and light computer chips, which made look-down radar in F-15s possible. The US government did not build enterprises. It subsidized the basic R&D, but it let the private sector take the risk of commercialization. Now, to some extent, the Chinese have tried to emulate that. If you look at the National People’s Congress, the entity which just passed this $2.2 trillion technology investment budget the end of May. In that People’s Congress, there are 100 billionaires. The different between the Chinese and the Russians is the Russians said, “You’re a good engineer. Have a good invention. We’ll give you the Order of Lenin and maybe a dacha.” The Chinese say, “You’re a good engineer. Produce a good invention. We’ll let you do an IPO in the Shanghai Market and become a billionaire.” So to some extent, the Chinese have combined that kind of incentive into their system, and let a lot of people take private sector risk. It’s sort of a mixed thing. Now, I believe that American ingenuity and the American system, if it’s unleashed, can do a lot better than China. I saw this in the 1970s and 1980s when I was a very young man. In the late 1970s, everybody thought Russia would win the Cold War. The Russian economy was doing wonderfully, and the United States was a declining power. Reagan came in. By 1982, it was clear that the United States would win a conventional war, and the Russians weren’t too sure they wanted to fight a nuclear war. That was the beginning of the end for communism. We turned them around in a very short period of time.

Richard Reinsch:

You used the word unleashed. What’s leashing, say, America’s tech firms now?

David Goldman:

If you look at what our kids are doing, we graduate, I think, about 40,000 mechanical engineers a year. That’s not half what Germany does. A tiny fraction of China. The smartest kids aren’t going into manufacturing because the smartest companies aren’t investing in manufacturing. Really ambitious kids at US universities want to either go with a software or a Goldman Sachs, so they study mathematical finance or computer science. The danger is we end up being, if you pardon the expression, geeks in a new Roman Empire. I think we need a very strong signal from the government, including very strong tax incentives and, in rare cases, subsidies for manufacturing investment. We have to get our best talent thinking about manufacturing, particularly the kind of artificial intelligence, computer-driven manufacturing, which the Chinese call the fourth industrial revolution. We need to restore the level of federal support for R&D that we had under Reagan and under Kennedy. We need to get US corporations to understand that their future depends on the future of the United States, and they have to put the kind of effort into R&D that they did back when Bell Labs was the wonder of the world. Nobody knows what happened to Bell Labs. Well, it still exists, because Nokia bought the assets of Lucent. It’s now called Shanghai Bell. It’s sitting in Shanghai, and Nokia employs 16,000 Chinese scientists and engineers in China doing research there. That’s our problem.

Richard Reinsch:

It’s interesting. You’re saying this is a national security exception to markets and we just need to draw that line, and the government has to step in in various ways to push things forward because the market itself isn’t, or American companies operating in the market aren’t recognizing this problem.

David Goldman:

There are always things government does for the general welfare, and promoting science and engineering research, basic research, is something the government legitimately can do. I don’t like the idea of the government picking winners. That always lead to corruption and cronyism and inefficiency. Entrepreneurs will take risks, but it’s hard to get entrepreneurs to take risks on the unknown unknowns, when you’re talking about something where the science isn’t yet established. When we talk about Bell Labs in the past producing Nobel Prize winners, it’s because they did basic science. Texas Instruments in 1958 invented the integrated circuit. That was basic science, and that happened because you had federal support for that. So I think there’s a legitimate basis for that, but there is a real world out there. We’ve got competitors. So to the extent that the Chinese have tilted the pool table by producing massive subsidies for capital-intensive industries … Not just the Chinese. Koreans and Japanese, as well. That’s the Asian model. We have no choice but to respond in kind in some cases. As much as I’m an old supply sider or old free marketer, our economy is being guided, as I said, to a great extent by somebody else’s industrial policy. We have an industrial policy like, “They’re not the problem. It’s not ours. It’s China’s.”

Richard Reinsch:

It seems to me also in this regard, and I don’t know what your thoughts are. Marco Rubio favors an industrial policy. This seem to be much more about bringing manufacturing jobs to America, and that’s a key element of it. I guess my fear is that actually doesn’t do what you want to do, which is advance science and research in order to push technological bounds with likely commercial applications. It seems to me this is more of a, “Well, we just want to bring the past back.”

David Goldman:

Richard, I share your views. I wrote a response to Senator Rubio’s paper, which I thought was a good contribution to the debate, on the website of Claremont, The American Mind. I said you have to treat these problems as different. If you want to make a case for promoting industrial employment because it’s a good thing for American workers, make that case separate. But we also have a national security issue, which has to be pursued on its own merits. If you lump these two things together in an overall industrial policy, you tend to get into a pinata grab for funding by people. Congressmen who want money for their district, and industries who want subsidies. We have to distinguish very carefully what the policy objectives are. Clearly, it can’t bring the past back. And in fact, the best kind of manufacturing, the kind that really could reshore efficiently American production is going to be very capital intensive. It won’t involve a whole lot of workers. If you look at the pinnacle of manufacturing today, that’s chip production. That involves 10 different processes, each of which is incredibly complex and involves massive amounts of investment. A new chip foundry costs about $20 billion and employs a few hundred workers. So what we have to figure, is that if we have a massive increase in productivity, that’s going to lead to all kinds of spinoff. Take the optical network. One result of that is we created hundreds of thousands of jobs in building out the cable TV industry. Building out cable created a massive surge in employment, and well-paid employment. There weren’t a lot of people employed produced in the lasers that went into the optical networks, but the secondary effects created a vast number of jobs.

Richard Reinsch:

Okay. Yeah, well said. Thinking here, you’re aware of this as well. I just want to go through, because there’s also a counter argument or counter thinking to your position on China, that the country may be more brittle than we might think. I want to get your response to those. Thinking about the Belt and Road Initiative, you’ve written a lot about that. What’s China doing there? But then also, is it not just sort of massively overextending itself and eventually creating a lot of debt problems? Basically, it’s just not going to recoup the gains that it’s invested.

David Goldman:

China has some serious problems. The Belt and Road Initiative has been very poorly done. Chinese really don’t have the expertise in dealing with a lot of countries where they’ve thrown a lot of money around and created a lot of white elephant projects and a lot of bad debt. They do have $3 trillion worth of foreign exchange reserves, and they do have a current account surplus. With that kind of starting position, you can afford a number of mistakes. But I think the Belt and Road has been, in many ways, a disappointment in some ways, in other ways it hasn’t. If you look at Southeast Asia for example, that’s 600 million people. China’s imports from Southeast Asia have just exploded. Southeast Asia has become a source of not just cheap raw materials, but cheap manufactured goods for China. As the cost of labor has gone up in China, they have substituted cheaper labor in Southeast Asia.

And as the Chinese labor force has ceased to grow, the Chinese population is stagnant, they’ve managed to integrate into the Chinese economy the labor of hundreds of millions of people in Southeast Asia. So it’s a very mixed picture. In terms of China’s debt profile, China’s debt to GDP is about the same as the United States. The difference is that government debt is much lower and corporate debt is much higher. Look at the corporate debt levels. They’re staggering. A lot of people have said, “Gee, aren’t they all going to go bankrupt?” Well, we did a study of this at Asia Times. The thing about China is that infrastructure has been the key to Chinese productivity growth, and the cost of that infrastructure was placed on the balance sheet of state-owned companies.

So the majority of corporate debt is related to building railroads, building oil refineries, building airports, building roads, harbors, and so forth. That shows up as corporate debt simply because you have state-owned companies doing that instead of having a municipal corporation that issues municipal bonds and builds the infrastructure. It’ll go onto the balance sheet of Shanghai Pudong Development Corporation, which does ports, or China Petroleum, or China Tower, which builds towers. So a lot of that debt is infrastructure related. Although it looks like a lot, it’s fairly sound. Now, where the Chinese have a serious problem is in the housing market. In the United States, the average cost of a house is four or fives the annual income. In China, 10 to 20 times the annual income, depending on the part of the country. Now, Hong Kong is 50 times. That’s because the savings of the Chinese people have gone overwhelmingly into houses, because they’ve never trusted the stock market. That’s viewed as a casino.

So housing prices are excessive. If they go up much further, people won’t be able to buy a house. If they go down, you wipe out the savings. So very carefully, the Chinese government is trying to shift household assets away from housing into the stock market, and make it better regulated and less a casino-like entity. That’s a significant problem. They’re trying to address it. That could lead to a major issue for them. Now, typically, countries that have current account surpluses … In other words, they’re not dependent on borrowing money from overseas. They’re not lenders to overseas … and very high savings rates and have economic growth don’t have unmanageable crisis. They have adjustments they can deal with. China has a current account surplus, a 44% national savings rate as opposed to about 18% in the United States.

Richard Reinsch:

I’m surprised it’s that high.

David Goldman:

Vast savings rate. High. That’s households, corporations, government. Very high savers. And it has economic growth. So the idea that China is going to have an unmanageable financial crisis as opposed to some painful adjustments here and there is, in my view, highly improbable. There’s simply no record of a country that has those three criteria getting into really crippling financial problems.

I don’t believe China’s demographic problems are going to hold them back massively. However, if China doesn’t fix them, China will go into a decline towards the end of the 21st century. 

Richard Reinsch:

Talk about how is capital deployed in China? I mean, is there this idea of a market of winners and losers, and it happens apart from state direction or state funding or financing. I mean, describe that process for us.

David Goldman:

Well, for most of the past 30 years, 40 years, capital in China has come from state-owned banks. A state-owned bank is basically a bureaucrat with a shovel standing next to a barrel of cash, waiting for a state-owned company to come along with a bucket, and he shovels some cash into the bucket. So even though you have this clever mandarin caste composed of the top exam scores in the country directing the investments, and they’re not stupid people, massive inefficiencies have cropped up in that. Increasingly, China is trying to use equity markets as source of financing. For example, Semiconductor International Corporation, SMIC, China’s biggest chip foundry, just did an IPO for tens of billions of dollars at a value that’s now tripled in the mainland markets.

Ant Financial, which is the biggest consumer payments company in the world with 900 million customers. That’s Jack Ma’s big company. Ant Financial is going to come to market and do an IPO for, I think, $40 billion, which would make it the biggest IPO in history. So there is a significant amount of money which is being channeled into new enterprises, new technologies through equity markets. That’s what China is trying to do. Now, of course when you allow the markets to make decisions, that is a certain kind of democracy. That gives the public a certain kind of veto on government policy. Because if they don’t like your policy, they don’t have to buy securities. Same with bonds. So that does mean a certain kind of concession of power away from the center to the public on the part of the Communist Party, and they’re trying to make that concession very carefully and very gradually.

By the way, one of the reasons they’ve invited American financial companies into China is to help them do that. Companies like J.P. Morgan and Goldman Sachs and Morgan Stanley now have wholly owned subsidiaries in China. The banks that are expected to manage this Ant Financial IPO, biggest IPO in history, are I believe Goldman Sachs, Morgan Stanley, and J.P. Morgan. So America’s financial sector is being given a huge incentive to help the Chinese government accomplish exactly this transition, and they’re very eager to do that.

Richard Reinsch:

Interesting. Thinking about other observations. One, you’ve mentioned the aging workforce, but also birthrates, demographics. How do you see China trying to surmount those problems that it presents long term?

David Goldman:

China traditionally had a high birth rate. Children were the most valued possession. China imposed, 40 years ago, a one-child policy, which is the cruelest demographic policy since King Herod or Pharaoh. It forced people to have only one child. Of course, the result is that China’s population growth is old. Its workforce has stopped growing. And it’s said, “Well, now you can go ahead and have two children.” It doesn’t appear that the population is responding very quickly to this incentive, partly because China created a set of winner-take-all incentives in which the average family will spend the equivalent of a year’s income in tutoring fees so their one child can get ahead in the university system, can get the brass ring. So whether the Chinese population will get out of this hole or not, is not clear. As I mentioned, a great deal of the motivation for the one belt, one road policy is for China to lock in the available pools of usable labor around the world, of which the biggest is the 600 million people in Southeast Asia. They’re not necessarily the biggest pool of labor. There are more people in Africa. But if you want to find people who will show up to work on time, follow instructions, and be able to read the users manual, that’s Southeast Asia. So to some extent, that will buffet.

For the next 20 or 30 years, which will be the critical years for us, I don’t believe China’s demographic problems are going to hold them back massively. However, if China doesn’t fix them, China will go into a decline towards the end of the 21st century. That, however, will not be soon enough to bail us out. So although it’s something to watch carefully, I don’t think we can count on China going into a demographic winter that’s going to cripple them as a strategic rival in the kind of time horizon that we really care about.

Richard Reinsch:

We should see them as a rival. Not as an enemy, not as an ally, but as a rival.

David Goldman:

It’s like meeting a tiger in the jungle. A tiger isn’t wicked. It doesn’t hate you. It just looks at you and thinks protein source.

China is the old pagan world. The concepts of good and evil don’t exist in the same way they exist in the Judeo-Christian worlds. Loyalty and obligation substitute for good and evil. So we will never be friends with China. It’ll take a very long time, if ever, for China to decide that the Judeo-Christian concept of human society is superior to theirs. They’ve been around for thousands of years, and they change very slowly. Our system is better. I believe in the sanctity of the individual as the highest good in society, and that’s entirely absent from the Chinese system. But the Chinese idea of, “Let’s have a meritocracy of the cleverest people who run everything from the top,” occasionally does better than the messy brawl of democracy, and unfortunately.

Richard Reinsch:

Yeah, and I’ve been mentioning China’s weaknesses. We need a whole other podcast to mention our weaknesses, which are glaring and evident to all right now. In many ways, to even take seriously what you’re proposing requires a great effort on our part.

David Goldman:

Well, we did this before. We worked miracles when we beat the Russians in the Cold War, when we beat them in the Space Race, when we beat the Axis powers with the arsenal of democracy. America’s capacity, for a generation, has astonished the world before. But I really think we have to understand that this is a lot more serious than we’ve been telling ourselves, and we need to say goodbye to a lot of self-consoling illusions about where we stand in the world. This is the biggest challenge we’ve ever faced.

Richard Reinsch:

Wow. David Goldman, well said. We’ve been talking with the author of You Will Be Assimilated: China’s Plan to Sino-form the World. Thank you so much.

David Goldman:

Thank you so much for the conversation, Richard. It’s always a pleasure.