Donald Trump should be careful what he wishes for as he shoulder-checks China's economy.
Some might go for a poking-the-dragon metaphor here. But the U.S. president is not provoking the second-biggest economy so much as tackling it in ways sure to leave America winded and, ultimately, disabled.
Much ink has been spilled over Trump's threats to impose tariffs on another $200 billion of Chinese imports. Many agree it could lop about half a percentage point off mainland growth. To flat-earth Trump advisers like Peter Navarro, that might seem a mere flesh wound for a nation that grew 6.9% in 2017.
It is not that simple. The big debate on China concerns how Beijing can put the quality of growth ahead of quantity. With Trump going for China's legs, you can forget President Xi Jinping pressing on with bold reforms. That creates two major threats to the global outlook.
One, hastening China's "Minsky moment." The reference here is to when a debt-fueled economic boom meets a nasty end. Japan in 1990, Southeast Asia in 1997, Russia in 1998, Wall Street in 2008, Europe in 2010 -- pick your precedent. All of these episodes are not necessarily Minsky events, but they represent debt reckonings that shocked markets.
China, as bond guru Bill Gross famously observed, is the "mystery meat" of global finance. Hedge-fund manager Jim Chanos once said Asia's biggest economy is on a "treadmill to hell." Hyperbolic perhaps, but sobering coming from one of the first to predict the collapse of Enron back in 2001. In recent years, Chanos has shorted Chinese developers.
Until now, doomsayers have not made loads of money. That could change as Trump's nihilistic assault on global trade throws China off balance. That gets us back to Beijing's date with the Minsky destiny that slams every industrializing nation from East to West, without fail.
There is a perception that China, run by the strongest leader in generations, is unstoppable. It can grow north of 6.5% year after year no matter what chaos might befall the U.S., Europe and Japan. Yet the bill for the rapid growth China generated since 2008 is coming due as Trump trips up the economy. Since then, Beijing's debt-to-GDP ratio has ballooned from 160% toward 300%.
The worry is that no one really knows China's true debt burden -- hence Gross' "mystery meat" viewpoint. In the five years after 2008, China's local-government debt -- that we know of -- exceeded Germany's $4 trillion GDP. Investors worry, too, about China Inc.'s corporate debt-to-GDP ratio. All that borrowing must be considered in the context of per capita income that has yet to reach $10,000. We take it for granted that Xi's economy will beat the "middle-income trap" with flying colors. Not so much if Trump's tariffs precipitate China's debt reckoning.
China's stock rout last week was as much about Trump as opacity. The People's Bank of China is in quite a bind. It needs to curb credit growth. If it hit the brakes, though, many companies might have trouble servicing debt. Thanks to a dearth of transparency, just a couple of headline-grabbing defaults could precipitate what analyst Chen Long of Gavekal Dragonomics calls "a self-reinforcing downward spiral."
"In a market sell-off," Chen says, "the banks would naturally issue margin calls. If borrowers were unable to meet those calls, the banks would normally begin to sell shares. However, given that many large shareholders face regulatory restrictions on stock sales, it is unclear whether lenders would be able to liquidate the collateral they hold. The consequence in a steep sell-off could be mass suspensions, a prospect which is just as unnerving for ordinary investors as forced sales."
In other words, China is home to a host of landmines that could blow up on investors -- and Trump's America, should a $14 trillion economy hit a wall.
Two, interrupting Xi's reform push. Between "Made in China 2025" and Xi's recently installed reform dream team, it seems change is well afoot in Beijing. Yet last week's plunge in Shanghai shares betrayed how much work Beijing needs to do to strengthen economic fundamentals.
Enter Trump, who keeps adding zeros to the dollar-value of Chinese goods he is targeting. Now consider those risks in the context of Xi being named, essentially, leader for life. Conventional wisdom holds that Xi's omnipotence will accelerate upgrades to wean China off exports. The same goes for reining in competing bubbles in credit, debt and property.
Confident he will stay at the helm for another 15 to 20 years, Xi, 65, will revolutionize state-owned enterprises, curb the shadow-banking industry, tame corruption and hasten the shift from smokestack industries to innovation and services. Yet the unique risks posed by Trump could have Xi taking another route.
On the one hand, Xi knows that fulfilling his dream of a three-decade-long reign depends on rapid growth. Legitimacy questions will abound if incomes do not surpass $10,000 in short order. On the other, local-government powerbrokers vying for national prominence see big GDP numbers as the best way to get Xi's attention.
Any move to rebalance the economy will drive growth markedly lower. Throughout the nation of 1.4 billion people, though, two dozen local governments have every incentive to hit the gas. Rather than disappoint Xi, they may order up new six-lane highways, international airports, universities, museums, civic centers, stadiums and other white-elephant projects.
The upshot could be even more credit, more debt, more opacity, more pollution and more imbalances, not a more stable and balanced China. Add in the Trump effect and all the associated risks, and you have a plausible recipe for a reckoning.Those risks increase as Asian governments retaliate. India last week became the latest to hit back, announcing new duties on agricultural items, chemicals and steel products. Import levies on chickpeas and Bengal gram lentils are headed to 70%. Xi's China, of course, has slapped taxes on some $50 billion of U.S. goods.
One risk that hit Gross of Janus Henderson Investors personally this year is that Beijing might dump large blocks of U.S. Treasury debt. In April, Xi's government pared nearly $6 billion of dollar bonds to $1.18 trillion. Fears Xi might weaponize dollar holdings to strike back has Russia frontrunning possible losses. In March and April, Moscow accelerated sales of Treasury holdings, which have halved over the lastyear. The resulting rise in U.S. yields has Gross' fund down 5.4% so far in 2018.
Chanos, meantime, might soon see his China shorts pay bigger dividends. His concerns that China is "an economic model built on debt" are a key theme of the new Alex Gibney documentary, "The China Hustle." And in Chanos' view, "the trade spat brewing between the U.S. and China is not going to help matters."
Well, short-sellers might be happy. But once the turbulence boomerang's back America's way, Trump may rue the day he tried to knock China off balance.
William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia, for his work for the Nikkei Asian Review.
