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China's Second Great Leap Forward

The People's Republic of China's first Great Leap Forward thrust it forward at the cost of some 40 million lives. And while its Second Great Leap Forward appears to come at a smaller cost in lives, it may prove to be equally fragile.

The saving grace of the PRC economy has been the willingness of Western companies to use it as a cheap labor market. Capitalism accomplished what Communism could not, giving its industrialization focus. But beneath that China is still a Party oligarchy which is stuck thinking in terms of giant projects and major goals. The New China is on its Second Great Leap Forward and still trapped in Mao's legacy.

mao-tse-iphone2China has achieved Mao's vision of becoming the world's dominant steel producer. China produces a third of the world's steel. Almost eight times as much as the United States. And its dumping of steel on the American market, along with domestic overregulation, has helped break down the American steel industry. But the Chinese steel industry is government subsidized and protected. Like so much else, it grows out of a command economy.

China's command economy depends on an undervalued currency which uses exports to fund industrial investment. More industry, more cheap exports and more revenue. The cycle of aggressive growth that follows is impressive, but also completely unstable. The growth is not natural, it's government funded. The costs of the growth are dispersed and hidden, but they are still there. Like most pyramid schemes, the numbers look good so long as a high rate of growth continues. But a setback exposes its weakness and topples the whole structure.

The PRC's official budget deficit isn't so terrible, but its real spending is often hidden behind a convoluted organizational web of state owned banks and investment corporations set up by local governments to lend themselves money from state owned banks. China's official budget listed revenues of 1.149 trillion and expenditures of 1.27 trillion. Not so bad compared to America's insane 2.092 trillion in revenues and 3.397 trillion in expenditures. Except when you start accounting for nearly an additional 4 trillion in debt that the PRC used to "stimulate" its economy via its own banks. This puts our own "stimulus plan" into perspective. The Chinese version is much worse than our own.

Obama suggests that we look to China. But that may just be because the Chinese model is his own taken to the worst possible extreme, more reckless, less transparent and headed for disaster. Massive infrastructure investments, irresponsible currency manipulation, piles of hidden debt and unrecognized long term consequences.

The disasters of the original Great Leap Forward were fed by a political bureaucracy, that like its Soviet counterparts, refused to acknowledge failure or pass along news of negative outcomes up the ladder. There is no sign that this has changed. The Russian and Chinese Communist command economies passed unworkable orders down to the fiefdoms of local officials who hid their failures until they couldn't be hidden anymore. The same thing is happening now under a capitalist veneer. And there is every sign that the disasters of the Great Leap Forward are repeating themselves.

Massive population displacement, home demolitions and land seizures in the countryside were a feature of the Great Leap Forward and they are a major feature of the Second Great Leap Forward. But this time the peasants aren't starving to death by the roadside, they're protesting loudly. While Westerners still think in terms of Tienanmen Square, there are tens of thousands mass anti-government protests happening every year in China. Some of them featuring crowds in the tens of thousands. These are not democracy protests by students. The modern Chinese students tends to be pro-regime and optimistic about making money. The peasant thrown out of his home by local officials does not.

obamastateoftheunion2012The displaced populations and a gender gap that will leave millions unable to marry represent a ticking social time bomb. Mao's China solved it with the mass murder of millions. The modern PRC is willing to evict millions from their homes, but not to actively execute or starve them all to death. Instead it plans to outgrow the problem. And its growth plan pumps money into local industrialization which leads to more evictions. More significantly it leads to the loss of arable land.

The original Great Leap Forward saw famine deaths in the tens of millions. Since then China has put a great deal of focus on self-sufficiency in wheat production and stockpiling wheat reserves, but its wheat, corn and even rice imports are rising dramatically. That is a dangerous sign in a country with a high population, devastating droughts and a long history of famines.

But China's own government funded industrialization is partly to blame for it. The PRC's Second Great Leap Forward has pumped money into rural development, throwing up power plants, dams and factories, and wiping out millions of hectares of arable land. Their solution to the problem is more government funded agriculture through farm subsidies, while raising the minimum purchase price on crops.

China has set minimum purchase prices on wheat and other crops to subsidize domestic agriculture while preventing the United States and other foreign competitors from dumping cheaper wheat on its marketplace. While American wheat was cheaper than Chinese wheat, it cannot be sold for less than Chinese wheat. Like so much else of China's economy, this setup depended on a high rate of growth. But rising global wheat prices combined with rising domestic demand and less arable land are making it dangerously vulnerable. Food prices in China are rising sharply, while its domestic production is unable to keep up.

China's agricultural spending is negligible compared to its massive infrastructure investments, that are often senseless, destructive and wasteful. The mentality was typical of the USSR, of North Korea and of China, which is throwing it has into massive projects without a realistic return on their investment. Like Dubai, China is spending enormous amounts of money and effort to maintain the boom image. But that image is built on massive piles of debt invested against artificial growth. With the whole thing rising like a neon lit deck of cards above a wobbly table.

The final and worst legacy of the Great Leap Forward is shoddy production. The Leap set target goals and tried to meet them by cutting every corner possible. The modern China is no longer trying to beat the UK's steel production numbers with backyard furnaces, as it did in Mao's day, but its steel is notoriously shoddy. So is everything else that is Made in China.

For now America is still putting cost over quality. As San Francisco did when it bought its new Bay Bridge in China. But rising steel prices, a weak dollar and an inevitable clash over China's undervalued currency mean that sooner or later, Chinese industry will be forced to compete on quality, not on price. And when that day comes, industries built on government subsidies and told to turn out products at the lowest price, will suddenly find themselves in big trouble.

Like most command economies, China is strictly big picture. Its higher ups are unconcerned with the details. Mao remained unaware for the longest time that backyard furnaces cannot produce high quality steel. Similarly the men and women at the top are ignorant of the details that keeps their economic miracle on track. Instead they celebrate big picture accomplishments like the opening of the world's longest bridge, the Qingdao Jiaozhou Bay Bridge, which is certainly a big bridge, with some safety issues, and happens to be completely unnecessary.

With debt at 80 percent of GDP, the only plan is to keep moving forward. But the level of growth needed is unsustainable. The "Big Picture" vision of the Second Great Leap Forward is about to collide with economic realities and unspoken truths.

Now as China indulges in military brinkmanship with its neighbors and pumps more money into its military budget, while growing more brazen about seizing entire US companies and hoarding raw materials, its aggressiveness is breaking apart the business relationships on which its economic boom was founded.

China's economic growth is parasitic on American and European growth. It has overinvested in a race against America and Europe, without understanding that it is running a race against itself. That it has not truly broken with the errors of the Great Leap Forward.

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