The emerging consensus about the U.S.–China trade standoff is that both sides are settling in for “the long haul,” as suggested in recent headlines from around the world using precisely that phrase. It seems obvious, though, that the “the long haul” means very different things to the two sides.
In the U.S., the body politic and the media are already consumed by a presidential election that is still 18 months away. They see Chinese president Xi Jinping as a strongman with a lifetime appointment and control over the political, military, and financial levers of power in his country. The conventional wisdom seems to be that President Xi can wait out President Trump while pressuring various elements of Trump’s electoral coalition, including blue-collar manufacturing workers and farmers, in hopes that his bid for reelection will fail.
But in China, the political establishment, which includes state-controlled media, is creating an alternative reality for public consumption, derived from what Xi himself is saying.
It’s always best when trying to assess China’s intentions to listen carefully to its leaders. They tend to speak with clear intent. In Xi’s precise words about the trade standoff, he is preparing China for what he calls “a new Long March.” He’s not saying “we’re in this for the long haul” or “this will be a long-term challenge.” While both may be true, the words he has chosen instead are not accidental. They connote something far more profound than a political cycle or two. Xi understands that China is edging along the precipice of a significant financial crisis, if not worse, and that Beijing cannot stop it. He is preparing the Chinese public for this eventuality.
As a historic event, the Long March was a massive military retreat by the Red Army in the face of likely annihilation by the army of the Chinese Nationalist party. It led to Mao Tse Tung’s consolidation of power within the Communist party and, some years later, to the party’s assumption of power. Mao declared the Long March “a propaganda force” that allowed him to solidify the image of the Red Army, and ultimately the Communist party, as the decisive actor in China.
One needn’t be an expert in Chinese history, language, or politics to assume that Xi understands both the history and the present-day propaganda potential of the Long March very well. He announced his “new Long March” in Jiangxi, where the first one began. In Jiangxi, he said that the Chinese people “must be conscious of the long-term and complex nature of various unfavorable factors at home and abroad, and properly prepare for the various difficult situations.”
It is hard to reconcile a setback in trade negotiations as it is seen in the U.S. with President Xi’s choice of terminology and imagery. He has raised the specter of one of the most formative experiences in the history of the PRC, and a world-historic military setback at that. Combined with his references to “complex . . . unfavorable factors” and “various difficult situations,” his posture hints at concerns far deeper than whether he can reach a deal with the Trump administration on the trade volume of soybeans and pork, or even on intellectual-property rights.
Notwithstanding its appearance of strength and prosperity, the Chinese economy has all the characteristics of an unstable market that can ill afford a shock from any direction. The pressure from the trade war is exposing cracks that have been there for anyone who wanted to see them well before now. This was probably inevitable either way, and Xi and the political class know it.
The most significant pending shock is the likelihood that China is on the cusp of being a net importer of goods and services. For the first time in a generation, a variety of factors are combining to create a current-account deficit for China. As The Economist noted in a recent article, “that China sells more to the world than it buys from it can seem like an immutable feature of the economic landscape.” It may not be much longer.
The implications of this shift are profound. It threatens one of China’s most powerful perceived assets: $3 trillion in foreign-exchange reserves — including $1 trillion in U.S. Treasury Bonds —and the image it has lent the country as a net creditor to the world. This is about to change. If it does, those reserves will go fast. It is certain the Chinese leaders understand as much, even if it seems not to be too important to American trade negotiators focused on the surplus China has with the United States. Together with the unstable underlying economic conditions of the country, sustained overall trade deficits and the ensuing challenges would justify Xi’s call for a strategic retreat, however difficult it will be.
There already is a lot of pressure on China’s reserves. Total debt in the country is approaching three times GDP — a figure that’s triple the debt-to-GDP ratio of the U.S. The government needs to bolster the banking system and keep liquidity in the economy. The reserves are also needed for currency protection, should Beijing make any meaningful attempts at it. The renminbi has drifted down 8 percent in the last year and is approaching 7 RMB/dollar, a level not seen since the financial crisis.
But if China experiences a sustained current-account deficit and becomes a net importer and therefore a net borrower in the world, those reserves will be needed even more. After preserving the banking system, protecting the currency, and financing trade, Xi will find that he doesn’t have much of that $3 trillion left.
The trends are not favorable. Even at their current level, the foreign reserves of the country are down from nearly half of GDP in 2010 to about a quarter of GDP today. Sustained trade deficits will accelerate that decline. And further deployment of the reserves that remain will have one-off effects that will create additional challenges. Dumping U.S. Treasuries, which constitute a significant portion of those reserves, would spur higher U.S. interest rates and possibly a slowdown in American economic growth, which would impact China, too, encouraging even more capital flight from the country.
When China was running large current-account surpluses and building reserves, it was afforded a certain freedom of movement and independence. The country weathered the financial crisis a decade ago with the help of government-stimulated liquidity. Trade surpluses, bolstered by a high savings rate, large foreign-exchange reserves, and a government-controlled banking system can cover a lot of ills. But if the trade balance flips the other way, it will be difficult for China to avoid the discipline imposed by global free-market forces. Beijing will have less control; that’s one of the realities of engaging in global trade. Indeed, America’s having run current-account deficits for many years is one of the primary reasons for President Trump’s long-held belief that trade is bad. Trade isn’t bad or good. But large shifts over time in a country’s position within the global trading system can have profound implications, as Beijing seems to be finding out now. Of course, the U.S. is fortunate to control the world’s reserve currency, the dollar. Without a fully convertible currency, China is in just about the exact opposite position. Being a net borrower that runs trade deficits will put tremendous pressure on its savings and reserves.
President Xi knows this is all unfolding against a challenging backdrop. The economy is groaning under the weight of government, corporate, and household debt. As it is in most underdeveloped economies, excessive debt in China is a government policy, driven by the use of easy money to stimulate economic growth. Demographic challenges loom from decades of disastrous social and family-planning policies; the number of retirees for every worker will more than double in the next decade and a half. China’s trade surpluses were driven by a high savings rate relative to individual consumption. As the elderly draw down those savings, they will put downward pressure on the current account.
For Beijing, there is added concern about the inevitable consequences of the growth in household debt among the urban elite in Beijing, Shanghai, Guangzhou, and other large cities. The easy money is driving mortgage and credit-card debt and creating real-estate bubbles. Empty shopping malls and condominium developments in overbuilt ghost cities are just one sign of the looming debt crisis.
Beneath all of this is persistent rural poverty. To be sure, the PRC has lifted hundreds of millions of Chinese from the levels of destitution that existed prior to the economic liberalizations under Deng Xiaoping and his successors. Xi has declared that the PRC intends to eliminate poverty by 2020. And based on the PRCs own poverty level of about $330/year in 2010 constant dollars, he may be able to keep that promise. But the World Bank estimates that there are nearly 400 million Chinese who subsist on less than $5.50 a day and therefore live below an internationally recognized poverty line.
That brings us to Chinese economic growth, which was 6.6 percent for fiscal year 2018, its lowest yearly level since 1990. It came in at 6.4 percent in the first quarter of this year, remaining flat from the previous quarter — and even that was better than some analysts expected, helped by additional government stimulus in the form of extra bank lending to offset the impact of the trade pressures.
For years, outside analysts have insisted that Beijing’s best and brightest could manipulate the controls and keep the economy cruising along. Indeed, after the 2008 financial crisis the worst effects of that period were avoided through such manipulation. But the effects of the decisions made then have taken their toll over time. Since 2010, total debt has doubled, economic growth has declined by four percentage points, or 40 percent, and foreign-exchange reserves relative to GDP have been cut nearly in half.
There is no more slack in the levers the government relied on in the past. Beijing is not in control of its own economic future. And flipping from a sustained current-account surplus to a deficit will accelerate other negative trends. Much like the Red Army in 1935, the Chinese economy is surrounded by forces it cannot defeat, and further action in any direction — economic stimulus, currency depreciation, or foreign-exchange release — will only exacerbate its underlying problems.
It’s not clear if Xi’s “new Long March” strategic retreat is feasible, but the rationale that underpins it is understandable. The country’s underlying weaknesses pre-date Xi’s ascendancy and were acknowledged by his predecessors. Again, when it comes to insightful analysis of China’s situation, you can’t do much better than listening to its leaders themselves. One recent leader described China’s economy as “unbalanced, unstable, uncoordinated, and unsustainable.” This was then-premier Wen Jiabao — in 2007, before the Great Recession, before Xi and Donald Trump (and Barack Obama, for that matter), and before the trade war.
Wen was right then, and Xi is right today. There is no way out of China’s current predicament other than something as audacious as a strategic retreat that allows it to live to fight another day while weathering the coming financial crisis, which it cannot avoid.
The “new Long March” could take many forms. In the most immediate sense, we should expect more resistance to trade liberalization, in the form of new import restrictions and capital controls. Import substitution is the classic default from global trade for emerging economies. Hence, Xi’s call for the public to “prepare for the various difficult situations” ahead.
We may also see Xi attempt some diversions. He could trigger a cross-strait confrontation with Taiwan, for instance, or attempt more adventurism in disputed territories in the South China Sea. There might be grandiose new infrastructure projects, inside China and abroad. We should expect even more intense repression of ethnic minorities, including the Muslim Uighur encirclement, and even more unsettling use of technology to further control the population across the country and monitor foreigners within it. And we should expect less cooperation than we’ve seen of late on multilateral challenges, including Iran and North Korea.
How should we respond? The U.S., Japan, and other allies would be best served by an enlightened unity in defense of their mutual interests, assuming that the Trump administration is interested in executing such a policy. The administration should attempt to use the pending crisis to encourage Beijing to further modernize its financial system, instituting banking-transparency measures, fully convertible currency, and other reforms that will both ease China’s ability to confront its new reality and connect it better with the world. Such efforts are worth trying, even if they prove futile.
Whatever policy response ensues, our confrontation with China goes well beyond trade and tariffs. Above all, it’s imperative that the Trump administration see China’s new Long March for what it is — a strategic economic retreat, accompanied by possible regional chauvinism and propaganda meant to placate the domestic audience — and plan accordingly.