Through July the Chinese national stock market at Shanghai went into free fall, despite the government’s efforts to buoy it by, among other things, injecting cash. The market had crashed several times before, but this time stock values had grown much higher than in the past, leading to much-increased investment (by Chinese citizens; foreigners were not allowed into the market). Many of the investors borrowed heavily in the expectation that the market would continue to grow, making them rich. The crash was thus a major disaster for Chinese citizens, many of whom had never previously invested in stocks. This financial crash is likely to have profound effects on China, both for its internal stability and for its foreign policy.
China is fortunate (or unfortunate) in having a mixed economy, largely based on free enterprise, but also controlled by the state, meaning the Chinese Communist Party. This economy includes large government organizations such as the weapon producers who are providing the equipment for a modernizing military machine. With its ideological arguments badly tattered by the rise of Chinese capitalism (and by the cynicism that followed the 1989 massacre in Tiananmen Square), the party relies on three arguments to maintain legitimacy: its guarantee of prosperity (most recently, in the form of paeans to an undefined “Chinese Dream”), its claim to a history of resisting Japanese aggression during World War II, and its assertion that without a single-party government, China will collapse into anarchy. Of these the most important is probably the claim that the party has created Chinese prosperity.
Unfortunately, there is no evidence that the party is particularly competent economically. Quite the opposite: The current Chinese economy is burdened with the results of a massive building boom ordered by local party bosses hoping to make their cities more impressive and also intent on providing large projects as a form of patronage. That means empty office and other buildings throughout the country. These were constructed by private contractors who had to be paid with money raised by borrowing from party-controlled banks. Very few of these loans are likely ever to be paid off, so to preserve stability the Bank of China has stepped in to take them.
‘Massive Corruption’
Most Chinese are painfully aware of the massive corruption that has accompanied big official projects. President (and Communist Party General Secretary) Xi Jinping is running an anti-corruption program, which is probably intended mainly to destroy potential rivals. In theory it is also a way to reduce public cynicism about the party, but the Chinese public is aware that Xi and his family have clearly benefited handsomely from the corruption he denounces. The party has, in theory, control of all news, but that breeds a lively rumor mill on the Internet and social media. Party attempts to control these outlets have not been successful. It is unlikely to help that the history taught in Chinese schools explains that the Nationalists under Chiang Kai-shek lost the Chinese Civil War because, unlike the honest Communists, they were grossly corrupt. Chinese culture embodies, moreover, the idea that governments must have the Mandate of Heaven; once it is withdrawn, they fall.
The party’s claim to guarantee prosperity amounts to an assertion that it has eliminated the boom-and-bust business cycle that afflicts every other capitalist country in the world. The current problems demonstrate the emptiness of that claim. China suffers from gross overcapacity (which is bankrupting many companies) and from an overinflated stock market. This combination has a great deal in common with what caused the massive world stock market crash of 1929. Then, as now, the sudden bursting of dreams as the market collapsed caused enormous bitterness. Newspapers in the United States have quoted individual Chinese investors saying that the party should have guaranteed against the crash.
Chinese manufacturers with overcapacity have tried to survive by drastically cutting their own prices, and also by forcing raw-material suppliers to cut theirs—in effect, by exporting a homegrown recession. China has not yet developed a big enough domestic market to consume most of what it makes. Exports are crucial. Under current World Trade Organization rules, the Chinese could be accused of dumping commodities, and Western governments may well take steps to protect their home industries. Denied the foreign markets on which they depend heavily, Chinese producers may collapse in large numbers. The party can try to prop them up, but it seems unlikely that China has the resources to do so while maintaining the current level of prosperity.
Whether or not the party had anything to do with the market crash, many Chinese are likely to connect it to the party’s apparent economic incompetence and to widespread official corruption. Xi has been erecting a cult of personality (like Mao’s or Stalin’s), but it is not clear whether most Chinese have bought into it. It seems more likely (to an outsider) that anyone living through the last three decades has become far too cynical to accept any official world. If the party created and then destroyed the stock market, the many who lost their savings are far likelier to blame it than their own credulity. The current severe crackdown on Chinese human-rights lawyers suggests that Xi has decided to stifle any form of dissent. That may suggest he sees difficult times coming.
Average Chinese are not likely to make a revolution, but the stock market losers may have included many in the army, the organization the party relies on to maintain public order. Moreover, China’s army controls and profits from parts of the country’s industry, hence has presumably been affected by the general downturn. Xi attacked several senior military officials for corruption; it remains to be seen whether that cowed or enraged his colleagues. Xi has also spoken of the need for military modernization. Anyone who remembers Stalin will see the parallel to the pre-1941 purge of leading generals and the simultaneous increase in military production. Virtually every party member in China has benefited from official corruption, so an anti-corruption campaign is easy to turn into a large-scale purge, perhaps reminiscent of Stalin’s. If Xi follows this path, he will retain control, but the dynamism of the current Chinese economy will most likely disappear.
Xi is probably aware of this possibility, and also of the possibility that some challenger will arise if he attacks too large a fraction of the party elite. He is therefore likely to fall back on nationalism as a way of avoiding questions about party economic incompetence. The dispute over the Spratlys and other parts of the South China Sea is almost ideal for this purpose. Those resisting Chinese aggression in this area are uniformly weak, and the United States is unlikely to begin backing them very strongly, at least until after the next presidential election. Even the dispute with Japan over the Senkaku Islands is most unlikely to ignite a dangerous war. For more than a year into the future, Xi can therefore present himself internally as the champion of Chinese national identity without risking some major reverse. He can hope that his economy will revive before the dispute becomes risky. This is obviously a somewhat dangerous course, but for Xi it is probably a lot safer than risking overthrow by the army. A great deal must, however, depend on whether Xi can avoid any test of his battered military.
The collapse of the Shanghai stock market reflects the reality that the party does not understand economics and cannot be trusted to maintain a Western-style economic system. Yet China badly needs a banking connection to the rest of the world. At present Hong Kong provides that outlet, because its banks are still bound not by the party but by Western standards of behavior. It is, however, clear that the party would very much like to take full control of Hong Kong. The democracy movement there presents the Chinese government with a painful choice. If it crushes the movement, the banks may have to leave. That will have gruesome effects on the export-driven Chinese economy. If the movement flourishes, however, many inside China may find it inspiring. When they took over Hong Kong, the Chinese promised “one country, two systems,” but that may be entirely unworkable, particularly in the face of a Stalin-style personality cult and dictatorship.
In the 1990s, other emerging Asian economies, such as Thailand’s and South Korea’s, found themselves floundering. The problem was a mixture of overconfidence (as in China) and corrupt or crony practices which made it difficult to invest honestly. The economic disaster led, in many places, to political demands and to democracy in one form or another. The Chinese stock market crash, and the wider recession, may be China’s version of this kind of development. It remains to be seen where it leads politically.
All of this of course leads up to the question of how well China can or will pursue military modernization. Modern weapons, such as missiles and aircraft carriers, are expensive, but in China they are generally produced by government-owned organizations subject to command rather than market forces. However, there is still a pricing mechanism, because the skilled workers who make the weapons have to be paid, and the Chinese labor market is fairly open. China must still pay cash for many of the natural resources she needs. Russia can supply much of what is wanted, but the Russians require cash, and the Chinese will have to pay for what they get. To a limited extent, too, China must still import key components. For example, China buys jet-fighter engines from Russia, and the Russians demand hard cash in return. The Chinese government can certainly print money to cover its needs, but in that case it must deal with inflation, which carries much the same risks as other forms of economic disaster, and it must still pay its foreign costs in uninflated terms. At the very least, a massive market crash sucks money out of the Chinese economy, and the recession in foreign trade does not help.