This essay, based on a column by Sankei Shimbun senior economic journalist Hideo Tamura, argues that China’s economic turmoil cannot be explained merely by the outcome of U.S.–China trade talks, but stems from the structural breakdown of its Communist Party-controlled financial system itself.
The author sharply points to the fiction of China’s GDP figures, the visible signs of recession during the Lunar New Year period, the limits of stimulus through tax cuts and infrastructure spending, and the structure under which the renminbi cannot be expanded freely because of declining foreign reserves and capital flight.
It further contends that China has reached a dangerous point where it cannot sustain its economy without external borrowing, and that Xi Jinping’s regime will therefore continue to send increasingly strong overtures toward cash-rich Japan, especially the Abe administration, as its last resort.

2019-03-11
In a Chinese society that has, to begin with, a tradition of not paying taxes, one must question how much consumption will really increase through tax cuts.

Hideo Tamura, special correspondent of Sankei Shimbun, is one of the very few genuine economic commentators, utterly different from those economic commentators and business reporters who are no more than parrots of the Ministry of Finance or little better than agents of China.
Needless to say, until August five years ago, when I was still subscribing to Asahi Shimbun, I knew absolutely nothing of him.
What follows is from his serialized column published in this month’s issue of Seiron.

Part 4.
Even with a “U.S.–China Truce,” China Remains in Turmoil.

The Chinese economic crisis that is weighing down the world economy is fundamentally caused by the self-destruction of the engine called the Communist Party-controlled financial system.
The current U.S.–China trade war is like a transmission that adjusts the speed of that process.
Even if there is a “U.S.–China truce,” China’s confusion will not subside, and if negotiations collapse, it will surely trigger a total economic breakdown.
China’s economy is such that GDP data, artificially manipulated by the Party leadership, do not reflect reality.
The officially announced real economic growth rate remains in the 6 percent range, a level that in other countries would naturally indicate exceptional strength, yet the view of the overwhelming majority of overseas China watchers is extremely negative.
In that respect, the Spring Festival, the Chinese Lunar New Year, during which a “mass migration” totaling 3 billion trips occurs, is an excellent opportunity to observe the economy.
The Spring Festival holiday is the one week in the first half of February.
In Guangdong Province, where export industries are concentrated, migrant workers returning from their hometowns are finding themselves at a loss because the factories where they worked have been shut down.
Local media also report that while people normally gather with their extended families to eat, drink, and celebrate, consumption this time in large cities such as Shanghai and Beijing was subdued.
The boom in the founding of internet-related startups, which until just a year earlier had drawn investment money from the wealthy and was flourishing, has also vanished.
“Investors, entrepreneurs, and the media call it the ‘icy winter’ of China’s internet sector” (Wall Street Journal online edition, February 6).
Japan’s media, overly soft on China, directs attention to the effect of Xi Jinping’s economic stimulus measures with such headlines as, “China’s Economic Stimulus Exceeds 40 Trillion Yen, Through Tax Cuts and Infrastructure” (Nikkei morning edition, January 29).
They are probably imagining the large-scale fiscal spending and monetary easing after the Lehman Shock of September 2008, but is that really the case?
The contents of the stimulus package are support for bank lending, income tax cuts, increased issuance of local government bonds for infrastructure investment, and subsidies limited to rural areas for the purchase of cars and home appliances, but omitted is the former route of quantitative monetary expansion in which the People’s Bank of China massively increased the supply of renminbi.
After Lehman, the People’s Bank printed money in abundance and, through state-owned commercial banks controlled by the Party Center, funneled it into state-owned enterprises and local governments run by Party bureaucrats, thereby boosting fixed-asset investment such as infrastructure and real estate development, and it was supposed to have returned China to a path of double-digit high growth, but this time there is no sign of such a thing.
In contrast to the Nikkei article, the Wall Street Journal reported, “Chinese Economy Slows, Government Cautious About Countermeasures” (online edition, January 22), and pointed out that unlike in 2008 and 2009, the People’s Bank is restraining the supply of funds, that is, “liquidity.”
It properly explains that, “Behind the change in the Chinese leadership’s attitude is the recognition that the options for stimulus are more limited than before. Past credit easing and profligate government finances drove growth, but also caused a surge in debt centered on local governments and state-owned enterprises.”
In short, this time they are pursuing an economic stimulus without printing money.
Accordingly, emphasis is placed on stimulating consumption through income tax cuts and on local government infrastructure investment, but in a Chinese society that has, to begin with, a tradition of not paying taxes, one must question how much consumption will really increase through tax cuts.
And as for local governments, after Lehman they created subsidiaries called “financing platforms,” seized land from farmers, and built large-scale “new towns,” yet with very few residents they turned into ghost towns.
It is only natural that cases of repayment default are occurring one after another.

They want to print, but cannot.

That said, it is not accurate to interpret this as meaning that the Xi administration has learned its lesson from the debt bubble and therefore will not print money.
It wants to print, but cannot.
Under the Chinese-style financial model, the People’s Bank of China issues renminbi funds backed by foreign currency.
It then lends through state-owned commercial banks and the like.
As long as this expands production and the real estate market and pushes up the economy, capital flows in from overseas.
Most of those investors are Chinese companies and investment institutions connected to Party cadres and based in Hong Kong, but they are by no means patriots.
Once the real estate market begins to worsen, they then shift their money via Hong Kong to tax havens in the Caribbean and elsewhere.
That is the capital flight peculiar to the Chinese economy.
Capital flows out because large quantities of renminbi are sold in the foreign exchange market, creating fear of a sharp fall in the currency, and Chinese investors who see this try all the more to move their money abroad.
The People’s Bank sells foreign currency and buys renminbi to support it, so foreign exchange reserves decline.
The Communist regime fears that if renminbi are issued without the backing of foreign currency, that is, dollar assets, confidence in the renminbi will vanish.
This is because it bears in mind the history in which Chiang Kai-shek’s Nationalist government recklessly issued paper currency, caused malignant inflation, lost the support of the people, and was defeated by Mao Zedong’s Communist forces, which maintained monetary discipline.
On the other hand, if renminbi funds are not supplied, the entire Chinese economy will suffer a cash shortage and fall into a great recession, so there are times when renminbi are issued out of necessity, but there is a limit.
Formerly, renminbi issuance by the People’s Bank was accompanied by 100 percent dollar assets, but recently it has fallen below 60 percent.
They can do no other than hesitate over further quantitative monetary expansion unsupported by foreign currency assets.
In the end, state-owned banks give priority lending to large state-owned enterprises favored by President Xi, but cut off new loans to private small and medium-sized enterprises and startups.
They do not circulate money to nonbanks or local governments.
As a result, bankruptcies among small and medium-sized firms continue one after another, and local governments that have devoted themselves to real estate development find it difficult to repay their debts.
This graph succinctly shows the deadlock of the Chinese-style financial model.
It compares, on a common dollar basis, the yearly total amount of new lending by banks and nonbanks, and the year-on-year change in the total amounts of foreign exchange reserves and external borrowing.
What is striking is that these three indicators are closely linked.
Foreign reserves fell sharply from the second half of 2015, recovered in the second half of 2017, but began to decline again in the second half of 2018.
As stated above, the decline in foreign reserves is caused by massive capital flight, and the Xi administration is desperately cracking down on it.
It has arrested or long detained involved Party cadres and popular actresses, and ordered major investors to sell and recover overseas assets.

The final hope is the Abe administration.

Even so, foreign reserves continue to fall.
If the People’s Bank’s foreign currency assets decline, renminbi issuance is hindered, so the desperate measure is borrowing foreign currency.
As the graph shows, external borrowing has continued to surge rapidly since 2017.
Even if it is borrowing, the foreign currency that flows in is bought up by the People’s Bank and made into foreign currency assets under the Chinese method.
A close look shows that foreign currency borrowing constantly exceeds the amount of change in foreign reserves.
In other words, even when money is borrowed from outside, only a portion of it remains within China, while much of it escapes.
Even so, they borrow from abroad, buy it up, and issue renminbi, but because foreign reserves do not increase at all, there is a limit to the increase in renminbi funds that can be distributed to banks and the like.
As a result, the volume of new domestic lending has, as the graph shows, fallen sharply from the second half of 2017 to the present.
Generally speaking, China is in the terrifying situation of being unable to issue money without external borrowing.
Seen in this way, China’s recession is in a kind of financial panic phase.
Whether knowingly or not, the Trump administration is striking at the core of this desperate condition.
Its trade sanctions on China are based on the goal of reducing the annual U.S. trade deficit with China by 200 billion dollars, while China’s current account surplus is only around 100 billion dollars a year, and if its surplus with the United States falls sharply, foreign reserves will decline by that amount alone and China’s financial system will fall into paralysis.
As a countermeasure, China could devalue the renminbi and thereby cancel out the amount of the U.S. punitive tariffs, but it must be cautious, because a weaker renminbi would invite capital flight.
Even if trade negotiations with the United States are concluded, foreign reserves will not increase, so China cannot print money.
If they collapse, capital flight will accelerate, and the financial system will become all but dead.
The Xi administration’s final hope is cash-rich Japan.
It will continue to send even stronger overtures toward the Shinzo Abe administration.