March 4, 2020

Threats, propaganda and the Orwellian dissolution of social trust cannot stop a withdrawal from the status quo.

Longtime readers know I've had an active interest in what differentiates empires/nations that survive crises and those that collapse. There is a lively academic literature on this topic, and it boils down to three general views:

1. Collapse is typically triggered by an external crisis that overwhelms the empire's ability to handle it. Absent the external shock, the empire could have continued on for decades or even centuries.

2. Crises that could have been handled in the "Spring" of rapid expansion are fatal in "Winter" when the costs of maintaining complex systems exceeds the empire's resources.

3. Civilization is cyclical and as population and consumption outstrip resources, the empire becomes increasingly vulnerable to external shocks.

External shocks include prolonged severe drought, pandemics and invasion. In many cases, the empire is beset by all three: some change in weather that reduces grain harvests, a pandemic introduced by trade or military adventure and/or invasion by forces from far-off lands with novel diseases and/or military technologies and tactics.

More controversial are claims that political structures become sclerotic and top-heavy after long periods of success , and these bloated, brittle hierarchies lose the flexibility and boldness needed to deal with multiple novel challenges hitting at the same time.

We lack internal-political records for most empires that have collapsed, but those records that have survived for the Western and Eastern Roman Empires suggest that eras of stability breed political sclerosis which manifests as a bloated, parasitic bureaucracy or as ruthless competition between elites that were once united in the expansive "Spring" phase.

By the "Winter" phase, the elite hierarchy is willing to sacrifice the unity needed to survive for its own short-term advantage.

All of this applies directly to China, which is experiencing not just a public health crisis (Covid-19 pandemic) but a host of overlapping crises triggered by the epidemic.

The external shock of the coronavirus has revealed the fragilities and weaknesses of China's social, political and financial orders. These include:

1. Healthcare system crisis. The system is a patchwork that leaves non-government workers largely on their own. One doctor in Wuhan reported that a pregnant woman in his care died when the family ran out of cash for her care. (The central government announced it would cover all costs shortly after the patient died.)

The for-profit nature of much of the healthcare system is not widely understood outside China. If you want high-quality care without long waits, you must have cash.

Additionally many of the "doctors" are trained only in traditional Chinese medicine, so there is a shortage of trained personnel and facilities.

2. Food system crisis. It's not just Swine Fever that's straining the system; shortages are widespread and rising costs have been crimping working-class household budgets for the past few years.

3. Economic crisis: consumption and exports. As employers slash wages or close down, incomes fall and the trauma of the pandemic doesn't engender a mindset of rampant consumption. The authorities are desperate to ramp up new car sales, for example, but everyone who can afford a car in China already has one. Demand was stagnant even before the virus.

As for the export economy: companies were already relocating abroad as a result of the trade war with the U.S. There is no reason for production that leaves to ever return to China, and there is no other source of employment and revenue to replace the export production that leaves.

On top of that structural erosion, China has adopted the just-in-time supply chain, and so it's unprepared to deal with the chaos as the supply chain is disrupted four layers deep.

4. Financial / debt crisis: local government debt, shadow banking defaults. China fueled its expansion since 2016 with unprecedented amounts of debt and speculation. Any activity dependent on debt and speculation is exceedingly vulnerable to disruption, as debt payments that can't be made trigger defaults which then collapse the pyramid of speculation built on the shaky foundation of debt.

This is especially problematic in China, where the shadow banking system of informal, non-institutional credit is so vast and pervasive. Private debts that default trigger defaults in the formal banking sector as counterparties fail to make good: if I fail to make my private-loan payment to you, you can't make your bank loan payment.

China's central bank can print money but it can't force bankrupt companies to borrow more or bankrupt lenders to issue loans to unqualified borrowers. The entire pyramid of debt in China could collapse even as the government prints money with abandon.

5. Social contract crisis: loss of trust in authorities and institutions. That the central government/Communist Party failed the citizenry is obvious. The Party betrayed the people to protect its own image, destroying the citizens' trust.

As I've noted before, betrayal has consequences. There is no quick or easy way to restore what has been lost in terms of trust and faith that the social contract between parasitic rulers and the ruled is worth restoring.

6. Housing bubble popping, threatening household wealth. Household wealth in China is concentrated in housing, and so the bursting of the housing bubble will have an extraordinarily adverse impact on household wealth and the "wealth effect" of people spending freely because they feel wealthier as their home rises in value.

The hope that the housing sector, already stagnating before the epidemic, will quickly roar back to life is completely unrealistic. Bubbles always burst, and this external shock has the potential to pop China's vast housing bubble.

7. High expectations dashed; confidence in the future dented. I've often written about the extremely high expectations of the Chinese people, which have only increased after three decades of uninterrupted growth. Low expectations prepare people for disappointment and are thus reservoirs of resilience; high expectations set people up for shattering losses of faith in institutions and the future.

8. Loss of international reputation/stature. The perceptions of China as a rising superpower on the move have been dismantled and replaced by a perception of autocratic incompetence, massive centralized bureaucratic failure, an elite willing to sacrifice its citizenry and a government that cannot be trusted, a government that will lie and fabricate whatever statistics it deems most salutary for its image.

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