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“Them smokestacks reachin’ like the arms of God, into a beautiful sky of soot and clay;
Here in Youngstown, here in Youngstown;
Sweet Jenny I’m sinkin’ down, Here darlin’ in Youngstown.” – Bruce Springsteen, “Youngstown”

By Greg Smith

Prophesizing China’s economic future does not require an MBA, CPA, or a lifetime subscription to WSJ.com. A search of the web turns up economic predictions that cite every manner of economic indicators but usually ignore the most accurate set of statistics: history.

In 1999 Americans were making huge paper returns from Internet start-up companies that were hemorrhaging borrowed money. Dot-coms were forecasting enormous losses into the future with little or no concern for turning a profit, focusing instead on market share. Investment capital went into massive ad budgets and the trappings of success as twenty-somethings mocked profit warnings from middle-aged accountants and the notion there could be any problem with this new paradigm of business.

By 2002 over $5 trillion in paper wealth had been wiped out when these dot-coms failed en masse. For perspective, U.S. gross domestic product in 2002 was $10.5 trillion. Had the dot-coms been human, coroners would have assumed it was the work of a serial killer because the post mortems of each generally shared one attribute of the deceased: ‘They tried to do too much too soon.’ This will be the epitaph of the Chinese economic miracle.

The huge number of predictions on China’s economic future run the spectrum from bullish to downright Malthusian, but these cite recent financials, which shouldn’t even be needed. No, China’s economic future was set in jade when it its reformist leaders decided in the 1970s they wanted the advantages of a market economy while keeping control over the economy. You can have one, you can have the other. You can’t have both.

The history of the mixed economy, which China’s is because of government control of credit and lending, heavy corruption and PLA involvement, is too well documented for anyone to believe China has somehow found a way to manage its financial system better than the market. Government cannot manage a lending system without a bureaucracy. Bureaucracy is a very powerful tool for maintaining minimum management standards, but it cannot rise to the level of quality in a free market, government will always end up too concerned with short-term objectives and political goals will take precedence over innovation and best business practices, causing massive misallocation of resources. The top-down model cannot adequately follow and understand the enormous changes in technology that will change global commerce in the next three decades.

How do I square this opinion with China’s enormous growth? Easy. The growth of the last three decades is due to the free market reforms, the benefits of which always kick in quickly. Business faces fewer impediments in China than in the U.S. Coca-Cola CEO Muhtar Kent said in 2011 China has a better business climate than the U.S. With a constant drive for new regulations and to place more social responsibilities on businesses, it is no mystery why commerce in the U.S. is at a comparative disadvantage.

On the other hand, as Japan’s economy showed in the 1980s, problems caused by politicized lending practices do not rear their ugly head overnight. They often take decades to come to fruition, snowballing into a massive drag on the economy. China is now facing a serious real estate bubble because after 2008 government policy flooded China’s economy with cheap credit, fueling a boom in speculative building based on assumptions that buyers would eventually appear.

Someone may point to the mortgage crisis in the U.S. to say the market is itself quite fallible. While lending is a far more decentralized, private function in the U.S. economy, the U.S. credit crisis was also a product of politicized lending and social engineering. Since 1970 government-sponsored corporations Fannie Mae and Freddie Mac have bought up mortgages from private lenders, allowing the lenders to put the funds back into new mortgages. Lenders could make loans without regard to property value or ability to repay, take their profits and sell the loan to Fannie or Freddie. Why was anyone surprised they actually did so?

Over the years the two mortgage giants also faced increased requirements to invest in affordable housing, which forced lending institutions to lend to lower income people who were less financially able to handle home ownership. Lenders also faced new anti-discrimination laws that made it easy for them to get sued or fined if they didn’t give out enough mortgages to this or that minority group, resulting in even more bad loans.

Had Fannie and Freddie not been government backed, the U.S. housing crisis would have never happened. Mortgage lenders would have been on the hook for bad loans they made, forcing them to rely on quality analysis based on facts, not happy thoughts and good intentions. Lenin once predicted, “The capitalists will sell us the rope with which we will hang them.” As well, lenders would have gladly lent to minorities who were in a position to put down some money and make their mortgage payments.

There are ample signs of economic slowdown in China, which is a normal part of the business cycle. The question is whether Beijing’s economy will pick back up again and continue to outperform Western economies to become the world’s largest, or has heavy government involvement exchanged quick GDP growth for long-term economic vitality and China will soon be the new Japan.

When government is involved in an economy its first goal usually is to create jobs. Creating jobs is easy. Stalin created millions of them. Jobs created by government inducement or edict create less wealth than those created independently, as the latter must stand on economic usefulness while the former cause huge misallocation of resources. If the jobs were that important to the economy, they would have already existed. As with America’s housing crisis, government involvement is what caused China’s real estate bubble that now has markets worried.

If China’s economy was built on such strong foundations, it should not have needed such a massive infusion of liquidity since 2008. Beijing’s economic gurus want greater domestic consumption, and a drop in Western demand for goods would have been a perfect time to tempt consumers with lower-priced goods. China bulls often celebrate Beijing’s one-party-rule ability to implement policy ‘on a dime’ so it certainly could have guided investment toward domestic consumption. Instead, to ensure social stability money flowed into infrastructure projects – which functioned as jobs programs — that were not needed.

China’s only hope at sustained growth is increasing domestic consumption, difficult to achieve when government-provided social security exists largely just on paper, and the One-Child Policy has left a rapidly aging population — in 15 years China will have just two workers for every person over 60 — less willing to spend on non-necessities the yuan they will need in old age.

Without dependable investment options, another cause of China’s real estate bubble, what money they can save will be eaten into by China’s somewhat high inflation.

The Middle Kingdom cannot continue to grow economically without major political reforms, which the Communist Party is not going to allow. Developing economies under dictatorial regimes can easily increase economic output. They falter in transition to mature economies that require social and political freedoms which help drive innovation and progress. Today, China is at that critical juncture and shows no signs of democratizing in any meaningful way. China’s economy, and with it Beijing’s power, is nearing its apogee and will soon be in relative decline.

I do not claim to be an expert on China’s economy. Even if I were such an expert, if individuals could truly understand something as massive and complicated as a national economy, then command economies could work and have long-term advantages over messy free markets.

History on the other hand is much easier to understand. Past economic experiences unambiguously show statist economies hit a brick wall before they are able to mature. Over the long haul free-market economies always outperform mixed economies because government involvement introduces many more non-economic decisions. Just as dot-com investors discovered, China will learn when something seems too good to be true, it usually is.

So in conclusion the Chinese are, as are the rest of us, better fat than fascist.   ©

Greg Smith is a freelance writer and political consultant who lives in Bantam, CT. His blog is found at www.betterfatthanfascist.com.