The Russian Financial Superpower Will Replace The US As China's Money Partner
Russia doesn't need China. China needs Russia.
After the USSR collapsed, China pillaged Russia and Ukraine. China's military technology caught up to Soviet levels by reverse engineering Soviet designs. There are those who claim that China is now going to finish the job by absorbing Russia economically. This won't happen. Instead, it is Russia that will rebuild its capital plants with Chinese capital goods and rapidly reindustrialize. China will be an equal partner, if not a junior partner. Russians aren't stupid. They see how the Chinese ripped off the Americans and the Europeans. The Japanese and Koreans did a better job of protecting their core industries, because they know what rip off artist industrialists get away with in the PRC. Not so the gullible Americans and Europeans. China thinks they're going to flush all their garbage loans down a Russian toilet. Don't they know revenge is a dish best served cold? Russia is going to pillage China after China bankrupts itself underwriting bad loans in Yuan. China sees the risk, though they don't discuss it. But us overfinancialized Americans live for the financial swindle. We can see the systemic weakness. China talks like a tough guy, but we all can see how much he's had to drink. Appear strong when you are weak, right? People just assume that China has already won this international money war with the US, which is why the Chinese proposed peace plan has been seized upon as a sign of Russian weakness. (https://www.theguardian.com/world/2023/mar/21/putin-welcomes-chinas-controversial-proposals-for-peace-in-ukraine), when in fact it is a sign of Chinese weakness. Russia is rich in arms, which means that it is rich in war. China is poor in arms and is losing trade because of the war. It's obvious which of the two benefits from peace in Ukraine. Russia is outproducing all of NATO. Why would they stop now?
This is why China wants peace in Ukraine (https://foreignpolicy.com/2023/04/04/china-xi-ukraine-russia-peace-plan-diplomacy-global-south/). Its financial markets are in deep trouble. Western suppliers have divested from China and cut it out of their supply chain. Chinese industry makes components for Western products. But without a few billion in semiconductors and other Western goods, the one trillion dollar Chinese electronic sector is worthless. It can't upgrade without modern components. It needs access to the tech to make its own (failed so far) or to trade for it. But they've been excluded from Western trade. Big deal you say? You are not following the money carefully. The newb says 'default' without realizing that also destroys the wealth of everybody in China holding assets abroad. It's a suicide move. So China has to find a way to swap out all of its dollar denominated debt without crashing the global market and harming its trade position even more. You think it can't be so bad? You've heard China is so rich? You heard wrong.
China's debts have clogged its financial arteries and its industrial economy is on borrowed time. In order to understand this better, one first needs to understand what it means that America runs on brains and burns normies for fuel.
Someone was so triggered by my article America Runs On Brains And Burns Normies For Fuel, that s/he unsubscribed. Econ is not for everyone. Urban Fox claimed that I ignored the Russian output of Engineers and CIS grads. Unfortunately this is an argument that ignores the thesis, which is that more STEM grads actually live and work in the USA. An accusation that I don't know that Russia has one of the best technical workforces in the world is an accusation only someone who didn't read my article (One Trillion Dollars... ) could make against me. There's an assumption in the alternative Russia analysis community that America is 'fake strong' somehow. In fact, part of why I wrote America Runs On Brains... is because I saw in the Russia analysis community an extreme underestimation of American productive capabilities. This is mostly because of an ignorance of economics. I would remind my regular readers that I didn't need some screwball theory to map and calculate Russia's military industrial capabilities, I used conventional economics.
The idea that the US was born on 3rd base and wouldn't be leading if it was ravaged by WW2 like Russia is like saying I wouldn't be so smart if I shot myself in the head. Precisely because Russia shot itself in the head is evidence of its fucked up political culture. When I'd ask my chess sensei, a homeless SF grandmaster-gone-master-due-to-schizophrenia named Fred Wreden. 'what would you do in my position?' He'd answer? “I wouldn't be in your position.” So it is with Russia and America. Stalin purged Tuchachevsky, not America. Stalin capitalized Russia by plundering 'kulak' gold and starving Ukrainians, not America. Stalin executed scientists and engineers for Lysenkoism, not America. Stalin sent good workers to the GULAG because someone accused them of being 'wreckers' not America. This whole idiotic assertion that America was born on 3rd base ignores that Russia was on 3rd base before America was even founded. The entire 19th century was one of long decline by a corrupt Czarist Russia and those demographic gains were damned to massacre in the 20th century. Even the Crimean war didn't teach Russia a lesson. America is in the same boat with its forever wars of the 21st century, but as Adam Smith said there's a lot of ruin in a nation. Russia needed another 60 years and a World War to collapse. America is in trouble, but hardly toast yet. China wasn't born on third base, China owned the entire baseball stadium. China's decline from the 18th century onward was also entirely due to a credit crisis. (https://www.fpri.org/article/2008/04/chinas-early-encounters-with-the-west-a-history-in-reverse/), not due to technology or some other racist justification you may have heard. No, America was not born on third base, it got there fair and square—by winning wars, building stuff, and trading well.
Does it matter that Russia graduates more scientists and engineers when America has eight times the Russian technical workforce? Extrapolating out from our last good year of data (2015) (https://stats.oecd.org/Index.aspx?DataSetCode=PERS_SCIENCE) Russia probably has 870k scientists & engineers. An outstanding number, but tiny compared to the USA's STEM workforce of 7 million.(https://ncses.nsf.gov/pubs/nsb20201/u-s-s-e-workforce). Like I have already argued, Russia is extremely strong, and the USA's economy is only 4 times bigger, not 8 times bigger as the STEM figure would suggest. And that is because these millions of workers would rather live in the USA than in Russia. Of course, STEM is not engineering and we also do not have good figures for the number of foreign born scientists and engineers only. But the aggregate total in the workforce says much about the US economy's ability to absorb the workers and convert their labor into capital-scientific-technical outcomes. Point being, for as many talented and brilliant people live in Russia and China, there are more in the rest of the world. One could call them capital chasers or lifestyle chasers. Another good contrast would be UK and Germany. Germany graduates more scientists and engineers, but UK has more, and way more per capita, because they'd rather live in UK than Germany. (https://2019.stateofeuropeantech.com/chart/118-1591) Of course we don't have good stats on the number of technical workers in Russia, but we can correlate per capita GDP to technical workers. Scientists and engineers correlate to the industrial superstructure and the technical workforce is more associated with the capital substructure. We see up to 2015 that Russia was 'top heavy' and the trend continued. With a big capital infusion, Russia should experience real growth. There is massive unsatisfied domestic demand there so import substitution will only help it grow.
Simplicius76 is a really smart guy. I super admire him. That's why I had no problem challenging his Pepe Escobar (https://www.theinteldrop.org/2023/01/19/pepe-escobar-gold-backed-currencies-to-replace-the-us-dollar/) inspired assertion that China/Russia will replace the dollar. I come from the land of friendly shit talk and spat some at him in hopes of provoking a more thoughtful response. He suggested that SVB vs China made China look favorable (https://simplicius76.substack.com/p/the-truth-about-russias-economic/comment/14218154#comment-14321818). Instead of being flippant and giving him some half-assed answer, I thought I would give a proper one. After all, he has given me so many puzzle pieces I could never have found myself. Simplicius76's military analysis has few peers.
But the econ analysis ignores the financial markets.
First off, SVB's bad loans were nothing compared to ICBC's bad loan portfolio. SVB was T bills. Ok, they got a small haircut, but the interest coupon still has the cash. It's just inflation is clobbering the actual yield. Compare that with ICBC's BAD LOAN portfolio (https://www.reuters.com/business/finance/top-china-bank-icbc-worlds-largest-posts-49-h1-profit-rise-2022-08-30/). SVB has/had a performing loan portfolio. ICBC, in addition to owning declining face-value bonds, ALSO owns bad debt.
You want to know how screwed China is? It's denying it has the same problems as SVB: (https://www.msn.com/en-us/money/markets/china-s-banking-troubles-are-not-the-same-as-silicon-valley-bank-economist-says/ar-AA19i43q). Only people unfamiliar with banking can believe Zhu Min “... pointed out that while those Chinese banks' structure and operations were unclear, they did not pose systemic risks to the broader economy.” Ok, then what happened to the mortgage boycott, muni bond crisis, and dollarized asset risk? Last time I checked (yesterday, lol), ICBC was still doing business in California, which means it is lending out dollars, which means it is banking dollar denominated assets. And that means it's exposed to dollar risk.
Circular 15 (https://thediplomat.com/2021/07/chinas-circular-15-addresses-local-governments-hidden-debts/) proves that China had no proper underwriting of loans. Circular 15 requires banks actually evaluate creditworthiness of municipal borrowers. That means the banks all underwrote and funded bad loans. We don't know how many, but the fact that they were instructed to evaluate creditworthiness means the default risk was assumed to be socialized/centralized. Circular 15 was an attempt to contain the banking contagion, but it won't work. You don't prohibit a behavior unless it has become a problem. Non performing loans and defaulting debtors collapses asset values. If it's Yuan, that doesn't matter—they can print more and inflate away everyone's money. If it's dollars, then they are at risk of dollar default. Not an auspicious way to market your own currency as a reserve.
In other words, cash turned to trash. There is a huge amount of money locked inside undercollateralized loans. An undercollateralized loan isn't a little bad, it's a lot bad. If you are underwater 10% on your loan and you sell to take a 10% loss, you have devalued all comparable assets by 10% because your sale was the most recent sale. This means all book value of loans loses value and then all the loans the loans secure are at risk. In order to get in front of this as a bank, maybe you dump your whole portfolio first, because you nosedive the value of everybody else's loans, which in turns incentivizes them to sell their loans. If you try to just get some interbank overnight rate, your counterparty bank might say, 'hey, we own the exact same trash as you. There's no way we're giving you good money to turn into more trash.' This is how the Great Financial Crisis metastasized.
A bear market is supposed to reveal which assets are bad. Those bad assets get destroyed and those owning good assets get rewarded. The evil are punished and the righteous are rewarded. This is why people who seek to prop up bubbles are evil. The powers that be that own everything cannot afford to be discredited at the same time most assets devalue.
Bad Belt and Road loans are another way we know how bad Chinese loan underwriting is and how dangerous it is to get in long term business deals with them. China wants to be the trading center, so it finances infrastructure loans to do business with China, but then China doesn't underwrite correct and even when it forecloses, it owns unprofitable enterprises that are expensive to operate and require subsidies. (https://www.theguardian.com/world/2023/mar/28/china-spent-240bn-belt-and-road-debts-between-2008-and-2021) China depends on the asset bubble increasing until it's truly bigger than the United States. Then they'll let the markets correct themselves and fix their capital problems. They too are playing with Modern Monetary Theory (https://en.wikipedia.org/wiki/Modern_Monetary_Theory). If all counterparty risk gets denominated in Yuan, then first off, doesn't it need to be fully convertible? China has no intention of allowing the Yuan to become fully convertible (https://www.ibtimes.com/chinese-yuan-may-become-fully-convertible-within-2-3-years-hsbc-1562714) and 9 years ago were saying it would be only 3 more years. To quote an ancient internet meme, of an even more ancient movie meme: it's a trap. Recently some billionaire named Mark Mobius tried moving his money out of China and discovered he could not (https://www.msn.com/en-us/money/markets/investor-mark-mobius-complains-his-money-is-stuck-in-china/ar-AA18gq9G). The USA can steal your money too, but the difference is at least there's stuff to spend it on here. Again, don't tell me that China has comparable draw and appeal to the USA, or even Europe. It does not. China wants to trap Saudi and Russian money the same way.
Covid was the beginning of the end for 'Chimerica' (https://en.wikipedia.org/wiki/Chimerica) which was amusingly enough a Chimera as well. US asset growth in exchange for Chinese GDP growth. If China is dedollarizing (https://www.scmp.com/economy/china-economy/article/3215857/chinas-yuan-makes-brazilian-inroads-de-dollarisation-reflects-cracks-us-currency-settlements), then how will it service its $2.6798 trillion dollar debt (http://www.news.cn/english/2021-10/02/c_1310223471.htm)? Do you know it increased from $2.4 trillion 3 years ago? (https://www.scmp.com/economy/china-economy/article/3135883/china-debt-has-it-changed-2021-and-how-big-it-now). China has dwindling dollar reserves and may boast about having $3.1 trillion in reserves, it's a state secret what exactly is its composition. That's a sign it's not great, or it could survive scrutiny. Another bad sign for reserve currency status. (https://www.ft.com/content/6359c170-6e52-11e5-8171-ba1968cf791a#axzz41jlhtmdT).
China's exported to the USA about $650 billion. USA exported to China $141 billion. Why doesn't China just cut the USA off? To the outside observer, it seems advantageous. But China is too weak to do it, as we just evaluated. It clearly needs the dollars more than it will benefit from the damage inflicted on the US. How will China debt service its dollar debt if it is de-dollarizing? Does it think it's going to get Eurodollars? Europe runs a deficit with the US. China has all this industry that exists to serve the US market. To re-purpose that requires cash. You just said they were rich a minute ago. Are they? Can't they just refinance and be done with it? Obviously not. Renminbi can't become a fully exchangeable currency without wrecking China's financial markets more. (https://www.thedailystar.net/opinion/views/project-syndicate/news/reality-check-the-renminbi-3291426) If they swap out all dollar debt they can only do that by emptying out their reserves. If their supposed $3.1 trillion in reserves was real, they could have paid it off their $2.7698 trillion (what a fishy number, just looks button-mashed) debt.
Therefore, the only move left to China is to get cash from fresh suckers. If Saudi Arabia and Russia give China all their cash, then maybe China can cover its dollar denominated debt and escape the dollar death trap. (https://www.scmp.com/economy/china-economy/article/3135883/china-debt-has-it-changed-2021-and-how-big-it-now) Bilateral trade creates currency risk. If China is going to be trading bilaterally with all its partners and not use the dollar, then it should be a good reserve currency. But it's not, as we already discussed. China doesn't have enough money to fix its own debt crisis and it's supposed to enforce a Bretton-Woods fixed exchange system between its partners? No way! Can't do that without Russia. And why would Russia do it? As we have mentioned, in a time of war, arms is wealth. Since Russia is outproducing NATO, Russia has the greatest 'war potential' in the world. China can't scale up arms production without loans. See the problem now? China benefits from peace and Russia benefits from war.
They rolled forward Evergrande debt into future equity (https://www3.nhk.or.jp/nhkworld/en/news/20230404_39/)... meaning they’re converting bad debt to equity in the hopes that the new equity will be lendable collateral. That way a new round of banks that doesn't underwrite can get soaked. Ie Russian and Saudis. The Saudis are dumb enough to fall for it, but it's laughable to think that Russia—a land filled with Math Kandidats—couldn't comprehend the economic consequences.
Forcing developers to finish projects & offering financing will just put more money in dead projects with real estate worth less than the capital spent on it (https://www.nbcnews.com/news/world/china-mortgage-boycott-rcna38650) is financial doom. Commercial lending is already in trouble. (https://www.reuters.com/breakingviews/chinas-mega-banks-are-priced-total-disaster-2022-09-01/) If you look at the timing of this (https://www.bloomberg.com/news/articles/2022-09-14/china-housing-homeowners-rush-to-pay-loans-despite-mortgage-boycotts?leadSource=uverify%20wall) you'll see that some repayments were forced due to social credit. How is this different than Soviet forced savings? This is supposed to be the guardian of the financial system? The US is like my dad. A really responsible guy who just became more and more degenerate over time. But China is like some street goon promising all that crime is behind him. It's more credible that the party that exhibited the capability in the past will exhibit it again in the future. China is doing all this stuff to convert national savings into assets in order to save its credit rating? Who's it fooling at this point?
Household debt (https://archive.is/HHpGv) + Foreign Debt + Non Performing Loans + Muni Bonds (https://archive.is/Nglea) = Kaboom!
Systemic financial collapse does not destroy everything, it just destroys value destroying enterprises. China is a gigantic value-destruction machine. It converts assets to GDP (assets to cash) by impoverishing its population. This is why the Chinese are terrified of financial collapse and do everything they can to avoid it. When their book value of assets zeroes out and they've burned everyone in the world, how are they supposed to refinance their way out of the deathtrap of their own making? They can't go back to pre-Deng economics.
What does this mean for Russia? China will have to sell everything it can to Russia in order to keep its exchange rate stable as it imports commodities. Otherwise another 'silver drain' type scenario recurs. When the war is over, do you think that China, India, and Iran will mass upscale their military industrial complex? Or will the arms market be flooded with cheap, battlefield tested Russian weapons? Does China even have the money to invest to match the Russian military industrial monster? Or will it forever be selling components to more advanced economies? You see, China is not looking to trade with Russia to dominate it. This is pure survival as far as the Chinese regime is concerned. If Russia doesn't export to China, then its commodity input prices go up and then how then can China export and re-capitalize? China wants bilateral trade with Russia to control its dollar exposure. Historically China needs commodities from Russia more than Russia needs capital goods from China, which is why Russia has the trade surplus. Bilateral trade signals the need from China to export to Russia. And if you think Moscow is going to accept bad Chinese promises for trade, you haven't been paying attention to the way Russia entraps a cocky opponent. Russia will be the money partner and China will long for the good old days of Chimerica.
Read Part 2:
What is your take on Jeff Snider’s theory of Eurodollar, and Feds inability to control the growth of debt denominated in US dollars?