Just how bad did China's economy get in 2023? A review of the headlines -- Happy 2024! China Boss News 1.5.24

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What happened in 2023

First things first - Happy 2024!

I hope you've had a restful holiday break and are off to a great start in the new year.

Over the holidays, I reviewed all China Boss 2023 posts on Substack for the most significant headlines that had impact.

One of the developments that immediately grabbed my attention was the escalation of China's tensions with the Philippines in the South China Sea.

This is something that I think everybody's going to need to start paying attention to if they haven't been. I’ll be watching it closely and will continue to provide the latest updates.

Photo by Anjo Cerdeña on Unsplash

SOUTH CHINA SEA THREATENS TO BOIL OVER: The Washington Post had a great year-end review of the incidents that show one of the world's hottest spots is only getting hotter.

At the beginning of the year, China pointed a military grade laser at a Philippine Coast Guard as it was approaching the second Thomas Shoal. The attack temporarily blinded the Filipino crew.

My favorite South China Sea tensions analyst Ray Powell, Sea Light Director of the Gordian Knots Center for National Security and Innovation at Stanford University, said that “This is where the Philippines made its choice.”

The Philippines coastguard began to release visuals of that attack for the world to see. This is a new thing for Manila, and Powell calls it “assertive transparency.”

Things only grew more intense after that.

In March and December, China swarmed Philippine vessels on resupply missions to contested islands. Swarming, according to the Washington Post, is the “deployment of a flotilla of vessels to intimidate or overwhelm a target,” and “has been a signature move used by China to assert its presence.”

One Manila-based analyst told the Post that swarming was “at the core of China's aggressive coercive behavior,” and that “all other actions are enabled by its capacity to swarm and bully its target.”

In August, China used a water cannon against a Philippine vessel that was attempting to resupply marines on the Second Thomas Shoal.

A maritime expert told the post that a water cannon can sink a smaller vessels, and “can definitely injure persons seriously and even fatally under the right conditions.”

In September, things got even more exciting: The Philippines cut a floating barrier that China had installed to guard its claim to Scarborough Shoal which is another disputed site in the West Philippine Sea. In the extraordinary images that were released on social media by the Philippine Coast Guard, we see several divers swimming to the bottom of the shallow seabed with a knife and slicing apart what looks like a primitive buoy system linked by mariners rope.

Finally, just last month, China used a water cannon eight times against one resupply mission comprised of fisherman in the vicinity of Scarborough Shoal and four times on a mission headed to Second Thomas Shoal.

The Philippines Coast Guard said that one of its vessels had to be towed back due to damage that “disabled the engine,” and that it was harassed by a total of 13 Chinese Coast Guard and militia ships.

And right before Christmas, a 30-vessel civilian convoy attempted to deliver gifts to Philippine marines manning the disputed outposts. The volunteer mission garnered a lot of press attention, and everyone was very excited about it, but the convoy had to turn back before reaching the soldiers when China intercepted it.

Rafaela David, one of the organizers, told reporters: “Our goal is to regularize and normalize the travel and movement of the Filipino people in this region. After all, it is ours.”

Photo by Brandon Mowinkel on Unsplash

AN UNPRECEDENTED YEAR IN CHINA LEGISLATION: Last year, members of Congress heard over 600 pieces of legislation on China. Many proposals were pushed by the new House Select Committee on the Strategic Competition between the United States and the Chinese Communist Party established in January.

I know this because I went to congress.gov to search legislation using the word “China.” I also skimmed through the documents, media, and issues tabs on the Select Committee’s website.

In January, alone, a host of bills and resolutions were introduced to protect America's petroleum reserves and Americans personal data from China, to prohibit China’s use of taxpayer funded platforms, and to reclassify fentanyl related substances as a weapon of mass destruction in an attempt to strong-arm China into cracking down on the producers inside its borders.

There was also a bill to defund Ecohealth Alliance which was the research group that partnered with the Wuhan Institute of Virology lab to study bat viruses prior to the Covid pandemic, a bill on PRC investments into strategic critical industries that was referred to the house committee on financial services, a bill introduced to hold the Chinese government accountable for controlling its currency, and a bill attempting to ban TikTok, among many, many more!

Many of the laws and orders you saw splashed across headlines, however, related to Biden's export controls on semiconductors which were super extensive, and additional US sanctions on Chinese firms for supporting the Russian military in its invasion of Ukraine or for being complicit in forced labor.

The US, as well as the EU and Canada, also banned Tik-Tok from government devices, and Biden unveiled new China investment curbs for the first time in US history that mandate government notification and tracking of new American investment into Chinese tech companies. The latter was highly controversial, as you can imagine, and there was a lot of pushback from businesses.

Photo by Oliver Cole on Unsplash

EUROPE STEPS BACK FROM CHINA: Finally, another trend that was evident as news reports rolled in throughout the year was Europe's big step back from China.

After months of official “hinting,” Italy officially informed China last month that it is leaving Xi Jinping’s signature Belt and Road Initiative, the European Commission in October announced that it was launching an anti-subsidy investigation on imported Chinese electrical vehicles, and Berlin earlier in the year banned Huawei and ZTE, a Chinese state-owned firm, from Germany's telecom network, ordering German telecoms to rip out all their equipment. Also in October, Belgian security services formally accused Chinese tech giant Alibaba of espionage at its Liège shipping hub in Belgium.

But out of all the news stories that China Boss featured in 2023, the one that came up most concerned China’s badly deteriorating economy.

Just how bad did China's economy get in 2023? Here are the shocking developments that occurred over the course of the year.

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Photo by Fauzan Saari on Unsplash

Top Story of 2023: China’s failed economic recovery

A FALSE START: The beginning of the year saw investors celebrating China’s reopening after several years of gloomily watching businesses stall and suffer under Xi’s draconian zero-Covid policies.

Many thought the worst was over, and Beijing ushered in a series of quick changes that seemed to support that view. It lifted a 2-year ban on Australian coal imports, for example, and looked as if it was lightening up on Chinese tech giants.

The powers-that-be in Beijing also dialed back their stringent “three red-lines” regulations designed to address speculation in the property market.

But the question on everyone's mind was whether the changes represented a long-term about-face in policy, or if they were something a little more temporary, like window-dressing to flatter markets until officials could hit their next national security target.

It wouldn't be long, however, before the truth became clearer.

‘The state is not going away’: That same month Reuters reported that Beijing had been taking “golden shares” in domestic units of Alibaba and Tencent. Analysts said that the move was Beijing's way of formalizing its role in overseeing the companies. The stakes were small, only 1%, it was reported, but they gave authoritarian governors a board seat and the right to review content.

They also provided the Communist party with the mechanism, the Financial Times said, to remain deeply involved in the private-held businesses. One source told FT that “the state is not going away” and “that this is the trend for the future.”

SIGNS OF TROUBLE: By the following month, it was obvious that China's economic recovery was in trouble.

Although Chinese stocks were the world's best performers in the early weeks of 2023 when the government promised everyone that China was “market-friendly” and “open for business,” experts said that those gains had been “over-hyped.”

South China Morning Post reported that global fund managers had slowed their net buying of yuan-denominated stocks from $21 billion in January to $5.4 by mid-February and local Chinese investors took $2.1 billion off Hong Kong’s Hang Seng around the same time.

Money also began leaving China in extraordinary sums. Forbes reported that “companies [were] pulling capital out of the country, resulting in ‘negative’ foreign direct investment,” while Jens Nordvig of Exante Data told Forbes staff that China’s “inflows have never been this weak.”

screenshot taken from Politico’s report

Another thing that made investors in Chinese markets jumpy was the “spy balloon” incident which seemed to validate concerns about geopolitical risks that even local Chinese investors had.

From that point forward, it was hard to keep up - as hit after hit pummeled Xi Jinping’s China Dream.

DECOUPLING ACCELERATES: In one of the most shocking developments in Chinese business, Bloomberg reported that Beijing had urged state firms to phase out using the “Big Four’ international accounting firms - Deloitte, PWC, EY, and KPMG. Recall that the bulk of China's industries are dominated by state-owned firms, not private firms, which tend to be small or medium sized, and, so, this is really a shocking move that can only accelerate US-China decoupling as Chinese auditors, except for those operating prior to Beijing’s national security law in Hong Kong, are not typically seen as independent by Western regulators.

That same week, the Financial Times would report that Western fashion brands were diversifying away from China due to supply chain chaos, as well as concerns about costs, working conditions and forced labor issues.

And in a separate report, the head of Japan's Kyocera, one of the world's largest makers of microchip components, told Financial Times that the business model of producing in China and exporting abroad was no longer viable due to the increase in the cost of labor and geopolitical risks. Kyocera holds 70% global market share in ceramic components for computer chip manufacturing equipment.

By March, an Amcham survey revealed that a majority of US firms “no longer [saw] China as a priority for investment.” Bloomberg staff said that “for the first time in about 25 years,” China had missed the rank of a top three investment priority for a majority of US firms.

After the survey - experts began to predict that the pace of “exiting” or “decoupling” or “diversifying” - or whatever you want to call it - from China could only accelerate. The same week, Bloomberg reported that Apple’s supplier Foxconn had announced it was building a $700m factory in India.

SPY LAW CHILLS FOREIGN INVESTMENT FURTHER: In April, Chinese lawmakers passed Beijing's anti-espionage legislation which banned the transfer of any information even remotely related to national security and significantly broadened the definition of spying.

The law was another blow to foreign investors in China as it did not state what activity or information falls under Beijing’s concept of national security and national interests, and it authorized police to carry out raids on firms suspected of violating the law. In these “probes,” iron-fisted security personnel enter the premises, shut you down and carry away company electronic equipment, as well as staff’s personal property. Nothing is off limits.

Police raids on US firms: Several US firms were raided under the new law in 2023, including the Shanghai office of well-heeled consultancy firm Bain, Mintz, the due diligence firm, and Capvision, another consulting firm.

screenshot taken from Financial Times’s report

US-LISTED CHINESE COMPANIES ABANDON SHIP: Meanwhile, something that didn't really start in 2023, but had accelerated by mid-June last year was the trend of US-listed Chinese companies who were switching from local franchises of Western auditors to new auditors based in the US and Singapore who are more likely to be independent and follow Western accounting standards.

In 2022, the Public Company Accounting Oversight Board (PCAOB), which is a non-profit established by US Congress to oversee listed firms’ financial practices, had found unacceptable irregularities at KPMG and PWC in Mainland, China and in Hong Kong. Under the 2020 Holding Foreign Companies Accountable Act (HFCAA), companies can be delisted from US stock exchanges if their foreign accounting audits are not up to US standards.

The delisting of Chinese companies has been an ongoing controversy between the US and China. Chinese officials prohibited the companies and their local KPMG and PWC auditors to release information on national security grounds, which made them at increased risk for being removed from American stock exchanges.

Nikkei Asia said that the “SEC [had] identified 174 US-listed Chinese companies with auditors that required inspection,” and “[o]f these 24 had changed auditors since 2022. As of June, more were planning to change auditing firms to avoid delisting. Many of those firms will have contracted directly with the Chinese government and Beijing - ever cautious over data - will be unsettled by the development. Watch this space.

AIIB WHISTLEBLOWER FLEES TO TOKYO: Another remarkable story that didn’t get enough attention, was the sudden flight from Beijing to Tokyo of Bob Pickard, a Canadian director general for communications at China's Asian Infrastructure Investment Bank (AIIB), which is a global development and policy bank, over fears he would be detained for whistle-blowing.

Pickard claims that China’s Communist Party was secretly controlling the world's second largest multi-lateral development institution even though the bank’s governing charter requires that its “resources and facilities … shall be used exclusively to . . . foster sustainable economic development, create wealth and improve infrastructure connectivity in Asia . . . with member-countries who are supposed to coordinate bank activities.”

Beijing angrily denied those allegations - which were pretty damning as Picard alleged that the institution was run by Communist party members who - he said - “operate like an internal secret police.” After an internal review, AIIB rejected claims of CCP interference, saying it follows the 'highest standards' of governance.

But the damage was done. CNN reported that the Canadian Finance Minister Christian Freeland had ordered the suspension of all government-led activity and would open an inquiry into the matter. Freeland also said she would discuss the implications with Canada's allies and partners, which raised the possibility that other bank member-countries may also suspend their memberships.

Since then, China-Canada relations have only worsened as Canadian officials initiated an inquiry that is still ongoing into allegations of election meddling by Beijing.

Last month, Canada expanded its probe of the AIIB, which has 106 global members, including Australia, France and Germany.

NO $550 BILLION SELL-OFF TO SEE HERE: In July, it became obvious to many China Watchers that China’s economic recovery was unlikely to occur in 2023. The news headlines that came in after reports of lagging second quarter growth were utterly dismal.

New York Times’ Keith Bradsher said that China's economy is “flashing many warning signs,” while Financial Times said that Beijing “needed to launch a weighty stimulus package.”

Award-winning reporter for the Wall Street Journal and author Ling lingwei, who was based in Beijing until China expelled her in 2020, laid much of the blame for the country’s struggles squarely on Xi Jinping, whom she accused of “choking off Western investment with an expanded anti-espionage campaign and a wave of raids investigations and detentions targeting foreign in businesses.”

Also by this point, China Inc., which underpins Beijing’s treasury, was seeing its coffers run dry at an alarming rate.

In one of my May newsletters, I tried to portray the sheer scale of that development with a story on how Beijing’s propaganda machine used Xi Jinping’s long over-due phone call to Ukraine's President Zelensky after Russia’s invasion to distract from a bombshell report recording a massive $550 billion drop in Chinese equities that came out the same day.

GULF STREAMS RISING: To manage the cash-crunch, Beijing has turned to deals with major Middle East players, like Saudi Arabia and United Arab Emirates, that are moving well beyond crude oil purchases, experts say.

Bloomberg published a report about the increase of Mid-East wealth flows to China. But investment streams are flowing both ways, according to The National News, a UAE English-language newspaper, who said Saudi Arabia’s special economic zones and the country’s continued push to diversify its economy has helped pave the way for tens of billions of dollars in new agreements that were signed during Xi Jinping's December 2022 visit.

Securing Gulf deals must have been extremely important for Xi to see to them personally. It also begs the question why Beijing, under Xi's leadership, doesn’t just ease his foreign pressure campaign and avoid the optics of groveling abroad?

But if you believe, as I do, that Xi Jinping is all about national security, and that national security in China is really just a euphemism for keeping the ruling elite in power, then it makes more sense to “maintain strategic focus” against economic headwinds, as one expert said to Financial Times.

“Xi Jinping does not define economic success in terms of GDP growth. He defines it in terms of tech self-sufficiency. As long as the government can hit its targets on this front, then his calculation is we can figure out how to spread the growth enough to keep people content,” said Arthur Kroeber, founding partner and head of research at Gavekal Dragonomics.

In 2024, Xi will likely continue pursuing Mid-East wealth to help rid China of Western influence.

LOCAL GOVERNMENTS GORGE ON DEBT AT XI’S ORDERS: I deliberately left the reams of news reports published last year on China's property crisis until now to illustrate how China's economic problems are not simply a result of its imploding real estate bubble.

But in an August edition of my newsletter, I talked about the vast complexity underlying that debt crisis and how, like his predecessors, Xi Jinping, has made the moral hazard problem worse, not better.

The title is “Xi is fattening up China's debt gray rhino” and the piece emerged from a story I had read in the South China Morning Post on why China's local government debt has become a gray rhino threat for Beijing.

The orthodox explanation of China's debt crisis, that Beijing also supports, is that mostly private Chinese property developers were enticed into dangerous levels of overleveraging as they speculated during the country’s breakneck speeds of infrastructure development and urbanization.

Fact stranger than fiction: But the truth is that the real terror underpinning China’s sputtering economy lies in the unknown levels of local government indebtedness.

Local governments in China also speculated wildly, but they had fewer options. Their funding had been drastically restricted in the 1990s by the central government’s new budget laws. As part of its budgetary reform, Beijing encouraged local officials to create so-called local government financing vehicles (LGFVs) so they could be more self-sufficient.

But local governments are not entrepreneurs, and corruption is rife in China. It wasn’t a far leap for ambitious cadres in a single-party system that controls national resources to use off-book LGFVs to enrich and empower themselves.

Unprecedented waste: According to Amanda Lee at the South China Morning Post, LGFVs were “actually a cornerstone of Chinese development over the last few decades: “There are now thousands of such vehicles in China driving investments in bridges, roads, homes and industrial parks and boosting the country's gross domestic product [through infrastructure development].”

But alongside unprecedented positive development came unprecedented waste, and stories abound of fiscal recklessness which shocked even Chinese citizens accustomed to seeing government excess.

Then in 2017, Chinese leader Xi Jinping took a firm step towards ending the feverish speculation that had made housing affordable the only way he knew how - by breaking the backs of its biggest high rollers. In October that year, Xi uttered the words that would guide government policy until now: “Housing is for living in, not for speculation,” and the government launched a $1.3 trillion real estate crackdown.

Xi’s ‘politically acceptable bail-out’: By September 2022, the Chinese economy was showing signs of destabilization.

With only weeks remaining until Xi would present himself for an unprecedented third term at the 20th party Congress, local governments were ordered to prop up a sinking real estate sector to the tune of tens of billions of dollars, as Financial Times reported.

One executive of an LGFV based in central Hunan Province told FT that, in late 2022, the local governments “played a critical role in keeping the land market and government revenues from falling off a cliff.”

Now those same LGFVs - who typically have little experience in property development and are known for their sluggish financial performance - are faced with paying back even more debt as China's economic growth stalls.

The IMF estimate of LGFV debt swelled to a record $9.2 billion this year, which is more than double the amount in 2017 when Xi made his “Houses are for living in…” statement.

US TRADE DATA REFLECTS DECOUPLING: Also in August, we got some startling trade data from the US Census Bureau that revealed a new 20-year low in US imports from China while purchases from Mexico, Canada, Europe, and other parts of Asia all rose significantly.

The Wall Street Journal plotted the declines in Chinese imports across a wide range of products, including machinery, electronics, smartphones, semiconductors, apparel and furniture.

David Lynch at the Washington Post wrote that U.S. companies are “accelerating” efforts at decoupling while “Washington and Beijing labor to put a floor under their sour relationship.”

“Decisions made in countless boardrooms — not the White House — are behind the change,” he said.

DEBT CRISIS SPREADS TO CHINA’S MASSIVE SHADOW BANK SECTOR: In a separate report the same week, the Washington Post noted that "loosely regulated" companies in China's $2.9 trillion trust industry [were] beginning to show signs of failure.

Firms "linked to financial giant Zhongzhi Enterprise Group Co.” missed payments on several high-yield investment products,” and were stoking new worries “at a sensitive time” in China’s economic recovery.

Zhongzhi is a shadow-banking giant that manages about $138 billion in assets. Worse, it holds a 33% stake in Zhongrong Trust, which has “270 products totaling 39.5 billion yuan coming due this year.”

Zhongzhi’s troubles are particularly worrisome because its investments are spread across many asset types, like real estate, stocks, bonds and commodities, and its missed payments come at a time when other bad economic indicators have emerged, like new signs of turmoil in China’s property market, hints of deflation, declining foreign investment and exports, rising unemployment and low household and business borrowing.

In November, as more news of Zhongzhi’s struggles rolled in, I wrote a post on LinkedIn saying it was the strongest evidence yet of financial contagion across sectors.

DOUBTS IN BEIJING’S ABILITY TO STOP THE BLEEDING WITH STIMULUS: Also in September, as the latest updates revealed that foreign investors had sold a record $12 billion worth of Chinese stocks the preceding month - the highest in the histories of the Shanghai and Shenzhen exchanges, Daniel Tu, founder and managing director at Active Creation Capital, shared an essay by respected Chinese economist Yan Guoying.

Yan wrote that China’s "overly-indebted economy, driven by the rapid expansion of the leverage ratio, has limited the government's ability to address the slumping economy with the massive and timely stimulus measures expected by the market."

“The brave will choose to face reality, no matter how cruel the reality is,” he said.

Bloomberg reported that "China is witnessing the biggest flight of capital in years, creating concern for authorities as it worsens pressure on the beleaguered yuan.”

In previous bouts of large outflows, Chinese regulators were able to slow the tide with various measures that addressed the perceived causes of China’s long-standing capital flight problem.

But Gary Ng, senior economist at Natixis SA, a French bank, told Bloomberg that the same might not work this time.

“Due to the divergence in monetary policies and the current macro environment, it is unlikely that China has reached the turning point with enough incentives to attract capital back,” he warned.

CHINA’S OVER-LEVERAGED CONSUMERS: In October, we learned that too many in China's fledgling middle class are drowning in personal debt at a time when the value of their primary asset class, real estate, which is also covered in debt, has plummeted.

Jeffrey B Dawson, national policy advisor at the Federal Reserve Bank of New York, explained why Chinese consumers were not spending in amounts that would support China’s economic recovery.

“The perennial challenge with China's growth model has been overly high investment spending relative to GDP and unusually low consumer spending. However a prolonged household borrowing binge, Covid scarring, and a deep slump in the property market in China have damaged household balance sheets and eroded consumer sentiment,” he said.

In 2021, South China Morning Post's award-winning reporter He Huifeng reported that "China’s household debt as a percentage of disposable income had reached a record high of 130.9 percent,” and that “[s]ervicing loan payments is eating up disposal income that could otherwise be used to buy goods and services to support the economy.”

A year-and-a-half earlier, He had said that China's "urban middle class," the wealthiest of the cohort, were already stretched to the max as "their incomes and assets [had taken] a hit” from China’s lagging economic growth and the U.S.-China trade and tech wars.

China’s household debt problem: This is a story that doesn't get enough attention. We talk and talk about China's consumption problem, but we do so in very abstract terms.

As a former debtor’s attorney, I'm fascinated that household debt is so high in a country known for thrifty savers. And while it might be true that China's middle class tend to save more than their counterparts in the West - what many folks miss is the real estate speculation that emptied their middle-class pockets. Now that the housing bubble is popping, Chinese consumers find themselves in financial distress.

Some experts say China’s current debt crisis is not the same as the West’s 2008 Financial Crisis, and I would agree.

It’s worse, much worse for the average Chinese citizen who now find themselves without a means to stop creditors “demanding their pound from flesh” since China does not have a personal bankruptcy law. The implications of their inability to consume are grave for China’s economy.

XI STRENGTHENS GRIP ON FINANCIAL SECTOR: In the last quarter of the year, Xi Jinping made sweeping gains towards bringing China’s financial sector into line.

In October, the Chinese Communist Party finished setting up the Central Financial Commission (CFC), which is an extraordinary watchdog with the power to plan and direct China's $61 trillion banking sector.

Some experts told the Financial Times that the upshot was that Beijing could act more quickly to close regulatory loopholes that might increase systemic risk.

But others seem to think that the problems inherent in the Party's close supervision of the banking sector, under the current leadership, could cancel out any benefits.

As China was working to fill seats in the CFC, it was also putting together the new National Administration of Financial Regulation (NAFR) in a massive overhaul of financial governance.

That body was created to replace the China Banking and Insurance Regulation Commission, and Beijing is using it to centralize - i.e. to remove and/or dilute the autonomy of - regional and local financial entities.

In establishing the NAFR, Xi consolidated all financial regulation, except that in the securities sector, under a single central authority.

Xi’s turn toward finance an ominous sign: The CFC, on the other hand, is a tool to ensure party discipline in the financial sector. I see it as akin to the feared Central Commission for Discipline Inspection (CCDI), but for bankers - a tool to identify new heads to roll if they can’t wrap themselves fully around Xi “thought.”

These organizations are new, and we are still watching to see how they will operate, but the most obvious risk in tying China's financial sector to the whims of one leader is that it will further loosen China's banks from their business judgments.

This is already happening at China’s central bank.

Although the People's Bank of China (PBOC) was never truly independent from Beijing, it did have some autonomy and had earned the trust of both local and foreign investors.

But in 2021, various branches and departmental heads began to receives visits from the Party discipline inspectors. Not long after, the PBOC eased liquidity reserves in line with Beijing’s attempts to aid economic recovery. Those efforts, as the PBOC’s technocrats then knew, would fail miserably, and public confidence in the ability of regulators to save the system took a nosedive.

Then in 2022, the CCDI, removed the chief of monetary policy, Sun Guofeng, for “leaking” macroeconomic indicators that the Party considers national secrets, even though similar information is publicly available in market economies. The inference is that the Party seeks to control its messaging on the economy and does not want independent analysis.

In sum, Xi’s turn toward finance is an ominous sign for China’s economy: It’s hard to see how cutting financial institutions off at the knees and threatening staff with visits by party whips will make China a better place for investment.

HALF OF CHINESE WORKFORCE HAMSTRUNG BY HUKOU: Finally, in December, I wrote a post on why I think China's economic recovery is unlikely to happen.

It emerged from a Reuters story I read which reported that the Chinese government is resisting its own reforms of its decades-old “hukou” household registration system.

The hukou system is China's way of controlling migration internally.

Every household in China is registered to a town or a village and a province, and based on that registration, Chinese residents get access to healthcare, education, and other government services.

The hukou has long been seen a hindrance to economic development. Even Beijing recognizes as much, and has tried to reform it in small, baby steps.

Earlier this year officials told cities with fewer than 3 million people to abolish the system entirely, but progress is “stalling,” according to Reuters, “due to reluctance to take decisive moves that might disrupt social stability and burden indebted cities with added costs.”

A government advisor told Reuters that changing the hukou for both Beijing and local governments “is a hard bone to chew.”

“While neither the central government nor local governments opposed hukou easing, implementation depends on cities having the funds and public service capacity,” he said.

One Central Bank advisor recently estimated that “migrant workers typically spend 23% less than those with Urban hukou, potentially depriving the economy of more than 2 trillion yuan or $281 billion in domestic consumption annually.”

That figure is equivalent to 1.7% of China’s 2022 GDP.

No city hukou, no security: Migrants spend less because they have less economic security than urban residents.

“They get smaller reimbursements for medical expenses,” and “cannot take their employer's contributions to retirement savings 2/3 of the pot with them when they return home,” Reuters staff noted.

The financial strapping of migrants would be less of an issue if there weren't so many.

Because they are not documented, they are difficult to quantify: But China's own 2020 census counted 376 million, and there could be many millions more.

Note that China's population is skewed towards the elderly and retirees because it is aging, and that, by the official data from 2022, its workforce was about half of its 1.4 billion people, around 733.5 million.

That means that roughly 50 per cent or more of the Chinese workforce may be hamstrung by the government's hukou security blanket.

In his latest Bloomberg op-ed, Claremont McKenna College Professor Minxin Pei said that, although on a downward trajectory, China's "[l]ong-term fundamentals are stronger than pessimists think," but "[a] real recovery . . . require[s] reforms the government simply won’t make."

"The government can’t tackle this problem because it is the problem. In the past decade, there’s been a fundamental shift in the survival strategy and governance structure of the ruling Chinese Communist Party. The regime has prioritized political control over economic development and systematically shifted resources from the private sector to state-owned firms, mainly through industrial policy programs such as Made in China 2025," Pei said.

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To watch in 2024

MORE OF THE SAME IN THE SOUTH CHINA SEA: In 2024, I think it's fair to say we should all be watching the South China Sea very closely.

China has invested a great deal of time, energy and money in military installations in the South China Sea, it's unlikely to back down and abandon its claims to contested waters near the Philippines.

Again, I remind you that for the most up-to-date information out there on what's happening in the South China Sea, follow Ray Powell of the Gordion Knot Center for National Security and Innovation on ‘X’, formerly Twitter, and on LinkedIn. He's often quoted in the news, too. But I'll be watching and tracking SCS activity in the newsletter, as well.

CHINA’S PNTR AT RISK: In 2024, we’ll also find out if some of those 600 proposals that Congress discussed in 2023 become laws.

Something that also surprised me is the amount of energy being exerted in Washington to change China’s Permanent Normal Trade Relations status with the US. I wrote about this in the last issue before the holiday break.

Last month, the House Committee on the CCP released a far reaching report outlining over 100 steps that the US government could take to address a "‘multidecade campaign of economic aggression’ that had undercut American firms, dominated crucial global industries and left the United States highly vulnerable in the event of a broader military conflict," New York Times staff said, citing language in the report.

One of the most controversial was to revoke China's normal trade status which reduces tariffs on Chinese goods imported to the US. This is not the first time that such a proposal has made its way into Congress, but this has been the the strongest effort to date.

The proposal, however, faces a lot of pushback, especially from influential groups tied to agricultural lobbies.

But the report was released, according to the Times, after months of bipartisan negotiations with only one member of the 24 -person voting against the final version.

EU’S NEW ANTI-SUBSIDY CHINA EV PROBE: It will be interesting to see the outcome of Brussels’ probe into Chinese EV subsidies. I'm not an expert on EU competition law, but I did take a class on it in a Masters’ program I completed in EU law, and I think I grasp the basics. To me - the kind of “help” the Chinese state gives any industry it wants to succeed is very likely to run afoul of Brussels’ competition rules. But we’ll just have to wait to see how the Commission proceeds while balancing EU-China relations.

CHINA’S STRUGGLING ECONOMY: Finally, investors are holding on to hope that China's economic recovery will gain speed in 2024.

The difficulty I'm having with that rosy outlook is the disregard for Xi Jinping’s tenacity and China's deep-rooted systemic problems. Some analyst are taking note - at least of the latter.

US ratings agency Moody's just downgraded China's A1 credit rating outlook from stable to negative last month, and the IMF has also become gloomier about China's longer-term outlook.

Zhongzhi files for bankruptcy: Before I forget, we just got word that the Chinese shadow bank I mentioned earlier, Zhongzhi, has filed for bankruptcy. That could be good or bad.

Evergrande, China’s giant property developer has been struggling to put a restructuring plan together that it's creditors will approve and is sitting in a kind of debtor’s “no man's land” right now after a Hong Kong judge delayed its liquidation to help Beijing find a politically acceptable solution.

Beijing will be very worried about Evergrande’s many incomplete real estate projects and the impact its insolvency will have on social stability. So if Zhongzhi’s insolvency raises similar issues, it may take a long time before we know what if any future there is for the company.

Again, Zhongzhi is a major player in China's $3 trillion shadow banking sector, which means it's heavily exposed to the investments that underpin much of China’s economy. It has apologized to investors saying that it is deeply insolvent with up to $64 billion in liabilities.

Back to Xi: But back to everyone’s favorite Supreme Leader, I believe that there is a great deal of tension in China over Xi Jinping's leadership. At year’s end, we got word that Xi expanded his purge of the country’s elite nuclear Rocket Force. These are the guys with their fingers on the button, so to speak - and Xi doesn’t feel confident about their loyalties. So there are significant uncertainties in how much power Xi actually has in China. But there is one thing you can be sure of, and that’s his commitment to his own political survival and his agenda for China. You don’t climb your way to individually rule over 1.4 billion people easily, and, where “might makes right,” a supremo doesn’t surrender.

Happy 2024 to all. See you in the regular China Boss News format next week.

Photo by Vincenzo De Simone on Unsplash