World Domination: Harder Than it Looks
Posted September 12, 2023
The scene is set in Riyadh.
Prince Bin Salman, or MBS, the de facto leader of Saudi Arabia, stands in front of the country’s elite.
Vast chandeliers above cast a golden hue, illuminating his resolute gaze.
In five years, he proclaims, the Middle East will transform into the new Europe, ushering in the next global renaissance.
"I want to see the Middle East on top of the world before I die. And I think this goal will be achieved 100%.”
That, by the way, was five years ago.
Since, we’ve seen pieces of the vision unfold.
Part of it is The Line, a linear smart city in Saudi Arabia’s region of Neom.
The Line is just one of NINE ambitious mega-city projects planned in the west coast of Saudi Arabia.
And it’s already getting no shortage of negative attention, a problem for international investors.
Environmentalists and human rights activists aside…
The famous architect Cian Piero Frassinello has said -- to much publicity -- that the project combines all of the dystopias imaginable into one place.
Also, we can’t help but be reminded of the Jeddah Tower, which broke ground in 2013.
It was going to be the world’s tallest building, taller than Dubai’s Burj Khalifa. And it was expected to take 63 months, or 5.25 years.
Ten years later? Its height hasn’t even surpassed Grand Hyatt Manila.
Jeddah isn’t alone. Villamar Towers. Sharq Crossing. Dubai Creek Tower. Dynamic Tower. Sultan Qaboos Port. All abandoned.
In fact, over 23% of all public-private partnerships of this scale are left to rot in the Mid-East.
Of course, Saudi Arabia isn’t the only nation gunning for global domination, but falling a tad short of its bold projections.
The Middle Kingdom
In 1978, China stood humble with a GDP shy of $150 billion.
By 2008, however, it had vaulted past the $3 trillion mark. Yearly growth rocketed past 10% from 1978-2005.
600 million souls emerged from the shadows of poverty.
By 2008, it wore the crown: The World’s Factory. From shirts to high-tech cars and laptops, China was the global makerspace.
Forty years back, there was also a popular economic idea called “takeoff theory.”
The gist: surging from low to middle income was the Herculean task; after that, the journey to high income is a breeze.
“It turns out,” says our colleague Jim Rickards, “that theory was completely wrong.”
To morph from a low to a mid-income giant? Not rocket science. All you need: teeming labor, a strong urban backbone, basic schooling, and foreign capital.
You're a manufacturing titan.
“The catch,” says Jim, “is that this manufacturing is mostly assembly-based. Investors may know that China is the source for about 90% of all iPhones. They may not know that Chinese value-added to the iPhone is only 6% of the sale price.”
China may put the pieces together, but only a tiny part (6%) of its total worth comes from this assembling process.
The rest of its value (94%) comes from the countries that created the individual puzzle pieces, like the U.S. who came up with the idea, Japan who made the special screen glass, South Korea who created the brain of the phone, and many others. So, China helps finish the iPhone, but most of its real value and innovation comes from other places.
Sure, in the global arena, tagging China as the “world’s second-largest economy” isn’t off the mark – if you look at the sum total.
But, as Jim points out, if you break it down per capita? The giant slips to 77th, jostling between Equatorial Guinea and Botswana. And the U.S.? Its income dwarfs China's by a whopping six-fold.
The Middle-Income Trap
Enter the “middle-income trap” -- a situation where a country's growth slows down after reaching a middle-income level, and it struggles to move up to a high-income status.
This happens because the methods that drove its growth (like cheap labor) no longer work, and the country finds it challenging to adopt new growth drivers, such as innovation or high-tech industries.
Below, Rickards will reveal why the Middle Kingdom’s bold plans for world domination have been greatly exaggerated…
And what it will take to escape to escape the middle-income trap.
Before you go down that rabbit hole, though…
Our VP, Doug Hill, has an important announcement.
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Moving forward, it’s set to transform everything about the way we do business.
(Don’t worry. It’s a good thing.)
And read on.
China Is Trapped
The way out of the middle-income trap is to develop your own high-technology intellectual property that you can then apply yourself and license to others.
The middle-income countries basically pay others licensing fees for the technology they need to grow.
It’s only when you develop your own technology that you can move to higher value-added in your manufacturing and earn fees from others. The key to forecasting Chinese growth in the years ahead is therefore technology.
Can China develop its own technology ahead of advanced economy competitors and create the high-value-added industries that come with it? The outlook here is not good.
They have shown little or no capacity to invent or produce in areas such as advanced semiconductors, high-capacity aircraft, medical diagnostics, nuclear reactors, 3D printing, AI, water purification, and virtual reality.
The projects that China does have on display that are advanced (such as their bullet trains that run quietly at 310 kph) are done with technology licensed from Germany or France or with stolen technology. China has produced major technological advances, but it has done so in non-sustainable ways including excessive debt and theft of intellectual property.
China has done little innovation on its own. The stolen technology channel is being shut down by bans on advanced semiconductor exports to China, and sanctions on the use of 5G systems from Huawei. Even China’s ability to import high-tech semiconductor manufacturing equipment as a path to developing their own semiconductors has been cut off through export bans from the U.S. and Netherlands.
The second hurdle to growth in China is its overreliance on investment to drive GDP. A country’s GDP account consists of consumption + investment + government spending + (exports–imports).
Investment can be a good way to drive an economy forward assuming the investment is carefully chosen and the returns on investment exceed any financing costs. That has not been the case in China.
Most developed economies (Germany is an exception) have consumption at about 50% to 70% of total growth with investment around 25%. In China, consumption is only 25% of GDP while investment is 45%. (Net exports are a large percentage).
China’s problem is that much of its investment is wasted. It consists of large white elephant infrastructure projects (such as the Nanjing South train station which I have visited; it has high marble walls and 128 escalators mostly empty). I’ve also visited the construction sites of the “ghost cities” one after the other almost to the horizon, also mostly empty.
This infrastructure binge is financed with debt that is now both unpayable and acts as a drag on real growth in other sectors of the economy. China has consistently failed to pivot its economy from investment to consumption with the result that the waste continues and the debt pile grows larger.
China is trapped in an infrastructure and debt dead-end with no way out.
There are many other headwinds to Chinese growth in addition to the middle-income trap and the debt trap. These include declining demographics, geopolitics, corruption, extreme income inequality, and the rise of Xi Jinping as the new Mao Zedong.
This comes at a time when the U.S., Europe, and Japan are facing their own headwinds (in terms of reduced commercial lending, declining manufacturing, and contracting world trade despite consumers remaining somewhat strong for the moment).
So, a Chinese collapse would be a force multiplier that might throw the world into a global financial panic.
In fact, China is facing a new financial crisis that may leave the rest in the shade. This involves the collapse of a shadow bank called Zhongrong International Trust. Zhongrong is not a pure play property developer like Evergrande nor is it a bank. Instead, it is a shadow bank (offering notes and investing the proceeds) with some property development activities, but many other investment schemes as well.
For years, Zhongrong relied on its reputation as one of the top financial groups in China. Yet, it’s now been revealed that assets taken in as wealth management products were transferred to corporate headquarters and used for various speculations not connected to any specific wealth management goal.
In this respect, Zhongrong resembles the notorious FTX crypto fraud in which billions of dollars of customer funds were diverted to proprietary speculation and spending sprees by the principals.
My expectation is that Chairman Xi and the CCP will not resort to fiscal stimulus this time, but will let the rotten edifice of bad debt and fraud collapse of its own weight. Chinese stock markets will fall 50% or more as a result. This will give China a chance to clean out the deadwood (with lots of fraud trials and jail terms) and reset the system.
Of course, a collapse of that size will not be confined to China. In fact, the CCP may be betting that much of the economic fallout will land in the United States. Investors in the U.S. should expect a U.S. stock market collapse along with bank failures and a wave of bad debts beginning late this year.
It’s not too late to prepare accordingly. Yet, this may be the last warning.