• Exit, the Dragon: China’s Economic Meltdown, and What it Means for Our Auto Industry

Global capitalism. Say what you will — it is a cesspool. Capitalism is a disgusting mass of greed and self-service, benefitting primarily the wealthiest, most corrupt and most powerful among us. It’s self-limiting, self-defeating, and self-corrupting. Global capitalism is a cesspool. But it’s our cesspool, and America knows it like no other. We were born there, after all.

What we know as modern free-market capitalism got its birth certificate the same year America did: 1776, when Adam Smith published The Wealth of Nations. That book shook the world, and forever changed how we would regulate economies and approach global trade. By the time our Constitution was ratified 11 years later, without a doubt, the guys who wrote our founding documents framed it with accommodation of Smith’s ideas in mind. The Constitution wasn’t quite written around free market trade. But there’s no disputing that capitalism is at least part of our national DNA.

China, on the other hand...well, put it like this: Going from a completely insular, self-contained, 5,000-year-old monarchy to an anti-capitalist commune does not prepare one’s immune system well for the cesspool that is global trade. When your most reliable economic indicator is the daily number of stock brokers leaping from skyscrapers, something has gone seriously wrong in the matrix.

So, with China’s economy stuttering to a standstill, and the yuan down 3.6 percent overnight to the dollar, the question today is: What does all this mean to us? All right, that’s not the question. There are others. But here in the heart of the cesspool, we’ve learned to focus on the one. Let’s get to it.

Note: Main Image via Yaxue Cao

The Background — 1949 to 2009

Point of order: I’ve promised certain editors that I will not give a history of China back to the Han Dynasty. So as much as I would love to spend some significant time talking about the European Trade period...let’s just start at 1949.

That was the year the Communist Party took control in China, and for these purposes, the year it established "economic planning." While not entirely a bad idea in moderation, full government control of all aspects of the economy ultimately wound up failing. By the early 1970s, China had become an almost entirely agricultural nation — second-world by our standards. By the late 1970s, the old guard of communist leadership was dead, and three consecutive years of bad weather had destroyed China’s agricultural economy. They began shifting to a more industrial model, similar to our own.

In 1978, China issued a series of sweeping economic reforms, essentially bringing it into the world of global industrial trade. It wasn’t a Western-style capitalist system, exactly. China’s new system was more a hybridization of capitalism and communism that effectively turned the country into one giant corporation.

About this same time, the United States got a new president with a new economic outlook. His name was Ronald Reagan, and that conservative economic theory was "trickle-down economics." The U.S. immediately became the world’s largest consumer of of low-grade consumer goods. Everyone had to have everything they could fill their lives with. Preferably ASAP, for the least money possible, and the least amount of work required to obtain that money. The "get rich quick" era was born, and the world gave unto us a time of excess known as "The 1980s."

China's new system was more a hybridization of capitalism and communism that effectively turned the country into one giant corporation.

That worked out really well for China, which specialized in producing vast quantities of inexpensive goods. Or, "cheap crap," if you want it a little more on the nose. America and China jumped with both feet into the Cheap Crap game, with us selling off our industrial assets to the highest bidder in exchange for vast quantities of low-priced garbage. China got our money and jobs, and in return sent us all the cheap crap we needed to fill our lives.

In the late 1990s and early 2000s, foreign investment in China exploded, and its gross domestic product more than doubled between 1995 and 2005. China had proven its combination of corporation and government could produce lots of goods on the low-low — mostly on the basis that it had about a billion potential employees standing by, ready to be given job offers they couldn’t refuse. And of course, an internal system of patent laws that ensured China Incorporated could reverse-engineer anyone else’s products with impunity.

All looked good for the growing giant. True, some people (some of us) held at the time that much of this was a matter of book-cooking and over-expansion on China’s part, and that it really didn’t have the industrial capital to sustain this kind of growth. Something seemed suspiciously perfect in China’s rapid ascension, and at least a few, including James R. Gorrie (The China Crisis, 2013) began to suspect the emperor truly did have no clothes.

Recession to Now

However, that didn’t seem to be the case during the worldwide financial meltdown in 2009. While everyone else was struggling in a state of panic, The People’s Republic seemed to be doing just fine. The collapse barely even registered there. In fact, according to the Chinese National Bureau of Statistics, their economy grew by a staggering 7 percent in the first two quarters of 2009 — even as our own shrank by 2.3 percent.

Even more staggering: That 7 percent figure was exactly the amount predicted by state forecasts a year before. In other words, "everything’s going according to plan." Again, at first glance, China seemed to have had it all figured out. But many saw something fishy, and again began to suspect chicanery in the NBS. This kind of stability should have been impossible, unless someone were artificially manipulating the figures.

Buick, Cadillac and Lincoln (long beloved in China), practically picked up shop and moved there.

Still, this apparent stability triggered even more fevered investment in China. American auto manufacturers like General Motors and Chrysler started moving money heavily Eastward. Buick, Cadillac and Lincoln (long beloved in China), practically picked up shop and moved there.

But the reality on the ground in China was a lot less rosy. Factories with boarded up windows. Entire industrial cities became virtual ghost towns overnight. And the factories that were running were down to 70 or 80 percent capacity versus two years before. Unemployment became rampant, people became hungry, and homelessness went epidemic. Yet, the numbers looked just perfect. A 7 percent rise, as expected.

More speculative buying, more investment, more car companies picking up and going East. Then, the emperor’s invisible shoe dropped.

Turns out, starting in 2006, China had begun flooding its market with money. Pumping out yuan notes by the ton just to keep money flowing and that perfect 7 percent figure on target. Between 2005 and 2008, China’s inflation rate had increased more than eight times over. They slowed down printing money during the recession, but by 2011 were back to printing cash at six times the rate they were in 2005.

Yet, because of its published figures, so vastly inflated and skewed from reality, speculative investment went on as usual. Real estate investors poured money into empty lots, expecting new factories to be built. Auto manufacturers built factories and designed new cars, expecting hordes of newly wealthy Chinese customers. Unfortunately, it turned out the "wealth" was a lot less than abundant, and what yuan notes there were were worth a lot less than the price of a new Buick.

Yuan Fire

For many years, the U.S. has been pressuring the Chinese government to stop artificially controlling its economy, and let things run as they should. If for no other reason than just to see where China actually stands on the world stage, without government accountants lying up the figures. After shoving the Trans Pacific Partnership deal though, the U.S. finally got its way, and China allowed the People’s Bank of China to determine the real value of their currency.

The result was climactic. The yuan immediately dropped 3 percent against the U.S. dollar on the international currency exchange. Meaning, everyone who had U.S. dollars invested in China just lost 3 percent of their money. And out of the hundreds of billions (if not trillions) that went into China, 3 percent is a lot of money to simply vaporize. And it came one day after China’s stock market suffered an unprecedented 23 percent drop.

So, what does all this mean? Especially for our automobile industry?

That’s the real question — and the simple fact is, nobody knows for sure.

Immediate Effects — Smoke and Burning Money

On one level, this is a very good sign for the U.S. as a whole. It means that we’re in a much stronger economic position than most thought. That means less investment in China, and more investment returning here. It’s all about uncertainty. After decades of cooking books and artificially manipulating their market, not even the Chinese government knows exactly where it stands in terms of economics. And it could be considerably worse than most expect even now. China’s dragon, it turns out, has long been more paper than fire.

Except for its burning money.

China’s People’s Bank didn’t devalue its currency without an OK from the government. The People’s Bank is analogous to our own Federal Reserve, and it ultimately follows the government’s orders. So, why would the government choose to drop its own equity by 3 percent overnight?

Because it makes China’s goods that much cheaper relative to our own.

Part of the reality on the ground in China is overproduction and stockpiling of goods. They’ve been busily building stuff with nobody buying. By dropping the value of their currency, China does gain a massive advantage in terms of selling its unique brand of cheap crap to American consumers. An advantage made all the greater by the TPP our president just signed.

China's dragon, it turns out, has long been more paper than fire.

Ironically, that’s bad news for some American manufacturers. At least in the short term. Because China just got even cheaper than it was, and we just got more expensive by comparison. And not just us: The same holds true for everyone, in particular Europe. In devaluing their currency relative to the dollar, China also devalued it relative to the Euro...probably by a slightly higher amount. That keeps China pretty solidly at the head of the Cheap Crap game, for now. At least, it stems the hemorrhaging long enough for them to figure out the extent of the real damage. It’s a holding measure — a tourniquet, or a finger in the dike.

But it may not last. With China finally forced to compete in the real world, all of its creative accounting has been rendered pointless, and the floodgates are open for an all-out currency war. One which will probably not end well for them.

We were born in this particular cesspool.

What About Our Auto Industry?

On the low end of the scale, China’s still in the Cheap Crap game. When it comes to the knock-offs, bargain basement clothes and low-grade consumer electronics they’ve stockpiled, China’s still holding. These things have been China’s specialty since the 1980s, and they’ve benefited well from their billion-strong force of low-paid employees. So when it comes to things you might buy at Wal-Mart, the Apple Store or off the rack at Trump Menswear clothing outlets, China’s at least holding for the moment. And it may for quite some time, if not indefinitely.

This devaluation is also good for commodities trading, so China may still hold on there as well.

But...things are slightly different on the higher end. In the "durable goods" department.

The automotive industry today works on two basic concepts: investment, and purchase. Consumption. Chinese cars as a rule don’t sell particularly well outside of China, on the basis that nobody wants knock-off Chevys when they can buy the real thing. And consumers in China don’t have the money to buy cars from anyone at this point. These kinds of shifts are almost always good for manufacturers of items where durability and quality count. They’re also good for countries with stable manufacturing bases, and robust, diverse economic strategies.

As of right now, the U.S. has two major things going for it in the auto industry:

1) Stability: With nobody, least of all China, knowing the state of China’s industrial and economic base, there’s just no way investors are going to risk their money there. Expect China’s stock market to continue to dive, and foreign investors to pull out in anticipation. Since they’ve got to put their money somewhere, expect a healthy expansion in our own high-end manufacturing base. That means more money for car manufacturers here, and probably Europe as well. That goes for ancillary industries, too, like steel manufacturing, mining and shipping.

2) Customers: Car manufacturers are like lions — they follow the food supply. Having recently realized the pickings are fairly slim in China, and the Far East won’t provide the growth explosion they were expecting, manufacturers are going to turn their attention back toward the U.S. That means they’ll be competing harder for a smaller slice of the pie, and that’s nothing but good for us.

New Cars, Better Cars and More Selection...for CHEAP!

This will likely affect the kind of cars we buy in several primary ways. The first, pretty ironic:

1) Lower Costs: Part of competition is to underbid the other guy. We can probably expect prices of American-made cars to go down slightly...and maybe significantly on base models. Price competition will be most extreme on mid-priced models with a wide spread between the highest and lowest-end trim levels (I.E. Camaro, Mustang, Cadillac CTS).

Why yes, I think I will take that 700 horsepower Hellcat engine in a $30,000, 2015 Dodge Challenger, and hold the A/C. Thank you.

2) Stripper Cars: Manufacturers make more money on selling options than they do making cars — but in the race to the bottom of the price heap, we might see a new breed of super-affordable "stripper" cars, devoid of any but the most basic options. Or, more accurately, cars with no options aside from those specified by the customer. Why yes, I think I will take that 700 horsepower Hellcat engine in a $30,000, 2015 Dodge Challenger, and hold the A/C. Thank you.

3) Better Gadgets: On the other end of the competition scale, manufacturers will probably begin offering lots more of the high-end options they make money on. Don’t be surprised to see some pretty low-end cars showing up with options like radar-assisted braking, full interior entertainment and navigation systems, sophisticated hybrid systems, and (inevitably) auto-pilot. See our two-part article on Self-Driving cars for more info on that here and here.

4) More Go-Fast, Greater Efficiency and Better Looks: Speed and sex sell — but these days, so does fuel efficiency. It’s hard to say whether or not this increased competition will trigger another all-out horsepower war, but it’s very likely we’ll see fuel economy figures start skyrocketing very soon. Expect better-looking, more striking cars with more exterior customization options as well.

5) Higher Quality: All right, this might be wishful thinking. But I’d like to think at some point, our inevitable drive toward higher prices and higher quality will mean cars with 50-year warranties instead of 5-year warranties. It’s not impossible; it’s just a matter of what priorities Millennial Generation buyers choose to put first.

Summary — Exit, the Dragon

Capitalism...it is a cesspool. But it’s part of our DNA. And because that cesspool is part of our DNA, the U.S. maintains at least some resistance to the most dangerous and deadly infections floating in it. Unfortunately, the same seems not to be true of certain paper dragons to the East. They don’t quite have the economic immune system we do.

Hey, it’s not the first time Westerners have gained victory by spreading infection. We’ve gotten pretty good at that, too.

But at the end of the day, all snark aside, we can at least be pretty confident that our automotive industry will come out of this deal looking good. Our cars are likely to be better and faster than ever, and we might even get some manufacturing jobs back so we can buy them. Wouldn’t that be nice? Now, if we can only stop buying sweat-shop shirts and iPhones, we might be getting somewhere.

One step at a time.

And maybe, one day, one of those steps could be out of the cesspool.

Richard Rowe
Richard Rowe
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