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Memento Mori

President Xi Jinping Accepts the Crown

It was in vain that the Emperor of Chin built the Great Wall,

Hoping to shut out those fiery hordes.

Where the wall stands, down to the Han Dynasty,

The beacon fires are still burning.

-Li Po, "The Long War"
The kind of party where you always know exactly what you're going to wear

In ancient Rome, military prowess in service of the Empire was rewarded with a parade through the heart of the city. These 'Triumphs' featured martial displays of the victorious legions, vanquished foes, newly enslaved peoples, spoils of all kinds, and were granted to generals--who were also politicians--by the Senate of the People of Rome as a sign of the Empire's gratitude and as a means of satisfying a victorious general's lust for glory.* These public holidays also provided an opportunity for brand building or political advertising and were highly sought after by the status-obsessed Patrician class of Roman society.

According to the Stoic philosopher Epictetus, the victorious general rode at the front of a miles-long procession accompanied by a slave who had just one task: to whisper in the general's ear "Memento mori," or "Remember that you are mortal." The constant reminder of mortality and the ephemeral nature of individual glory purposed to lift the general's sights to the only eternal thing: the glory of Rome. It served, then, as a mechanism to sublimate the glory of Rome and to subordinate individual glory to it.

Never Get High on Your Own Supply

And so it is that we have this likely apocryphal story of the powerless slave whose sole function was to speak truth to power. Regardless of the veracity of the tradition, it is an effective trope in demonstrating two eternal truths: the first, that it is human nature to want to believe your own hype; and second, that those imbued with all human power are tempted to become gods.

Persons in power are rarely challenged by those whose own power flows from and is derived from the power of the principal. They have dual disincentives to controvert the principal's belief in their own supremacy. This is why powerful people are surrounded by sycophants. The speaker-to-power in the ancient tradition is a slave because the slave has nothing to gain or lose by bearing witness to the Truth.

The primary reason that one-person rule is so damaging to states is that the natural feedback mechanism is subverted by the principal's inability or refusal to apprehend or understand the Truth. Bad judgment is not punished. Good judgment is not rewarded. It is the philosophical and political equivalent of flying blind. The inadequacy of the principal is only revealed when the consequences of bad judgment become existential: the state fails in conflict with another state or misjudges the temper of the body politic as revolution foments within.

Your state might have a problem if your leader sees themself in world-historical terms

We've written before that we consider China to be uninvestable.** Much apart from its disregard for human and labor rights, or indeed its status as the largest carbon emitter in the world (more than twice that of the second-place holder, the United States), it has for many years experienced decelerating Gross Domestic Product growth. While official government statistics have never been believable as to level, the trend is nonetheless clear: from growth of over 15% in 1998, growth has likely slowed to 0%.

Probably (definitely) not the real number

The most recent reading of official statistics was delayed in its release because...actually, we don't know why. No explanation for the lack of promptness was given. As the data coincided with the meeting of the 2022 National People's Congress (the Chinese Communist Party's once-every-five-year meeting) it is possible that President Xi Jinping didn't want weaker economic figures to distract from his formal coronation as dictator-for-life, and so asked for them to be delayed. It is possible, though, that he didn't have to. Were they disappointing, the ministers responsible for calculation and dissemination know what to do.

But this pace of growth, anemic for a developing country, is particularly problematic for China, as it requires high rates of growth to continue to lift its citizenry out of poverty. The Communist Party of China remains in power partly because it has so far delivered increasing prosperity for its people. In exchange for this elevation of living standards, the Chinese people tolerate a high degree of political corruption, environmental degradation, liberty deprivation, and privacy abrogation. There is also a not-inconsiderable amount of these adversities that the populace is willing to accept for political stability. This is not to say that people, much less the Chinese people, are so materialistic as to be able to be bought with a few points of GDP--far from it--however, there is a direct relationship between a people's sense of material wellbeing and their faith in government. One has only to look at the post-industrial corners of the Developed West to find evidence of this truth.

President Xi has set a goal for China to become a medium-developed country by 2035. This entails a new, giant leap in productivity to realize, an increase on the order of a doubling of output according to popular estimates. Over the past two decades, the vast majority of China's productivity has been the result of capital investment: trains, roads, bridges, apartment buildings, etc. The problem that this mode of development entails is that sooner or later you run out of productive capital investments to make. Of course, you can keep making them, but every additional project has diminishing marginal returns. Fixed capital investment is flat-to-falling over the past 15 years, which is reflected in the GDP growth collapse over the same period.

Increasing prosperity is one thing, but the real problem for Chinese growth is population decline. As we wrote last week, productivity growth, which is generally but not completely consonant with human development, depends upon population growth or capital growth for its continued increase. China's population began to fall below the replacement rate in 1974 and shows no signs of reversing. As a result, China faces the unenviable position of having one worker for every two retirees in the coming decades, as well as the cultural expectation that children care for their parents in old age. To continue growth, the Chinese Communist Party seeks to develop a high-tech autarkic economy as rapidly as possible and has dedicated so much of its military, intelligence, and industrial resources to the realization of that goal.

We do not believe that China is ripe for revolution any day now. It is extremely difficult to get a true sense for the Chinese people's satisfaction with the Communist Party's track record. Criticism is not tolerated, and dissent is viciously punished. The state surveillance apparatus is exceedingly effective, especially now that measures put in place to monitor and prevent the spread of COVID-19 are so easily repurposed to monitor and prevent the spread of criticism and dissent. One reason we believe that President Xi and the Chinese Communist Party are such avid advocates of COVID-zero policies is that it gives them a rationale to continue their intrusive and pervasive surveillance of the body politic. They know every mobile-phone owner's precise location, data usage, message contents, and interlocutors both virtual and physical. The mobile phone is the panopticon in your pocket. "The Party" in George Orwell's 1984 could only dream of such surveillant intimacy.

Cracks Appear in the Feet of the Statue

Yet all is not well in the State of China. Chinese government debt currently stands at an unconcerning 78% of GDP. (Compare that to the profligate United States, which boasts 137.2%.) We know that this is how much debt the Chinese government owes because that's how much it has told us it owes.

While this percentage of GDP of debt is manageable at current levels, it is forecast to grow over the coming decades to exceed 100% of GDP by 2027. Developed countries often shoulder over 100% of GDP in debt; emerging economies, however, often strain beneath debt burdens at this level because they must borrow at higher rates than developed countries and they often borrow in the international debt markets--frequently in currencies not their own.

How high's the water, momma? Well, it's 78% of GDP and risin'.

But like its productivity statistics, its word cannot be taken at face value when it comes to the debt commitments of the Chinese Government. To fund its development over the past decades, China's banks have lent ever more to its State-Owned Enterprises. The extent to which the Chinese government is willing to rescue the banks that stand to lose upon default of these loans is unclear.

In the early 1980's China's then-leader Deng Xiaoping pioneered 'Socialism with Chinese Characteristics'--a form of State Capitalism that allows for the tacit existence of property rights and a market economy, but one which is dominated by state-owned banks and the state-owned enterprises they finance. It seeks to harness the efficiencies of market capitalism while maintaining political control. Consequently, China's state-owned banks and enterprises have operated with limited degrees of autonomy from the Chinese Communist Party's agenda. This has not only stymied the allocation of capital to the highest return projects, reducing Chinese economic growth, but it has also encouraged corruption and undermined the development of strong financial institutions. China would undoubtedly be richer had it truly embraced market capitalism.

Like most governments, the Chinese government borrows money from the international debt markets partially to fund itself, and partially to establish a yield curve so that internal and external market participants have a reference rate with which to price the issuance of non-government debt. This process of financialization is necessary for any country that wants to grow. But it is equally important to develop robust institutions to provide effective monitoring and regulation of the inevitable information asymmetry and moral hazard problems that debt markets are heir to.

China's Lehman-style Bust

While China has done a lot to develop capital markets for debt and equity over the past decade, it has failed to develop these to the point where there is enough capacity to satisfy the country's appetite for saving. This, along with a cultural propensity to invest in real property, has partially contributed in an overinvestment in real estate development. A simple web search for 'Ghost Cities China' reveals the extent of this excess supply wherein perhaps as much as 65 MM units, about 10% of the number of households, sit vacant. Much of China's growth over the last several decades has been the result of employing what was formerly agricultural labor in manufacturing instead, the higher and best use. This necessitated the relocation of that labor from the rural countryside to the urban metropolis--and therefore the building of housing to accommodate them. However, given large scale vacancies in suburban areas, it would appear that China's housing stock has excess capacity.

The propensity to invest in brick-and-mortar real assets should be familiar to our American readers. The world economy has already seen the effects of one Chinese savings-funded property bubble. Global markets for capital are like balloons, however: if you squeeze one part of the balloon, it expands in another. Investment that once found its way into financing residential real estate construction in the United States was onshored in China over the past decade, resulting in unprecedented levels of construction.

But irrational exuberance in asset markets, while wealth-destructive and unfortunate, is nonetheless both a necessary feature of the system and typically not system-threatening. Bubbles inflate and deflate, but don't take down financial systems or economies with them--unless they also involve the immoderate use of debt. (This may be the reason that the deflation of the Cryptoasset bubble has failed to register in other asset prices besides speculative technology stocks and used luxury watches.) Alongside the massive investment in residential property, we've also seen an equally extraordinary increase in household debt. These debt levels are high and increasing, as we have mentioned before, but it has been noted that, given China's spectacular population size, the amount of debt is not remarkable. That point is incontrovertible. Yet when adjusted for the size of the working population--since it is ultimately workers that must service the debt load, the numbers seem a little less reassuring. And after converting the future expenses of caring for its aging population into liabilities and adding these to the existing debt load, one begins to wonder if there are not cracks in the foundation of this mighty statue.

Not headed in the right direction

High indebtedness coupled with asset price deterioration results in financial distress and in the case of the individual consumer a negative wealth effect. Chinese savers that put their investable capital in real estate have seen these values fall precipitously, making them feel poorer and thus less willing (or able) to consume, and therefore less likely to replace the Western consumers that the Chinese Communist Party had hoped they would. Despite the belief of Nationalists who fawn over its supposed benefits, Autarky isn't all it's cracked up to be.

The Beacon Fires Are Still Burning

Recently, protests have erupted that are broad in geography and wide in scale. Unrest on this level hasn't been seen since the Tiananmen Square Democracy protests of 1989. The proximate cause of these demonstrations is reportedly frustration with Zero Covid policies that have shuttered wide swathes of the country, restricting freedom of movement, ability to work, and to some extent, further curtailing what little freedom of expression its populace enjoys. But they also come at a time when China is experiencing a loss in the quality of life due to inflation, currency deflation, and the aforementioned wealth effect of seeing one's savings evaporate along with property developers' promises and the once promising tech sector. President Xi's Great Wall, which for so long has kept Covid-19 and internal dissent at bay, may finally be surmounted by that indomitable spirit: the human drive for freedom.

*We read in Plutarch's Lives that, upon realizing that he had not yet achieved the same world-historical status by age 33 as his idol Alexander of Macedon did by conquering the world, Julius Caesar is supposed to have been reduced to tears.

**The Chinese Communist Party's recent crackdown on its technology titans demonstrates its Mao-like paranoia regarding domestic challenges to its supremacy and centrality.

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