In my first post in this series I described China’s elites as the descendants of the fighters who remained with Mao on the famous Long March, a 6,000 mile strategic retreat from Jiangxi to Shaanxi stretching from the fall of 1934 to the fall of 1935. Although only 10% of those who began the march finished it, the core of Mao’s army was saved. Following the end of World War II, Mao’s forces defeated Chang Kai-shek, who retreated to Taiwan under the protection of the Americans.

From the formation of the Chinese Communist state right up to the present day, the elites and their descendants have dominated China. Those elites nearly ran the country into the ground, à la the USSR, in the 1970s and 1980s by remaining ideologically committed to top-down, socialist economic policies despite the obvious fact that China was falling further and further behind the West. China was saved by Deng Xiaoping, who launched market-based economic reforms in the late 1970s.(1) In 1980 China’s GDP was about RMB yuan 300 billion and had been essentially flat since the PRC came into being. Over the next twenty-five years GDP grew to RMB yuan 18 trillion.

But the elites, having failed to destroy the society the first time around, are trying again. This time the descendants of the Long March veterans have undermined China via an epidemic of corruption almost unprecedented in the long and sordid history of national governance. Every society deals with corruption, of course, and authoritarian societies suffer from it more than others. But it is rare for virtually every official in a country to be corrupt to the bone and on a vast scale. China, however, has somehow managed to accomplish this.

Yu Hua, the novelist, quotes a professor of literature who calls this state of affairs “the economics of corrupt officialdom.”(2) So corrupt is the Chinese elite that – bizarrely – it sometimes works to the nation’s advantage. For example, economists have long wondered why it is that China can stimulate the hell out of its economy decade after decade with few inflationary concerns. The answer (according to Yu) is that a huge proportion of reported GDP disappears into the pockets of corrupt officials, rather than being circulated back into the economy. One wonders if the US Fed has considered this strategy.

With financial corruption so pervasive, so vast and so persistent (going back essentially to 1978 when Deng Xiaoping’s policies allowed wealth to be created), it’s no surprise that corruption has spiraled far beyond the financial sphere and has insinuated itself into the intellectual, moral and emotional life of the country. This is what Michael Fathers, reviewing Evan Osnos’ book, Chasing Dragons, refers to as “the vast scope of official corruption, double speak, tyranny and paranoia that runs through all levels of the Communist Party.”(3)

It’s no mystery what China needs to do to move beyond simple industrialization into a modern, consumer-driven, post-industrial society that will enable it to survive and prosper: China needs to eliminate top-down planning; to close the vast, corrupt, inefficient state-owned-enterprises; to democratize; to protect human rights. But we see none of this. All we see is highly targeted attacks on corruption by Xi Jinping that are thinly veiled attempts to eliminate political rivals.

The reason China doesn’t do what it needs to do is that the Party’s leaders are unable to think straight about the matter. Once you reach a certain stage of corruption – the same stage the Soviet Union reached in the 1970s and 1980s – you begin to imagine that the interests of the country and its population are identical to your own interests. In other words, “The more money I can steal, the better off China is.”

In such a narcissistic world China’s future looks grim. Shifting to a consumer-driven economy means that power has to move to consumers. But that means in turn that Chinese elites could no longer milk the SOEs for their personal benefit. Therefore, China won’t move in any large way or any time soon to a consumer-driven economy. As a result, China’s growth will continue to slow and, inevitably, the Chinese Communist Party will risk collapse in the face of popular revolt.

And note that if the Party collapses, the Red Army and the vast internal security apparatus in China will collapse with it. That will allow significant parts of the Chinese state to split off, USSR-style: Tibet, Xinjiang, Inner Mongolia, and Manchuria, certainly. Query whether even among the core Han population there mightn’t be ruptures between the north and south, and/or between the coastal cities and the countryside.

The failure of Europe’s elites has led to the rise of alarming parties and individuals, but because the European countries are democracies the elites can lose power without causing widespread social disruption. But China isn’t a democracy – even fake elections aren’t held. When (not if) the failures of the Chinese elites causes the Party to fall, the results are likely to be socially catastrophic.

(1) Deng had earlier been saved by Zhou En-Lai after being purged twice by Mao because of Deng’s unorthodox economic thinking.

(2) “Follow the Money, China-Style,” New York Times, 5/13/14.

(3) “Chasing Dragons,” Wall Street Journal, 5/20/14.

Next up: Our Floundering Elites, Part 5: The Indians

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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.