Is the Next Shoe to Fall a Chinese Collapse?

industrial manufacturing
So much manufacturing is done in China.

We’ve talked about the possibility of an economic collapse in the U.S., but what would happen if the COVID lockdown in China goes so far that their GDP plunges by double digits? It’s obviously a bad time to be in China if they won’t let you leave your building, force those that do to sleep in parks and under bridges, refuse to open factories, and cannot feed all those on lockdown. But what would it mean to the rest of the world if the goods that we rely on stopped shipping for more than just a few weeks? How would manufacturers react if the minerals and other raw materials they source from China dry up and are no longer being produced? Where would the world get its rare earth elements, lithium and other in-demand minerals our modern era requires if China halted production?

Worse yet, what would it mean to markets if Chinese companies defaulted on their debts because they had no income? The Chinese government wouldn’t be able to bail them out because the yuan would be worthless. How far would this collapse echo throughout the world? We’re seeing all sorts of problems caused by sanctions on Russia, which is less integrated into the supply chain. Imagine how much worse things would be if no one could buy from or sell to China because their economic system collapsed, their currency became worthless, and they had no credit.

What if the combination of a collapse and the lockdown led to a rebellion in China? How many iterations of a new government would they need to go through before things settled down and China could get back to business? Some companies would weather than kind of collapse and come out the other side intact, but many would go bankrupt or dissolve as the house of cards made up of Chinese debt collapses.

China is on Rocky Ground

Much like President Bide, who has had a rough year since his bungled withdrawal from Afghanistan, the past six months have been rough on China and its president. After success in avoiding the coronavirus, Xi’s zero-tolerance policy is causing more problems than it is solving and threatens China’s economy. His move to strengthen ties with Russia seems to have backfired as it came weeks before Russia invaded Ukraine and faced global condemnation. Any plans China made to invade Taiwan are no doubt being rethought and delayed after seeing the global response to Russia. China is reportedly looking at ways it can protect itself from similar financial sanctions and protects its foreign reserves.

Recent crackdowns on tech companies, movie starts, celebrities, and billionaires have also created tension within the country, and the collapse of major property developers in 2021 has shown there are cracks in China’s economic façade. Perhaps the possibility of a Chinese collapse is not that farfetched?

Supply Chain SNAFU

If you think the supply chain was bad during the height of COVID, just imagine how bad it would be if China went through a revolution or collapse. In that scenario, it could be years or even decades before the country’s production returned to pre-COVID levels.

Companies would still produce goods in other Asian countries if China collapsed, but many of them count on raw materials and components from China. The supply chain is lengthy, complex, and has many links in China. It would not function smoothly, and parts of it may fail entirely, without China.

When the U.S. shipped textile and other manufacturing jobs overseas, many times they sent the machines from the U.S. factories, setting them up in Mexico or an overseas plant. In other words, there was a carefully planned transition. In a collapse, there is no planning, no transition. There is also no way to recover the equipment and ship it to another location. Companies would not only need to rebuild their supply chain, they would have to build their own suppliers and possibly produce their own raw materials, becoming vertically integrated. Even if the knowledge to do that exists in the United States, there may not be the workforce or resources to do it.

In that scenario, we would not be dealing just with shortages, we would be dealing with absences. Goods would just be gone from the market, nothing left but a hole in the supply chain caused by a few missing links. We could be looking at years without advanced consumer electronics and other technology-driven products.

Falling Dominoes

Like much of the First World, the United States relies on China to be its production center. The loss of that much manufacturing capacity would cause the failure of more than a few American companies. Even companies that assemble products in the U.S. rely on components and subassemblies made in China. Well known retailers also count on housewares, apparel, and other goods made in China. What would be on the shelves in Walmart and many other big box retailers if they could not get goods from China? Amazon sales would also plummet without goods from China.

The economic damage caused by the collapse of a country that large would not just cause ripples, it would cause tidal waves. Like a traditional tidal wave, the damage would be deep, broad, and long lasting. A collapse of China would be far worse than a collapse or Russia. If it did not bring down other countries, it would leave them damaged and hurting.

The Lockdown

As the lockdown continues well into its second month and may spread to Beijing, I think we have to consider if the sudden loss of China as a trading partner is possible. We don’t know how long plants will be closed, shipments limited, or how quickly companies can get back up to speed. As we saw after our own lockdowns, restarting a complicated supply chain is no simple matter, as every link has to be up and running at the right time, in the correct order. Delays in getting one small part can bring to a halt production of a much larger piece of equipment.

I’m predicting that the economic fallout and supply chain repercussions will be worse than anyone expects. If you need something made in China, buy it now. In fact, buy a two-year supply. This has the potential to make the baby formula shortage look like a minor problem.