The Chinese Great Depression: Factories Full, Wallets Empty – History Repeats | Digging into China

Hi, I'm Dong Xiong. Welcome to Digging into China, where we explore China in depth to review unique perspectives. Friends who are well-read in the history of economics should know that there have only been two major deflations in human history worth mentioning. One is Japan's lost 30 years, and the other is the American Great Depression on the eve of World War II. And, of course, there is a third one happening right now, China's current Great Deflation. The last time China's CPI entered the moderate inflation range above 2% was all the way back in January 2023. And because China and Japan are quite similar, and both countries share the problems of a real estate bubble and an aging population, a lot of people are comparing Japan's lost 30 years to China's Great Deflation. But in reality, if we are only going to compare the Great Deflation aspect, the Great Depression that kicked off in the United States in the 1930s is actually a closer parallel to China. Between the end of World War I in 1921 and 1929, the United States and the rest of the world ushered in the high-speed growth of the Roaring Twenties. During this phase, the American economy took off like a Chinese-made EV with no brakes, and U.S. manufacturing quickly surged. Over those 10 years, the average annual growth rate for U.S. industrial output hit 7%. U.S. industrial output at one point accounted for 46% of the world's total, making it the absolute number one industrial nation globally. The industries that were really rolling were mainly heavy ones like automotives, steel, and power generation. In 1921, the U.S. only produced 1.3 million cars annually. By the end of 1929, that number had already jumped to 4.8 million, more than a three-fold increase. Electricity generation also soared from 3.3 million MWh in 1921 to 9 million MWh in 1929, nearly tripling. As for steel output, while the leap wasn't quite as dramatic, it still rose from 27 million tons in 1921 to 59 million tons in 1929. This pace was certainly no slower than what China experienced during its reform and opening up era. Naturally, the U.S. also developed a certain asset bubble. Though compared to China, America's asset bubble was mainly concentrated in the stock market. The Dow Jones Industrial Average also rose six-fold in those 10 years. Now, this high-speed rolling didn't came without a price. What was the price America paid back then? It was strikingly similar to what we see in China today. One was insufficient consumption stemming from a low human rights advantage and a low human capital advantage. And the other, massive over-investment. After World War I, to keep its products competitive among a host of developed countries, the U.S. constantly and aggressively suppressed labor rights. Of course, the American way of suppressing workers' rights was a bit different from China's. America mainly focused on crushing labor unions. In 1970, the U.S. first passed the Espionage Act and then followed up with the Sedition Act in 1980. Ostensibly, these bills were all about maintaining the stability of the national government and protecting America's stability. But the sharp tip of the spear was actually pointed directly at the labor force. The Espionage Act claimed to target spies, but in reality, it targeted union leaders. The Sedition Act claimed to oppose foreign influences, but in practice, it targeted union strike activity. Under the one-two punch of these two acts, American labor unions were quickly and thoroughly annihilated. During this period, the number of unions in the U.S. saw a cliff-like decline, and the number of striking workers also plummeted. In 1919, 21% of American workers participated in strikes that year, but by 1929, that figure was only 1.2%. This made the U.S. the country with the longest working hours among capitalist nations. At the time, at its peak during the Roaring Twenties, the average U.S. workweek reached 50.7 hours, a figure that would make even Chinese people today cringe. America at this time was all about pure liberalism, believing the market would solve everything. If your wages are low, it's just because you are not trying hard enough. If you were competitive, your wages would naturally rise. If your working hours are long, it's purely because your productivity is low, and you are not working hard. Plenty of people will work hard, can you lead our great America to rise if you don't hustle? Simultaneously, due to low taxes and minimal labor rights during this period, America's wealth gap drastically widened. In 1920, the income of the top 1% in the U.S. only accounted for 13% of the total national income. But by 1929, this group accounted for 24% of the total income. Another cost paid during this period was the unchecked expansion of capital. While the U.S. was relentlessly cracking down on labor, it was completely hands-off with the capital market. Regulatory thresholds for the capital market were lowered to an extreme degree. A prime example was the extremely low bar for bank lending. In 1928, U.S. banking regulations were not fully developed, and banking was not a particularly elite profession in America. Anyone with a little cash could jump in and play a few rounds. There were about 25,000 banks across the U.S. at the time, and 90% of them were small, state-chartered banks. For context, the total number of banks in the U.S. today is only about 4,500. To make a name for themselves in the capital market and crush their competitors, these 25,000 banks set the lending threshold extremely low. If you wanted to open a factory, you could walk into a bank today and have a long tomorrow, and the leverage could be pushed sky high. At the time, a dollar's worth of collateral could unlock 15 times the leverage for consumption, meaning you could borrow $15 for $1 of collateral. If you were playing the stock market, you could unlock 10 times the leverage, borrowing $10 for $1. And if you were building a factory, you could get 8 times the leverage, borrowing $8 for $1. This lenient regulatory system greatly facilitated the uncontrolled expansion of U.S. manufacturing. So America had this huge disconnect. On one hand, terrible treatment for workers, extremely slow income growth, very little time for consumption, and wealth highly concentrated. And on the other hand, the unchecked expansion of capital and manufacturing. This massive dislocation caused a clear decoupling between America's production capacity and its consumption power. During the roaring 20s, U.S. industrial output grew at an average annual rate of 7%, but wage growth was only 1.8% per year, and consumption growth was 2.1% per year. That is clearly abnormal. Naturally, this aggressive roar was bound to be a kitten roar. It couldn't last for more than a few days. And it quickly went bust. On October 24, 1929, a mundane Thursday, the U.S. stock market suddenly crashed, plunging 11% right after the opening bell. The biggest stock market disaster in U.S. history and a global Great Depression had arrived. Throughout the depression, the problems of America's previous overexpansion were completely exposed. Deflation began to show its full face. The U.S. and even the world sank into an unprecedented Great Deflation. Ford cars, which had previously seen a massive increase in production, became unwanted junk in parking lots. Piles of steel rusted in factories, and various expanded power plants halted production. The Dow Jones index dropped all the way from its high of 380 points to less than 50. U.S. unemployment hit a new high, and out of the 25,000 banks, more than 9,000 went belly up. Comparing the two, the mechanism that produced China's deflation is basically very similar to America's. China's current deflation is also mainly composed of two major parts. One is the unchecked expansion of capital, and the other is consumption that simply cannot be boosted. The products Chinese companies are currently manufacturing are clearly in surplus, which is most evident in the automotive and solar photovoltaic industries. At the same time, China also has a massive lack of consumption. The spending power of the Chinese people simply cannot keep pace with growth of its industry. Between 2000 and 2020, China's rolling two decades, the average annual growth rate for industrial output hit 9.6%, but the growth rate for demand was only 4%. The growth of income, consumption, and production capacity clearly suffered from a severe decoupling. Of course, China's Great Deflation still has one key difference from America's Great Depression. The main difference lies in how they came to be. The reason China cannot boost consumption is similar to America's. It's because ordinary people have excessively low incomes, overly long working hours, and too large a wealth gap, which makes it impossible to boost consumption. However, the poor treatment of Chinese labor is not because unions are suppressed. After all, China has never had unions in the first place. The reality in China is that there is essentially no labor law to speak of. If you don't pay social security contributions in China, the CCP will hit you hard. But if an enterprise runs a 996 schedule every single day, no one is going to lift a finger to stop them. Naturally, China also has a severe wealth gap. America's wealth gap was caused by excessive freedom of capital, which led to the Matthew Effect. China, however, is caused by the huge wealth disparity brought about by the privileges of the powerful elite. In terms of investment, China has clearly seen overcapacity as well. Early on, this surplus appeared in various major infrastructure projects. But now, it appears in technology products favored by Xi Jinping, including electric vehicles and solar photovoltaic panels. However, the reason for China's unchecked expansion of capital is the exact opposite of America's back then. America's was due to overly lax regulation, while China is due to too much government control, especially in industries like solar and new energy. The overcapacity isn't caused by a lack of government oversight, but precisely because the government is too involved. The Chinese government constantly uses its administrative advantage to support these industries with massive capital and uses policy guidance to steer funds into them. Beyond that, there are a few other subtle differences between China and the U.S. today. For example, America's bubble was mainly concentrated in the stock market, while the Chinese people's bubble is primarily concentrated in the housing market. Furthermore, because of a lack of government oversight, the U.S. also lacked strong regulatory tools when the crisis first hit, which led to a cliff-like deflation. During the four-year peak of deflation after 1929, the U.S. annual CPI hit a negative 7%. China's CPI decline has been notably slower, more in line with Japan's slow downward style back in the day. But overall, comparing the U.S.'s Great Depression and modern China's Great Deflation, the underlying causes are very similar, and the overall degree of similarity is quite high. So, having discussed the similarities, let's talk about how the U.S. climbed out of the Great Depression and whether China can successfully copy the old path the U.S. took to end deflation. First off, America's initial reaction to the Great Depression was to hike tariffs. The logic was simple. Why is there deflation? Because goods can't be sold and the prices keep dropping. If I impose tariffs and keep foreign goods out, consumers will be forced to buy domestic goods, and then domestic goods will be able to sell, right? So in 1930, the year after the Great Depression began, the Smoot-Hawley Tariff Act came into being. This tariff act instantly raised the U.S. tariffs to an extremely high level, but the reality quickly delivered a resounding slap to the face of this act. The Smoot-Hawley Tariff Act not only failed to alleviate America's deflation, it actually intensified the problem. Because as the act passed, other countries also began retaliatory tariff hikes. At this point, the U.S., as the world's number one industrial nation and a trade surplus country, naturally suffered a huge loss, and American goods became even harder to sell. However, after that brief misstep, the true savior of the Great Depression arrived, which is the well-known New Deal under Roosevelt. But many people have a very one-sided understanding of what the New Deal actually was. They say Roosevelt implemented work relief and built the Hoover Dam, meaning Roosevelt mobilized government resources for massive infrastructure projects, construction to pull the U.S. out of the Depression. The New Deal definitely included work relief, and it was a very crucial part. But two other Roosevelt policies were equally important, and it was precisely these two policies that solved the two critical issues that triggered the Great Depression in the first place. 1. Insufficient Consumption and Production Overcapacity On the consumption side, Roosevelt did a 180-degree turnaround after taking office. He instantly reversed the previous U.S. government's rejection of labor unions and began to seriously raise worker welfare, quickly proposing various laws and policies related to the protection of labor rights. Roosevelt first passed an act called the National Industrial Recovery Act, which established a National Recovery Administration, codenamed NRA. He then used the NRA to force over two million enterprises to voluntarily sign the NRA Blue Eagle Agreement. This agreement mainly required these companies to promise to provide a minimum wage higher than before the Depression, and also required them to shorten the work week to under 40 hours. The condition for this was that the government would temporarily suspend its monopoly investigations against them. Then, in 1935, Roosevelt passed the National Labor Relations Act, which confirmed workers' right to strike and established the National Labor Relations Board. Finally, in 1938, Roosevelt passed the Fair Labor Standards Act, which officially promoted the eight-hour workday and the minimum wage system across the entire United States. Before the Great Depression in 1925, the average work week for U.S. laborers was 50.7 hours, higher than China today. But by 1940, with the support of the eight-hour workday and the New Deal, U.S. working hours instantly dropped to 37.6 hours. Simultaneously, to reduce the wealth gap, U.S. personal income tax rates began to rise rapidly, with the top marginal rate quickly increased from 25% to 63%. The wage income tax also went from 12% to 13.75%. The inheritance tax also doubled at this time. The government used income tax to narrow the wealth gap. By the end of World War II, the income share of the wealthiest 1% in the U.S. had fallen from 24% on the eve of the Great Depression to 11%. Though, I should note, the income tax hike was mainly achieved through the 1932 Revenue Act, which was proposed by Hoover, not Roosevelt. On the other hand, Roosevelt also quickly strengthened the banking regulation. The Glass-Steagall Act was swiftly passed. This act restricted the possibility of banks using depositors' funds for higher-leverage stock speculation. And it also created the Federal Deposit Insurance Corporation, FDIC, to prevent banks from gambling away all the depositors' money. Finally, Roosevelt gradually moved the dollar away from the gold standard to create an opportunity for the dollar to depreciate. So, what does China desperately need right now? It needs to expand domestic demand. And how do you expand domestic demand? You need to give money to workers so they have cash to spend. You need to give workers time off so they have time to spend. At the same time, China should also adjust its tax and distribution mechanism, instead of messing with the social security contribution base. By the numbers, the social security contribution rate and the hidden tax burden rate for the poor are even higher than for the rich. China today is a strong state, rich state-owned enterprises and poor people. China must reverse this situation. Simultaneously, China also needs to fix the problem of the unchecked expansion of capital. Though the way to fix it is not for the government to strengthen regulation like Roosevelt did, but for the Chinese government to simply let go of regulation. Xi Jinping should stop having sudden flashes of inspiration, today deciding to go big on the chip industry and then using government support and guidance to let massive funds rush disorderly into the chip sector, tomorrow deciding to go big on electric vehicles and then using subsidies to let massive funds flow into EVs. He should give the market more initiative and let the market regulate itself. Of course, Xi Jinping has not done this, but has instead gone down another path, one that looks a bit like a Hitler's path. In our history book, we should have learned the saying that the U.S. recovered from the Great Depression because of Roosevelt's New Deal. But Germany, which had no New Deal and only Hitler's tyranny, eventually started World War II. So, what exactly was the difference between Hitler's tyranny and Roosevelt's New Deal? First, in the traditional sense of work relief, there was no difference between the two. In fact, Hitler's work relief was even more intense. Roosevelt was merely building dams, Hitler was going both dams and a massive military build-up. In the second month after Hitler came to power in 1933, he established the National Labor Service, mobilizing unemployed youths to build infrastructure projects like highways and railways. Furthermore, Hitler drastically ramped up military industrial construction. By 1935, Germany's military spending accounted for 15% of the national GDP. This single item was already more than the total amount spent on America's work relief programs. You could say that Hitler's version of work relief was far more extreme than Roosevelt's. If Hitler was also doing work relief, where was his real difference from Roosevelt's? It lay in how he viewed the labor issue. As the birthplace of Marx, Germany had a relatively early development of labor rights. Germany was the first to introduce the 8-hour workday in 1918. Of course, this was not the modern 8-hour workday with a 5-day week, but a 6-day, 8-hour workday. Even so, this 8-hour workday was a breath of fresh air internationally. Because, theoretically, modern China hasn't even fully achieved this 6-day, 8-hour work system. Furthermore, in the 1919 Weimar Constitution, Germany explicitly affirmed the legality of labor unions. And in 1927, Germany established the world's first unemployment insurance system. But once Hitler came to power, he began a ferocious assault on these systems. In the third month after taking office, he launched the Union Cleansing Operation, leading the SA to wipe out all labor unions in Germany. A new labor organization law was also issued. In this act, a worker was redefined from an ordinary laborer to a member dedicated to the nation. Nazi Germany at the time had a classic line, labor is not a commodity, but an obligation to serve the nation. Of course, just like in China, once things start to be sung with a lofty tone, the people listening to that lofty tone are usually the ones who suffer. Once the rhetoric was elevated, you couldn't mention things like raising wages or the 8-hour workday. You are dedicating yourself to the nation, and bringing up those things would be far too vulgar. German working hours instantly climbed from a weekly average of 39 hours when Hitler came to power in 1932 to 52 hours in 1939, right before World War II began and Germany invaded Poland. This combination of low wages and long working hours clearly further compressed Germany's consumption capacity, and Germany's deflation problem became even more severe. Although Hitler briefly suppressed the Great Deflation by freezing prices after taking office, he did not achieve a slow inflationary recovery in Germany. Germany's actual real inflation level remained around zero from 1935 until the early stage of World War II. Hitler also staked his fortunes on the military industries. By 1939, military expenditure alone accounted for 25% of Germany's GDP, and the military industry became Germany's sole pillar industry. So, what do you do with so many airplanes, tanks, and artillery pieces you've built? Rather than letting them rot, you might as well follow the example of capitalists pouring milk into the river. So Hitler had no choice but to send Poland to war, seizing resources through war and converting military products into cash. In fact, by tracing Hitler's economic path, from his decision to increase working hours to his bet on the military industry, we can see that Germany's launch of World War II was only a matter of time. Of course, from a historical perspective, we all know today that Roosevelt was right and Hitler was wrong. And since Hitler was so completely wrong and we have this case study in front of us, why would Xi Jinping still be learning from Hitler? Why, against the backdrop of a Great Deflation, is he further suppressing workers' conditions? That's because, while we stand here with the benefit of hindsight, knowing Roosevelt was right and Hitler was wrong, when people were actually facing that situation back then, they might not all have thought Roosevelt was right. Some might even have thought Roosevelt was committing suicide. Because Hitler's answer also made a certain amount of sense. When there is a global Great Depression and a global Great Deflation, and you can't even sell your own products, what's the first solution you might think of? Maybe raising tariffs, or perhaps choosing to continue lowering product prices and increasing product competitiveness, not forcefully raising wages like Roosevelt. After all, what Roosevelt did carried a risk. The Blue Eagle Agreement's minimum wage definitely raised worker welfare, but it also clearly increased the burden on enterprises, which could have easily led to the wholesale bankruptcy of these companies during the depression, causing an even bigger financial crisis. Hitler's approach of continuing to squeeze employees' working hours and wages to drive down product prices and further enhance the competitiveness of domestic companies and products was not necessarily seen as an impossible path to a solution by people at the time. However, in the end, Roosevelt made the right bet, an America bet right on Roosevelt's approach, trusting that Americans, if they just had money, could support America's massive manufacturing sector through their own consumption. From a historical perspective, Hitler was bound to lose, and America was bound to win. The difference between them mainly lies in their political systems. The greatest advantage of a democratic system has never been that it will definitely elect a leader who makes the right decisions, but that when the country makes a wrong policy, it can quickly adjust the country's strategy by voting the wrong leader out of office. After the Great Depression began, the U.S. also went through the period of Hoover's wrong policies, even passing that absurd Tariff Act. Although Hoover's attitude towards labor was not as outrageous as Hitler's, he adamantly rejected government intervention. But Hoover being wrong didn't matter, because the U.S. wouldn't give a wrong-headed president the chance to keep governing. Soon, with the continuous economic decline, Hoover, who adhered to mistaken economic policies, was voted out, and Roosevelt, whose policies were completely different from Hoover's, took office. This ability to quickly adjust one's policy to do a 180-degree turnaround is the fundamental reason why America was able to reverse its economic malice. Under a democratic system, policies can compete. But in Hitler's Germany and today's China, they can't. Hitler actually benefited from the mistaken policies of the previous leader. Germany's chancellor before Hitler, Brüning, had policies that were basically identical to Hoover's, refusing social relief, refusing to raise welfare, and only raising taxes. But Germany at the time was under a democratic system, so Brüning was quickly voted out, and Hitler came in to correct the error. Hitler did adjust the strategy after taking office, but while adjusting the strategy, Hitler also destroyed Germany's democratic system. This meant that when Hitler's political policies went wrong again, no one could correct them. Hitler himself was also unwilling to abandon his established policies, as it would cause him to lose faith and authority. From then on, Germany could only plunge ahead relentlessly down Hitler's mistaken path. And this also applies to China today. Xi Jinping is actually caught in a Hitler-esque panic. Faced with falling exports and severe deflation, he chooses to further squeeze working conditions and increase working hours to boost the competitiveness of Chinese products and fight a He is only paying lip services to stimulating consumption, but lacks the momentum for big, genuine consumption-boosting reform, and won't give up his so-called great leap forward for chips and electric cars. And more importantly, with Xi Jinping's indefinite tenure and infinite power, there is no one who can fundamentally correct Xi Jinping. This is also the core difficulty of an autocratic system. We cannot always expect an autocratic system to produce a general secretary like Deng Xiaoping or Hu Jintao and Wen Jiabao. It is also bound to produce people like Mao Zedong and Xi Jinping. We can not only look at how fast China's economy grew during Deng Xiaoping and Hu Wen eras, we must also see how slow China's economy grows when a person like Mao Zedong appears. Under an autocratic system, if a country gets such a leader, the entire country is completely helpless and can only rush wildly down his mistaken path. For China though, the small silver lining in this misfortune is that Xi Jinping is indeed betting on solving China's deflation problem by suppressing workers' conditions and increase working hours. But he hasn't completely copied Hitler. His expectations for manufacturing are still focused on high-tech products rather than the military industry. And that is definitely a good thing for China. Otherwise, if Xi Jinping were to really follow Hitler and bet the entire manufacturing sector on the military industry, then the world would truly not be far from a third world war. Thank you so much for watching. 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