WEBVTT - Just How Bad Is the Economy Getting in China? 0:00:10.000 --> 0:00:13.400 Hello, and welcome to another episode of the Odd Thoughts Podcast. 0:00:13.480 --> 0:00:16.840 I'm Tracy Alloway and I'm Joe Wise. Joe, what is 0:00:16.880 --> 0:00:19.560 going on in China right now? That is a good question, 0:00:19.680 --> 0:00:22.520 and it's it's a question we actually haven't been talking 0:00:22.560 --> 0:00:26.000 about enough. Lots of focus on energy, lots of focus 0:00:26.079 --> 0:00:30.200 on Europe, Mac Road, the FED recession. But my understanding 0:00:30.240 --> 0:00:32.680 is that things aren't great in China either. I feel 0:00:32.720 --> 0:00:36.760 like in a normal year where everyone wasn't distracted by 0:00:36.960 --> 0:00:40.040 domestic US inflation and the question of whether or not 0:00:40.520 --> 0:00:43.559 interest rate hikes are going to spark a recession, I 0:00:43.600 --> 0:00:46.800 feel like China would be taking center stage with everything 0:00:46.840 --> 0:00:50.320 that's going on. But it feels like it's sort of 0:00:50.360 --> 0:00:53.280 been tangential. Like you hear a little bit about what's 0:00:53.320 --> 0:00:57.000 going on, but people like aren't really focused on it. Well, 0:00:57.160 --> 0:01:00.080 I would see it feels contained in a way, you know. 0:01:00.240 --> 0:01:03.640 So obviously, one of the big stories is the country's 0:01:03.680 --> 0:01:08.080 ongoing commitment to COVID zero, which obviously has a negative 0:01:08.120 --> 0:01:11.679 impact just on sort of economic activity sort of measured broadly. 0:01:11.720 --> 0:01:14.960 But then there are other things happening. The real estate 0:01:15.040 --> 0:01:18.679 sector seems very troubled, with more and more people basically 0:01:18.720 --> 0:01:21.160 refusing to pay mortgages on houses that have yet to 0:01:21.160 --> 0:01:23.840 be completed. You know, that's a big story. There's a 0:01:23.880 --> 0:01:26.760 big drought happening, a really intense heat waves, so they're 0:01:26.760 --> 0:01:30.080 having their own weather climate stress. But yeah, I still 0:01:30.120 --> 0:01:33.120 don't totally get how it all fits together, right. I 0:01:33.120 --> 0:01:37.200 feel like people have been warning of a Chinese property 0:01:37.240 --> 0:01:40.720 bust for so long and it hasn't happened that we've 0:01:40.720 --> 0:01:43.720 all sort of become a nerd to the idea that 0:01:43.760 --> 0:01:47.480 it could actually happen. And maybe we're seeing the beginnings 0:01:47.560 --> 0:01:49.960 of it, but again, maybe we're not. Because China is 0:01:50.040 --> 0:01:53.600 very good at coming in and rescuing particular sectors when 0:01:53.640 --> 0:01:55.640 it needs to. That's the key thing. And of course 0:01:55.680 --> 0:01:58.640 we've talked about, say ever Grant a few times on 0:01:58.800 --> 0:02:02.080 the show. So there are are these busts that happened, 0:02:02.120 --> 0:02:04.320 and they're all these troubles, but it always seems like 0:02:04.400 --> 0:02:07.200 in the past that the government has been able to 0:02:07.320 --> 0:02:11.880 use its balance sheet to prevent some like wholesale collapse. Yeah, 0:02:11.919 --> 0:02:14.959 but now, of course we know that she and Ping 0:02:15.600 --> 0:02:18.760 is on a mission to pop a lot of bubbles 0:02:18.800 --> 0:02:22.040 in the Chinese economy to crack down on certain sectors 0:02:22.040 --> 0:02:25.560 that he thinks are not economic or efficient, and so 0:02:25.720 --> 0:02:28.240 maybe it's different this time, but maybe it isn't. So 0:02:28.520 --> 0:02:30.440 let's see, let's find out. I have to say, we 0:02:30.480 --> 0:02:33.520 really do have the perfect guest to discuss this. We 0:02:33.560 --> 0:02:35.560 are going to be speaking with Tom or Like. He's 0:02:35.600 --> 0:02:38.760 the chief economist at Bloomberg Economics. He is also the 0:02:38.840 --> 0:02:42.880 author of China The Bubble That Never Pops, so we 0:02:42.919 --> 0:02:44.680 get to ask him if it is going to pop 0:02:44.720 --> 0:02:47.200 this time. There is a second edition of the book 0:02:47.320 --> 0:02:50.280 coming out in September, so it really is a great 0:02:50.320 --> 0:02:52.800 time to catch up with him. Tom, thanks for coming 0:02:52.800 --> 0:02:55.040 back on all thoughts. Great to be here, Thanks for 0:02:55.080 --> 0:02:58.800 having me, Tracy J. So maybe just to set the scene, 0:02:59.000 --> 0:03:02.200 let's start with the big question, which is I think 0:03:02.280 --> 0:03:05.720 most people at this point know that China's economy is heavily, 0:03:05.800 --> 0:03:10.480 heavily reliant on real estate and properties. Something like of 0:03:10.560 --> 0:03:14.560 total GDP is accounted for it by real estate. How 0:03:14.600 --> 0:03:17.880 did that come to be? Why is China's economy so 0:03:18.240 --> 0:03:22.480 leverage to this one particular sector. That's a really good question, Tracy, 0:03:22.840 --> 0:03:25.680 And there's a bunch of factors at work. So the 0:03:25.720 --> 0:03:29.600 first thing to think about is the strength of fundamental demand. 0:03:29.880 --> 0:03:34.680 So remember that in the eighties and early nineties, China 0:03:34.760 --> 0:03:38.600 did not have a private property market. If you lived 0:03:38.600 --> 0:03:42.320 in a city, you almost certainly lived in a dilapidated 0:03:42.640 --> 0:03:47.600 government apartment or dingy house. And so when the private 0:03:47.640 --> 0:03:51.240 market sprang into life in the late nine there was 0:03:51.440 --> 0:03:55.960 enormous pent up demand for real estate. Adding to that, 0:03:56.600 --> 0:04:01.200 China's households have enjoyed decades of strongly rise incomes, and 0:04:01.240 --> 0:04:03.640 of course, when your income rises, one of the first 0:04:03.720 --> 0:04:06.760 things you want to do is buy somewhere nice to live. 0:04:07.680 --> 0:04:10.760 And China has had an urbanization boom, with hundreds of 0:04:10.800 --> 0:04:14.119 millions of people moving from the countryside to the cities. 0:04:14.480 --> 0:04:17.400 So the first reason why real estate has been so 0:04:17.480 --> 0:04:20.800 important in driving China's growth is just that there's been 0:04:21.000 --> 0:04:25.680 enormous demand for real estate. The second contributing factor is 0:04:25.720 --> 0:04:30.000 that speculators got in on the game. China's investors don't 0:04:30.040 --> 0:04:33.520 have brilliant options. There isn't much of a kind of 0:04:33.560 --> 0:04:36.960 retail financial market. There aren't a lot of money market 0:04:37.040 --> 0:04:39.800 funds and things like that you can park your cash in. 0:04:40.040 --> 0:04:42.520 If you put your money in a bank deposit, very 0:04:42.520 --> 0:04:45.480 often the interest rate is below the level of inflation, 0:04:45.600 --> 0:04:48.520 so you're essentially losing money if you put your money 0:04:48.560 --> 0:04:52.039 in the stock market. It's a roller coaster. So a 0:04:52.120 --> 0:04:55.359 lot of investment funds went into real estate, and that 0:04:55.480 --> 0:05:01.800 speculative demand added substantially to the fundamental demand. By some estimates, 0:05:01.960 --> 0:05:06.080 as much as of property in China is sold to 0:05:06.120 --> 0:05:10.159 speculators who hold it empty hoping for capital gains. So 0:05:10.240 --> 0:05:14.840 those factors together drove China's real estate boom and pushed 0:05:14.880 --> 0:05:18.880 its contribution to GDP. Taking account of all the construction activity, 0:05:19.320 --> 0:05:22.320 all of the impact on steel and punkrey and home 0:05:22.400 --> 0:05:24.960 electronics and furniture in a car to put in the 0:05:25.000 --> 0:05:30.400 garage up to that number which Tracy mentioned. So my understanding, 0:05:30.680 --> 0:05:33.120 and this is just that we've had, you know, we've 0:05:33.240 --> 0:05:36.400 we talked about ever grant a few times last year. 0:05:36.440 --> 0:05:39.520 But my understanding is that there's this broader problem of 0:05:40.200 --> 0:05:44.880 real estate developers essentially running into financial trouble, running into 0:05:44.920 --> 0:05:50.800 operational trouble, having a difficult time delivering on houses that 0:05:50.880 --> 0:05:54.480 it's sold, that that they pre sold essentially, and now 0:05:54.680 --> 0:05:57.159 the people who bought those mortgages saying, look, you haven't 0:05:57.160 --> 0:05:59.680 delivered the house that I bought. I'm not sure that 0:05:59.760 --> 0:06:01.679 time aiming of when you're going to deliver those times, 0:06:01.880 --> 0:06:04.039 so I'm not going to pay. Is that an accurate 0:06:04.320 --> 0:06:07.359 characterization of it? And how big is this movement that 0:06:07.440 --> 0:06:09.560 we're seeing where people are saying we're not paying our 0:06:09.600 --> 0:06:12.719 mortgage right now? Yeah, I think that's completely right, Joe. 0:06:12.839 --> 0:06:17.760 For the last few decades, given the very strong demand, 0:06:18.320 --> 0:06:22.400 given the continually rising prices in China's real estate sector, 0:06:23.160 --> 0:06:26.839 the best strategy for real estate developers was just to 0:06:26.920 --> 0:06:30.560 build as much as possible as quickly as possible. And 0:06:31.279 --> 0:06:34.960 in executing on that strategy, many of China's real estate 0:06:34.960 --> 0:06:40.080 developers engaged in some sharp practices. One of those sharp 0:06:40.120 --> 0:06:45.440 practices was selling homes off the plan, so not selling 0:06:45.440 --> 0:06:47.840 a home they'd already built, but selling a home they 0:06:47.839 --> 0:06:51.680 were promising to build, and then taking the funds from 0:06:51.680 --> 0:06:55.159 those pre sales and instead of using them to complete 0:06:55.160 --> 0:06:59.640 the project, using them to buy land to start another project. Now, 0:07:00.240 --> 0:07:02.840 as long as the demand was there, as long as 0:07:02.839 --> 0:07:05.240 they could sell that second project, and as long as 0:07:05.279 --> 0:07:07.520 they could get access to bank finance, as long as 0:07:07.520 --> 0:07:09.840 the banks were willing to loan the money to fill 0:07:09.840 --> 0:07:13.760 in any short term shortfalls. That strategy worked really well, 0:07:14.920 --> 0:07:18.280 but what's happened in the last two or three years 0:07:18.720 --> 0:07:21.320 is that the government has stepped in and said, no, 0:07:22.040 --> 0:07:25.480 this is not a sustainable trajectory for the real estate sector. 0:07:26.240 --> 0:07:30.480 We need real estate developers to get their finances in order, 0:07:30.960 --> 0:07:33.880 and we're going to cut off sources of finance for 0:07:33.960 --> 0:07:37.440 real estate developers that we think have engaged in too 0:07:37.440 --> 0:07:40.760 many sharp practices, that have borrowed too much money, that 0:07:40.800 --> 0:07:44.760 have too much leverage. At the same time, the fundamental 0:07:44.880 --> 0:07:48.800 demand story which has driven China's real estate boom has 0:07:48.880 --> 0:07:53.200 kind of come to an end. China's demographics have become 0:07:53.200 --> 0:07:55.679 a drag, and of course, when you have less people, 0:07:55.800 --> 0:08:01.160 you need less accommodation. China's urbanization story it's not quite over, 0:08:01.400 --> 0:08:04.800 but it's not delivering the same impetus that it was 0:08:04.920 --> 0:08:07.800 ten years certainly not the same impetus it was delivering 0:08:07.800 --> 0:08:10.680 twenty years ago. And what that means is the real 0:08:10.800 --> 0:08:14.000 estate developers who took money to build a project and 0:08:14.000 --> 0:08:17.400 then use that money to start another project, now I 0:08:17.440 --> 0:08:20.000 find they don't have enough funds to finish the houses 0:08:20.040 --> 0:08:23.840 they promised to finish. So this actually leads into a 0:08:23.960 --> 0:08:26.400 question I wanted to ask, So, we have the situation 0:08:26.440 --> 0:08:30.880 where something like se of all Chinese property sales are 0:08:30.960 --> 0:08:34.640 pre sales, so for units that are going to be constructed, 0:08:35.160 --> 0:08:39.920 and people have pinpointed that or pointed to that as 0:08:40.120 --> 0:08:42.839 a source of weakness for a while, and even the 0:08:42.920 --> 0:08:46.320 Chinese government, as you just mentioned, basically started cracking down 0:08:46.320 --> 0:08:49.440 on it and saying this is problematic. So how much 0:08:49.600 --> 0:08:53.559 of the current situation where you have this mortgage boycott, 0:08:53.920 --> 0:08:57.400 people refusing to pay um the money that they owe 0:08:57.440 --> 0:09:00.480 to developers for houses that are under construction, and you 0:09:00.559 --> 0:09:04.360 have house prices deteriorating, and you have property developers under pressure, 0:09:04.760 --> 0:09:09.720 how much of that is engineered by the Chinese authorities 0:09:09.760 --> 0:09:14.840 themselves as part of property sector reform versus things that 0:09:14.920 --> 0:09:18.079 are maybe a little bit more macro, maybe outside of 0:09:18.120 --> 0:09:22.120 their control, such as the impact of the pandemic or 0:09:22.160 --> 0:09:24.920 you know, interest rates and things like that. So it's 0:09:24.920 --> 0:09:27.520 a complicated picture, Tracy, and I think you have to 0:09:27.520 --> 0:09:31.160 give China's government some of the blame for allowing the 0:09:31.240 --> 0:09:34.600 situation to get to the point which it has, also 0:09:34.679 --> 0:09:38.600 some of the credit for attempting to move ahead of 0:09:38.640 --> 0:09:41.920 a crisis, right to try and tamp down the problem 0:09:42.080 --> 0:09:44.680 before it really blows up. And of course, like all 0:09:44.720 --> 0:09:47.559 governments in the world, they've been the victims of bad luck. 0:09:47.960 --> 0:09:52.520 The COVID pandemic hasn't made anything easier. It certainly hasn't 0:09:52.559 --> 0:09:55.480 made dealing with a real estate crisis and easier. So 0:09:55.720 --> 0:09:58.040 it's not easy to put a sort of size and 0:09:58.120 --> 0:10:02.320 scope on this problem. Hin as government has clearly decided 0:10:02.360 --> 0:10:06.840 that the mortgage boycott is a sort of extremely sensitive issue, 0:10:07.160 --> 0:10:10.160 and so they're actually making it rather hard to get 0:10:10.160 --> 0:10:15.000 a handle on it. There aren't good numbers from private 0:10:15.040 --> 0:10:18.800 real estate information companies, for example, who would be positioned 0:10:19.000 --> 0:10:21.800 to tell us exactly how many delayed projects there are. 0:10:21.880 --> 0:10:24.200 But we've got a super smart team on the ground 0:10:24.440 --> 0:10:27.400 and they've done some fancy footwork with the data that 0:10:27.559 --> 0:10:31.080 is available to try and put a magnitude on the 0:10:31.120 --> 0:10:34.120 size of the problem. So the starting point of their 0:10:34.120 --> 0:10:38.200 calculations is the fact that on average, it takes about 0:10:38.280 --> 0:10:42.760 three years to finish a property project. And if we 0:10:42.800 --> 0:10:46.480 look at the historical data in general, if you have 0:10:47.000 --> 0:10:51.880 a hundred projects started in year one, then in year four, 0:10:52.320 --> 0:10:56.079 three years later, eighty of those projects will be completed. 0:10:56.520 --> 0:11:00.560 So three years in there's an eight completion rate. But 0:11:00.600 --> 0:11:03.479 when we look at the data for twenty one and two, 0:11:04.000 --> 0:11:06.880 what we see is that completion rate has dropped all 0:11:06.880 --> 0:11:10.800 the way down to And because we know how much 0:11:10.840 --> 0:11:13.280 it costs to build a house, and because we know 0:11:13.880 --> 0:11:17.360 on average how much of house purchases are paid for 0:11:17.679 --> 0:11:22.360 with mortgages, we can then use that drop from a 0:11:22.440 --> 0:11:26.640 completion rate to a completion rate to calculate the magnitude 0:11:26.679 --> 0:11:30.160 of the problem. And what that calculation tells us is 0:11:30.200 --> 0:11:34.200 that the value of mortgages attached to unfinished properties right 0:11:34.240 --> 0:11:38.480 now is around one point six trillion un That's about 0:11:38.480 --> 0:11:42.800 one point four percent of China's GDP. Now that's already 0:11:42.840 --> 0:11:45.520 really big, certainly big enough to make this a systemic 0:11:45.559 --> 0:11:49.480 issue for China's economy and financial system. If the problem 0:11:49.520 --> 0:11:54.400 is left unaddressed and that fifty completion ratio holds until 0:11:54.760 --> 0:11:57.760 the end of the size of the problem is going 0:11:57.800 --> 0:12:00.480 to go up to four point four trillion UM, which 0:12:00.480 --> 0:12:04.000 will be close to four percent of China's GDP. Wow, 0:12:04.880 --> 0:12:08.160 why is the completion rate followed? How much is the 0:12:08.320 --> 0:12:11.800 change in finances? And how much you know, I don't 0:12:11.800 --> 0:12:16.400 know our Chinese developers are they also facing supply chain 0:12:16.880 --> 0:12:20.679 and commodity constraints like basically everywhere else in the world. 0:12:21.520 --> 0:12:25.320 So I think it is a substantially a financing issue 0:12:25.480 --> 0:12:31.120 for China's developers. In China's government introduced something they called 0:12:31.160 --> 0:12:36.000 the three Red Lines policy, essentially a set of constraints 0:12:36.040 --> 0:12:40.120 on access to credit for China's property developers. One of 0:12:40.120 --> 0:12:42.760 the red lines, for example, was if you don't have 0:12:42.880 --> 0:12:45.960 enough cash or liquid assets to cover all of your 0:12:45.960 --> 0:12:49.640 short term debts, you're not allowed to borrow any more money, 0:12:49.880 --> 0:12:54.079 and that clampdown on access to finance for developers. It 0:12:54.240 --> 0:12:57.359 kind of made it really hard for them to continue 0:12:57.360 --> 0:13:01.840 with that game where they sold projects on plan and 0:13:01.880 --> 0:13:04.760 then use the funds to start another project. But that 0:13:04.840 --> 0:13:06.480 was okay because they could always go to the bank 0:13:06.559 --> 0:13:09.520 to borrow any extra funds they needed to make sure 0:13:09.600 --> 0:13:12.840 everything was completed. So I think access to finance has 0:13:12.880 --> 0:13:15.200 been a really big part of it. But of course 0:13:15.200 --> 0:13:19.200 there are other factors coming into players well. COVID zero 0:13:19.640 --> 0:13:23.080 China's insistence on keeping the sort of COVID rate right 0:13:23.120 --> 0:13:26.840 down in the sort of low single digits obviously means 0:13:26.920 --> 0:13:29.720 that at different points in different parts of the country 0:13:29.960 --> 0:13:32.320 it's just hard to get things done because you can't 0:13:32.400 --> 0:13:36.199 leave your apartment just really quickly. Though, So if it's 0:13:36.360 --> 0:13:40.520 largely a finance problem, what are the drawbacks of yet 0:13:40.559 --> 0:13:45.120 another sort of government intervention telling that having the bank's 0:13:45.160 --> 0:13:47.040 helping the taps to say, here's the money, get to 0:13:47.160 --> 0:13:50.680 get the apartments built. So I think there's a couple 0:13:50.720 --> 0:13:53.240 of things going on, Joe. So the first is a 0:13:53.320 --> 0:13:57.320 kind of a recognition that the fundamental demand story in 0:13:57.440 --> 0:14:02.480 China's real estate sector has changed the demographics. The end 0:14:02.520 --> 0:14:06.120 of the urbanization boom mean, we're just not going to 0:14:06.240 --> 0:14:10.000 go back to the years of rapid growth in real 0:14:10.120 --> 0:14:14.440 estate construction contributing to rapid growth in China's GDP. So 0:14:14.480 --> 0:14:18.040 that's the first reason China's central government are reluctant to 0:14:18.080 --> 0:14:21.720 turn the financial taps back on. The second reason is that, 0:14:22.560 --> 0:14:26.040 in part, the real estate boom has been underpinned by 0:14:26.160 --> 0:14:31.320 moral hazard, the belief by real estate developers and investors 0:14:31.360 --> 0:14:34.040 in real estate that they can take any risk they 0:14:34.120 --> 0:14:36.960 like and if it pays off, they're going to make 0:14:36.960 --> 0:14:40.440 massive profits. And if it doesn't pay off, don't worry. 0:14:40.680 --> 0:14:43.240 The government's going to be in there to backstop our 0:14:43.320 --> 0:14:47.800 borrowing and make sure we stay solvent. So China's government 0:14:47.880 --> 0:14:51.440 is very keen to address that problem of moral hazard. 0:14:52.120 --> 0:14:55.800 That's why they allowed ever Grand to go into default. 0:14:56.120 --> 0:14:59.640 That's why they've allowed another quite large set of property 0:14:59.680 --> 0:15:04.240 developed us to go into default. That said, China's government 0:15:04.400 --> 0:15:08.920 are not crazy. I remember reading Timothy Gaitner's book on 0:15:09.120 --> 0:15:13.240 his experience in the financial crisis, and he says people 0:15:13.320 --> 0:15:18.160 who worry about moral hazard in a financial crisis are 0:15:18.200 --> 0:15:21.600 like people who would allow a house to burn to 0:15:21.680 --> 0:15:25.080 the ground without calling the fire brigade. To teach people 0:15:25.440 --> 0:15:28.280 about the importance of not playing with matches, and I 0:15:28.280 --> 0:15:30.920 think China's government very much sort of hold to that 0:15:31.000 --> 0:15:34.600 general philosophy. They don't see this as a one round game. 0:15:35.080 --> 0:15:38.400 They see it as a multi round game. They've imposed 0:15:38.400 --> 0:15:41.640 a bunch of pain on China's property developers and China's 0:15:41.640 --> 0:15:45.560 property investors by allowing the defaults which have taken place 0:15:45.640 --> 0:15:48.400 so far. I don't think they're going to pursue their 0:15:48.440 --> 0:15:51.920 campaign against moral hazards so far that they tipped the 0:15:52.080 --> 0:15:57.080 entire Chinese economy and financial system into crisis. So just 0:15:57.200 --> 0:16:00.680 on this topic, I mean, we have seen China announce 0:16:01.120 --> 0:16:04.160 quite a few stimulus measures just in the past week, 0:16:04.200 --> 0:16:06.560 and I should mention we are recording this on August, 0:16:07.640 --> 0:16:10.960 and I think it was August or something like that. 0:16:11.000 --> 0:16:15.480 They announced I think nineteen new measures to stimulate the 0:16:15.480 --> 0:16:18.600 economy that are worth more than one trillion u N, 0:16:18.880 --> 0:16:22.600 which is about a hundred fifty billion dollars. And one 0:16:22.600 --> 0:16:26.800 of the things that's in there is allowing local governments 0:16:27.200 --> 0:16:31.800 to raise more money, issue more special bonds, raise more money, 0:16:31.920 --> 0:16:36.040 and allowing them some more leeway to potentially allocate that 0:16:36.080 --> 0:16:40.280 to housing to try to figure out this pre sale problem. 0:16:40.320 --> 0:16:44.440 So how effective will that measure be? And to the 0:16:44.520 --> 0:16:49.120 point of this tension between stimulating the economy and reinflating 0:16:49.640 --> 0:16:52.960 a bubble, is there a possibility that local governments just 0:16:53.000 --> 0:16:56.440 start unleashing a torrent of credit that makes the problem 0:16:56.480 --> 0:16:59.600 worth Maybe one way of thinking about this is thinking 0:16:59.600 --> 0:17:05.320 about two extremes, right, So one extreme is do nothing, 0:17:06.560 --> 0:17:11.760 allow the mortgage boycotts to continue increasing, allow more and 0:17:11.800 --> 0:17:16.439 more real estate developers to go into bankruptcy, allow that 0:17:16.560 --> 0:17:20.080 to spill over into a massive increase in non performing 0:17:20.119 --> 0:17:24.160 loans in the banks, and allow that ultimately to sort 0:17:24.200 --> 0:17:29.520 of metasta size into a Chinese version of the US 0:17:29.560 --> 0:17:34.240 subprime crisis and Great Recession, right, So that's one extreme. 0:17:35.200 --> 0:17:38.040 At the other extreme, you've got something which looks like 0:17:38.119 --> 0:17:41.560 China's response to the Great Financial Crisis, the global financial 0:17:41.600 --> 0:17:44.480 crisis in two thousand and eight, where they opened the 0:17:44.560 --> 0:17:48.920 credit taps and delivered that massive stimulus which got the 0:17:49.000 --> 0:17:52.719 Chinese economy going again and got the global economy going again, 0:17:53.280 --> 0:17:56.560 but put them on this unsustainable trajectory where they had 0:17:56.600 --> 0:17:59.400 to keep on borrowing more and more money to pay 0:17:59.440 --> 0:18:03.600 for more more over capacity in real estate, over capacity 0:18:03.680 --> 0:18:08.120 in industry. So neither of those extremes are particularly attractive. 0:18:08.920 --> 0:18:12.439 What's China trying to do right now? They're attempting to 0:18:12.560 --> 0:18:15.760 have find a kind of a middle path between the two. 0:18:16.080 --> 0:18:19.280 And that's why we're having this sort of drip drip 0:18:19.359 --> 0:18:24.240 of what I would call sort of relatively small stimulus 0:18:24.240 --> 0:18:29.720 announcements PBC cutting interest rates a little bit, local governments 0:18:29.760 --> 0:18:32.760 being able to issue a few more bonds to pay 0:18:32.800 --> 0:18:36.040 for infrastructure, and perhaps provide a little bit of support 0:18:36.280 --> 0:18:38.760 to the real estate sector. It's not what the market 0:18:38.840 --> 0:18:41.080 wants to hear. They want to hear that kind of 0:18:41.119 --> 0:18:44.640 shock and or stimulus announcement like they heard from Wen 0:18:44.720 --> 0:18:47.120 Jiaobao at the end of two thousand and eight. They're 0:18:47.160 --> 0:18:50.480 not going to get that shock and or stimulus announcement. 0:18:50.960 --> 0:18:55.600 China doesn't want to restart another unsustainable boom, but neither 0:18:55.840 --> 0:18:58.679 is the kind of nightmare scenario of a do nothing 0:18:58.880 --> 0:19:02.200 Chinese government which allows the real estate sector to melt 0:19:02.200 --> 0:19:05.880 down going to play out. You mentioned the banks. What 0:19:06.000 --> 0:19:10.680 position are the banks in to recognize these types of losses? 0:19:10.800 --> 0:19:13.040 And one of the things that I occasionally hear from 0:19:13.040 --> 0:19:15.359 people in China is that, oh, it's not such a 0:19:15.359 --> 0:19:17.760 big deal because a lot of the pre sales lending 0:19:17.840 --> 0:19:19.960 was done by regional banks, or a lot of the 0:19:20.000 --> 0:19:22.679 property lending, I should say, was done by regional banks, 0:19:22.960 --> 0:19:26.480 which no one ever really regarded as safe anyway, So 0:19:26.560 --> 0:19:29.320 it's not that much of an issue. So this is 0:19:29.560 --> 0:19:32.400 this is potentially a big problem for China's banks. If 0:19:32.400 --> 0:19:36.639 we think about the history of financial crises, real estate 0:19:36.880 --> 0:19:39.879 often plays a very significant role. It was real estate 0:19:40.080 --> 0:19:45.720 which kicked off the meltdown in Japan's economy, which ended 0:19:45.800 --> 0:19:50.119 Japan's development miracle and pushed them into that lost decade 0:19:50.160 --> 0:19:54.399 of low growth and falling prices. Of course, it was 0:19:54.400 --> 0:19:58.080 the subprime crisis here in the United States, which kicked 0:19:58.080 --> 0:20:02.320 off the Great Recession, and real estate also played a 0:20:02.320 --> 0:20:06.120 big role in the Asian financial crisis back in so 0:20:06.520 --> 0:20:09.719 problems in real estate do have a track record of 0:20:10.040 --> 0:20:14.000 spilling over into the financial system, and China's financial system 0:20:14.160 --> 0:20:17.400 is heavily exposed to real estate. There are a lot 0:20:17.480 --> 0:20:21.280 of loans to households to buy homes. There are a 0:20:21.280 --> 0:20:24.280 lot of loans to property developers, and a lot of 0:20:24.320 --> 0:20:27.240 loans which are not directly to the property sector are 0:20:27.320 --> 0:20:32.919 collateralized by property or land, which means a drop in 0:20:32.960 --> 0:20:37.160 property prices or land prices would affect those loans as well. 0:20:38.080 --> 0:20:41.080 So there's a substantial risk there. How should we think 0:20:41.080 --> 0:20:43.440 about how that risk is going to impact I think 0:20:43.440 --> 0:20:48.199 it's useful to think about two different types of Chinese banks. 0:20:48.720 --> 0:20:51.040 At the top of the kind of chain, you've got 0:20:51.080 --> 0:20:54.080 the big state owned banks, the I C, B c 0:20:54.359 --> 0:20:58.399 s and C cbs and A B c's of the world. 0:20:58.760 --> 0:21:04.119 They are extremely well funded and they have a huge 0:21:04.160 --> 0:21:09.679 capital buffer. They are also diversified around the country, which 0:21:09.720 --> 0:21:13.080 means that problems in a particular city or a particular 0:21:13.160 --> 0:21:16.080 province aren't going to be good news. For them, but 0:21:16.160 --> 0:21:19.280 they're not going to affect their entire loan book. I 0:21:19.320 --> 0:21:21.640 don't think we're going to see problems for China's big 0:21:21.680 --> 0:21:24.720 state owned banks. At the other end of the spectrum, 0:21:24.760 --> 0:21:29.440 you've got small city banks. Now, small city banks tends 0:21:29.480 --> 0:21:33.640 to have a much less stable funding base, they tend 0:21:33.640 --> 0:21:36.639 to have a smaller capital buffer, and they tend to 0:21:36.680 --> 0:21:42.280 be heavily exposed to lending in their own city. And 0:21:42.320 --> 0:21:45.800 that means it's pretty easy to imagine a scenario where 0:21:45.800 --> 0:21:48.879 you've got a city with a bunch of stalled property projects, 0:21:48.880 --> 0:21:51.919 with a bunch of mortgage boycotts going on, with a 0:21:51.920 --> 0:21:54.600 city bank that doesn't have good funding, that doesn't have 0:21:54.640 --> 0:21:57.760 a strong capital buffer, and which runs into problems. We're 0:21:57.800 --> 0:22:01.560 not quite there yet, but I wouldn't be surprised if 0:22:01.600 --> 0:22:04.639 in the next one to three years we saw a 0:22:04.680 --> 0:22:07.880 bunch of small city banks that needed a capital injection 0:22:24.800 --> 0:22:28.080 on a pivot off of real estate a little bit 0:22:28.240 --> 0:22:30.920 and talk about you know, the story of the world 0:22:31.200 --> 0:22:35.679 right now is clearly commodity scarcity, and most of the 0:22:35.720 --> 0:22:40.199 attention is focused on Europe and this soaring price of 0:22:40.240 --> 0:22:43.080 power there, but it's really it's not just a Europe story. 0:22:43.160 --> 0:22:45.960 A lot of developed markets everyday their story is about 0:22:46.040 --> 0:22:50.680 some sort of rationing or export curbs or rolling blackouts 0:22:50.840 --> 0:22:53.800 or surging price of price of food. I feel like, 0:22:54.160 --> 0:22:56.520 you know, just sort of big picture, what is China's 0:22:56.560 --> 0:23:00.840 commodity position? How much is that story affecting the Chinese 0:23:00.840 --> 0:23:03.600 economy right now? Or to what degree is the is 0:23:03.680 --> 0:23:06.200 China insulated from it? You know, Joe I would almost 0:23:06.200 --> 0:23:09.840 flip that question around and think about how what's happening 0:23:09.880 --> 0:23:13.560 in China right now is impacting the global commodity story. 0:23:13.760 --> 0:23:17.879 So let's imagine that China was running a repeat of 0:23:17.920 --> 0:23:21.720 its two thousand and eight massive stimulus play and getting 0:23:21.720 --> 0:23:25.359 the economy back growing at six percent a year now. 0:23:25.640 --> 0:23:29.399 If that happened, it would drive enormoust demand for energy, 0:23:29.520 --> 0:23:34.000 in almost demand for metals, in almost demand for agricultural commodities, 0:23:34.359 --> 0:23:37.080 and the biggest problem for the rest of the world 0:23:37.200 --> 0:23:41.320 right now, high inflation driven in part by high commodity prices, 0:23:41.600 --> 0:23:43.919 would be a lot worse. China is not running a 0:23:43.920 --> 0:23:46.840 repeat of its two thousand and eight stimulus play. That 0:23:46.920 --> 0:23:50.439 means growth is very weak. Second quarter we had actually 0:23:50.440 --> 0:23:54.240 a contraction in GDP. Most people think the rebound in 0:23:54.280 --> 0:23:56.239 the second half of the year is going to be 0:23:56.320 --> 0:23:59.280 tepid at best. And what that means is China's commodity 0:23:59.320 --> 0:24:02.880 demand just isn't where the markets expected it to be 0:24:03.040 --> 0:24:06.480 a few months ago. That's one of the factors weighing 0:24:06.560 --> 0:24:11.960 on energy prices, metals prices, agricultural commodity prices. So that's 0:24:11.960 --> 0:24:14.000 actually making the biggest problem for the rest of the 0:24:14.040 --> 0:24:16.840 world right now, the inflation problem a little bit easier 0:24:16.880 --> 0:24:20.520 to grapple with, Tracy, you know, to timas point, something 0:24:20.520 --> 0:24:22.640 I've been thinking about is, you know, all these US 0:24:22.760 --> 0:24:27.000 retailers talk about how much excess inventory they have right now, 0:24:27.480 --> 0:24:30.040 and in a way, you know, these hard lockdowns then 0:24:30.080 --> 0:24:32.639 we saw in China, it's almost like kind of comes 0:24:32.880 --> 0:24:36.320 almost at a fortuitous time in the sense that this 0:24:36.440 --> 0:24:39.159 is not a time where you know, retailers want to 0:24:39.200 --> 0:24:41.240 have a lot of like inventory or stuff coming in 0:24:41.280 --> 0:24:43.720 from China. Well, this was actually going to be my 0:24:43.760 --> 0:24:48.160