Speaker 1: Hello, and welcome to another episode of the Odd Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe Wise. Joe, what is
Speaker 1: going on in China right now? That is a good question,
Speaker 1: and it's it's a question we actually haven't been talking
Speaker 1: about enough. Lots of focus on energy, lots of focus
Speaker 1: on Europe, Mac Road, the FED recession. But my understanding
Speaker 1: is that things aren't great in China either. I feel
Speaker 1: like in a normal year where everyone wasn't distracted by
Speaker 1: domestic US inflation and the question of whether or not
Speaker 1: interest rate hikes are going to spark a recession, I
Speaker 1: feel like China would be taking center stage with everything
Speaker 1: that's going on. But it feels like it's sort of
Speaker 1: been tangential. Like you hear a little bit about what's
Speaker 1: going on, but people like aren't really focused on it. Well,
Speaker 1: I would see it feels contained in a way, you know.
Speaker 1: So obviously, one of the big stories is the country's
Speaker 1: ongoing commitment to COVID zero, which obviously has a negative
Speaker 1: impact just on sort of economic activity sort of measured broadly.
Speaker 1: But then there are other things happening. The real estate
Speaker 1: sector seems very troubled, with more and more people basically
Speaker 1: refusing to pay mortgages on houses that have yet to
Speaker 1: be completed. You know, that's a big story. There's a
Speaker 1: big drought happening, a really intense heat waves, so they're
Speaker 1: having their own weather climate stress. But yeah, I still
Speaker 1: don't totally get how it all fits together, right. I
Speaker 1: feel like people have been warning of a Chinese property
Speaker 1: bust for so long and it hasn't happened that we've
Speaker 1: all sort of become a nerd to the idea that
Speaker 1: it could actually happen. And maybe we're seeing the beginnings
Speaker 1: of it, but again, maybe we're not. Because China is
Speaker 1: very good at coming in and rescuing particular sectors when
Speaker 1: it needs to. That's the key thing. And of course
Speaker 1: we've talked about, say ever Grant a few times on
Speaker 1: the show. So there are are these busts that happened,
Speaker 1: and they're all these troubles, but it always seems like
Speaker 1: in the past that the government has been able to
Speaker 1: use its balance sheet to prevent some like wholesale collapse. Yeah,
Speaker 1: but now, of course we know that she and Ping
Speaker 1: is on a mission to pop a lot of bubbles
Speaker 1: in the Chinese economy to crack down on certain sectors
Speaker 1: that he thinks are not economic or efficient, and so
Speaker 1: maybe it's different this time, but maybe it isn't. So
Speaker 1: let's see, let's find out. I have to say, we
Speaker 1: really do have the perfect guest to discuss this. We
Speaker 1: are going to be speaking with Tom or Like. He's
Speaker 1: the chief economist at Bloomberg Economics. He is also the
Speaker 1: author of China The Bubble That Never Pops, so we
Speaker 1: get to ask him if it is going to pop
Speaker 1: this time. There is a second edition of the book
Speaker 1: coming out in September, so it really is a great
Speaker 1: time to catch up with him. Tom, thanks for coming
Speaker 1: back on all thoughts. Great to be here, Thanks for
Speaker 1: having me, Tracy J. So maybe just to set the scene,
Speaker 1: let's start with the big question, which is I think
Speaker 1: most people at this point know that China's economy is heavily,
Speaker 1: heavily reliant on real estate and properties. Something like of
Speaker 1: total GDP is accounted for it by real estate. How
Speaker 1: did that come to be? Why is China's economy so
Speaker 1: leverage to this one particular sector. That's a really good question, Tracy,
Speaker 1: And there's a bunch of factors at work. So the
Speaker 1: first thing to think about is the strength of fundamental demand.
Speaker 1: So remember that in the eighties and early nineties, China
Speaker 1: did not have a private property market. If you lived
Speaker 1: in a city, you almost certainly lived in a dilapidated
Speaker 1: government apartment or dingy house. And so when the private
Speaker 1: market sprang into life in the late nine there was
Speaker 1: enormous pent up demand for real estate. Adding to that,
Speaker 1: China's households have enjoyed decades of strongly rise incomes, and
Speaker 1: of course, when your income rises, one of the first
Speaker 1: things you want to do is buy somewhere nice to live.
Speaker 1: And China has had an urbanization boom, with hundreds of
Speaker 1: millions of people moving from the countryside to the cities.
Speaker 1: So the first reason why real estate has been so
Speaker 1: important in driving China's growth is just that there's been
Speaker 1: enormous demand for real estate. The second contributing factor is
Speaker 1: that speculators got in on the game. China's investors don't
Speaker 1: have brilliant options. There isn't much of a kind of
Speaker 1: retail financial market. There aren't a lot of money market
Speaker 1: funds and things like that you can park your cash in.
Speaker 1: If you put your money in a bank deposit, very
Speaker 1: often the interest rate is below the level of inflation,
Speaker 1: so you're essentially losing money if you put your money
Speaker 1: in the stock market. It's a roller coaster. So a
Speaker 1: lot of investment funds went into real estate, and that
Speaker 1: speculative demand added substantially to the fundamental demand. By some estimates,
Speaker 1: as much as of property in China is sold to
Speaker 1: speculators who hold it empty hoping for capital gains. So
Speaker 1: those factors together drove China's real estate boom and pushed
Speaker 1: its contribution to GDP. Taking account of all the construction activity,
Speaker 1: all of the impact on steel and punkrey and home
Speaker 1: electronics and furniture in a car to put in the
Speaker 1: garage up to that number which Tracy mentioned. So my understanding,
Speaker 1: and this is just that we've had, you know, we've
Speaker 1: we talked about ever grant a few times last year.
Speaker 1: But my understanding is that there's this broader problem of
Speaker 1: real estate developers essentially running into financial trouble, running into
Speaker 1: operational trouble, having a difficult time delivering on houses that
Speaker 1: it's sold, that that they pre sold essentially, and now
Speaker 1: the people who bought those mortgages saying, look, you haven't
Speaker 1: delivered the house that I bought. I'm not sure that
Speaker 1: time aiming of when you're going to deliver those times,
Speaker 1: so I'm not going to pay. Is that an accurate
Speaker 1: characterization of it? And how big is this movement that
Speaker 1: we're seeing where people are saying we're not paying our
Speaker 1: mortgage right now? Yeah, I think that's completely right, Joe.
Speaker 1: For the last few decades, given the very strong demand,
Speaker 1: given the continually rising prices in China's real estate sector,
Speaker 1: the best strategy for real estate developers was just to
Speaker 1: build as much as possible as quickly as possible. And
Speaker 1: in executing on that strategy, many of China's real estate
Speaker 1: developers engaged in some sharp practices. One of those sharp
Speaker 1: practices was selling homes off the plan, so not selling
Speaker 1: a home they'd already built, but selling a home they
Speaker 1: were promising to build, and then taking the funds from
Speaker 1: those pre sales and instead of using them to complete
Speaker 1: the project, using them to buy land to start another project. Now,
Speaker 1: as long as the demand was there, as long as
Speaker 1: they could sell that second project, and as long as
Speaker 1: they could get access to bank finance, as long as
Speaker 1: the banks were willing to loan the money to fill
Speaker 1: in any short term shortfalls. That strategy worked really well,
Speaker 1: but what's happened in the last two or three years
Speaker 1: is that the government has stepped in and said, no,
Speaker 1: this is not a sustainable trajectory for the real estate sector.
Speaker 1: We need real estate developers to get their finances in order,
Speaker 1: and we're going to cut off sources of finance for
Speaker 1: real estate developers that we think have engaged in too
Speaker 1: many sharp practices, that have borrowed too much money, that
Speaker 1: have too much leverage. At the same time, the fundamental
Speaker 1: demand story which has driven China's real estate boom has
Speaker 1: kind of come to an end. China's demographics have become
Speaker 1: a drag, and of course, when you have less people,
Speaker 1: you need less accommodation. China's urbanization story it's not quite over,
Speaker 1: but it's not delivering the same impetus that it was
Speaker 1: ten years certainly not the same impetus it was delivering
Speaker 1: twenty years ago. And what that means is the real
Speaker 1: estate developers who took money to build a project and
Speaker 1: then use that money to start another project, now I
Speaker 1: find they don't have enough funds to finish the houses
Speaker 1: they promised to finish. So this actually leads into a
Speaker 1: question I wanted to ask, So, we have the situation
Speaker 1: where something like se of all Chinese property sales are
Speaker 1: pre sales, so for units that are going to be constructed,
Speaker 1: and people have pinpointed that or pointed to that as
Speaker 1: a source of weakness for a while, and even the
Speaker 1: Chinese government, as you just mentioned, basically started cracking down
Speaker 1: on it and saying this is problematic. So how much
Speaker 1: of the current situation where you have this mortgage boycott,
Speaker 1: people refusing to pay um the money that they owe
Speaker 1: to developers for houses that are under construction, and you
Speaker 1: have house prices deteriorating, and you have property developers under pressure,
Speaker 1: how much of that is engineered by the Chinese authorities
Speaker 1: themselves as part of property sector reform versus things that
Speaker 1: are maybe a little bit more macro, maybe outside of
Speaker 1: their control, such as the impact of the pandemic or
Speaker 1: you know, interest rates and things like that. So it's
Speaker 1: a complicated picture, Tracy, and I think you have to
Speaker 1: give China's government some of the blame for allowing the
Speaker 1: situation to get to the point which it has, also
Speaker 1: some of the credit for attempting to move ahead of
Speaker 1: a crisis, right to try and tamp down the problem
Speaker 1: before it really blows up. And of course, like all
Speaker 1: governments in the world, they've been the victims of bad luck.
Speaker 1: The COVID pandemic hasn't made anything easier. It certainly hasn't
Speaker 1: made dealing with a real estate crisis and easier. So
Speaker 1: it's not easy to put a sort of size and
Speaker 1: scope on this problem. Hin as government has clearly decided
Speaker 1: that the mortgage boycott is a sort of extremely sensitive issue,
Speaker 1: and so they're actually making it rather hard to get
Speaker 1: a handle on it. There aren't good numbers from private
Speaker 1: real estate information companies, for example, who would be positioned
Speaker 1: to tell us exactly how many delayed projects there are.
Speaker 1: But we've got a super smart team on the ground
Speaker 1: and they've done some fancy footwork with the data that
Speaker 1: is available to try and put a magnitude on the
Speaker 1: size of the problem. So the starting point of their
Speaker 1: calculations is the fact that on average, it takes about
Speaker 1: three years to finish a property project. And if we
Speaker 1: look at the historical data in general, if you have
Speaker 1: a hundred projects started in year one, then in year four,
Speaker 1: three years later, eighty of those projects will be completed.
Speaker 1: So three years in there's an eight completion rate. But
Speaker 1: when we look at the data for twenty one and two,
Speaker 1: what we see is that completion rate has dropped all
Speaker 1: the way down to And because we know how much
Speaker 1: it costs to build a house, and because we know
Speaker 1: on average how much of house purchases are paid for
Speaker 1: with mortgages, we can then use that drop from a
Speaker 1: completion rate to a completion rate to calculate the magnitude
Speaker 1: of the problem. And what that calculation tells us is
Speaker 1: that the value of mortgages attached to unfinished properties right
Speaker 1: now is around one point six trillion un That's about
Speaker 1: one point four percent of China's GDP. Now that's already
Speaker 1: really big, certainly big enough to make this a systemic
Speaker 1: issue for China's economy and financial system. If the problem
Speaker 1: is left unaddressed and that fifty completion ratio holds until
Speaker 1: the end of the size of the problem is going
Speaker 1: to go up to four point four trillion UM, which
Speaker 1: will be close to four percent of China's GDP. Wow,
Speaker 1: why is the completion rate followed? How much is the
Speaker 1: change in finances? And how much you know, I don't
Speaker 1: know our Chinese developers are they also facing supply chain
Speaker 1: and commodity constraints like basically everywhere else in the world.
Speaker 1: So I think it is a substantially a financing issue
Speaker 1: for China's developers. In China's government introduced something they called
Speaker 1: the three Red Lines policy, essentially a set of constraints
Speaker 1: on access to credit for China's property developers. One of
Speaker 1: the red lines, for example, was if you don't have
Speaker 1: enough cash or liquid assets to cover all of your
Speaker 1: short term debts, you're not allowed to borrow any more money,
Speaker 1: and that clampdown on access to finance for developers. It
Speaker 1: kind of made it really hard for them to continue
Speaker 1: with that game where they sold projects on plan and
Speaker 1: then use the funds to start another project. But that
Speaker 1: was okay because they could always go to the bank
Speaker 1: to borrow any extra funds they needed to make sure
Speaker 1: everything was completed. So I think access to finance has
Speaker 1: been a really big part of it. But of course
Speaker 1: there are other factors coming into players well. COVID zero
Speaker 1: China's insistence on keeping the sort of COVID rate right
Speaker 1: down in the sort of low single digits obviously means
Speaker 1: that at different points in different parts of the country
Speaker 1: it's just hard to get things done because you can't
Speaker 1: leave your apartment just really quickly. Though, So if it's
Speaker 1: largely a finance problem, what are the drawbacks of yet
Speaker 1: another sort of government intervention telling that having the bank's
Speaker 1: helping the taps to say, here's the money, get to
Speaker 1: get the apartments built. So I think there's a couple
Speaker 1: of things going on, Joe. So the first is a
Speaker 1: kind of a recognition that the fundamental demand story in
Speaker 1: China's real estate sector has changed the demographics. The end
Speaker 1: of the urbanization boom mean, we're just not going to
Speaker 1: go back to the years of rapid growth in real
Speaker 1: estate construction contributing to rapid growth in China's GDP. So
Speaker 1: that's the first reason China's central government are reluctant to
Speaker 1: turn the financial taps back on. The second reason is that,
Speaker 1: in part, the real estate boom has been underpinned by
Speaker 1: moral hazard, the belief by real estate developers and investors
Speaker 1: in real estate that they can take any risk they
Speaker 1: like and if it pays off, they're going to make
Speaker 1: massive profits. And if it doesn't pay off, don't worry.
Speaker 1: The government's going to be in there to backstop our
Speaker 1: borrowing and make sure we stay solvent. So China's government
Speaker 1: is very keen to address that problem of moral hazard.
Speaker 1: That's why they allowed ever Grand to go into default.
Speaker 1: That's why they've allowed another quite large set of property
Speaker 1: developed us to go into default. That said, China's government
Speaker 1: are not crazy. I remember reading Timothy Gaitner's book on
Speaker 1: his experience in the financial crisis, and he says people
Speaker 1: who worry about moral hazard in a financial crisis are
Speaker 1: like people who would allow a house to burn to
Speaker 1: the ground without calling the fire brigade. To teach people
Speaker 1: about the importance of not playing with matches, and I
Speaker 1: think China's government very much sort of hold to that
Speaker 1: general philosophy. They don't see this as a one round game.
Speaker 1: They see it as a multi round game. They've imposed
Speaker 1: a bunch of pain on China's property developers and China's
Speaker 1: property investors by allowing the defaults which have taken place
Speaker 1: so far. I don't think they're going to pursue their
Speaker 1: campaign against moral hazards so far that they tipped the
Speaker 1: entire Chinese economy and financial system into crisis. So just
Speaker 1: on this topic, I mean, we have seen China announce
Speaker 1: quite a few stimulus measures just in the past week,
Speaker 1: and I should mention we are recording this on August,
Speaker 1: and I think it was August or something like that.
Speaker 1: They announced I think nineteen new measures to stimulate the
Speaker 1: economy that are worth more than one trillion u N,
Speaker 1: which is about a hundred fifty billion dollars. And one
Speaker 1: of the things that's in there is allowing local governments
Speaker 1: to raise more money, issue more special bonds, raise more money,
Speaker 1: and allowing them some more leeway to potentially allocate that
Speaker 1: to housing to try to figure out this pre sale problem.
Speaker 1: So how effective will that measure be? And to the
Speaker 1: point of this tension between stimulating the economy and reinflating
Speaker 1: a bubble, is there a possibility that local governments just
Speaker 1: start unleashing a torrent of credit that makes the problem
Speaker 1: worth Maybe one way of thinking about this is thinking
Speaker 1: about two extremes, right, So one extreme is do nothing,
Speaker 1: allow the mortgage boycotts to continue increasing, allow more and
Speaker 1: more real estate developers to go into bankruptcy, allow that
Speaker 1: to spill over into a massive increase in non performing
Speaker 1: loans in the banks, and allow that ultimately to sort
Speaker 1: of metasta size into a Chinese version of the US
Speaker 1: subprime crisis and Great Recession, right, So that's one extreme.
Speaker 1: At the other extreme, you've got something which looks like
Speaker 1: China's response to the Great Financial Crisis, the global financial
Speaker 1: crisis in two thousand and eight, where they opened the
Speaker 1: credit taps and delivered that massive stimulus which got the
Speaker 1: Chinese economy going again and got the global economy going again,
Speaker 1: but put them on this unsustainable trajectory where they had
Speaker 1: to keep on borrowing more and more money to pay
Speaker 1: for more more over capacity in real estate, over capacity
Speaker 1: in industry. So neither of those extremes are particularly attractive.
Speaker 1: What's China trying to do right now? They're attempting to
Speaker 1: have find a kind of a middle path between the two.
Speaker 1: And that's why we're having this sort of drip drip
Speaker 1: of what I would call sort of relatively small stimulus
Speaker 1: announcements PBC cutting interest rates a little bit, local governments
Speaker 1: being able to issue a few more bonds to pay
Speaker 1: for infrastructure, and perhaps provide a little bit of support
Speaker 1: to the real estate sector. It's not what the market
Speaker 1: wants to hear. They want to hear that kind of
Speaker 1: shock and or stimulus announcement like they heard from Wen
Speaker 1: Jiaobao at the end of two thousand and eight. They're
Speaker 1: not going to get that shock and or stimulus announcement.
Speaker 1: China doesn't want to restart another unsustainable boom, but neither
Speaker 1: is the kind of nightmare scenario of a do nothing
Speaker 1: Chinese government which allows the real estate sector to melt
Speaker 1: down going to play out. You mentioned the banks. What
Speaker 1: position are the banks in to recognize these types of losses?
Speaker 1: And one of the things that I occasionally hear from
Speaker 1: people in China is that, oh, it's not such a
Speaker 1: big deal because a lot of the pre sales lending
Speaker 1: was done by regional banks, or a lot of the
Speaker 1: property lending, I should say, was done by regional banks,
Speaker 1: which no one ever really regarded as safe anyway, So
Speaker 1: it's not that much of an issue. So this is
Speaker 1: this is potentially a big problem for China's banks. If
Speaker 1: we think about the history of financial crises, real estate
Speaker 1: often plays a very significant role. It was real estate
Speaker 1: which kicked off the meltdown in Japan's economy, which ended
Speaker 1: Japan's development miracle and pushed them into that lost decade
Speaker 1: of low growth and falling prices. Of course, it was
Speaker 1: the subprime crisis here in the United States, which kicked
Speaker 1: off the Great Recession, and real estate also played a
Speaker 1: big role in the Asian financial crisis back in so
Speaker 1: problems in real estate do have a track record of
Speaker 1: spilling over into the financial system, and China's financial system
Speaker 1: is heavily exposed to real estate. There are a lot
Speaker 1: of loans to households to buy homes. There are a
Speaker 1: lot of loans to property developers, and a lot of
Speaker 1: loans which are not directly to the property sector are
Speaker 1: collateralized by property or land, which means a drop in
Speaker 1: property prices or land prices would affect those loans as well.
Speaker 1: So there's a substantial risk there. How should we think
Speaker 1: about how that risk is going to impact I think
Speaker 1: it's useful to think about two different types of Chinese banks.
Speaker 1: At the top of the kind of chain, you've got
Speaker 1: the big state owned banks, the I C, B c
Speaker 1: s and C cbs and A B c's of the world.
Speaker 1: They are extremely well funded and they have a huge
Speaker 1: capital buffer. They are also diversified around the country, which
Speaker 1: means that problems in a particular city or a particular
Speaker 1: province aren't going to be good news. For them, but
Speaker 1: they're not going to affect their entire loan book. I
Speaker 1: don't think we're going to see problems for China's big
Speaker 1: state owned banks. At the other end of the spectrum,
Speaker 1: you've got small city banks. Now, small city banks tends
Speaker 1: to have a much less stable funding base, they tend
Speaker 1: to have a smaller capital buffer, and they tend to
Speaker 1: be heavily exposed to lending in their own city. And
Speaker 1: that means it's pretty easy to imagine a scenario where
Speaker 1: you've got a city with a bunch of stalled property projects,
Speaker 1: with a bunch of mortgage boycotts going on, with a
Speaker 1: city bank that doesn't have good funding, that doesn't have
Speaker 1: a strong capital buffer, and which runs into problems. We're
Speaker 1: not quite there yet, but I wouldn't be surprised if
Speaker 1: in the next one to three years we saw a
Speaker 1: bunch of small city banks that needed a capital injection
Speaker 1: on a pivot off of real estate a little bit
Speaker 1: and talk about you know, the story of the world
Speaker 1: right now is clearly commodity scarcity, and most of the
Speaker 1: attention is focused on Europe and this soaring price of
Speaker 1: power there, but it's really it's not just a Europe story.
Speaker 1: A lot of developed markets everyday their story is about
Speaker 1: some sort of rationing or export curbs or rolling blackouts
Speaker 1: or surging price of price of food. I feel like,
Speaker 1: you know, just sort of big picture, what is China's
Speaker 1: commodity position? How much is that story affecting the Chinese
Speaker 1: economy right now? Or to what degree is the is
Speaker 1: China insulated from it? You know, Joe I would almost
Speaker 1: flip that question around and think about how what's happening
Speaker 1: in China right now is impacting the global commodity story.
Speaker 1: So let's imagine that China was running a repeat of
Speaker 1: its two thousand and eight massive stimulus play and getting
Speaker 1: the economy back growing at six percent a year now.
Speaker 1: If that happened, it would drive enormoust demand for energy,
Speaker 1: in almost demand for metals, in almost demand for agricultural commodities,
Speaker 1: and the biggest problem for the rest of the world
Speaker 1: right now, high inflation driven in part by high commodity prices,
Speaker 1: would be a lot worse. China is not running a
Speaker 1: repeat of its two thousand and eight stimulus play. That
Speaker 1: means growth is very weak. Second quarter we had actually
Speaker 1: a contraction in GDP. Most people think the rebound in
Speaker 1: the second half of the year is going to be
Speaker 1: tepid at best. And what that means is China's commodity
Speaker 1: demand just isn't where the markets expected it to be
Speaker 1: a few months ago. That's one of the factors weighing
Speaker 1: on energy prices, metals prices, agricultural commodity prices. So that's
Speaker 1: actually making the biggest problem for the rest of the
Speaker 1: world right now, the inflation problem a little bit easier
Speaker 1: to grapple with, Tracy, you know, to timas point, something
Speaker 1: I've been thinking about is, you know, all these US
Speaker 1: retailers talk about how much excess inventory they have right now,
Speaker 1: and in a way, you know, these hard lockdowns then
Speaker 1: we saw in China, it's almost like kind of comes
Speaker 1: almost at a fortuitous time in the sense that this
Speaker 1: is not a time where you know, retailers want to
Speaker 1: have a lot of like inventory or stuff coming in
Speaker 1: from China. Well, this was actually going to be my
Speaker 1: next question, which is, how does the FEDS inflation fight
Speaker 1: and the fact that they seem to be even more
Speaker 1: explicitly now trying to take a chunk out of consumer
Speaker 1: demand to bring down prices, how is that going to
Speaker 1: impact the Chinese economy at a time when it's already
Speaker 1: quite fragile. It's a great question. I think you kind
Speaker 1: of hid it in your in your introduction to the
Speaker 1: To the Whole podcast. In normal circumstances, if China's economy
Speaker 1: contracted like it did in the second quarter of the year,
Speaker 1: if China's real estate sector was in crisis like it is,
Speaker 1: then we'd all be waking up every day and seeing
Speaker 1: that on the top of our Bloomberg terminal, checking the
Speaker 1: un fixing that exactly, and we're not right. We're wondering
Speaker 1: what your own Powell is going to say at Jackson Hole.
Speaker 1: We're wondering if the European Central Bank is going to
Speaker 1: deliver an outsize hike. So, at least on the sort
Speaker 1: of the pr front, the sort of the inflation challenge
Speaker 1: which the US and the rest of the world is
Speaker 1: facing and which is absorbing all the attention of the
Speaker 1: global financial markets, is actually doing China a bit of
Speaker 1: a favor. They're in a crisis and they wants watching.
Speaker 1: In a broader sense, though it is not good news
Speaker 1: for China. China is going to spend certainly the rest
Speaker 1: of this year and very likely several years ahead, working
Speaker 1: through the problem of overcapacity in the real estate sector,
Speaker 1: also grappling with COVID zero, and how ultimately to exit
Speaker 1: from COVID zero. All of these things are going to
Speaker 1: be bad news for domestic demand. Now, what do you
Speaker 1: want when domestic demand is weak? You want external demand.
Speaker 1: You want export demand to be super strong to provide
Speaker 1: a buffer. Clearly, that's not going to happen. The FED
Speaker 1: is very aggressively focused on tightening to bring inflation under control.
Speaker 1: Very likely that's going to tip the U S economy
Speaker 1: into recession. Same story in Europe. China's two x big
Speaker 1: biggest export destinations are both going to be contracting at
Speaker 1: exactly the moment China really needs them to be booming.
Speaker 1: Talk to us a little bit more about the COVID
Speaker 1: zero restrictions, because I feel like these are the things
Speaker 1: the backdrop against which all of this economic drama is
Speaker 1: actually happening. And this is a choice made by the
Speaker 1: Chinese authority is to have very very restrictive COVID zero
Speaker 1: policies to prevent free movement of goods and people, to
Speaker 1: be very gung ho when it comes to lockdowns and
Speaker 1: things like that. What's the motivation there and at what
Speaker 1: point would you expect those to start to ease off
Speaker 1: a bit. So, if we were having this conversation at
Speaker 1: the end of or the end of, China would look
Speaker 1: pretty clever on its management of its domestic COVID outbreak.
Speaker 1: They contained the virus, saved a bunch of lives, and
Speaker 1: they got the economy growing again. They were the only
Speaker 1: major economy in the world to have a v shaped recovery.
Speaker 1: From where we are heading further into the second half
Speaker 1: of China is looking much less clever. Here in the
Speaker 1: US and in Europe. At enormous expense in human life,
Speaker 1: the population has a measure of immunity from the virus,
Speaker 1: partly because many people have got sick and then recovered,
Speaker 1: so they have natural immunity. Partly because we have this
Speaker 1: sort of more advanced and effective mRNA vaccines, so normal
Speaker 1: life has resumed. I'm I'm recording this Odd Lots of
Speaker 1: podcast from the Bloomberg office. I dropped my children off
Speaker 1: in school this morning. In China, because the population hasn't
Speaker 1: experienced a wave of COVID infections, and because they've stuck
Speaker 1: with their domestic vaccines and not imported or developed their
Speaker 1: own version of mr NA. The population is COVID naive.
Speaker 1: That's just a really big problem for China's government. But
Speaker 1: now the decision has been to prioritize public health, so
Speaker 1: they're sticking with the COVID zero strategy. Even when they
Speaker 1: see a handful of cases break out in a particular city,
Speaker 1: that city is locked down. That's pretty successful at saving lives.
Speaker 1: It's a bit of a catastrophe for the economy. We
Speaker 1: saw a contraction in the second quarter of this year.
Speaker 1: It's entirely possible looking into the second half that will
Speaker 1: see more cases in more major cities. Those cities will
Speaker 1: be locked down, will see a further blow to growth.
Speaker 1: Looking forward, I think the kind of the consensus expectation
Speaker 1: is that at the Party Congress in the fall, President
Speaker 1: Hijinping will get a third term in charge of the country,
Speaker 1: and at that point, with that third term secured, the
Speaker 1: attention of the government will shift towards how to exit
Speaker 1: from COVID zero. One reason to kind of query or
Speaker 1: or have some questions about that consensus view is what's
Speaker 1: happening with vaccines. As far as I'm aware, China hasn't
Speaker 1: moved to secure the one point four billion m r
Speaker 1: n A doses it would need to give its population
Speaker 1: the maximum protection ahead of opening up. Neither do they
Speaker 1: seem to have their own domestic alternative, and that failure
Speaker 1: to sort of move ahead aggressively on the vaccine front
Speaker 1: raises some questions about what their end game is on
Speaker 1: COVID zero. How long can it be sustained? Just the
Speaker 1: economic damage that comes from retailers or restaurants or anything
Speaker 1: in person in major cities seeing their demand and get
Speaker 1: crushed the way it is, where they have so much uncertainty,
Speaker 1: like does this do permanent supply side damage to the
Speaker 1: Chinese economy? To have like such a long I mean,
Speaker 1: we're we're facing in the US and as you mentioned,
Speaker 1: we took a major loss of human life and a
Speaker 1: lot of people got sick but bed because we sort
Speaker 1: of made the choice to reopen very quickly and we're
Speaker 1: still feeling the shocks of it, would intuitively seem like
Speaker 1: a very long term damaging thing to have this much
Speaker 1: supply side degradation and halt of so many businesses. Yeah,
Speaker 1: I think that's completely right, Joe. So when we think
Speaker 1: about sort of China's economy kind of broadly understood, we
Speaker 1: think about a bunch of imbalances that have to be addressed.
Speaker 1: So too much emphasis on industry, not enough emphasis on services,
Speaker 1: too much investment and exports, not enough consumption, too much debt.
Speaker 1: The state sector is too big, the private sector small,
Speaker 1: private sector firms are too small. COVID lockdowns make all
Speaker 1: of those imbalances worse. COVID lockdowns are a disaster, but
Speaker 1: the services sector. COVID lockdowns hammer consumption whilst they leave
Speaker 1: industrial output broadly untouched. COVID lockdowns require an increase in
Speaker 1: debt to keep businesses solvent, and state owned enterprises, which
Speaker 1: tend to be bigger and have better access to finance
Speaker 1: a better place to survive COVID lockdowns than they're smaller
Speaker 1: private sector rivals. So is the Chinese gonna economy going
Speaker 1: to fall over tomorrow because of COVID lockdowns? I didn't
Speaker 1: think so. I think one of the lessons of the
Speaker 1: last two or three years is that actually pretty resilient
Speaker 1: can be locked down and reopened. But certainly the longer
Speaker 1: this goes on, the worst those imbalances are going to get,
Speaker 1: and the higher the cost ultimately of unwind those unbalances
Speaker 1: will be. So I have a big picture question based
Speaker 1: on that, which is, how much of the problems that
Speaker 1: we've been discussing, so the impact of COVID restrictions, impact
Speaker 1: of lockdowns and COVID zero policies, and the influx of
Speaker 1: money that has gone into the real estate sector as
Speaker 1: you described at the beginning of this conversation, how much
Speaker 1: of that could be fixed by strengthening China's social safety
Speaker 1: nets such that people didn't have to put all their
Speaker 1: savings into property because there were was, you know, a
Speaker 1: government funded retirement option or national healthcare and things like that.
Speaker 1: Are stronger healthcare services, I should say so. One of
Speaker 1: the fundamental imbalances in China's economy is the imbalance in
Speaker 1: the drivers of demand. Consumption plays a relatively small role
Speaker 1: in driving demand. Investment and exports play a substantially larger
Speaker 1: role in driving demand. Now, why is consumption weak? Well,
Speaker 1: an important reason, as you suggested, Tracy, is because of
Speaker 1: the absence of a social safety net. Because Chinese households
Speaker 1: feel like they need to protect themselves against the risk
Speaker 1: of unemployment or illness, or provide some funding to fall
Speaker 1: back on when they retire, they save a substantial share
Speaker 1: of their income. That saving goes into paying for investment,
Speaker 1: and it also means they have less money to pay
Speaker 1: for consumption. Now, there are other factors at work as well.
Speaker 1: The one child policy has been an important driver of
Speaker 1: that imbalance. If you have only one child, you just
Speaker 1: spend less because you don't need such a big house,
Speaker 1: you don't need to buy so many clothes, you don't
Speaker 1: need to buy so much food, you don't need to
Speaker 1: spend so much money on tutoring and so on. And
Speaker 1: because you only have one child, you're worried they won't
Speaker 1: be able to support you in your old age, so
Speaker 1: you also save more. Financial repression has played a role
Speaker 1: as well, so we mentioned earlier on that interest rates
Speaker 1: were often lower than the level of inflation. That's been
Speaker 1: a kind of deliberate government policy aimed at making it
Speaker 1: cheaper to invest, but it also meant that Chinese households
Speaker 1: needed to save more if they wanted to reach their
Speaker 1: target for retirement. So all of these factors are at work.
Speaker 1: The lack of a welfare state is one of them.
Speaker 1: To China's government's credit, over the last twenty years, they
Speaker 1: have been kind of progressively moving into place the kind
Speaker 1: of the elements of a welfare state. So education, it's
Speaker 1: not perfect, but it is now free and universal up
Speaker 1: to the end of high school. The entire country has
Speaker 1: least basic health insurance provided by the state. So it's
Speaker 1: still a problem, but policy, at least in that respect,
Speaker 1: is moving in the right direction. I brought up the
Speaker 1: commodity and power question earlier, and as you noted, in
Speaker 1: a way, the world is fortunate that Chinese demand for
Speaker 1: a lot of industrial or energy commodities or even add
Speaker 1: commodities is not as high as it might have been
Speaker 1: in an alternate policy scenario. One commonality, however, and this
Speaker 1: seems to this is a story that's getting a lot
Speaker 1: more attention, is the effective simply extreme weather on the
Speaker 1: production of energy itself, and that also is worsening things
Speaker 1: in Europe. And there's a terrible heat wave and drought,
Speaker 1: or certainly a heat wave happening in China right now.
Speaker 1: How much is this adding to the pain? How significant
Speaker 1: is this? How much are you watching the effect of
Speaker 1: extreme weather and climate change on China's own ability to
Speaker 1: provide for itself. So China is one of the countries
Speaker 1: in the world which is most at risk from climate change,
Speaker 1: Most of the population or the plurality of the population,
Speaker 1: live on the East coast, which means they're exposed to
Speaker 1: the risk of rising sea levels. A large share of
Speaker 1: the population still work in agriculture. Agriculture, of course, is
Speaker 1: one of the sectors which is most at risk as
Speaker 1: temperatures rise. So thinking on a kind of multi decade trajectory,
Speaker 1: China faces some significant risks from climate change, and that's
Speaker 1: why climate change is one of the few areas where
Speaker 1: China still wants to do business with the United States
Speaker 1: and get some stuff done. The situation right now with
Speaker 1: a high temperatures meaning that there's not enough water supply
Speaker 1: to power hydroelectricity, and that's contributing to power shortages. That's
Speaker 1: an additional negative of China's economy at a moment, where
Speaker 1: with real estate in crisis, with COVID zero imposing some costs,
Speaker 1: they don't need an extra problem to deal with. I
Speaker 1: wouldn't say it was the kind of the dominant narrative
Speaker 1: or the biggest problem that they're facing right now. So
Speaker 1: there is a very big event coming up, which is
Speaker 1: the National Party Congress, the big gathering of China's policymakers
Speaker 1: and Traditionally, when that happens, you often see the government
Speaker 1: start to say or do things that would be expected
Speaker 1: to boost the economy and push up stocks so that
Speaker 1: everyone is fairly happy going into this big event. What
Speaker 1: do you expect from this year's congress? So, Tracy, you
Speaker 1: are in Hong Kong at the same time as I
Speaker 1: was in Beijing, so you know as well as me
Speaker 1: that ahead of these big political events, what China's policymakers want,
Speaker 1: What the Communist Party wants is stability. They want stability
Speaker 1: in the economy, they want stability in the financial markets,
Speaker 1: and this time around they're not going to have it.
Speaker 1: The real estate crisis, I think, is going to run
Speaker 1: for certainly months, and the drag from real estate is
Speaker 1: going to last few years. There's no sign so far
Speaker 1: that the government is willing to exit from COVID zero,
Speaker 1: and when they do ultimately exit from COVID zero, that's
Speaker 1: going to be a very messy and very costly process.
Speaker 1: So my expectation ahead of the Party Congress is that
Speaker 1: we're going to see a sort of a continued drip
Speaker 1: drip of stimulus measures. The government is going to want
Speaker 1: to bring a measure of stability to the real estate sector,
Speaker 1: a measure of stability to the bond and equity markets.
Speaker 1: But they're not going to be able to deliver the
Speaker 1: kind of massive stimulus which will be need. It's kind
Speaker 1: of significantly turn the situation around and create that kind
Speaker 1: of feel good factor which they normally like to have
Speaker 1: heading into these big political events. So I'll just ask
Speaker 1: one more big picture question. But your book China The
Speaker 1: Bubble that Never Popped, and the second edition is coming out,
Speaker 1: and of course the people have been talking about the
Speaker 1: China bubble collapsing for years and years all certainly for
Speaker 1: as long as our career man traces, and as your
Speaker 1: book notes, it never seems to happen. I mean, is
Speaker 1: it does it feel different this time or is this
Speaker 1: like look, China goes has these periods where there's lots
Speaker 1: of stress like many other countries like Europe, like the US,
Speaker 1: and uh, you know, eventually it models through and finds
Speaker 1: way out. Does it feel different this time is well,
Speaker 1: how does it feel compared to other periods of stress
Speaker 1: and turmoil for China's economic history? So it feels worse,
Speaker 1: Joe Um. I think there's a confluence of the factors
Speaker 1: which which you're sort of coming together right now, and
Speaker 1: which will also weigh on China's growth going forward. So
Speaker 1: we've talked about real estate. China has had real estate
Speaker 1: busts in the past, but this one looks more severe.
Speaker 1: We've talked about COVID zero that's already a drag on growth,
Speaker 1: and there's the big unanswered question of how they exit
Speaker 1: from it. One thing we haven't talked about, but which
Speaker 1: is also really important is China's kind of growing international isolation.
Speaker 1: China is a big exporting country. China is a net
Speaker 1: beneficiary of technology transfer. Big driver of China's growth has
Speaker 1: been learning from or if we're less charitable, stealing advanced
Speaker 1: technologies from other parts of the world. That's just going
Speaker 1: to be much more difficult in the years ahead as
Speaker 1: hostility to China in the US in big European countries increases.
Speaker 1: So all of these factors are sort of hitting China
Speaker 1: right now and threatening to weigh on China in the
Speaker 1: years ahead. At the same time, I think it's important
Speaker 1: to recognize that China retains pretty significant resources for resilience.
Speaker 1: China is at a relatively low stage of development. Gdpe
Speaker 1: per capita in China is still just a third of
Speaker 1: g D peper capita in the United States. That means
Speaker 1: China has continued and substantial room to grow, not by
Speaker 1: sort of doing anything particularly innovative or inventive, but just
Speaker 1: by continuing to kind of move up a technology ladder
Speaker 1: which it can already see in front of it. Don't
Speaker 1: forget that Japan fell over when it's g D peper
Speaker 1: capital was of the level in the United States, so
Speaker 1: China has a long way to go before it reaches
Speaker 1: that level. Secondly, because China's policymakers remain ingenious in their
Speaker 1: capacity to think about inventive solutions to economic and financial problems,
Speaker 1: they can tinue to have a certain amount of space,
Speaker 1: certainly less space than they did in the past, but
Speaker 1: still some space for maneuver as they address those problems.
Speaker 1: And philosophically, China's policymakers, I don't want to see everything
Speaker 1: burned down, right, They would sooner see a bit more
Speaker 1: imbalance than a lot of collections, all right, Tom or Like,
Speaker 1: chief economist at Bloomberg Economics and the author of China
Speaker 1: The Bubble That Never Pops, thank you so much for
Speaker 1: coming back on our thoughts. That was great, great to
Speaker 1: be here. That was great, Tom, Thank you so Joe.
Speaker 1: Clearly a lot of things to pull out of this conversation,
Speaker 1: but I think the overwhelming one is just this tension
Speaker 1: between solving the problem versus recreate hinting the problem in
Speaker 1: some respects or accepting those balances that Tom was describing, Like,
Speaker 1: there does seem to be that fundamental tension though. That
Speaker 1: was actually the most interesting or one of the interesting
Speaker 1: ideas that I hadn't thought about before. The degree to
Speaker 1: which COVID zero policies push back reforms, the degree to
Speaker 1: which they favor s O s over smaller companies, the
Speaker 1: degree to which they favor industry over services, the degree
Speaker 1: to which they forced the private sector into deeper debt,
Speaker 1: the degree to which it diminishes consumption. I hadn't thought about,
Speaker 1: like all of these structural imbalances that we've talked about
Speaker 1: for years with several guests, the degree to which COVID
Speaker 1: zero is like this huge setback on those and COVID
Speaker 1: zero in exacerbating the economic problems that we've just described,
Speaker 1: seems to be creating a double whammy. Right, So, on
Speaker 1: the one hand, it stopped some of the reforms that
Speaker 1: the Chinese government might want to see like the shift
Speaker 1: two services. And on the other hand, it all so
Speaker 1: means that you have to enact stimulus measures, and most
Speaker 1: of Chinese stimulus, you know, it tends to be large
Speaker 1: scale infrastructure projects or more credit to build more houses,
Speaker 1: which is problematic in the current situation. You know what.
Speaker 1: At the end, he gave I thought a follow up
Speaker 1: podcast that we should do with someone that I don't
Speaker 1: think it's gotten enough discussion. Is the long term or
Speaker 1: medium term effects of geopolitical isolation for China, which I
Speaker 1: hadn't really thought of, but as he mentioned, whether it's
Speaker 1: technology transfer however you want to use that term, other
Speaker 1: aspects of just being a country that's heavily dependent on exports, etcetera.
Speaker 1: Like what does it mean for China in ten, five,
Speaker 1: fifteen years to have this sort of you know, basically
Speaker 1: deglobalization in a sense from the Chinese perspective. Yeah, I
Speaker 1: would be totally into that. I think it's an interesting
Speaker 1: question because on the one hand, yes, it's an export
Speaker 1: based economy, they don't want to be completely disconnected from
Speaker 1: the global economy. But on the other hand, there are
Speaker 1: ways in which isolation could benefit China's economic reforms by
Speaker 1: building up technology self sufficiency as you just mentioned, or
Speaker 1: you know, even keeping capital more in the country versus
Speaker 1: having outflows. It's a really interesting question. Let's follow up
Speaker 1: on it, all right, shall we leave it there for
Speaker 1: let's leave it there. Okay, this has been another episode
Speaker 1: of the ad Thoughts podcast. I'm Tracy Alloway. You can
Speaker 1: follow me on Twitter at Tracy Alloway, and I'm Joe
Speaker 1: wisn't Thal. You can follow me on Twitter at The Stalwart.
Speaker 1: Follow our guest tom Orlick. He's at tom Orlick, and
Speaker 1: check out his book, which a new edition is coming
Speaker 1: out of China, The Bubble That Never Pops. Follow our
Speaker 1: producer Kerman Rodriguez at Kerman Armine, and check out all
Speaker 1: of the Bloomberg podcasts on Twitter under the handle at podcasts.
Speaker 1: Thanks for listening year to