Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway.
Speaker 2: And I'm Joe Wysn't thal Joe.
Speaker 1: Do you remember at the beginning of the year there
Speaker 1: was so much excitement about China reopening.
Speaker 2: Yes. Absolutely.
Speaker 1: You know.
Speaker 3: It is interesting because I think if you go back
Speaker 3: to last fall, there was all this talking's like, why
Speaker 3: is it China giving up on COVID zero? When is
Speaker 3: China going to give up on COVID zero? And then
Speaker 3: and they're like, oh, it's not going to happen anytime soon.
Speaker 3: And then one day it just happened, and everyone's like, Okay,
Speaker 3: here comes China, Here comes all the demand from China.
Speaker 2: It's on, that's right.
Speaker 1: And so a big plank or portion of the Boll
Speaker 1: thesis for twenty twenty three was that because China was
Speaker 1: reopening its economy after basically being shut for three years,
Speaker 1: you were going to get all this additional economic activity.
Speaker 1: And while we have seen markets rally, it is not
Speaker 1: it is definitely not because of China. In fact, China
Speaker 1: really seems to be struggling here. So we have you know,
Speaker 1: Chinese manufacturing is still at or nearer contraction. I think
Speaker 1: exports are flagging. Inflation is basically around zero, which might
Speaker 1: sound great to a number of other countries right now,
Speaker 1: but of course it means that in China growth is subpar.
Speaker 2: Yeah, I mean, I think it also.
Speaker 3: The big story for the world too has been oil demand,
Speaker 3: and there's a lot of expectation that's like, Okay, commodity
Speaker 3: prices are kind of soft, but China's going to reopen.
Speaker 3: Oil demand is going to surge, and that was expected
Speaker 3: to contribute to like further inflationary pressures throughout the world oil, copper,
Speaker 3: et cetera. And so yeah, that's that totally caught that
Speaker 3: market by surprise and changed a lot of the sort
Speaker 3: of macro dynamics globally that people were expecting.
Speaker 4: Yep.
Speaker 1: So now is the perfect time to dig into what
Speaker 1: is going on with the Chinese economy, and you know,
Speaker 1: to some degree, the weakness this year sort of highlights
Speaker 1: these longer term concerns around China. How is it actually
Speaker 1: transitioning or developing its economy. Is it going to be
Speaker 1: able to achieve the ultra high levels of growth that
Speaker 1: we've seen in the past, or is it going to
Speaker 1: fall into something like a middle income trap what's going
Speaker 1: on with Chinese local government debt that's been in the
Speaker 1: headlines quite a bit recently, and all of that put
Speaker 1: together has given rise to this idea of Japanification risk
Speaker 1: for China. So the notion that you might have ultra
Speaker 1: high levels of debt that weigh on future growth because
Speaker 1: everyone has to spend their money basically paying down their
Speaker 1: debt rather than investing in new and exciting things.
Speaker 3: Yeah, it's weird because I feel like there's like, now,
Speaker 3: there's two conflicting themes that I think about with China.
Speaker 3: So one is exactly as you said that there is
Speaker 3: this sort of sluggish growth, over capacity, debt, indebted cities
Speaker 3: and so forth, lack of domestic consumption. And then the
Speaker 3: other one is this sort of awe that the world
Speaker 3: has that like the booming electric vehicle exports, that they
Speaker 3: finally got the first flight of their domestic wide body
Speaker 3: aviation that first planned the COMAC that we talked about
Speaker 3: with Brad Setser, and of course all the anxiety about
Speaker 3: the chip progress that the country has made, which is
Speaker 3: why the Biden administration has cut off access to various
Speaker 3: high tech, cutting edge semiconductor equipment. So there's these two things.
Speaker 3: There's this like sort of like shokunawe at the success
Speaker 3: they're having in batteries, cars and so forth. At the
Speaker 3: same time, like the macro numbers do not look good.
Speaker 1: It's true China is always like a giant waiting in
Speaker 1: the wings to take over everyone else's economy. And also simultaneously,
Speaker 1: this bundle of vulnerabilities that people are worried is going
Speaker 1: to tip into a massive financial crisis. That's always the case.
Speaker 1: But okay, I have to say, we really do have
Speaker 1: the perfect guest to discuss all of this. We're going
Speaker 1: to be speaking with Richard Ku, chief economist at the
Speaker 1: Nomora Research Institute, which is the research arm of Japan's
Speaker 1: biggest brokerage to Moora. And of course he is also
Speaker 1: the man who basically wrote the book on balance sheet recession.
Speaker 1: So Richard, thank you so much for coming back on
Speaker 1: all thoughts.
Speaker 4: Well, thank you for having me.
Speaker 1: Yeah, really appreciate it. Maybe just to begin with, I
Speaker 1: know you've been talking and writing about this theme of
Speaker 1: a potential balance sheet recession in China. You also have
Speaker 1: a book that came out I think it was just
Speaker 1: last year called Pursued Economy, where you talk quite a
Speaker 1: lot about the trajectory of China's economy, but talk to
Speaker 1: us about what you're seeing now that suggests there may
Speaker 1: be signs of a Japan style balance sheet recession in China.
Speaker 5: Well, a lot of Chinese journalists economists are being contacted
Speaker 5: me on this issue also, that are we going to
Speaker 5: be Japan soon or are we already on that path?
Speaker 4: And my answer to that is that.
Speaker 5: A lot of similarities between what happened to Japan thirty
Speaker 5: years ago and what's happening to China today, but they
Speaker 5: are also important differences. And what the Chinese economists worried
Speaker 5: about is that China may be following fall into what
Speaker 5: I call balance recession. And balance recession is triggered by
Speaker 5: this whole notion that people feel uncomfortable with their balance sheets,
Speaker 5: suppose that the debt is too large relative to their assets,
Speaker 5: and that typically happens after the bursting of a bubble.
Speaker 5: If the bubble is financed with debt, and as the
Speaker 5: prices collapse but the liabilities remain, people realize that their
Speaker 5: balance is underwater. And if the balance is underwater, you
Speaker 5: have to fix it, or how do you fix it?
Speaker 5: You pay down debt. Well, that's the right thing to
Speaker 5: do at the individual level, but when everybody does this
Speaker 5: all at the same time, we got into a fallacy
Speaker 5: of composition problems in that in the national economy, if
Speaker 5: someone is saving money or paying down debt, you need
Speaker 5: someone else to borrow and spend those money to keep
Speaker 5: the economy going. And in the usual economy, you bring
Speaker 5: you give too few borrowers, you bring interest rates down.
Speaker 5: Too many borrowers, you push interest rates higher, and then
Speaker 5: that's how you keep the economy is going. But when
Speaker 5: the big bubble burst and as the prices collapse, everyone
Speaker 5: will be paying down there no one will be borrowing
Speaker 5: money even at zero interest rates, because if your balance
Speaker 5: is underwater, you're not going to borrow money even if
Speaker 5: interust rates come down to zero. And that's the prospect
Speaker 5: that Chinese are worried about. And China got this huge bubble,
Speaker 5: especially in the residential real estate, and the amount of
Speaker 5: price increase that China observed on the residential real estate
Speaker 5: is almost same as what happened to Japan thirty years
Speaker 5: ago in Tokyo and Osaka. And so when the real
Speaker 5: estate bubbles start collapsing last year, all these Chinese economists
Speaker 5: begin to worry about japan like situation where so many
Speaker 5: people are paying down there all at the same time,
Speaker 5: and economy could then fall into a deflationary spiral. I
Speaker 5: think that is actually already happening in China. A lot
Speaker 5: of people are saying very few people borrowing, so many
Speaker 5: people are paying down debt even with these low interest rates,
Speaker 5: and that's a very bad sign macroeconomically. Individually they might
Speaker 5: be doing the right things, but collectively they may be
Speaker 5: killing the economy. But there's also a big difference between
Speaker 5: the Chinese situation and the Japanese one, and that is
Speaker 5: that Chinese are already very much aware of this risk
Speaker 5: called balance recession. And thirty some years ago, when this
Speaker 5: thing was happening in Japan, no one in Japan, including myself,
Speaker 5: had any idea about this balance recession because it was
Speaker 5: not taught in economic books. I mean certainly not when
Speaker 5: I was going through. And so when the economy began
Speaker 5: to lose forward momentums and Bank of Japan brought rays
Speaker 5: down to very low levels, nothing happens. Structural reform, nothing happens.
Speaker 5: Fiscal stimulus, well, fiscal stimulus always worked, but that was
Speaker 5: cut short because they thought every time the economy showed
Speaker 5: even the slightest sign of growth, they say, ah, we
Speaker 5: don't need physical stimulus anymore. Economy is improving. And then
Speaker 5: the economy tanked a game, and it tanked a game
Speaker 5: because people were still repairing balance sheets and when a
Speaker 5: large bubble burst, and as the prices collapsed badly, it's
Speaker 5: going to take five ten years easily to repair those
Speaker 5: balance sheets. And in the Japanese case, it was bubble
Speaker 5: was led by the commercial real estate. The commercial real
Speaker 5: estate prices fell eighty seven percent nationwide, not just in
Speaker 5: the little corner of Tokyo, but the entire country. And
Speaker 5: so the balance sheet challenge that Japanese companies face was
Speaker 5: absolutely massive. They all start paying down that all at
Speaker 5: the same time, and that's how we got into this
Speaker 5: very slow growth. But the government did not know how
Speaker 5: to handle this type of recessions because in economics we
Speaker 5: will never talk to look at balance sheets, and so
Speaker 5: Japanese responses were very inconsistent, I should say, whereas in
Speaker 5: the Chinese case, they are fully aware of this recession
Speaker 5: called balance recession. That's why they have been calling me
Speaker 5: very frequently these days. I was told I don't know,
Speaker 5: I have no way to prove this, but one Chinese
Speaker 5: professor told me that about half of the PhD dissertations
Speaker 5: written on economics in China today based on my work
Speaker 5: on balance sheet recession. Now I don't know whether it
Speaker 5: was just making that number up, but what that suggests
Speaker 5: to me is that now the Chinese government know that
Speaker 5: there is this disease called balance recession, and they should
Speaker 5: know how to handle it. Also because once you know
Speaker 5: that this is a recession which is produced by lack
Speaker 5: of borrowers, and the borrowers are not coming into borrow
Speaker 5: money because they have balanceing problems, So the private sector
Speaker 5: themselves cannot change their behavior. After they are doing the
Speaker 5: right things trying to repair their balance sheets, then the
Speaker 5: government has to come in and borrow and put that
Speaker 5: money back into the income stream, which means fiscal stimulus
Speaker 5: is absolutely essential once you're in balance recession. And so
Speaker 5: my guess is that Chinese government will put in the
Speaker 5: fiscal stimulus, which they are actually quite good at, and
Speaker 5: that will keep the recession from turning into a depression
Speaker 5: or something. So that's the key difference between the Japanese situation.
Speaker 5: Thirty years ago, and what the Chinese resent, what the
Speaker 5: Chinese may be faced with today, that they already know
Speaker 5: what disease they are dealing with, and they are probably
Speaker 5: they are not going to waste any money, waste any
Speaker 5: time trying monetary easy or structural reform policies. My guess
Speaker 5: is that they'll go straight into the fiscal stimulus to
Speaker 5: keep the economy from losing its power.
Speaker 3: So you mentioned that one advantage perhaps that China has
Speaker 3: is having seen the experience of Japan. Incidentally, the US
Speaker 3: also had that advantage when we had the two thousand
Speaker 3: and eight two thousand and nine financial crisis. You wrote
Speaker 3: a whole book on it, the Holy Grail of Macroeconomics.
Speaker 3: Of course, US policymakers didn't exactly listen or heed the
Speaker 3: warnings of that book, and we had this pretty awful
Speaker 3: decade for growth.
Speaker 2: You know, I'm.
Speaker 3: Curious though, just in terms of balance sheets diving in, like,
Speaker 3: how do you see the distribution of debt in China?
Speaker 3: So the federal government doesn't have much debt, we know
Speaker 3: that is it? How much is it corporates versus real
Speaker 3: estate developers, versus households versus local cities and municipalities, like
Speaker 3: what does the distribution of debt in China look like?
Speaker 4: Well?
Speaker 5: Can I first comment on your first comment about the US. Sure, Well,
Speaker 5: when I was trying to explain to my formal colleagues
Speaker 5: at the Federal Reserve that we were suffering from balance
Speaker 5: saing session in Japan and therefore we need fiscal stimulus,
Speaker 5: not structural reform. And as a formal recipient of doctoral
Speaker 5: fellowship from the Board of Goldness, I have been, you know,
Speaker 5: going back to the FED to give seminars on this
Speaker 5: issue throughout the nineties, and as you mentioned just now,
Speaker 5: they did not take any of my warnings. I was
Speaker 5: bashed every step of the way, with the FED economist saying,
Speaker 5: come on, just Bank of Japan printing the money and
Speaker 5: then everything be fine. But I would try to explain
Speaker 5: that that doesn't work when they are now borrowers. Well,
Speaker 5: once two thousand and eight Lehman crisis happened, someone I
Speaker 5: don't know who brought my book to the attention of
Speaker 5: Jimmer Benenki and he read it the Holy Gramach Economics,
Speaker 5: the book you mentioned, and he told so many other
Speaker 5: people in the Federal Reserve to read it as well.
Speaker 5: And if you notice that at the beginning he was
Speaker 5: arguing that yes, monetary policy can handle it, as he
Speaker 5: was a disciple of Milton Freeman, who argue that if
Speaker 5: the Fed acted more responsible during a great depression, things
Speaker 5: wouldn't have gone so bad. But after reading my book,
Speaker 5: he started talking about fiscal cliff, which is the opposite
Speaker 5: of what treatment was saying. And I thought that was
Speaker 5: a very important change in the US policy when Germin
Speaker 5: Minanke at various events kept on saying we cannot afford
Speaker 5: the fall off the fiscal cliff. The government has to
Speaker 5: continue borrowing and spending money, meaning that fiscal policy is
Speaker 5: absolutely essential. And I think that is the key difference
Speaker 5: between the United States and Europe, because Europe really did
Speaker 5: not heed any of my advice, especially at the top level,
Speaker 5: and so they fell into a really serious balance recession
Speaker 5: and that recession lasted for almost ten years, whereas in
Speaker 5: the United States, the epicenter of this global financial crisis,
Speaker 5: because of the efforts made by Jimmerman and get the
Speaker 5: Fed and Larry Summers also, who actually endorsed my book
Speaker 5: The Holy grailm Microeconomics. He talked about the importance of
Speaker 5: fiscal stimulus. It has to be speedy, substantial, and sustained.
Speaker 5: So Obama administration was trying to put in fiscal stimulus.
Speaker 5: They made a lot of resistance from them from the Republicans,
Speaker 5: but at least US was trying to do all the
Speaker 5: right things, and I think that's why US came out
Speaker 5: of balance sheet recession much faster than the Europeans. So
Speaker 5: I would say that my book actually did have an
Speaker 5: impact on the US policy. If it had impact earlier,
Speaker 5: it would have probably helped the US economy even sooner.
Speaker 5: So that's one comment I want to make, and that
Speaker 5: is that US policy makers realize that they're facing balance
Speaker 5: sheet recession like EO too into the recession and made
Speaker 5: all the appropriate changes to fight it. Now, going back
Speaker 5: to the Chinese issue of where the debt might be,
Speaker 5: you know a lot of people like to talk about
Speaker 5: the size of the debt, but what is really important
Speaker 5: is the difference between the size of the debt and
Speaker 5: the size of the savings. And the fact that the
Speaker 5: Chinese interest rates, for example, ten year Chinese government bounds
Speaker 5: today is offering what two point six percent suggests that
Speaker 5: savings are far bigger than the debt because if the
Speaker 5: debt or the borrowing is probabiger than the savings. Interest
Speaker 5: rates should be higher, not lower, and the fact that
Speaker 5: ten year government bounce is down to two point six
Speaker 5: percent suggest to me that overall China's biggest problem is
Speaker 5: that there are too much savings relative to borrowings. So,
Speaker 5: having said that, who has the capacity to borrow and
Speaker 5: spend this money? Well, as you correctly mentioned, the federal
Speaker 5: government of the central government probably has plenty of rooms
Speaker 5: left to borrow and spend. But the regional governments I understand,
Speaker 5: are in very sad shape because they can't sell the
Speaker 5: land as easily or as expensively as before, and they
Speaker 5: have used up quite a bit of their resources in
Speaker 5: the previous years trying to support the economy, and also
Speaker 5: during the COVID nineteen and so the feeling I get
Speaker 5: is that regional governments are really overburdened already, and probably
Speaker 5: they will require quite a bit of help from the
Speaker 5: central government going forward if they are going to be
Speaker 5: the one who will be actually implementing fiscal stimulus, which
Speaker 5: is needed during the balancey recession.
Speaker 1: So, just on the idea of physical stimulus, historically, it
Speaker 1: does feel like a lot of China's stimulus has come
Speaker 1: in the shape of support measures to companies or these
Speaker 1: huge construction projects, big infrastructure and development projects of one
Speaker 1: sort or another. What would be the ideal form of
Speaker 1: stimulus this time around, because, of course, China is trying
Speaker 1: to balance various needs and goals here. It's talked a
Speaker 1: lot about retooling its economy away from manufacturing and real
Speaker 1: estate and more towards consumption. And yet historically we haven't
Speaker 1: seen a lot of fiscal support for households and individuals.
Speaker 1: It just hasn't been a very big thing in China.
Speaker 5: In terms of I mean, fiscal stimulus can come in
Speaker 5: various forms, right, You can have tax cuts of all
Speaker 5: of fiscal policy, or government actually borrowing and spending money,
Speaker 5: and the spending can go to in very many different places.
Speaker 5: First of all, tax cuts during balance research is not
Speaker 5: going to be very effective, and the reason is quite simple.
Speaker 5: Those people who get a tax cut who use the
Speaker 5: money to pay down debt, and that's good for that
Speaker 5: at the individual level perhaps, but collectively that won't help
Speaker 5: the GDP from collapsing. And so during balanceing recession, tax
Speaker 5: cuts should not be the main force of supporting the economy.
Speaker 5: So the government has to borrow and spend money, so
Speaker 5: within that what will be most effective. And I would
Speaker 5: argue that all those residential housing projects that were started
Speaker 5: but are now put on hold because the construction companies
Speaker 5: either have gone bankrupt or having so much financial problems
Speaker 5: they cannot move forward. I would recommend Chinese government to
Speaker 5: go in there and help those construction companies so that
Speaker 5: all the promised construction will be actually complete. I think
Speaker 5: that would be the most effective way to spend fiscal
Speaker 5: stimulus fiscal money, because that way, those people who were
Speaker 5: feeling very insecure, I mean they paid for the apartment
Speaker 5: house already or put the down payment. Now they're wondering
Speaker 5: whether they will get anything from all the investments they made,
Speaker 5: will at least get that apartments built and they can
Speaker 5: look forward to perhaps some larger apartments as a result.
Speaker 5: And the same part would be helping the construction industries.
Speaker 5: And one key difference between the Japanese and the Chinese
Speaker 5: situation is that construction is such a large part of
Speaker 5: Chinese GDP. Construction accounts was something like twenty six percent
Speaker 5: of Chinese GDP, whereas during the bubble days in Japan
Speaker 5: it was only around twenty percent, and it wasn't a
Speaker 5: big part of the picture, whereas in the Chinese bubble
Speaker 5: it came with a huge construction boom. And so when
Speaker 5: acid prices collapse but construction boom also go bust, then
Speaker 5: you are hit from both the real side as well
Speaker 5: as from the balance EAT side and BALANCEA side. There's
Speaker 5: not much one can do. But on the construction side,
Speaker 5: if government comes in and help finish those projects that
Speaker 5: was started, I think that kind of money will probably
Speaker 5: go a long way in helping the Chinese economy.
Speaker 3: Can I ask what about the role of the foreign
Speaker 3: sector when we sort of break down the Chinese economy
Speaker 3: and a sort of sectoral model. So it's like, Okay,
Speaker 3: we know that domestic households have a high level of savings.
Speaker 3: We know the federal government has not borrowed a lot.
Speaker 3: But on the other hand, the trade surpluses are massive.
Speaker 3: And again I sort of mentioned in the intro that
Speaker 3: one of the themes right now is that Chinese advanced exports,
Speaker 3: particularly in areas like batteries and evs and other cutting
Speaker 3: edge stuff, is kind of booming.
Speaker 2: If it continues to boom, can.
Speaker 3: That go some ways in sort of mitigating the need
Speaker 3: for federal government borrowing absolutely.
Speaker 5: I mean, if Chinese companies keeps on coming up with
Speaker 5: new fantastic products, and both Chinese and non Chinese are
Speaker 5: willing to borrow money to buy those products, then that
Speaker 5: will be helping the Chinese economy in massive, massive fashion.
Speaker 5: And I realized, as you mentioned already, that there are
Speaker 5: many Chinese companies that are highly innovative, coming up with
Speaker 5: a lot of interesting products, and they should find plenty
Speaker 5: of export markets for those products, So that part is
Speaker 5: definitely there. My concern, however, is the same concern that
Speaker 5: Japan had back in those days. At that time thirty
Speaker 5: years ago, Japan was running the largest trade of pluses
Speaker 5: in the world. So many people wanted to buy Japanese cameras,
Speaker 5: Japanese cars, Japanese appliances, and it was running such a
Speaker 5: large trade surplus.
Speaker 4: It could not push it even more.
Speaker 5: In that if Japan wanted to export even more by,
Speaker 5: for example, bringing the Japanese end down a little bit,
Speaker 5: Americans would be very upset. The USTR will be knocking
Speaker 5: on the Japanese and said, no, you ben opened your
Speaker 5: market not sending these additional products to US. And I
Speaker 5: was actually involved in the US Japan trade friction back
Speaker 5: thirty years ago. At that time, the US Ambassador to
Speaker 5: Japan was mister Walter Mondale, a former Vice president, who
Speaker 5: asked away. Recently he found out that this guy Richard Ko,
Speaker 5: who is frequently appearing in Japanese television programs, actually carries
Speaker 5: an American passport. So he asked me to come over,
Speaker 5: and he basically asked me to represent the United States
Speaker 5: in all these Japanese TV programs on US Japan trade friction.
Speaker 5: And at that time, usgvent trade friction was really really bad, serious, ugly,
Speaker 5: you name it. It was really terrible. So I tried
Speaker 5: to ill go to the US embassy to get a
Speaker 5: food briefing from staff first there and then go to
Speaker 5: the television's studios to try to explain the American position
Speaker 5: to the Japanese audience, even though I was actually employed
Speaker 5: by the Japanese Research Institute, and all these other Japanese
Speaker 5: on the program waiting with their guns to shoot me down.
Speaker 5: You know, that was that kind of situation. So I
Speaker 5: learned a lot about trade friction back in those days,
Speaker 5: and Japan really could not rely on additional exports because
Speaker 5: it was already running such a large trade surplus. So
Speaker 5: if Japan could have used exports by bringing the Japanese
Speaker 5: hand down a little bit and export its way out,
Speaker 5: that would have shortened the balanceing recession by some considerable years.
Speaker 5: But that option really was not available to Japan at
Speaker 5: that time because it was such a large trade cirplust country.
Speaker 5: And I think that applies to China today as well
Speaker 5: as you know.
Speaker 4: China.
Speaker 5: As you mentioned, China is the largest trade circlust country
Speaker 5: in the world, and if China tries to bring exchange
Speaker 5: rates down and try to export its way out, I'm
Speaker 5: sure a lot of countries will be complaining. So there's
Speaker 5: something that Chinese can do in that export side, especially
Speaker 5: they're coming up with new products so that other people
Speaker 5: in the United States, Japan, or or Western Europe have
Speaker 5: no reason to resist because there's no domestic manufacturers for
Speaker 5: those new products. Still, overall, I don't think it's a
Speaker 5: good idea for China to rely too much on exports
Speaker 5: because that could produce backlash called trade friction, which is
Speaker 5: why Japan faced thirty years ago as well.
Speaker 1: Just going back to today, we've been talking a lot
Speaker 1: about both the parallels and the difference between China's current
Speaker 1: situation and the one that Japan found itself in a
Speaker 1: few decades ago. But we haven't yet touched on demographics,
Speaker 1: and of course population growth or the lack of it,
Speaker 1: is something that is much discussed when it comes to
Speaker 1: Japan's economy. Is a similar concern going to emerge for China?
Speaker 4: Well, I know.
Speaker 5: That's the kind of a standout Washington consensusy if I.
Speaker 4: May, on Japan.
Speaker 5: But if you look at the actual statistics, Japan's population
Speaker 5: peaked two thousand and nine. What that means is that
Speaker 5: the bubble burst nineteen ninety, So there was nineteen years,
Speaker 5: almost two decades, where Japanese population was actually growing, but
Speaker 5: Japan was stealing deflation. In fact, that twenty years, Japan
Speaker 5: was experienced the most serious deflation because everyone was paying
Speaker 5: down debt and so so I would argue that most
Speaker 5: of the decline that a lot of people referred to population.
Speaker 5: One can use that perhaps the recent ten years, but
Speaker 5: certainly not the first twenty years of after the bursting
Speaker 5: of the bubble. The first twenty years came almost exclusively
Speaker 5: exclusively from balance sheet problems, not from population problems. Having
Speaker 5: said that, then you look at the Chinese situation, and
Speaker 5: we noticed that Chinese populations start shrinking well this year
Speaker 5: or last year. That's the same year the bubble burst,
Speaker 5: So Japan had nineteen years before the population started shrinking.
Speaker 5: In a Chinese case, bursting of the bubble and decline
Speaker 5: of the population are happening on the same year, and
Speaker 5: that is likely to make Chinese policy response that much
Speaker 5: more challenging.
Speaker 3: You know, you mentioned that one constructive thing that the
Speaker 3: federal government in China or the central government could do
Speaker 3: is just make sure the apartments get built. That people
Speaker 3: have all this uncertainty because they put down payments on
Speaker 3: apartments they're waiting for that the developers are then hobbled,
Speaker 3: and there's all kinds that creates all kinds of stagnation.
Speaker 2: Suppose that happens.
Speaker 3: Is there something further that's next, because presumably China doesn't
Speaker 3: want to just go back to the old model where
Speaker 3: construction is twenty five or twenty six percent of GDP,
Speaker 3: or presumably that wouldn't be your prescription to just go back.
Speaker 3: So let's say that somehow they were able to clean
Speaker 3: up the mess that the developers and remove some of
Speaker 3: that overhang is there some structural move that should be
Speaker 3: then done further, whether it's direct support to household something
Speaker 3: with the safety net, et cetera, that the government should
Speaker 3: then undertake to sort of continue on these reforms and
Speaker 3: not fall back into.
Speaker 2: A debt trap.
Speaker 5: Well, I'm actually concerned about the fact that Chinese companies
Speaker 5: stop borrowing money long before the bubble burst. When you
Speaker 5: look at the Chinese flow funds data, and if you
Speaker 5: look at the corporate sector, they stop borrowing money around
Speaker 5: twenty sixteen. Well up to twenty sixteen, they were borrowing
Speaker 5: quite a bit of twenty fifteen, they were borrowing quite
Speaker 5: a bit of money. So household sector was saving money,
Speaker 5: corporate sector was borrowing money, and that's how economists are
Speaker 5: supposed to move forward. But starting twenty sixteen, the corporate
Speaker 5: borrowing starts shrinking quite substantially, and that was, in my view,
Speaker 5: the most disturbing development in the Chinese economy that we
Speaker 5: should pay great attention to. And that is because you
Speaker 5: mentioned earlier, Chinese companies are coming up with all these
Speaker 5: new products, great products on electric vehicles, batteries and other areas.
Speaker 5: They should be borrowing money at this stage of Chinese
Speaker 5: economic development. Just like you know the United States in
Speaker 5: the fifties and sixties or Japan in the seventies when
Speaker 5: they had lots of competitive advantage, great new products. Those
Speaker 5: companies should be borrowing money, not saving money. But for
Speaker 5: some reason, Chinese companies start reducing their borrowings stock in
Speaker 5: twenty sixteen, so they were like in the balance reat recession,
Speaker 5: long before the bubble burst. And I really want to
Speaker 5: find out what is the cost of this Chinese non
Speaker 5: borrowing before the bubble burst.
Speaker 4: After the bubble burst, you can explain everything on bolonce.
Speaker 5: Sheets, but with the borrowings are shrinking before that, you
Speaker 5: cannot use balance argument to say why these these companies
Speaker 5: are not borrowing money. And if the reason why these
Speaker 5: companies are not borrowing money is due to this renewed
Speaker 5: trade issues with the United States, then it's a much
Speaker 5: more serious problem for the Chinese economy because the trade
Speaker 5: friction and the possible de coupling with the outside world.
Speaker 5: But the coupling with the Western world means Chinese companies
Speaker 5: will be losing some of their best customers and the
Speaker 5: richest customers because the Western nations have far higher per
Speaker 5: capita GDP than the rest, so if the coupling happens,
Speaker 5: all these companies will lose their export markets or they
Speaker 5: cannot rely on export market as much as they were
Speaker 5: able to do before. And if that's the reason companies
Speaker 5: were not borrowing money, then Chinese economic problem has a
Speaker 5: much deeper, much deeper problems to resolve. And as a
Speaker 5: result of these companies not borrowing money, but the household
Speaker 5: sector is still saving money. Chinese government actually had to
Speaker 5: borrow money and spend it to keep the Chinese economy
Speaker 5: going for five six years before the bubble burst, and
Speaker 5: that borrowing, mostly done by the regional governments, is putting
Speaker 5: regional governments in very difficult position now because they have
Speaker 5: basically used up quite a bit of their borrowing power
Speaker 5: already before the balance recession is starting, and there I
Speaker 5: think they will have to come up with a lot
Speaker 5: of new financing techniques to make sure that these regional
Speaker 5: governments can continue to borrow and do whatever the fiscal
Speaker 5: stimulus that is needed to fight the balance recession. But
Speaker 5: until we find out why Chinese companies stop borrowing money
Speaker 5: around starting twenty sixteen, it's very difficult to predict where
Speaker 5: the Chinese economy is going. Because if that if Chinese
Speaker 5: companies reduce their borrowings start in twenty sixteen because of
Speaker 5: the coupling fears with the West, or regulatory uncertainties, because
Speaker 5: Chinese government have been putting in all sorts of regulatory
Speaker 5: shocks to the IT industry, to the education industry, financial industry,
Speaker 5: and of course the real estate industry. If those are
Speaker 5: the reasons why Chinese companies stop holding back their investments
Speaker 5: and borrowings, then even after balancey problems are resolved, those
Speaker 5: problems will be still with us, and that will be
Speaker 5: a huge drag on the Chinese economy going forward.
Speaker 1: This was going to be my next question, actually, which
Speaker 1: is I think in twenty fifteen we had some supply
Speaker 1: side reforms from China, but then in later years we
Speaker 1: had various crackdowns on things like the technology sector, on
Speaker 1: property developers, some parts of the education system. Very famously
Speaker 1: when it came to real estate, we had the three
Speaker 1: Red Lines missive and things like that. Are there signs
Speaker 1: in your opinion that this type of regulatory uncertainty is
Speaker 1: making companies more nervous about perhaps ramping up their borrowing
Speaker 1: or their investment.
Speaker 5: Well, it's very difficult to ask that directly. Because you
Speaker 5: know how it is in China. People are not free
Speaker 5: to say things these days. But talking to a lot
Speaker 5: of people, I get the sense that those are the
Speaker 5: concerns that many companies have. And on top of it,
Speaker 5: China is in the middle of what economists will call
Speaker 5: middle income trap. You know, middle income chap is if
Speaker 5: you are the lowest cost producer, all the companies will
Speaker 5: be moving factories to China because you can produce things
Speaker 5: at the.
Speaker 4: Lowest cost in China.
Speaker 5: But once your wages start increasing and other places like Vietnam, Indonesia,
Speaker 5: Bangladesh start offering even more attractive places to produce products,
Speaker 5: then these factories will start moving abroad. And China is
Speaker 5: in the middle of the middle income trap per capital
Speaker 5: GDP of about one hundred and twenty thousand US. At
Speaker 5: that point, they should be very careful to encourage more
Speaker 5: companies to come in and stay invested in China. But
Speaker 5: those regulatory interventions from the Chinese government's doing the opposite
Speaker 5: of what Chinese governments should be doing. So if you
Speaker 5: add that on top of all the other things, that
Speaker 5: China is already in the middle income trap for capital
Speaker 5: GDP twelve thousand, that's when these things become very important.
Speaker 5: That may be one of the key reason why people
Speaker 5: companies are not investing in China.
Speaker 3: You know, I just want to ask one sort of
Speaker 3: I have one last question from my perspective, and I
Speaker 3: actually would love to just shift at the end here
Speaker 3: to your perspective on the US. And you know, if
Speaker 3: the US in two thousand and nine was a bit
Speaker 3: slow out of the gate with the fiscal response, it
Speaker 3: certainly was not slow in twenty twenty, in twenty twenty one,
Speaker 3: persistent fiscal support in twenty twenty two and twenty twenty
Speaker 3: three with some of the public investment acts, et cetera.
Speaker 3: How much would you attribute, say, the above trend inflation
Speaker 3: in the US to the fiscal support And do you
Speaker 3: see some sort of fiscal cutbacks as necessary in order
Speaker 3: to get inflation back to target or can monetary policy
Speaker 3: and just sort of stabilization and normalization get the job done.
Speaker 5: Wow, So we are moving to the US, right, I
Speaker 5: think what happened to the United States? Of course, at
Speaker 5: the beginning during the pandemic, people kind of allow inventories
Speaker 5: to fall because they never knew when people will come
Speaker 5: back to their stores again. And then once they realized
Speaker 5: that COVID nineteen problems behind us. I don't know what
Speaker 5: that's actually behind us, because I'm seeing quite a few
Speaker 5: people getting sick recently, even in Taiwan, and so I
Speaker 5: don't know whether we are really behind this thing. But
Speaker 5: suddenly everybody start ordering for more goods to replenish their inventories.
Speaker 5: But here, of course, you get into a fanancy or
Speaker 5: composition problems again. Right, if you're just doing if you're
Speaker 5: the only one doing it, it's not a big deal.
Speaker 5: But when everybody does it all of the same time,
Speaker 5: then there will be bottlenecks everywhere. And I think that's
Speaker 5: how the whole thing started, this inflation talk started. But
Speaker 5: what else that happened is that, you know, the United
Speaker 5: States lost for twenty two million jobs during the pandemic.
Speaker 5: The first part of the pandemic. When that many people
Speaker 5: lose jobs all of the same time, these workers cannot
Speaker 5: afford to stay in the same city waiting to find
Speaker 5: jobs in the same industry any longer. Many of them
Speaker 5: had to find jobs that will pay them in any industry,
Speaker 5: in any geographical location. But when people start moving all
Speaker 5: over the place to look for jobs, their expertise know
Speaker 5: how skills will be lost because they are not going
Speaker 5: back to the same jobs. And I think that really
Speaker 5: effectively moved labors apply curve to the left. That is
Speaker 5: to say, if you want to get the same people
Speaker 5: with the same set of skills, you just had to
Speaker 5: pay more because there's so few of them left in
Speaker 5: your neighborhood. And if you look at countries where unemployment skyrocketed,
Speaker 5: like the United States and Canada, wages have also gone
Speaker 5: up quite sharply this time around, Whereas when you look
Speaker 5: at Japan, where companies tried to hold on to their
Speaker 5: workers as long as they can, and so unemployment rate
Speaker 5: in Japan only went up to three point four percent,
Speaker 5: that was the worst, and that was just for a
Speaker 5: month or two and then start coming down again.
Speaker 4: Most of the workers are still with the company, all
Speaker 4: the skills are still available, so when the demand picked
Speaker 4: up the game, the kind of labor shortage that the
Speaker 4: United States and Canada faced were not seeing in Japan.
Speaker 4: And as a.
Speaker 5: Result, wage increases are much lower, much lower than US
Speaker 5: or Canada. And so a lot depends on what kind
Speaker 5: of labor mahak you had. In the case of our
Speaker 5: United States. Because of this rather sharp left wood shift
Speaker 5: of labor supply. Earth US ended up having wages going
Speaker 5: up sharply higher, and that's adding to the inflation that
Speaker 5: we are talking about now. Whereas those countries where workers
Speaker 5: stayed with the companies wages are moving up much more slowly.
Speaker 5: So we have to make adjustments for these key differences
Speaker 5: between the countries.
Speaker 1: I think you know, I have just one more question,
Speaker 1: which is when we last had you on the podcast.
Speaker 1: I think it was something like May twenty twenty, and
Speaker 1: a lot of these decisions about how to respond to
Speaker 1: the pandemic were just being made at that time, and
Speaker 1: I think the headline of our podcast was something like
Speaker 1: Richard Coo on why the recovery will be difficult. So,
Speaker 1: looking back now, was there anything that surprised you about
Speaker 1: the speed or shape of the recovery in the US
Speaker 1: or the Western world.
Speaker 5: Well, actually, the vaccines were developed much faster than anyone
Speaker 5: had right to expect. You know, typically the things takes
Speaker 5: five to ten years before it's fully approved, but this
Speaker 5: time around they will approved much sooner. And people of
Speaker 5: course came out with these highly innovative vaccines that no
Speaker 5: one thought of before, So that was a big surprise
Speaker 5: from the medical side, and the government also putting, as
Speaker 5: I mentioned earlier, these massive monetary and physical help to
Speaker 5: the people so that they really didn't have to deplete
Speaker 5: their savings. As it were, I thought recovery would be
Speaker 5: slow because one of the reasons I thought recovery would
Speaker 5: be slow is because I thought a lot of people
Speaker 5: would be depleting their savings during these lockdowns, and so
Speaker 5: once the economy begins to normalize, I thought these people
Speaker 5: would be rebuilding their savings. But if they're rebuilding their savings,
Speaker 5: replenish their savings to the previous level of possible to
Speaker 5: go even higher, that would be like another balanceing recession
Speaker 5: in that so many people be replenishing their savings and
Speaker 5: as a result, there will be excess savings in the
Speaker 5: private sector. That was slow that the economic recovery. That
Speaker 5: was one of the thought that I had back in
Speaker 5: those days. But instead the governments supplied quite a bit
Speaker 5: of support to these households, and we ended up talking
Speaker 5: about excess savings in the household sector that can propel
Speaker 5: the economy further. That was not in my mind when
Speaker 5: we last spoke in May of twenty twenty. So those
Speaker 5: are the surprises that I was not anticipating at the time.
Speaker 5: But then you turn this thing around. In the Chinese case,
Speaker 5: Chinese government really did not give as generously as the
Speaker 5: American government or the European governments to these people who
Speaker 5: were suffering on the lockdowns, and as a result, the
Speaker 5: sense I get is that a lot of Chinese households
Speaker 5: and Chinese companies, small and medium sized companies, they had
Speaker 5: to really draw down their savings to whether the lockdowns.
Speaker 5: And if those Chinese companies felt that they don't have
Speaker 5: enough savings to whether the future rainy days and they
Speaker 5: would like to increase their savings to make sure that
Speaker 5: they have enough ammunition to fight the next round, then
Speaker 5: we may end up having something like balanceet recession, but
Speaker 5: this time it's on the asset side of the balance sheet,
Speaker 5: not on the liability side of the balance sheet. But
Speaker 5: the effect will be the same. If all these Chinese
Speaker 5: households and companies try to rebuild their savings all at
Speaker 5: the same time, then Chinese economy would be that much
Speaker 5: more weaker. It's very difficult to get any data on
Speaker 5: something like this from the Chinese side, but my sense
Speaker 5: is that this could be a bigger problem in China
Speaker 5: than in the United States or in Europe.
Speaker 1: Well, Richard, you brought us back full circle to China.
Speaker 1: So thank you so much. We really appreciate you coming
Speaker 1: back on all a delight to have you here with
Speaker 1: us once again and hear what you are thinking about
Speaker 1: the current situation in China and elsewhere in the world.
Speaker 1: So thank you so much.
Speaker 4: Oh, thank you. I love them.
Speaker 1: So Joe, that was so much fun. I thought it
Speaker 1: was really fascinating the distinction he drew between what happened
Speaker 1: in Japan and what might be happening in China now,
Speaker 1: and the idea of the big difference being that today
Speaker 1: people do have this idea of a balance sheet recession
Speaker 1: in their minds, so you can identify the problem, diagnose it,
Speaker 1: and then try to identify policy solutions that will hopefully
Speaker 1: help fix it. Whereas in Japan after the property bubble burst,
Speaker 1: no one was really quite sure what was happening or
Speaker 1: what the economic consequences of it.
Speaker 3: It might be right, which is why you know the
Speaker 3: title of his book, The Holy Grail of Macroeconomics, which
Speaker 3: is all about that Japanese balance sheet recession. You know,
Speaker 3: the idea being you can look at Japan and just
Speaker 3: learn so much about how economies work. I still think
Speaker 3: he gives you a policymakers like too much credit for
Speaker 3: the amount of physical.
Speaker 2: Supports to Europe.
Speaker 1: Very strange China.
Speaker 2: So it'll be interesting, you know.
Speaker 3: I remember if we just talked to Brad Setser and his.
Speaker 2: Conclusion was that.
Speaker 5: Deep.
Speaker 2: So I think or at least a.
Speaker 3: Deep skeptic in support to households. So it'll be really
Speaker 3: interesting to see if and when the government decides, look,
Speaker 3: GDP is slow, it's not getting better, we really have
Speaker 3: to do something.
Speaker 5: Yeah.
Speaker 1: Well, in my mind, and I remember we spoke about
Speaker 1: this with Brad Setzer as well, it is very strange
Speaker 1: to me that China does seem to have this reluctance
Speaker 1: to support the household sector in ways that we have
Speaker 1: seen in other parts of the world. So I think
Speaker 1: during the COVID pandemic, and remember the shutdown in China,
Speaker 1: those shutdown measures were in many respects much harsher than
Speaker 1: what we saw in other parts of the world, and
Speaker 1: yet there was very little support for individuals. If you
Speaker 1: lost your job, if you became unemployed, you basically had
Speaker 1: to live off of your savings. I think there were
Speaker 1: some parts of China where maybe people got consumption vouchers,
Speaker 1: spending vouchers, things like that, but it really wasn't for
Speaker 1: very much money. And so if you're trying to reorient
Speaker 1: your economy towards more of a consumption driven one and
Speaker 1: simultaneously revive economic growth, it seems to me like supporting
Speaker 1: households and individuals would appear to be a slam dunk.
Speaker 1: But for some reason that just hasn't happened. And the
Speaker 1: other thing I would say, and I think this is
Speaker 1: what is confusing to a lot of people, is that
Speaker 1: now we see more support or more momentum towards potential
Speaker 1: fiscal stimulus, and it seems like once again it's going
Speaker 1: to take the form of perhaps bailing out property developers
Speaker 1: finishing up some of those big construction projects. And yet
Speaker 1: just a couple of years ago we saw President Shei
Speaker 1: shin ping really cracked down on that sector. And so
Speaker 1: there seems to be a little bit of whiplash here,
Speaker 1: maybe a little bit of mixed messaging. But I guess
Speaker 1: in China the idea of opposing or conflicting messages are
Speaker 1: not that unusual.
Speaker 3: You know, what I thought was really interesting, and I
Speaker 3: hadn't really thought about this before, which is that, you know,
Speaker 3: obviously China runs a massive trade surplus.
Speaker 2: And this idea that eventually.
Speaker 3: Gigantic trade surpluses invokes some sort of political reaction globally
Speaker 3: that eventually the world does not want to be the
Speaker 3: buyer of last resort for your economy and you could
Speaker 3: only push it so far, which I thought was like
Speaker 3: super interesting. And that really started under Trump obviously with
Speaker 3: the tariffs, and then is sort of continued under Biden
Speaker 3: with some of the various trade restrictions and so forth.
Speaker 3: But this idea that's sort of like politically there might
Speaker 3: not be even Yes, exports may be growing, but there
Speaker 3: isn't a lot of juice and the squeeze to that
Speaker 3: just because at some point you sort of get this
Speaker 3: global political backlash to your export dominance.
Speaker 1: Yep, absolutely, shall we get there? All right? This has
Speaker 1: been another episode of the ad Thoughts Podcast. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal. You can follow me on Twitter
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