Speaker 1: Hello, and welcome to Stephanomics, the podcast that brings the
Speaker 1: global economy to you. My name is Tom Orlick. I'm
Speaker 1: the chief economist for Bloomberg and this Halloween Week with
Speaker 1: regular hosts Stephanie Flanders, busy putting the finishing touches to
Speaker 1: her modern monetary theory costume, I'm stepping in as master
Speaker 1: of Ceremonies. In keeping with the spirit of the season,
Speaker 1: we have a Frankenstein's Monster of a show for you,
Speaker 1: stitching together some of the scariest risks in the global economy.
Speaker 1: In a bit, we'll hear from Logan Rights of Rhodium
Speaker 1: Group and Bloomberg's own David Chu on why the ghost
Speaker 1: time problem that has long haunted China's economy is coming
Speaker 1: to a head. To start, though, Bloomberg's own Tom Hancock
Speaker 1: has gone trick or treating at the Hong Kong headquarters
Speaker 1: of ever Grandy, one of the developers that built all
Speaker 1: that empty property. Let's see what candy he collected. Yeah,
Speaker 1: I've come to the headquarters of China Evergrand Group in
Speaker 1: Hong Kong, the epicenter of a burgeoning debt crisis that
Speaker 1: the sharply slowed growth in the Chinese economy. The sides
Speaker 1: of the twenty six story building are plastered with advertisements
Speaker 1: for Evergrands luxury property developments, but it's the headquarters itself
Speaker 1: which has been up for sale this year. Evergrand tried
Speaker 1: to raise two billion dollars by selling it off to
Speaker 1: pay debt, but the deal hasn't progressed. Evergrand staff who
Speaker 1: walked the lobby's marble floor and take elevators to their
Speaker 1: offices face an uncertain future. In a cafe next to
Speaker 1: the building's lobby, Evergrand staff meet over covees or soft
Speaker 1: piano music plays. More than a month after entering its
Speaker 1: acute phase, the financial drama at the company that had
Speaker 1: been China's largest property developer until recently is far from over.
Speaker 1: After waiting about a month for an interest payment, some
Speaker 1: of Evergrand's dollar bond holders received their money over the weekend,
Speaker 1: allowing the company to avoid a default for now, but
Speaker 1: investors have little insight into how long Evergrand can continue
Speaker 1: to pay its bills. The bonds initially had a bit
Speaker 1: of a pop and then sort of very quickly came
Speaker 1: back down to almost unchanged. On the day. That's Monica
Speaker 1: saw of Triatic Capital an asset manager UM. I think
Speaker 1: that UM it made made sense for them to pay
Speaker 1: this just pretty much about a day before the end
Speaker 1: of the grace period in order to kick the can
Speaker 1: down the road while they figure out a comprehensive resolution
Speaker 1: to this. This whole Osaka, like many in the market south,
Speaker 1: sees the hand of China's government behind the scenes. Evergrand
Speaker 1: status as China's biggest dollar bond issue means whether it
Speaker 1: pays its bills will help determine how easy it is
Speaker 1: for other Chinese companies to access overseas lending in the future.
Speaker 1: So the payment of this coupon, I would assume does
Speaker 1: involve the government, including the p POC, in order to
Speaker 1: maintain stability of the whole financial system. I think that
Speaker 1: much is sort of clear to the market. The heart
Speaker 1: of evergrands troubles are its high debt burden. It counts
Speaker 1: more than three hundred billion dollars in liabilities and a
Speaker 1: slowdown in sales attributable to the Chinese state itself. According
Speaker 1: to Juning, a former advisor to China's Central Bank, the
Speaker 1: Chinese government is trying to reduce the economy's dependence on
Speaker 1: real estate. He argues that a constant expectation of rising
Speaker 1: prices among households has created a bubble that threatens financial stability.
Speaker 1: Team but in the process of trying to deflate the
Speaker 1: bubble by slowing housing sales, officials are undermining the finances
Speaker 1: of huge companies like ever Ground, that in turn creates
Speaker 1: a threat to financial stability. If you crack down the bubble,
Speaker 1: you would create a financial brisks on its own. But
Speaker 1: if you don't, you wouldn't be able to convince the
Speaker 1: market that you really minute. I think that's the here
Speaker 1: in challenge Chinese regulate or Chinese comment phase. Evergrund sales
Speaker 1: fell by a whopping nine percent during China's October holidays,
Speaker 1: usually a peak period for home buying, as the government
Speaker 1: told banks to limit mortgage lending and buyers also worried
Speaker 1: about ever grounds ability to complete its construction projects. Juning
Speaker 1: believes that Beijing will continue to try to slow housing
Speaker 1: sales until households lads their expectations that the government will
Speaker 1: always step in to support house prices. I think the
Speaker 1: end of it is to have the market, have the
Speaker 1: household to have been fairly study explanation of the housing part,
Speaker 1: but I don't think we're reaching that point yet, Evergrand
Speaker 1: needs to focus more on selling off its considerable assets
Speaker 1: to keep servicing its huge debt pile, since it has
Speaker 1: less money coming in the door from home bias. The
Speaker 1: trouble is it's having difficulties finding any bias for those
Speaker 1: as well. Evergrand has also tried to sell its property
Speaker 1: management arm, which charges homeowners fees for organizing services like
Speaker 1: security and cleaning. It hoped that that would bring in
Speaker 1: two point six billion dollars, but talks about that also
Speaker 1: ended without a deal. Evergrand's founder and chairman, Wakayan, has
Speaker 1: always been a risk taker. He was born into grinding
Speaker 1: poverty in the central province of her Nan in the
Speaker 1: nineties fifties and founded his property company just as China
Speaker 1: began to create a commercial housing market in the late
Speaker 1: night nineties. Two decades later, in seventeen, he was China's
Speaker 1: second richest man. So far, Way has been low key
Speaker 1: about the details of Everground's finances, avoiding media engagements. However,
Speaker 1: local press accounts suggest he is sticking with the kind
Speaker 1: of big, bold bets that have defined his career. The
Speaker 1: Securities Times reported that Way plans to scale down real
Speaker 1: estate operations and won't buy much land for another ten years.
Speaker 1: The new focus designing and manufacturing electric vehicles. The company
Speaker 1: got into the new energy vehicle's business a couple of
Speaker 1: years ago, but as yet to manufacture a single car.
Speaker 1: Everground faces more tests in the coming weeks as the
Speaker 1: grace periods on more bonds expire. The fate of one
Speaker 1: of the world's largest real estate firms and the world's
Speaker 1: biggest real estate market still hangs in the balance. For
Speaker 1: Bloomberg News, I'm Tom Hancock in Hong Kong. Scary stuff
Speaker 1: forever grandy bond holders and with ever grandy emblematic broader
Speaker 1: problems in an overbuilt, an over leverage property sector. Scary
Speaker 1: stuff also for China's economy and financial system as a whole.
Speaker 1: To get into those broader issues, I'm joined now by
Speaker 1: Lugan Right, a director at Radium Group and veteran analyst
Speaker 1: of China's financial system, and Bloomberg's David Chew, both of
Speaker 1: them dialing in from Hong Kong. Logan, let me start
Speaker 1: with you. Why is a downturn in real estate potentially
Speaker 1: such a big problem for China. I think it's a
Speaker 1: it's a big problem largely because just of the size
Speaker 1: of the property sector within China's economy, which most analysts
Speaker 1: estimate between twenty of GDP. Overall property sales in China
Speaker 1: in terms of just the pre construction sales are as
Speaker 1: high as fifteen point seven trillion u N over the
Speaker 1: last um year, of the last twelve months. And so
Speaker 1: if you hypothetically look in the future and if property
Speaker 1: sales decline by let's say over the next year and
Speaker 1: prices are down by say ten percent um, that's a
Speaker 1: huge gap that it's very difficult for developers to make up.
Speaker 1: It's a gap as high as three point five percent
Speaker 1: of g d P. It is not a an imbalance
Speaker 1: that is easily remedied by policy. So this is one
Speaker 1: reason that the you know, the potential costs of such
Speaker 1: a property downturn that exemplified by ever grands difficulties are
Speaker 1: so significant. And it's not just a growth risk we're
Speaker 1: talking about here, is it a slump in the property
Speaker 1: sector could mean defaults on loans and end up in
Speaker 1: a financial crisis, a Lehman movement for China, if you
Speaker 1: will lugan, how could that plan? The more likely scenario
Speaker 1: that we would be concerned about in terms of financial
Speaker 1: distress in China stems through local governments and the difficulties
Speaker 1: of property developers continuing to um slow down their purchases
Speaker 1: of land, which would add to financial stress among China's
Speaker 1: local governments which depend heavily upon land sales for revenue
Speaker 1: and repaying their own significant debt burdens. So what you
Speaker 1: could see is if you have a continued slow down
Speaker 1: in land purchases, you could have a rise in financial
Speaker 1: distress at smaller banks that lend to these local government
Speaker 1: financing vehicles, which have really lad the expansion in China's
Speaker 1: debt over the past decade, which were also essential to
Speaker 1: the funding um the investment that has taken place. David Chew,
Speaker 1: You've worked inside the People's Bank of China, and not
Speaker 1: just inside the People's Bank of China, but inside the
Speaker 1: financial stability vision of China's Central Bank, the group which
Speaker 1: cares most and focuses most on this kind of problems.
Speaker 1: How do you think China's policymakers are thinking about what's
Speaker 1: going on with ever Grandy and some of the broader
Speaker 1: risks that Logan has described for China's financial sector. The
Speaker 1: banking sector is the key, particularly the big banks are
Speaker 1: the key. They are the natural firewall for the financial
Speaker 1: crisis or financial risks because they have the guarantee from
Speaker 1: the government. So for example, if you're deposit the money
Speaker 1: into i CBC, that means you are you are depositing
Speaker 1: it with with the with the government, so that is
Speaker 1: the SEBC. Under the big banks, they are steign credit
Speaker 1: so that this makes them a natural firewall during a
Speaker 1: credit crisis or credit risk. Remember what happened thirty years
Speaker 1: ago in ninety nineties, hialized banks used that to have
Speaker 1: at pent on the Rachel but the banks was still surviving.
Speaker 1: And that tells us how confident that people are to
Speaker 1: the banking sector. So the principle for us is even
Speaker 1: the banking sector remains good and this do have the
Speaker 1: credibility things will be good. So data is the the
Speaker 1: most ultimate backdop or backstorm for for the all the argument, logan,
Speaker 1: help me out with one crucial question before we get
Speaker 1: back to the substance of this ever grand or ever grandy.
Speaker 1: I've heard both the translations I've been What I hear
Speaker 1: most often is ever grant, But you know, technically it's
Speaker 1: a you know, it's und do so it's a question
Speaker 1: of whatever English and translation prefer, the Chinese will still
Speaker 1: operate historic. I went with ever Grand, but ever Grandy
Speaker 1: seems to have much more of a dramatic flourish to it,
Speaker 1: So I think I'm going to put the accent on
Speaker 1: the going forwards fair fair enough, So so Logan and
Speaker 1: David makes an important point, doesn't he There is a
Speaker 1: powerful firewall in the financial system in China, which is
Speaker 1: the credibility of the big banks. And as long as
Speaker 1: the I C, B c s and the China construction
Speaker 1: banks of the world a solid it's difficult to imagine
Speaker 1: a systemic crisis in China. Do you agree with that point?
Speaker 1: And what could happen in your view to start eroding
Speaker 1: confidence not just in a property developer or a local bank,
Speaker 1: but in the giant state banks which dominate the system.
Speaker 1: I mean, I think it's very improbable that giant state
Speaker 1: banks would suddenly lose confidence among the local population. But
Speaker 1: the concern I would have is in state guarantees being
Speaker 1: eroded over time. The issue in China's financial system has
Speaker 1: been that the system expanded when there was a high
Speaker 1: degree of moral hazard um that was pervasive throughout a
Speaker 1: number of different asset markets. So the idea was that
Speaker 1: even when there was financial stress that occurred, investors didn't
Speaker 1: need to protect themselves because they could always count on
Speaker 1: Beijing to step in in the case of any financial stress.
Speaker 1: We saw this during even the stock market meltdown in
Speaker 1: we saw this during the inner bank market turmoil. And
Speaker 1: so that assumption, that track record of interventions over time
Speaker 1: created the impression that there would always be um some
Speaker 1: sort of government support. But that is changing and it
Speaker 1: had to change. In fact, it was natural that that
Speaker 1: guarantee would change because Beijing really had no interest in
Speaker 1: defending these very risky and peri ferral parts of the
Speaker 1: financial system when the shadow banking system, when peer to
Speaker 1: peer lending network started expanding, and as those guarantees have
Speaker 1: been eroded, it causes investors to start questioning where those
Speaker 1: Beijing's guarantees will truly extend, where they will stop looking
Speaker 1: longer term logan, China has to transition away from property
Speaker 1: as a driver of growth. You mentioned that contribution of
Speaker 1: property to GDP that has to come down. That's going
Speaker 1: to be a painful process, isn't it. I would think.
Speaker 1: So the issue is just that when an industry is
Speaker 1: that large, there's no obvious replacement. When something that goes
Speaker 1: from powering the economy becomes a meaningful drag on the economy.
Speaker 1: You can talk about transitioning growth models, but that becomes
Speaker 1: a longer term process, and it requires the costs of
Speaker 1: the previous investment to be to be paid and new
Speaker 1: investment decisions to be made, which which take time to
Speaker 1: be productive. So it does mean that, you know, whatever
Speaker 1: you're thinking about China's long term growth trajectory becoming um
Speaker 1: it probably involves that being a couple of percentage points
Speaker 1: lower in the immediate future. David, the last word to you,
Speaker 1: We've already seen China's economy really screeched to a halt
Speaker 1: in the third quarter. If you look at the quarter
Speaker 1: on court at growth rate just no point two, way
Speaker 1: down from numbers we used to see in the pre
Speaker 1: COVID era. Do you share Logan's view that working through
Speaker 1: these deep problems is going to require a period of
Speaker 1: lower growth. Before answering this question, we should think of
Speaker 1: one thing. It is why the authorities are so tough.
Speaker 1: Could real actate a sector for the past of a
Speaker 1: couple of years. So I think we can we need
Speaker 1: to think of it in the bigger picture, and in
Speaker 1: my mind, I think that the UH, the top leaders,
Speaker 1: they realized that China needs the transition and they are
Speaker 1: willing to UH to endure a period of slower growth
Speaker 1: UH in the next couple of years. That is the
Speaker 1: price for transition. I think that is what in their minds.
Speaker 1: So this can explain what happened in the past several
Speaker 1: quarters after China recovered from the COVID nineteen that they
Speaker 1: accelerated the reform and the transition and many of the
Speaker 1: Titan issue Titan policies issued. I think the view it
Speaker 1: a time window for the transition and they are willing
Speaker 1: to pay some price for that. But on the other hand,
Speaker 1: I think they won't allow the growth to to to
Speaker 1: break the bottom line. I think one of the bottom
Speaker 1: line is the employment. So if we see the rise
Speaker 1: of the unemployment, we will see some policies to be
Speaker 1: made to relate to the the economy. Well, if we
Speaker 1: have to sum up such a complex discussion, I guess
Speaker 1: we can say that, Ever, Grandy is probably not going
Speaker 1: to be China's Lehman moment. A financial crisis is not
Speaker 1: an immediate prospect, but a period of lower growth as
Speaker 1: the economy works through the problems of overbuilding and over
Speaker 1: capacity is a very real prospect. David, you logan, right,
Speaker 1: thanks very much, thank you. Well, It's Halloween this Sunday,
Speaker 1: and so in the spirit of the season, we've invited
Speaker 1: Bloomberg Economics best vampire hunters and monster slayers to tell
Speaker 1: us about the biggest risks, the scariest risks facing the
Speaker 1: global economy and markets. Very pleased to be joy by
Speaker 1: chief US economist and a Wall dialing in from Washington,
Speaker 1: d C. Senior UK economist Dan Hansen joining us from London,
Speaker 1: and Chief Emerging Markets economist z Dowd dialing in from Dubai. Zad.
Speaker 1: Let's start with you tell us about the beastly problem
Speaker 1: facing the emerging markets. So we know do things from history.
Speaker 1: We know the first thing is that rising US rates
Speaker 1: have a negative spill over to emerging markets, and the
Speaker 1: second thing is that weaker economies in the developing world
Speaker 1: gets hit harder. We saw that repeatedly in recent years,
Speaker 1: including the two thousand and thirteen Taper tantrum. We saw
Speaker 1: it also in the twenty eighteen emergent market crisis. Now
Speaker 1: US rates are rising, and some emerging markets are vulnerable
Speaker 1: this time around. So who is the most exposed was
Speaker 1: the group of countries that we group under the acronym BEAST.
Speaker 1: These are Brazil, Egypt, Argentina, South Africa and Turkey. These
Speaker 1: economies have law foreign exchange reserves, have high external debt
Speaker 1: and sizeable current account deficits, and the particularly exposed if
Speaker 1: you get any surprises in terms of interest rates in
Speaker 1: the US now, fans of the horror genre will know
Speaker 1: that often the sequel is gorrier than the original. In
Speaker 1: the UK, we had strikes, shortages, garbage, even corpses piling
Speaker 1: up in the street. The crisis was so bad it
Speaker 1: became known as the Winter of Discontent, Dan Hansen, does
Speaker 1: the UK now face winter of discontent? The return? We've
Speaker 1: had a year of two halves in the UK. We've
Speaker 1: had a blistering recovery following the end of the lockdown
Speaker 1: earlier in the year, but since then the economy has
Speaker 1: slowed and much of that has been due to, as
Speaker 1: you mentioned, supply constraints both global and domestic as well,
Speaker 1: and they've really hindered the ability of the economy to
Speaker 1: make meaningful further progress. And we've had a look at
Speaker 1: what recent supply disruptions might cost the economy, and we
Speaker 1: think it could knock as much as one point three
Speaker 1: percent off the level of g d P by the
Speaker 1: end of the year, and it could add as much
Speaker 1: as point four percentage point to headline inflation, which as
Speaker 1: we know, is already pretty high in the UK. It's
Speaker 1: running at about three point one percent at the moment,
Speaker 1: and I think if we look ahead, it's important to
Speaker 1: recognize that that loss of growth momentum has occurred at
Speaker 1: a time when more headwinds are appearing on the horizon.
Speaker 1: Inflation is likely to go higher still on energy prices
Speaker 1: this winter, moving above four percent, more than doubling the
Speaker 1: Bank of England's target, and that will crimp real income growth.
Speaker 1: And meanwhile you've got fiscal support being tapered, and there's
Speaker 1: also a risk of a rising unemployment following the end
Speaker 1: of the furlough scheme, which the government's wage support scheme.
Speaker 1: So if we bring all of that together, it's it's
Speaker 1: not hard to see why references to stagflation are on
Speaker 1: the rise um, though we don't think we're quite there yet.
Speaker 1: Our baseline view is that the economy will continue to grow,
Speaker 1: albeit at a significantly lower pace than in earlier in
Speaker 1: the year, And our baseline also sees GDP passing its
Speaker 1: pre virus peak in the first quarter of next year,
Speaker 1: which is a little bit later than we previously envisaged.
Speaker 1: Sometimes in horror films, the problem gets so bad that
Speaker 1: the heroes have to adopt a scorched Earth policy to
Speaker 1: wiping out the villains. Remember Ripley in Aliens promising to
Speaker 1: take off and nuke the entire site from orbit. It's
Speaker 1: the only way to be sure, Anna Wong, was inflation
Speaker 1: in the United States reached that proportion, should we be
Speaker 1: worried that the Federal Reserve will have to lift off
Speaker 1: and nuke the economy from orbit to bring price pressure
Speaker 1: under control. So dud, everybody is worried about inflation here,
Speaker 1: even my my, my nanny is worried about inflation. And
Speaker 1: the risks of inflation moving higher than the FED prediction
Speaker 1: right now seems higher than a couple of weeks ago, indeed.
Speaker 1: But to me, the scarier scenario is not so much
Speaker 1: inflation running away to the level we have seen in
Speaker 1: nineteen seventies, because for that to happen, the FED has
Speaker 1: to make policy errors for many, many years, and I
Speaker 1: just don't think that's likely. The Fed will move, will
Speaker 1: raise rates next year if inflation runs hotter than much
Speaker 1: hotter than they expected. But the real scary thing is
Speaker 1: what happens to the economy when the Fed does move
Speaker 1: under the new policy framework. The FET is only going
Speaker 1: to move until the labor market is really hot, right,
Speaker 1: So when they do finally start to move, they have
Speaker 1: to move faster and quicker, and the path of FED
Speaker 1: rates will be steeper. And we have had two years
Speaker 1: of very easy conditions monetary conditions. We have many bubbles now,
Speaker 1: we have asset record highs in many asset markets. So
Speaker 1: when the FED brings this party to a halt, it
Speaker 1: will be very hard. And historically the FED does not
Speaker 1: have a very good track or record in engineering soft lending. Okay,
Speaker 1: let's round this section out by talking about perhaps the
Speaker 1: biggest fear out there for some investors, the fear that
Speaker 1: record highs for the stock market are the sign of
Speaker 1: a bubble and that that bubble could burst Z. How
Speaker 1: should we think about that risk? Right? So, the main
Speaker 1: question is whether the stock market is in a bubble
Speaker 1: or not right now, with the SMP hitting record highs.
Speaker 1: So to answer this question, we use an econometric model
Speaker 1: that estimates the large notable bubble based on the speed
Speaker 1: of decoupling of equity prices from their fundamentals, in this
Speaker 1: case is dividends. The method finds that we are on
Speaker 1: the cusp of a bubble. We're not in a bubble
Speaker 1: territory yet, but we are very close now. Economically speaking,
Speaker 1: the direct effect of a sharp correction in the stock
Speaker 1: market on the US economy my not be very large,
Speaker 1: but at a time where we have other risks such
Speaker 1: as the spreading of the coronavirus variant, the rise of
Speaker 1: global interest rates, the slow down the Chinese economy, and
Speaker 1: the disruption and the supply chains. Adding a another risk
Speaker 1: in the form of an assetprise bubble would compand these
Speaker 1: risks and add an additional layer of uncertainty to the
Speaker 1: global economy. Well, Anna, Dan and Zad didn't enter into
Speaker 1: the Halloween spirit quite as fully as I did, But
Speaker 1: then I guess on a show like this, it's really
Speaker 1: economic expertise that counts, and that's about all we have
Speaker 1: time for on this week's Stephonomics. So it's the door
Speaker 1: of the crypt Creaks closed, it only remains for me
Speaker 1: to thank our contributors, Tom Warlock, Logan White and Demon
Speaker 1: Chew as Yeah Dead, The Ghost of Anime, Wong and
Speaker 1: Dan Hank, Song producer Magnus the Thing Henrickson, and executive
Speaker 1: producer Mike the Exorcist Sasso join us next week, when
Speaker 1: regular host Stephanie Flanders will be back, The guest host
Speaker 1: Nightmare will be over, and normal standards of economic analysis
Speaker 1: and editorial judgment will be restored