Episode Info
- Season9
- Episode1
Hosted by Christina Ruffini and Sir Richard Dearlove
Guest
Charlene Chu
Charlene Chu is renowned as the 'rockstar of Chinese debt analysis' and provides forecasts and warnings about China's property bubble and economic pressures.
Episode Summary
Ten years ago, Charlene Chu, dubbed the 'rockstar of Chinese debt analysis' sent shockwaves across the world by sounding a warning over China's escalating debt problem and the risk it presented to the global financial system. Today, two years after the outbreak of the covid pandemic, in the midst of a war in Europe, and a worldwide supply-chain and energy crisis, President Xi is grappling with his zero-covid policy and easing China back into business. But one of the biggest worries that senior analysts like Chu have, is the precarious property bubble that threatens to burst - potentially taking much of the Chinese, and even global, economy with it. Chu sits down with One Decision to give her forecast and warnings for 2022 and beyond.
Listen & Subscribe
- Watch on YouTube
- Listen on Apple Podcasts
- Listen on Spotify
Transcript
COLD OPEN
Mcfarlane: You're listening to One Decision. I'm your host Julia McFarlane. Chinese growth powers the world. Many of us may be half a world away, but all of us are likely to be impacted by changes in the Chinese economy. For risk analysts and market watchers, Beijing's lack of transparency makes reading the economic tea leaves a notoriously difficult task. Enter Charlene Chu, senior analyst at Autonomous Research, formerly of Fitch Ratings. Once dubbed the rock star of Chinese debt analysis by The Wall Street Journal, her work once compelled the Chinese government to take action, and she was one of the earliest voices to sound the alarm over its rising debt. Charlene doesn't often do interviews, so we were thrilled to have her on One Decision to explain what she thinks lies ahead for the Chinese and therefore global economy.
INTRODUCTION
Mcfarlane: I am super excited to welcome our guest today, Charlene Chu. She is a world renowned expert in Chinese debt and macroeconomics, currently a senior analyst with Autonomous Research. Charlene's also previously worked at Fitch Ratings and as a Senior Analyst in the Federal Reserve Bank of New York's Emerging Markets and International Affairs Group. Charlene, I am so grateful for you for coming to talk to us on the podcast today. As a foreign correspondent, I am completely unqualified to talk to you about the Chinese economy, but I am going to do my best. I'm probably going to ask you to explain or go into things in layman terms. I really want to take advantage of your expertise and make it as accessible for our listeners as much as possible. So I hope that's okay. Sure. I think we have to start with how the pandemic has really rocked the global economy and shown just how interdependent we all are on each other. Recently, the Chinese government enacted extremely limiting lockdowns on its financial capital Shanghai, one of the longest, toughest lockdowns anywhere in the world as part of its zero tolerance COVID policy. As a result of these shutdowns, factory closures, the world economy has faced significant supply chain issues. China's strict pandemic policy is affecting pocketbooks around the world. So I wanted to ask you, what are your thoughts on this policy?
INTERVIEW
Chu: It's a huge concern, particularly for multinational companies with operations in China because there's no real carve out for them, and this makes it incredibly difficult for them to meet orders, to keep on production schedules, and this is why you've got a lot of multinational companies looking at investing in operations in other parts of the world, I think, to get away from this zero COVID policy. But on top of that, as you said, the pandemic has taught us a lot of things, and one of those things is that we are relying too much on one country and, in particular, China for the sourcing of many inputs or final goods. And that needs to change, and we need to have more supply chain diversification globally.
Mcfarlane: I think that's absolutely right. And that leads me on very nicely to my next question, which is on growth. There's this report last year from McKinsey, which found that China's wealth rose from $7,000,000,000,000 in 2000 to a staggering 120,000,000,000,000 in 2020. The wealth of The US is estimated to be around $90,000,000,000,000. China has, by these reports, now overtaken America to be the richest nation in the world. But that growth has been quite messy as well as frighteningly fast. And one of the biggest issues is that it has been built on vast amounts of credit. Back in 2014, the BBC interviewed you and asked you about the scale of Chinese lending that we've seen since the financial crash in 2008. And you said it's off the charts. Most people are aware we've had a credit boom in China, but they don't know the scale. At the beginning of all of this in 2008, the Chinese banking sector was roughly $10,000,000,000,000 in size. Now it's on the order of twenty four to twenty five trillion dollars. That incremental increase of 14 to 15,000,000,000,000 is equivalent to the size of the entire US commercial banking sector, which took more than a century to build. So that means China will have replicated the entire US system in the span of half a decade. That quote blew my mind then, still blows my mind now. You caused a bit of a storm with your warnings back then that China's financial bubble was growing too fast and that it was potentially a disaster in the making. So several years later, the Chinese economy is arguably causing concern, but there hasn't been a disaster or a crash yet. So I would like to ask you to revisit your assessments. Were you wrong? Are you yet to be proven right? Or did the Chinese government take your warnings seriously just enough in time?
Chu: So there were two things that were going on at that time. One was the very rapid growth of the banking sector. The other was the very rapid growth of what we would call the shadow credit or shadow banking sector, which was a large portion of the financial system at that time. This was things like what we had during the global financial crisis, where we had securitization of loans into investment products and then those investment products investing in other investment products, and that space was going extremely rapidly. And there was a real risk around 2014 to '16 that there was going to be an accident in the shadow credit sector that would lead to a big reckoning across the entire financial sector, including the formal banking sector. So the good news is they identified that, they addressed it, and that risk of any kind of problem in the financial sector spinning into something like what we saw in 2008 in The US and Europe was minimized. Now all of that said, what has happened since then is we still have a rapidly growing banking sector, and that number that you cited before from my earlier quote of 25,000,000,000,000 is now 42,000,000,000,000 US dollars and climbing. So we continue to be in a climate where the Chinese government is growing credit at very, very rapid rates. And longer term, this does have a cost. The cost of a financial crisis, I think, is lower than it was several years ago. I don't think there is a high probability of that happening. Where it does matter is it starts to squeeze overall economic growth. The more you saddle households and businesses with debt, the more each dollar or renminbi of revenue they get or income that they get from wages is going to repay debt, and that's not going to consume goods. It's not going to new capital expenditure to drive growth and business. So we are in a situation, I think, now where the debt bubble continues to grow, and it is, I think, one of the structural issues that is weighing on Chinese growth and one of the reasons why we think we are entering an era here where we are gonna be looking at low to mid single digit growth in China at best as the country really starts to slow down from this.
Mcfarlane: I'm interested in you saying that there is a low risk of a large scale financial crisis in China just now. But why is there a low risk? And surely such exponential growth of debt is unsustainable. I mean, how long can it keep growing at such a dizzying amount? What is the ceiling?
Chu: I think right now, there was certainly a very big threat when we had that enormous shadow credit growth that something like that could have made banks very worried about the health of each other because it was so hidden. Nobody knew what anyone else was carrying. Now that that's reduced, we are left with more transparent figures that we can all observe and do analysis on and say, okay, well, that bank, you know what? They really don't look good, and everybody knows that. This other bank looks fine. And I think that leads to a more orderly workout of these problems. But there's no question. Our view is that even though the risk of financial crisis is low, there are still very substantial losses that are gonna have to be booked on these loans. And I would note that when the authorities launched this de-risking, deleveraging campaign, they started to pressure banks to write off more bad debt. And last year, we saw 3,100,000,000,000 renminbi in write-offs. That's almost 500,000,000,000 US dollars. And we saw a similarly very elevated number the year before that. So they are very quietly in the background working off a lot of this bad debt. But the question just becomes, this all works when the economy is growing really rapidly and banks are earning enough money, so they have the profits to write this stuff off. But if growth slows, bank earnings slow, they don't have as much capacity to write the stuff off, and we've still got big losses, that's when it gets more tricky.
Mcfarlane: Now, I wanted to ask you, ten years later, what we have now is President Xi focusing on this twentieth party congress later this year, and it marks his ten years in power. He's hoping to be confirmed for an unprecedented third term in office. He has been implementing vast amounts of change in the Chinese economy in many areas, returning parts of it to extreme state control. One example is wiping out its entire for-profit education sector last summer, which caused huge amounts of rattling in The US markets where a lot of those companies are based. Going back to shadow banking, and you mentioned the write-offs, we have another example, which is the government cracking down on those practices. He's also clamping down on tech firms. He's trying to persuade Chinese investment to return home. It's a huge period of economic reform going on at the moment. And I wanted to ask you, because of all this, does reform inevitably mean instability? What is your assessment of Xi's approach in dressing up the Chinese economy for the Party Congress in order to put himself in the best possible light? And is he exposing himself to political risk by doing so?
Chu: I think this reform campaign, to be honest, really started with the crackdown on shadow credit in 2017. And I think the authorities saw that as the most vulnerable link in the entire economy and country. They addressed that. They then started moving on to other sectors. And, yes, it is very big. It does entail, in many cases, a significant hit to unemployment. So in the case of the tech companies that you mentioned as well as education sector and also the property sector, all three of those have contributed to a rise in unemployment that is now, we just got the latest data yesterday, 6.9% in the top 31 cities. That's a full percentage point above where China was during peak COVID when the virus first broke out in 2020. So we are seeing a dramatic hit to unemployment. And, yes, there is a cost to all of these reforms, but I think there is also an objective that the authorities are trying to accomplish. And in many cases, it is justifiable and they are holding the line and doing the right thing.
Mcfarlane: You mentioned some of the other issues with China's economy. And so that takes me to property. That McKinsey report that I mentioned last year, it also found that 68% of the world's wealth lies in real estate. And so Evergrande, it hit global attention last year when there were protests across China outside their offices. It's the second largest property developer in China. It sells homes at a dizzying rate to investors and future homeowners, many of which haven't even been built yet. So it owes money to all of these people who are expected to have a house at some point. It also owes money to bondholders at home and overseas. It also has more debt than any other property company in the world, $300,000,000,000. And when the Chinese government issued new rules on how much debt a company can hold and how much cash it needs to have on hand, that threw its prospects into disarray with fears that it could collapse. Now, some people have said that Evergrande is too big to fail. That is a refrain we've all heard before with regard to the Lehman Brothers. So is Evergrande too big to fail in your opinion? Is it likely to fail? And also, what's the bigger picture here? Because Evergrande is just one developer out of many in China.
Chu: So in reality, Evergrande has already defaulted on bonds. It defaulted last fall. It is still, however, functioning as a company and trying to meet its obligations to households. So I wouldn't say we are in a scenario like we were with Lehman where the company truly defaulted, failed, and was closed, and we just had to net out assets and liabilities and close the entity down. This is still a going concern that is operating, but clearly has a fair amount of liabilities that it simply is not going to be able to repay. So we are effectively in a restructuring scenario now with Evergrande, and they are still working on their plan for that restructuring. And once we get that, we'll have a better idea of the direction of travel of that particular institution. I would just add that Evergrande has gotten a lot of attention, and that's because it was the biggest and most vulnerable company midyear last year, fall of last year. But since then, we have had 30 Chinese property developers default since the beginning of 2021. Evergrande's total liabilities are about 2,000,000,000,000 renminbi. If these 30 companies combined, if you include Evergrande, their total liabilities are 6,000,000,000,000 renminbi. And this is, you know, right around 1,000,000,000,000 US dollars. So we have a substantial problem here in the property market that is much bigger than Evergrande. Now they just were the canary in the coal mine warning everyone about the weakness in the sector and what was coming down the line.
Mcfarlane: So, I mean, I'm gobsmacked. I wasn't aware of that stat. 30 companies have defaulted since 2021. What does that mean? What have, have there been any real world sort of consequences as of that? How has that impacted the Chinese economy as of yet?
Chu: Yeah. So interestingly, you know, if you had pulled all of the China analysts aside in 2020 and said, you're gonna see 30 property companies defaulting, including the second largest company in the country, Evergrande, what do you think this is gonna mean? I think we all would have said we would have had a really serious problem with growth as well as in the financial sector in terms of bad debt. But what has happened in reality is as we've looked at more of the data, the bank's loans to these developers are secured by collateral, and the banks are effectively saying, even if the company defaults, I have the collateral. So the loss given default, a specific term in finance, is actually quite low, and so they're not really booking substantial losses on that stuff. Where we are seeing more pressure is in the bond market, and particularly the offshore bond market in Hong Kong. A lot of Chinese property developers issued bonds in Hong Kong to raise funds to keep up their operations, but were not able to repay that. And we've had a lot of defaults in that market. And there are a lot of questions about whether those investors are gonna get any money back because they seem to fall much lower in the capital structure when you actually start saying who's actually gonna get whatever money is left over at this company. So, you know, in reality, we've had very big losses, but because the financial institutions are not booking them, this has not become a really big financial crisis problem yet. But we are still in this situation. It is live. It is developing every day. Every month, we've got another one or two companies that are defaulting, and we've got zero COVID going on, which is also creating its own dislocations and problems with growth.
Mcfarlane: I understand how attention may be elsewhere because there's just, I mean, the whole world is on fire in so many ways at the moment. But I mean, you say that the real world impact hasn't really manifested yet because a lot of these losses haven't been actualized yet because they've not been booked by the banks yet. Explain to a lay person what that means. Does that mean they're just delaying the actualization of these losses? How long can they do that? How long can people know that these losses are coming, but they're not sort of, they're not booked yet? I mean, how does that work? And when will these losses be actualized?
Chu: So I think part of it gets to what I said in the beginning, which is the banks feel more comfortable because these are collateralized loans. It's one thing if you are a bank and you lend money to a company and there's no security behind it. So if they default on it, you are not able to seize any collateral or any assets related to that. This is a situation where there is collateral. It's actually the property behind the loan, and therefore, the banks are saying, even if they default, we'll take the building, and we'll sell the building. And the loss that we will actually incur is gonna be far less than what you would think. So we're just so early in this process of these defaults happening, and restructurings usually take quite a long time, that we haven't really gotten to the point of saying, okay, well, what really is gonna happen with that building? Okay, maybe the bank is gonna take that over, and then they're gonna have to net out, well, what did they get back on the building versus what was owed and that type of thing. But we're just not through that process yet, really. The other thing, which I think would have to be a bigger risk, but the question would be, would people, individual a Chinese individual start defaulting on mortgages? And that has not been happening yet, but again, is also a risk in this climate where, as I mentioned earlier, we've now got unemployment at 6.9% in the top 31 cities. We've got negative growth of retail sales, but deeply negative growth of retail sales the last two months. We've got zero COVID. We've got property sector that is almost dead and barely growing and used to employ huge numbers of people and a lot of downstream industries for furniture and home goods and electronics and appliances, all of that is getting impacted by this property slowdown. And that's why I think we're still early in the game here. We don't know where this is gonna go, but it is very significant.
Mcfarlane: Right. I mean, you say that the fact that the banks have collateral on these loans is sort of staving off things going to meltdown for now. But one of Xi Jinping's policies, particularly this party congress that he is so focused on at the moment, he's got this project on common prosperity. And part of that is, I believe he's actually trying to cool down the property market. He's trying to lower house prices. So if collateral in the form of property is the security against these loans, what happens when the government tries to depress house prices to try and make housing more attainable for the Chinese people? I mean, what happens in that scenario to this capital and the security of these loans?
Chu: So you've definitely highlighted an area where things could start to get a lot more ugly, and that is do the banks at some point have to start revaluing that collateral lower, and therefore, they will start to realize they're not covered as well as they thought in that loan. We have never been here in China, so this is totally new territory. We don't know how the banks are going to be with collateral valuation. What we do know is the official data on property prices has been telling us on a year on year basis that prices in tier one and two cities are still positive growth, and it's only the smaller cities where we've seen negative growth. We have an alternative indicator that was telling us we're down about 11% year on year through May. So a more meaningful correction, which I think lines up better with what people observe on the ground. But I think the bigger point that you made, which is really important, which is this is a government initiated property slowdown. This has been going on for well over a year now. This is their intention, but it is creating a dramatic pullback in this market. It has been said that Chinese property sector is the most important sector in the world because of how much it consumes in terms of commodities, how important it is to the domestic economy of the second largest economy in the world. What we have seen since last spring is sales are down 16% from their peak. New starts are down 24% from their peak, and we've got the price correction of 11% that I just mentioned. And we have 30 companies who've defaulted with total liabilities of around 1,000,000,000,000 US dollars. So this has been a really painful campaign, but the authorities are sticking to their guns on it. And I think they are doing the right thing. And the reason I say that is I'll just lay out for you how ridiculous some of the numbers were. So on a per capita basis, if we go back to last March, China was building the equivalent of about 18 square feet in property for every single person in that country, and they have 1,400,000,000 people. So the amount of building that was going on was enormous. And if you think about the idea of, well, we'll just let it continue to grow 5% a year, well, then five years later, you're looking at 23 square feet per person. Another five years later, it becomes 29 or 30 square feet. And we need to keep in mind the declining demographics in China. The total population is believed to have peaked last year. The working age population, which is really the property consuming group, peaked in 2015 at 801,000,000 people and is already down 20,000,000 people since 2015. So we would be talking about an astronomical amount of property growth that would allow property construction to continue to grow to even more unbelievable levels at the same time that the population is declining, and you just can't consume all of that.
Mcfarlane: I think that's also fascinating and also terrifying in equal measure. And I think it's really important for listeners around the world to understand, because I feel like there is this misconception about China and its economy and that Chinese growth is not actually built on manufacturing, being the world's workshop, exporting Chinese made goods all over the world. I believe its driver of growth is property, as you say. And I think that's a staggering statistic of how frenetically it's been building per capita. That's an insane amount of building. A lot of reasons to be concerned. That's all my questions. I found that absolutely fascinating. Thank you so much, Charlene. Let's now bring in my cohost, Sir Richard Dearlove, for his thoughts on Charlene Chu's assessment of the risk of China's unsustainable growth.
ANALYSIS WITH SIR RICHARD DEARLOVE
Dearlove: I thought it was a very logical explanation, and then I thought the sort of onward discussion was fascinating too, because it does take us to the central issue, which is the, you know, the extent to which the Chinese leadership, rather than the markets now, are driving the direction of the Chinese economy, despite the fact that when Xi came into power, he made all these optimistic statements about following the market. But then clearly, I think got very frightened, or let's say experts rather got frightened and advised him that, you know, they had to do something radical to reassert their party control. So I think it's almost a seminal interview, because she explains that pretty well.
Mcfarlane: Yeah, I mean, I think what's so interesting is that you see this sort of, you see this conflict between free forces of markets and how they shape us, and how we sort of treat them as kind of like autonomous, almost like sentient things. You know, you have all these experts who try to predict what the market's gonna do, try to, you know, try and read the tea leaves. And then you have authoritarian governments like China and also Russia. We see how the Russians are trying to maintain a grip on their economy, trying to cushion the impact of sanctions by managing their banks and cooking their own books in a way so as to protect the ruble. And, you know, it's so interesting to see how the two sides play out. You have, you know, the Western liberal democracies who give markets a free rein, and then you have these authoritarian countries who try to control the markets, and how that impacts the people who live in those respective countries.
Dearlove: Yeah, well, I think what you clearly had happening in China was, I mean, what's sort of described as a disorderly expansion of the market. And you had a lot of Chinese startups pre the shadow banking sector really being dependent on foreign investment, on sort of cheap money coming from The United States, and also a sort of very libertarian attitude towards the development of Chinese companies, which was seriously sort of at odds with what the party's longer term plans were. And once you get beyond the sort of first stage of the development of the sort of internet platform companies, which everyone was very enthusiastic about, and then the Chinese getting very afraid. And of course, you know, what's so symbolic is the way that the Chinese leadership go after somebody like Jack Ma and Alibaba, yeah, stop the flotation of Ant, at the very last moment, you know, when you're on the cusp of what, $37,000,000,000 flotation of a company. It's absolutely fascinating. I mean, quite a long time ago, I was at a, I was asked to speak in Switzerland at a global wealth conference organized by Goldman Sachs, and there weren't many people there. They were a very sort of exclusive group of guests, one of them was Jack Ma. And it was fascinating spending several days with him, because he was at the sort of beginning of his mega success then. And he seemed actually such an unlikely figure to become this huge, you know, entrepreneur and to develop this very dominant position in the Chinese economy. And I must say, I thought afterwards, I wonder how long it will be before the Chinese, you know, want to rein him in and, you know, make him feel the power of the state. And they've done that to so many of these sort of rapidly rich entrepreneurs who they've really had to sort of grasp and control to make sure they didn't become too independent figures. I think it's absolutely fascinating.
Mcfarlane: Yeah. So I mean, I find it so interesting that there's such a duality. There's such a constant vying for control in China between Xi and between things that give China its success story. So like its economy, its fast growing economy, you know, entrepreneurs like Jack Ma who have generated the wealth upon which China's success story has been built. You have this country which has enjoyed vast amounts of wealth very, very quickly, and a lot of that has been propelled by the power of the Chinese consumer. You know, like, Singles Day sales and Alibaba, property and the quote, the Chinese dream as like a direct, you know, opposite to the American dream. Then yet, you also have this ideology of Xi, which is increasingly sort of morally puritanical. And he's been trying to clamp down on things like excessive displays of wealth and all of these film stars who've come under trouble for their taxes. And it's interesting how, you know, you have this duality in modern day China. I mean, the idea of a communist version of capitalism. I mean, what does that even mean? And we're seeing the struggles of that sort of paradox play out with things like, as you mentioned, killing the IPO of Alibaba and clamping down on all of this, it's fascinating.
Dearlove: Well, I think that, yeah, there are two aspects to it, because you've got the Chinese Communist Party making sort of moral statements about excessive wealth, then also making statements about, you know, young people not spending too much time on social media, and taking a very, very clear stand on that. But on the other hand, I also think that you have a shifting view amongst the Chinese leadership of their strategy for the economy, so suddenly you get emphasis from the leadership for investment on things which they see as crucial to the strategic development of China, and I'm talking about defense and national security. So you get a move away from sort of social media internet platforms, and suddenly you're looking at things like quantum computing, artificial intelligence, genetics, I mean, things, and then data manipulation, so things that have a clear strategic importance for China. And then you see the party trying to steer and encourage and also actually being active in terms of investing in the bits of the economy it sees as important. And I think the other aspect to this, which is fascinating, is that I think a lot of domestic wealth in China has been tied up with the property market. You have an excessive expansion of the property market, but suddenly Chinese population actually is beginning to fall. So where does it, you know, if you have an excessive supply, where does it go next? And I mean, you discussed this with Charlene Chu and I thought it was fascinating, the whole business of Evergrande and, you know, the sort of uncertainty that has suddenly entered the issue of property ownership, and, you know, whether investment in property is going to sustain its value and what the long term impact of that is. So I mean, I think in a way, one could argue now that, you know, the Chinese economy is really on the cusp with this huge sort of state intervention, which dates back to 2017 and has got more and more emphatic and more and more precise, and in a way the whole system much more authoritarian. I mean Deng Xiaoping famously said, it doesn't matter whether the cat is black or white as long as it catches mice. What you see with Xi is he's saying, well it does matter what color the cat is, and we're bloody well gonna make sure that it's the color we want it to be, and it's going to be catching the mice that we think are important. So it's a huge shift in, I think, the Chinese leadership's psychology towards the market. And now it coincides with, you know, a massive change in the international economic situation with the end of liquidity, well, end of, you know, a very loose liquidity, quantitative easing, and a deterioration in globalization, and probably emphasis on the West of diversifying away dependence on the Chinese market. So in a way, you've got two developments intersecting. You've got this authoritarian view of the economy plus international developments. And I think it means that the way forward, and hats off to Charlene Chu because in a way her commentary, which I think is so impressive, really anticipates this shift, which from very, very early on, she's talking about the economy in quite a critical way, pointing out, you know, where the weakness is and where the shift in emphasis is going to occur.
Mcfarlane: Yeah. And I think this has profound implications for the future of China and the future of the Chinese Communist Party. And you, Richard, you have said quite a few times that you believe that Xi's grip on power, the Chinese Communist Party's grip on power is not as strong as a lot of people in the West take it for. And I think this issue is so key because money talks. Currency is the most important currency when it comes to maintaining your grip on power. And how many revolutions, revolts, rebellions have we seen around the world that have been sparked by financial crisis and people feeling the stress on their wallets. So, from the Arab Spring, it was a stress on everyday people's finances. And what this is going to really test is whether the average Chinese citizen is as fully invested in Xi's ideology and what the party stands for, versus their everyday livelihoods, the ability to put food on the table, their economic prosperity. And so when we see things like, as you say, the property market where so many ordinary Chinese people have invested their wealth, a lot of them, more than a million Chinese families have bought properties with Evergrande that have not yet been built. And for this company to be on the brink is excruciatingly worrisome for these people. And so I think, you know, Xi can have his ideology and he can have his own philosophy about how best to manage the economy. But if he doesn't provide financial stability for the Chinese people, that is when his real grip on power and his communion with the Chinese people will really be tested.
Dearlove: Yeah. I think, I mean, the Chinese have been massively successful at lifting millions of people out of poverty. And you have to credit them with that success. But in parallel, since Tiananmen, they're terrified of losing control of the country, you know, and they almost lost control of it during Tiananmen, and I think that's why the reaction to Tiananmen at the time was so extreme and so decisive and so rigid, as it were. And I think that that still haunts them as, you know, a possibility. And you're absolutely right, the problem is if you've been lifting out of poverty and you've been making people wealthier and, you know, they have investment in the property market, in a way, you need to go on doing the same. And you need to continuously build on your success. And at the moment, I think we would all look at the Chinese economy and see clearly where the fragilities are. It doesn't mean it's gonna fall apart or but, you know, certainly, you know, if there were to be a massive property related crisis, I think that would provoke all sorts of problems. And I think at the moment, because of this shift in emphasis in the global economy too, it makes China much more vulnerable to what happens, you know, in its domestic market and what happens at home. So we'll see. You know, I think we've so much assumed that China's rise is sort of mono directional, i.e. it goes up, it gets more powerful, it gets richer. And I think I've said to you a number of times before, I think that assumption is probably flawed, because if we think that China is going to avoid sort of internal crisis, I think we're being naive.
Mcfarlane: Right. And I mean, much of this expectation of everlasting Chinese growth is so baked into our international structures, and how the business plans and business models of so many industries that rely on ever increasing appetite from China. But I think you're totally right that, you know, the situation in China is fragile. It's tenuous. But what does that mean? I mean, we're not here either of us saying, you know, the Chinese property bubble is going to, you know, lead to the downfall of Xi. No. But what is gonna be really, really interesting is how does Xi and how does the Communist Party deal with disgruntled Chinese citizens? Because he has developed this zero tolerance of dissent, of any form of democratic engagement. How does he interact with Chinese people who are not happy at some of his policies? What happens when the Chinese start losing their money? They start seeing their savings wiped out because the companies from whom they have plowed savings into buy properties have folded before their properties have been brought into existence. So they lose that investment. And then all of a sudden, life savings are gone and they are unhappy with, you know, a lot of the direction of the Chinese Communist Party. How do they express that? How did Xi backtrack on some?
Dearlove: Yeah. But I think that if we, I think what we understand is that every morning in what's called the fishing platform they review, you know, what's happened in China in the last twenty four hours. And there are all sorts of tensions and problems that we never hear about, we never learn about. And a lot of those are to do with social unrest on a small scale and, you know, labor unrest in various areas of the country. And I mean, the Chinese, you know, in their minds, the leadership aggregate that and are very, you know, worried about what the implications may be. And generally, they're reacting to these minor crises, but there are an awful lot of them, like fires breaking out and needing to be put out so that they don't become a general conflagration. And I think, at the moment, probably we've seen quite a lot of social unrest and tension during lockdown in Shanghai, evidenced on social media. But I'm sure a lot of that, you know, has been also suppressed, so that in the West we're not aware of the detail and we don't really see what's happened. But, I mean, you can see the complexity of these issues. Of course, the economic knock-on effect globally, the shutting down of bits of the Chinese economy, has been huge. And in a way, it shows the vulnerability of our economies to dependence on Chinese manufacturing. And I think one of the consequences over time of where we are now is going to be diversification of manufacturing away from China. I think a lot of Western businesses are going to think again about their policy. And, you know, that too has huge implications for the Chinese economy. I mean, the other thing about, I think, understanding China, and this is from, you know, talking to people who are much more expert than I am, you've got this tension socially because you've got this continuous stream of labor coming from the countryside and being absorbed into an industrial economy. So you've got the development from agricultural aspects of the economy, and that's almost like a continuous belt. But I think one questions now whether that era is coming to an end. I mean, the world has benefited hugely over the last, let's say, thirty years by the addition to the global workforce of China and India, where you've got rural peasantry becoming industrial workers. That process, in terms of the benefit to the global economy, is coming to an end. So I think we are at a pretty seminal moment, and of course everything now is suddenly exaggerated by these global tensions generated by Ukraine, by COVID, by lockdown, by higher inflation, and by, let's say, a deterioration of globalization too.
Mcfarlane: Yeah, I mean, you're so right to point out that the rural urban inequality in China is a vast chasm. And so, you know, that leads to all kinds of societal tensions and issues that spawn from that. Then an obvious question that follows on from that is, what happens, you know, in the years to come when a country that has built a lot of its wealth from manufacturing and from cheap vast cheap labor, such as you point out, what happens when a lot of that labor is replaced by robotics? You know, what happens when the workforce is going to need to change much as it is in a lot of countries in the West. But when you have a vast population with a lot of regions full of inequality, you've got sort of varying levels of education. What happens then? How does China adapt to survive technological advances in the future? And that's not even to consider the rivalry and the threat of tech barons and what challenge they will pose to people, to autocrats like Xi. I mean, there is just so many extremely important moving parts that make it very difficult to try and see what direction China is going to go in.
Dearlove: Yeah, but I think now you see clear evidence of that anxiety with the leadership, Xi Jinping, trying to steer domestic and international investment in the Chinese economy towards the sectors that the party sees as crucial and strategic. And they are very much about defense, about national security, about, as it were, augmenting the power of the state and not allowing these sort of independent companies to create bubbles which have little strategic benefit for their vision of China. And I think in a way, you know, for that reason we're sitting at a crossroads, and obviously, you know, COVID and the zero COVID policy has aggravated this and also massively increased the sort of autocratic power of the state. I mean, just like in the West, you know, lockdown and everything, we've lived through unprecedented times in terms of the state's control over the lives of private citizens. But, you know, if you look at what's happened in China, the mere if you were ill with or you tested positive with COVID, you didn't stay at home, you had to go into some government controlled quarantine and stay there for a considerable amount of time. I mean, it's pretty extraordinary the way they've dealt with this. And I mean, is he going to lose the COVID battle? I mean, Omicron is so infectious, I would have thought that their chances of actually being successful must be limited. And what do they do? Lock down harder and harder and harder to try to stop this. Maybe at some point, anyway, there'll be a new variant and they'll have another battle on their hands.
Mcfarlane: Yeah. I think a real problem for Xi is the way he has presented himself as an infallible authority. And, you know, one who implements policy with a voice speaking ex cathedra like the pope. And, you know, what happens when he is forced to backtrack on a policy? When it becomes so damaging to the economy and to China's interests, to its foreign investment? What happens when it gets to the point he has to backtrack? Can he do that? Will he allow himself to backtrack? Because that will shatter his extremely carefully built image of always getting it right.
Dearlove: Yeah. I think that's, but you put your finger on the problem. I mean, it's a very brittle system. You invest all your authority and energy in a policy, and in a way there's no reverse gear. How do you get out of it if you discover you've done the wrong thing or you've made the wrong set of decisions? And I think in a way Xi's invested hugely in this zero COVID policy. Right? I mean, I think the problem the Chinese have got specifically with COVID is that, as I understand it, you've got an aging population because of the one child policy. You've got a lot of cultural resistance to being vaccinated. In addition, you've got a Chinese vaccination that doesn't work very well. So the problem is if you let COVID rip in China, the fatalities are likely to be very, very high because of the ineffective vaccine and the aging population. So you can understand in a way why he sort of fixed himself to, you know, zero COVID, because in some respects it makes sense, and of course, if you had huge fatalities in China, that would really undermine the authority of the party and create these tensions that we're talking about. But I mean, I think it's fascinating because if you think this through, and you think through the other aspects of the Chinese economy we've just been talking about, you know, China is not some solid monolith that, you know, is sort of set on this road and is going to roll forward and nothing's going to stop it. My god, they've got problems. And I'd rather have our problems than their problems, if you see what I mean.
Mcfarlane: Yeah. Well, I'd also rather have our problems than America's problems right now, but that's a conversation for a different day. That's it for this week's episode of One Decision. You can stay up to date on all our latest interviews and analysis by subscribing to us wherever you get your podcasts. Search One Decision Podcast for our exclusive behind the scenes from the recent historic NATO conference in Madrid. We sat down with world leaders, ambassadors, and senior ministers across the alliance. How prepared is NATO to take on Putin? Will Ukraine prevail? And what is the cost of sanctioning Moscow during a global energy crisis? We cover it all. From me and the team, thanks for listening. See you next time.
