Episode Info
- Season23
- Episode1
Hosted by Christina Ruffini and Sir Richard Dearlove
Guest
Charlene Chu
Charlene Chu is a world-renowned economic analyst whose warnings in 2014 prompted the Chinese government to change economic policies and returns to One Decision to discuss Evergrande as the canary in the coal mine.
Episode Summary
Charlene Chu, the world-renowned economic analyst whose warnings in 2014 prompted the Chinese government to hastily change their economic policies, is back on One Decision to discuss the fallout from the liquidation of the Hong Kong assets of Evergrande, China’s massive, troubled property developer that she described as “the canary in the coal mine”. As scores of developers default on their debts, countless Chinese homeowners see the value of their savings and assets plummet, and the CCP considers putting foreign investors on the hook for massive losses to protect the domestic market—what are the global ramifications of the property market crisis? Chu’s analysis on the latest stage of the crisis comes with a dire warning of a different looming challenge, one that could be an even bigger catastrophe for China—and the world—and is coming down the track soon. Plus analysis from One Decision’s Sir Richard Dearlove, the former chief of MI6.
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Transcript
INTRODUCTION
Mcfarlane: You're listening to One Decision. I'm your host, Julia McFarlane.
Dearlove: And I'm Richard Dearlove, former chief of British intelligence, otherwise known as MI6.
Mcfarlane: Together, Richard and I look at the key strategic choices and decisions that have global impact. We hear from the key decision makers, players, and experts how they arrive at the choices they face and how they impact us all. When it comes to the Chinese economy, one of those experts really comes to the fore. Charlene Chu, senior analyst at Autonomous Research, is often described as the world expert on the Chinese economy. Now it's no exaggeration to describe her as such. Ten years ago, she was one of the first to issue a stark warning about the Chinese economy, specifically about the danger posed by China's massive shadow banking sector, which was hiding an extraordinary amount of debt. She made global headlines, but more importantly, her analysis actually prompted the Chinese government to take action and start to reform the sector. Two years ago, we spoke to her about the Evergrande property crisis, and she gave us this worrying prediction.
Chu: 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: We decided to catch up with her again now that news finally came recently that a Hong Kong court had ordered the liquidation of Evergrande and its assets in the city. Charlene and I caught up a few days ago. And as always, stay tuned for analysis from my co-host, Sir Richard Dearlove, after the interview.
INTERVIEW
Mcfarlane: Charlene, it is a pleasure to have you returning to One Decision. A lot has happened since we last spoke about the Chinese property bubble. Is that liquidation of Evergrande as a symbol of these financial troubles for Beijing? Or is it just something that the media has fixated upon because it was an easy reach, an easy story to tell?
Chu: So I think it really comes down to are the offshore investors that are holding many of those bonds that Evergrande defaulted on, and has now been put into a winding up situation. Are they going to be able to access the 90% of assets that are onshore? And the assumption in the market, and I would agree with this, is that it would be so destabilizing for domestic Chinese authorities to allow foreign investors to have access to these assets and wind those down and liquidate them and get their hands on the cash that it is very unlikely that that is going to happen. And how are they gonna treat Evergrande? And the assumption is, you know, whatever precedent they set for Evergrande will continue on for all of the other big players that have problems like Country Garden, and then people will know what's going to happen. So there is a chance that this could be very significant, but the reality is there's not many expectations that they'll allow access to the domestic assets. And a key reason for that, just to give some background on this, these developers in China have presold millions of units two to three years ahead of delivery and have not delivered them because they misappropriated the funds in the escrow accounts. And so there are all of these units in China that are still unfinished. And if the authorities were to allow some of these companies to be truly wound down right now, there would be a lot of questions about how are these units ever gonna get finished. So they need to have the developers still operating to a degree, and that's why it's hard to see how they would allow a liquidation to happen domestically.
Mcfarlane: You've said a bunch of stuff that I wanna follow up in different sort of subject matters. I'll start with, you mentioned the liability for the foreign investors who have stakes in Evergrande. And it's interesting because before this liquidation order was announced, I was reading some analysis by another economist specializing in China, George Magnus, I'm sure you know him. He was saying before this happened that the CCP were unlikely to bail out Evergrande. They weren't likely to reward this property with cash having done such a dismal job in the last few years. He said that the most likely scenario was that foreign bondholders would be the ones on the hook for the losses. And so, obviously, you mentioned that the Chinese would not want foreign investors to be able to divest and get their assets out of Evergrande before it was too late. But if they are on the hook for those losses as a way to protect Chinese citizens, what are the ramifications of that? Because obviously the CCP are trying to balance a lot of different things, but undermining confidence in China as a place of investment is also damaging, is it not? What do you make of this route that the CCP may go down?
Chu: The biggest ramifications of allowing a disproportionate share of the losses to be imposed on foreign investors offshore is that, of course, you damage their sentiment. And you make it very clear that they do not rank nearly as high in the capital structure as they think they do. And chances are, in the future, they will get hit with the losses first. We have not seen very much bond issuance offshore in China the last couple of years given everything that's been going on. But if we ever get back to the point where that market is open and active again, I would assume that the interest rates are gonna have a higher margin than they used to because of this increased risk of not being able to get your hands on the assets. And there's always a risk because of this in the extreme scenario that foreign investors just sour completely on Chinese bonds just saying, you know, unless the assets are offshore that they can feel that they have more access to in the event of a default. But it's always possible that the foreign investors say, look, we don't even really wanna get into this situation anymore where we're trying to go after assets onshore that we're never going to be able to. So it's also possible that the market just shuts down to Chinese issuers offshore.
Mcfarlane: I read in Bloomberg recently that foreign businesses' direct investment into China last year increased by the lowest amount since the early 1990s, underscoring challenges for the nation as Beijing seeks more overseas funds to help its economy. The problems that the Chinese are currently facing with dealing with the economy, the fact that it's growing a lot slower than it has in recent years, and that there is all this unhealthy debt and all these expensive debts that households as well as the government needs to service, which is further hampering its growth. Is this a hole that China can dig itself out of with a decreasing amount of overseas investment?
Chu: There's a lot behind why foreign investors have soured on China, and there's the portfolio investors, which would be the equity and debt investors, but also the multinationals and the FDI that you just referenced has also turned negative, net negative in Q3 for the first time. Q4 was positive again, but still this is at very reduced levels versus where it used to be a few years ago. So this is a very significant change in China. And in my conversations with foreign companies on this issue, a lot of it has to do simply with the fact that there is a recognition by these multinationals that the China growth story and the China revenue opportunity isn't what it used to be, and they need to be looking elsewhere to invest. This isn't the only place in town in terms of where they can expect, you know, a good runway for growth over the next couple of decades. And then you layer on top of that, of course, the pressure to diversify supply chains in the wake of all of the issues that we had during the pandemic. And then the last issue, I think, is we start getting into some of the geopolitical concerns that people have, and the experience that occurred with the Ukraine invasion and how so many western companies wound up having to exit Russia very rapidly and realized they had not really optimally set up their operations in Russia to handle such an exit scenario. We've now got multinationals also looking at, well, one day are we potentially gonna have to exit China? And if so, how do we want everything structured onshore? So all of this has been contributing to outflow of money or a net reduction in inflows of FDI versus where we've been in the past. And I don't think this is necessarily ending anytime soon. I mean, these are all bigger trends that I've been talking about that will be continuing for a while. So that is gonna be difficult for China because one of the things we've been pointing out for people, why growth just continues to be so disappointing, why the various stimulus measures the authorities announced don't seem to go anywhere is because a lot of holes in activity have been created over the last few years. And when you sum those up, they are not small. And these very incremental things authorities are trying to do to reheat growth just don't go toward filling them. But one of the holes is that we are now in a situation where we are no longer looking at a country that's receiving several hundred billion US dollars in FDI annually. It's actually much lower, and there's a risk of it going negative on that front, not to mention all of the equity and debt outflows that we've seen on the portfolio side. So there are a lot of things at work here, but this is why the authorities are struggling so much to have traction in turning things around. But we are in the middle of a massive and unprecedented property collapse that is still really the main thing that is weighing on the economy at this point.
Mcfarlane: And so where are we at the moment with the property crisis? I mean, in 2022, we saw protests in China. We saw people were boycotting their mortgage payments because they were paying for, as you mentioned, presold units, presold housing units that had not yet been made but were owned by property developers who had gone bust. There was a lot of unease. And of course, that is a huge concern for Beijing. This liquidation of Evergrande only in Hong Kong is a big splashy headline. You've explained why it's not the big bang that perhaps everyone was waiting for. But how are things at the moment?
Chu: So to be honest, I mean, we are now entering our third year of this. And to be honest, there has not been much improvement at all. Things have on almost every parameter gotten worse. So we are now in a situation where new starts, so this is new property starts by developers, are down 60% from their peak, got sales that are down about 43% from their peak. This is all on rolling twelve month basis. Property price declines are actually steepening over the last several months. January was different. We just got a data point that was a little bit better, but still we've had some very steep price declines in recent months that is keeping everyone on the sidelines because nobody wants to come in. Even though prices have come down a lot and down payment requirements have come down a lot, no one wants to come in and buy something that may be worth 10% less a year from now. So everyone is staying on the sidelines due to that. And then there's another issue that I think has emerged more recently. This was not an issue early in the property crisis. But one of the things that a lot of people don't understand about China is if we go back, let's say, fifteen or twenty years ago, this market was almost entirely new homes for sale. This was not a market that had almost any existing home sales to speak of. And, you know, if we look at someplace like The US, existing home sales are about 87% of all home sales in The US. In China, it would have been the exact opposite, let's say, fifteen years ago. But one of the things that's happened during this crisis is a lot of people realize they're holding excess real estate. They wanna get out. They are selling it. We therefore have had an influx of units onto the secondary market. And now people are looking at that and saying, well, why would I even take the risk of pre-buying a unit two or three years early when the developer may default when I can just buy something on the secondary market that's an existing home. And so that is also starting to attract away a lot of activity. So in the background, what is continuing to happen is just weaker sales, weaker new starts, less cash going to developers, more of them defaulting, not even being able to meet some of their restructured debt agreements and, you know, continuing to have problems there. And then we do have what you had mentioned, the mortgage boycott movement, which broke out around July 2022. The authorities have been emphasizing that developers need to finish their units, and there is some progress on this front, but nowhere near what we would have expected. To be honest, when that movement broke out in July 2022, I thought, okay, this is finally what is gonna make them panic and what is gonna make them say we will just create a fund. We'll put in a few trillion renminbi to pay for all of this to be done. But they haven't done that. The banks have been reticent to lend for these projects because they're saying, where is the money coming to repay the loan? Because the unit was already paid for and you misappropriated the money. So we're just in this logjam where the authorities are failing to really get any traction on anything. And in the meantime, the market just continues to deteriorate. The hope is that we will hit some point where we get to a level of demand where we can't see sales coming down any further. But to be honest, when we've looked at property corrections in other markets, this can go down way beyond where the natural level of demand would be. Because again, everybody just gets spooked about is now really the time to be buying. So I still think there is a lot of room here for continued pain in the property sector throughout 2024.
Mcfarlane: And overall, the picture is still bleak and there's still a big depression in the overall cost of homes. You said just then there is still room for a lot more pain to be had when it comes to the property market. I suppose my next question is how far does the road go and what breaks the camel's back? You must find it so wearisome when journalists keep grasping for metaphors about growing bubbles that burst, the balloon that pops. But I am interested in what the outcome is. If things do not improve, if things continue to get worse, if all of this unhealthy debt continues to grow and spiral out of control, what breaks the camel's back in that situation? Is there a real, all of a sudden, like, I don't know, like a Lehman Brothers sort of moment for China when the contagion just spreads and it's out of the control of the CCP? Or is it more an emotional stick that breaks the camel's back?
Chu: I think in any other country, given all of the pressures that the property market has been under, we would have already had a financial crisis. That has not happened in China for a number of reasons, and I suspect those reasons are going to continue to contribute to financial stability. But one of the reasons is that developers actually have much less debt than people realize. Only about 17 trillion renminbi in explicit debt that we can see in terms of bank loans and trust products and this type of thing, and that compares to a total debt stock in the 300 to 400 trillion range. So this is really modest. When we look at the defaults on the property bonds, most of the defaults have been on offshore bonds. The defaults that have occurred onshore, they are starting to grow just over time. It's hard to avoid not defaulting onshore. But the reality is that Chinese real estate developers have only issued 2% of total corporate bonds outstanding in the market. So even if 50% of the bonds were defaulted on, that's still just 1% of the issuance. So there are some reasons why the contagion here has been very limited, and I think that those are going to continue. On top of that, we have a situation where the regulators have told banks, if you've got a nonperforming loan to a developer, you don't need to mark it as nonperforming. So we call that forbearance. You can mark it as nonperforming if you want to and some bigger banks are doing that. But we have, I think, a lot of smaller banks that are not by any means acknowledging all of the bad debt on their books from this. And if we stay in this type of situation where the authorities allow that to go on, this can go on for quite a while before we get into any type of financial instability. That means, well, what could trigger bigger problems in this space? And I do think the growth side, and this has always been our argument for a very long time. We've been talking about all the debt problems in China and how risky they are. But, really, our view was that this will play out as a growth crisis, and that is actually what is happening right now. And I think the risk, let's say, over the next five years, is that growth starts to slow down a lot more rapidly than people think is possible because all of these debt problems are weighing on things. And Japan was a very good example of this. They had a bursting of the property bubble. They had a shift in the demographics. They were entering deflation, and they started to have all of these banking sector issues that were then contributing to the deteriorating macro environment. And it's really not until you clean up the banking system that you can move forward from those things. But I don't get any sense that China's authorities are remotely close to recognizing the debt problems, truly recognizing them, and clearing them out of the system. I hope they get there at some point, but that is not something on the horizon for 2024. So that leaves us again with, you know, the most likely triggers of a problem are gonna be negative growth surprises. So what happens, for example, retail sales growth last year was 7.2%, but that was after 2022's reopening in the low base. And so that was understandable. We think it's gonna be in the 3% range this year. But what if it comes out and we start seeing 1% numbers, one to two? You know, the market is really gonna start saying what is going on in China. There will be another layer of loss of confidence, and we will have issues there. You know, a second scenario would be what happens with this strategy of just manufacture all that you can to get the output to market as GDP that is way beyond domestic demand and then just dump it in other countries. That's clearly been the strategy here for a couple of years, but we're starting to see more pushback from other countries. So what happens if the EU stands up and says, no, we're not going to allow large exports of EVs and other countries, you know, step up and say, no, no steel dumping, no wind turbines, no solar. All of this stuff will start piling up in China. It will lead to a big wave of deflation domestically, and they will have to start closing plants and laying people off. So there are risks here, I think, on the macro side over the next few years that could lead to a bleaker picture than this, you know, gradual deceleration in growth that we're clearly in right now that I think could be shocking. To your questions about social instability, I lived in Beijing for eight years. My takeaway from that experience is Chinese people have a really high threshold for hitting the streets because of the consequences from Tiananmen. It took them almost three years of zero COVID before they hit the streets. Right? I mean, think about that. In any other country, that would have been happening in mid 2020. I don't feel like Chinese people are there yet. They may be someday they do hit the streets over all of these economic issues, but I don't feel like they're there yet.
Mcfarlane: I think they'll need to be pushed even more before we would get to that point given the consequences these days. What a fascinating answer. And those potential illustrations that you give about, you know, what happens if we get to 1% or 2% growth and what that means physically is very hard to imagine in actuality, but of course anything's possible. You mentioned briefly countries having, in some cases, de-risking or trying to onshore more of their supply chains and how that impacts China. Obviously, that is happening. But what is also happening is countries are continuing to do business with China. A growing number of Latin American countries have reached agreements with China. Brazil is trading with China. They've agreed to trade in their own denominated currencies, cutting out the dollar. I thought that was something really fascinating and potentially very concerning for The US, likely to see that with more bilateral trade agreements. Just in the last few months of 2023, we saw Serbia, South Africa striking recent trade deals with China worth billions of dollars. There are a lot of countries that don't yet seem to be worried about some of the hazards of doing business in China. They still see that there is money to be made, at least in the short term. What do you make of some of those recent announcements?
Chu: I would say that a country like The US, or let's say Brazil, let's take those two examples, The US is facing a very different set of risks related to China than Brazil is. There is a real possibility that there is going to be conflict, military conflict between The US and China at some point over the next twenty years over Taiwan. Hopefully, that is a low probability, but still, I think there is a chance of that happening, and that doesn't necessarily exist with Brazil. And so it's very clear that China's game plan here is to try to create a different orbit that can substitute out for declining business with the West. And that orbit is predominantly emerging markets and the hope is that, you know, these are young and rapidly growing economies. And fifty years from now, they'll be very important. And, you know, we invest now, we get our foot in the door, and decades from now, this will pay off. And I don't think that's necessarily wrong at all. I can see why China is strategically doing that, and they are having quite a bit of success in the emerging world in that regard. I think one area that will be interesting though is what is gonna be happening here to the dumping issue because we are starting to see complaints not just, you know, The US, of course, we've heard for a long time, but not even just in the EU. We're starting to see, you know, Brazil, India, Thailand stand up to dumping of various goods in their markets. And I think it'll be interesting to see over time, do emerging markets start to realize that there is, you know, a negative impact from some of the business that they're doing with China in respect to the damage to their own domestic industries.
Mcfarlane: Can you go a bit more into that kind of dumping? What kind of, I mean, you mentioned like wind turbines and big, so obviously, like steel and that kind of big industrial manufacturing content that China mass produces and ships around the world. That kind of stuff being dumped around different countries because the other thing that has been going on is China's been getting very, very involved in Africa. It's wanting to secure access to a lot of rare earth materials because one thing that we are never gonna stop wanting to buy is electronics and that kind of stuff, which, you know, so much of the iPhone is manufactured in China, for example. This dumping, what kind of stuff does that involve?
Chu: So I'd say the stuff that creates the most tension in other countries is definitely steel. So there was an issue last year where, you know, with reopening, everybody thought, okay, China's coming back and property market will bottom out, and we'll have more construction. And then, of course, that did not play out. Property continued to worsen, and yet iron ore prices remained elevated. And, you know, people were starting to say that, you know, this isn't playing out in commodity markets the way we would have thought if the property crisis is deepening. What is going on with, you know, steel remaining relatively robust? And effectively, what was going on was, you know, Chinese authorities deciding that they did not wanna close the steel mills on top of everything else. And basically saying, just keep producing. Just keep producing and we'll figure it out in terms of where we're gonna sell this stuff. And so it just started moving into other countries effectively as dumping. On the EV side, I would say is the biggest headline these days in terms of what is China really trying to aggressively push in terms of exports. But in one year, to surpass Japan as the world's leading exporter of autos is really a remarkable thing, and China is ramping up to increase that even further this year and the next year and the year after that. So I think this is clearly part of the strategy to offset some of the growth pressures.
Mcfarlane: That's interesting. I wanted to ask you about EVs because I think the headline of Chinese EVs outselling Tesla, that was quite a moment that was marked. Even someone like me that doesn't always check in with the business news, I thought that was a really, really striking moment. And, you know, I have to be guilty in this. I don't have an EV, but I did test drive a Polestar, and it was the nicest car I'd ever been in my whole life. I absolutely loved it. Would buy that in an instant if I could afford it. You talk about, you know, if it is a strategy to offset, do you foresee a situation where the Chinese government decide, okay, let's cut our losses. Let's shutter a lot of our steel manufacturing output and really throw our growth strategy in things like EVs, like laptops, like computers, tech that the world is hungry for?
Chu: I think they would love to do that. And I think, you know, let's say in 2024, if the EU does not push back aggressively on sales of EVs into Europe, I suspect we're gonna continue to see those numbers rising in terms of Chinese exports into Europe. And that may ease some of the pressure in terms of, well, we've got to keep the steel plants open as well. So I don't think they want to be in this situation where they're saying, let's just overproduce way beyond what we would ever need and necessarily even what the international economy needs as well. So I think they would love to be able to ramp some of that down. But it's very clear that EVs is part of the strategic focus here for the next decade or two without a doubt. And to be honest, China has really achieved a lot on that front, and I think they do, you know, deserve a lot of credit. There's been tremendous innovation there. And, you know, we've got products that I know people have test driven a lot of these different cars and just been amazed at how high quality the Chinese offerings are and how much cheaper by multiples, not, you know, 10 or 20% cheaper, but multiples cheaper than some of the western EV equivalents.
Mcfarlane: I found it very interesting when I saw, now a small proportion in terms of the overall figures, but still a rapidly growing proportion of migrants arriving at the southern border of The United States are Chinese from the Mainland. And there are obviously a lot of economic problems, there's a lot of unemployment. It struck me that there is economic malaise that could have that kind of impact of people choosing to leave.
Chu: Yes. I think absolutely. And when we talk about a crisis of confidence in China, and there certainly is one right now because even the consumer confidence data that comes out monthly is basically saying confidence in China is only marginally better than it was during the peak of the Shanghai lockdown in 2022. So it's really remarkable when you look at that chart that there's not been much improvement from those levels. I think there's more to this issue than just property markets crashed and negative wealth effect on households and, you know, tough job market and that type of thing. I think there is also a real concern and fear about where is China going over the next twenty years. What direction exactly is Xi Jinping taking the country and taking the economy? And I think that does create a lot of anxiety in people given China's past, which has been very tumultuous. And it does, I think, incline some people to say, well, let's try to get our money out if we can. Let's try to get out ourselves if we can. And there are certainly some people who have just made the conclusion that they just don't feel like the trajectory is gonna be particularly positive, and now is the time to just leave. So this is all playing out, you know, as we speak.
Mcfarlane: And the longer the economic problems go on, the more the property problems deepen, you know, the more this becomes an issue, I think. I mean, you used to talk about Alibaba and Singles Day and how China was trying to empower its younger people, and, of course, the Chinese dream versus the American dream. I mean, are things looking bleak for the young up and coming Chinese middle class?
Chu: I think they feel from their perspective that things are bleak. And this is why we, you know, hear about the lying flat movement and people just saying, I just wanna check out, and I don't even necessarily want to work, and I'll just be a permanent adult child living with my parents. And I think, you know, the most devastating area where this is taking an effect is in the birth rate. China came out with official data for the number of births last year of nine million. There were reports from other entities late last year that the figure was more like 7.9, and those were removed from the web. But the reason that is devastating is what I tell people is, you know, what China's population is gonna be by 2100 is effectively what is the number of people gonna be born between now and then because all of us will be gone. So the question really is what is the average birth rate over the eighty years? And if you're at 9,000,000 now and slowing or you're at 7.9, you know, chances are China is looking at a six or 7,000,000 average birth rate over the next eighty years, which, you know, puts us in a region of about 480 to 500,000,000 population by the end of the century, and they're at 1,400,000,000 today. So we are looking at an unprecedented demographic decline of one of the biggest economies in the world. This is one reason why foreign investors have gotten so negative on China. It's one reason why foreign multinationals are saying we need to look for other sources of growth because the demographics are so bad. But the young people are critical to this, and they're feeling that there is no hope for them or that they're just not even gonna remotely be able to do as well as their parents did, you know, it is absolutely a factor here contributing to this.
Mcfarlane: God, you're right. It is so bleak. And those anxieties, I mean, there are anxieties that are shared with demographics in countries all over the world, but you're right, I mean, it wasn't just the legacy of the one child policy that gave China a bit of a ticking demographic time bomb. It's also, as you say, people feeling that they can't afford to have families. I mean, that's something that people here in The UK and certainly in a lot of Western countries are sympathizing with. It is really concerning. And you know, when you look at South Korea and you look at Japan and you look at how they are already sort of, in many ways, several decades ahead of our aging population crisis. They have like janitors and they have street sweepers and they have people in their nineties, you know, still working. It's a sad, bleak picture and, yeah, it's something that the whole world needs to figure out how to resolve, really.
Chu: Absolutely. And the aging that is and will take place in China is more rapid than Japan and Korea. And it's one of the reasons why domestic demand is never gonna go back to where it was because the number of employed people in China is down 21,000,000 just from 2019 to 2022. That's a 2.8% decline in the employed population, which is the main consuming population in the country. So there's no way that they can ever really get back to previous levels of consumption when they've got this demographic drag going on. So the authorities are facing a tremendous number of very big issues, none of which are very easily solvable. And I think it's a key reason why progress has been so hard for them the last few years and why it will remain to be that way.
Mcfarlane: Well, Charlene, we asked to talk to you again to discuss one huge economic crisis facing China. You delivered and you've also given me a new economic crisis of China to obsess over for the next few years. Thank you so much. That was such a fascinating discussion.
Chu: Sure. Thank you so much for coming back and joining us again. Thank you.
ANALYSIS WITH SIR RICHARD DEARLOVE
Mcfarlane: So Richard, that was such a fascinating and wide ranging conversation with Charlene Chu. I have a bunch of questions for you on what you make of some of her assessment, but to top it off, what do you think was the headline?
Dearlove: Well, the headline is that the property market in China is in dire trouble, and large chunks of the wealthier Chinese population have their money invested in property. What does this mean for the future of China economically and politically? And how is the average, let's say, middle class Chinese family — I mean it's strange talking about middle class families in China because it's meant to be a communist country, but we all know that family wealth is a really important part of the Chinese system. How are they reacting to the prospects when a lot of them have put their money into property and it's turned out to be an absolutely tragically lousy investment and they've lost their money. So you have this festering situation and there's no evidence yet of a political knock-on. But of course, what happened after the Twentieth Party Congress was that this very, you know, confident presentation of China's future has not been, as it were, evidenced in what subsequently happened to the country since Xi took such a dominant position of leadership. So I think things are probably in a parlous and rather difficult situation. I'm not suggesting one's on the point of collapse or anything like that. But China is clearly entering a very, very difficult economic phase. And the difficult economic phase will be for the Chinese leadership a difficult social and political phase, although the evidence of that will be minimal for us.
Mcfarlane: The other really interesting thing that Charlene mentioned was the potential dumping of mass overproduced Chinese goods being dumped all around the world. And it was interesting because quite recently, actually, that was something that was raised by US treasury officials who were on a visit to Beijing. They warned the Chinese that the West would take action if China, as it tries to dig itself out of its own domestic hole, tries to sort out some of its problems such as its overcapacity problem with its industry, and tries to sort it out by dumping a lot of these goods. Charlene mentioned like wind turbines, a lot of green industrial goods on international markets, that would cause a huge problem for the international community.
Dearlove: I mean, you could go back and say, look, the admission of China to the WTO was a massive global mistake. It didn't look like it at the time. But if you look at the terms of the WTO, its enforcement mechanisms have more or less broken down. So dumping complaints become bilateral issues because they can't be resolved at the WTO, you know, which was a successor to GATT, the General Agreement on Tariffs and Trade. And I think dumping is going to be a huge problem because of overproduction in certain areas of heavily subsidized Chinese industries. Both the EU and The United States now have draconian regulations to protect their own industries against dumping. So going forward, global trade doesn't look as though it's in a very healthy state because you have all the material for massive disagreements and disputes, which are already in evidence to an extent. I mean, they're coming down the track. They haven't arrived in quite this sort of forceful nature that they will become a problem.
Mcfarlane: Yeah. And this is a big issue. You mentioned the fact that China is increasingly signing up new partners in international aid. It's been very, very busy signing up new trade deals with countries around the world, not just around the developing world. They very recently signed a trade deal with Serbia, which, of course, isn't in the EU, but has long wanting to join the EU along with its neighbor that it has a tempestuous relationship with, Kosovo. But that's another story. I think it's really interesting that, you know, you mentioned The Gulf. That, of course, comes off the back of the Chinese brokering the normalization of relations between Saudi Arabia and Iran. And it is very interesting that Xi has been working on diplomacy and trade. And while more than I think 140 countries have signed up to the Belt and Road Initiative in some form or another, while there's a lot of skepticism over that in the West, other countries have not been adverse to it. Other countries are increasingly willing to talk to China. And we just saw just over a month ago, all three candidates who were going for the Taiwanese election, not one of them ran on a we're not going to trade or talk to China, which was quite noticeable and something that actually I thought didn't get enough attention. Even the party that won, the candidate who campaigned on a platform of independence, he was still saying, you know, we should talk and trade with China. It's interesting, isn't it? Is the West being left behind?
Dearlove: Well, I don't think we know the answer to that question. I think what's happening is you've got a sort of realignment of global and international trading links. So for the Chinese at the moment, the GCC and Africa are very much at the top of their priorities. They're using BRI, the Belt and Road Initiative, to reinforce and forge those relationships. There's no question that GCC countries are awash with cash because of the energy market are seen by the Chinese as very attractive partners because of their capacity for investment in maybe BRI projects. But now I think the question is, is this realignment of trading relationships which really is replacing the sort of global trade that we were very much used to as a model pre the financial crisis of 2008, is something different in the process of being created. You know, it's a five, ten year event for this to happen. And as you've mentioned, you've got all the construction pieces in place or available, but it hasn't happened yet. And I think it's very difficult to predict.
Mcfarlane: And, I mean, the last thing that I had to get your opinion of was a topic that we hadn't planned on talking about. But since Charlene mentioned that, of course, actually, perhaps an even more serious economic issue for China that is coming up on the horizon that is going to potentially dwarf all the others is the fact that they have got this absolutely catastrophic demographic time bomb coming up, not just a legacy of the one child policy of yesteryear, but the fact that increasingly young Chinese are rejecting the idea of having families, of having children. They are rejecting the idea of being as economically productive as perhaps the Chinese Communist Party would like them to be. It's causing all kinds of issues. And all of the ways we are seeing an old and aging population manifesting in places like South Korea and Japan, she reckons that's going to be multiplied a million times worse in China and a lot faster too because of the size of their population and how exponentially these problems are going to affect them.
Dearlove: Yeah, you identify and correctly raise a massive problem. It's a slow burn problem, but if you project forward it's catastrophic. And you're absolutely right, China has absolutely lousy demographics, which is mostly the result of the one child policy, but is also the result of the reluctance of young Chinese to have children in the current economic environment in China. And there's not a lot, or there doesn't seem to be a lot at the moment, that the Chinese Communist Party leadership is able to do about that. And of course there is also this phenomenon amongst Chinese youth of what's called lying flat, which is basically trying not to get involved in, you know, the nastier aspects of Chinese civil society and, you know, living with your parents and doing very little and just keeping your head down and not getting involved politically with anything that might get you into trouble. And, you know, one of the big objectives of the Twentieth Party Congress was to reinvigorate Chinese youth and excite them about, you know, China's journey to wealth in the twenty first century. But I don't think that that aspect of the Twentieth Party Congress is really seen or there's no evidence that there's any positive result at all. But the demographics look really a big deal and you've identified of course the countries which are aging fast. You know South Korea has a major problem, Japan has a major problem, and there are similarly European countries, Italy in particular, they're going down the same track, even in The UK, the demographics don't look great at the moment, but they're not nearly as bad. And of course, the other country which has appalling demographics is Russia too. So I mean, you know, this is something in future we ought to get, you know, a Malthusian economist who looks clearly at population issues and do a podcast because it's a big deal, but it's a big deal which people tend to push at the back of their minds because it doesn't affect them immediately. Because it falls outside the parameter of the political election cycle.
Mcfarlane: Exactly. So nobody wants to talk about it.
Dearlove: Exactly. It's like climate change. Yeah. It's a ten, fifteen, twenty year issue. And it doesn't fall within the sort of planning cycle except in the minds of, you know, forward looking academics and the forward looking economists who are deeply worried. But you're right to pinpoint it.
Mcfarlane: On that note and perhaps a look ahead to another upcoming podcast, we'll try not to be too gloomy with our next topic. If you enjoyed this episode, why not like and subscribe so you don't miss our next big decision? Or why not leave a review if you're feeling generous? We drop new episodes every Thursday. From me, Sir Richard, and the team, thank you so much for listening. See you next time.
