Nothing Miraculous about It: China's Economic Growth and Great Wall of Debt

good morning everybody welcome to the Wilson Center and to our annual st. Patrick's Day all Irish presentation you have Daly and McMahon this year we are very happy to have as our speaker Denis McMahon who is now a fellow at the Paulson Institute's think-tank in Chicago which is called macro polo prior to joining the Paulson Institute Denis spent two years as a fellow here at the Wilson Center where many of you I hope have had the opportunity to hear him on this very stage before joining us here at Wilson he spent 10 years working as a financial journalist in China with the Wall Street Journal in Beijing from 2009 to 2015 and previously with Dow Jones Newswires in Shanghai where his reporting focused on the valuation of the UN and China's foreign exchange market in both cities in Beijing and Shanghai both by profession and by disposition he was not only at the stock markets and in with China's leaders and policymakers but also out on the street learning what China's economic policies meant for ordinary Chinese Denis has a bachelor's degree in commerce and the arts from the University of New South Wales in Sydney and he also attended the johns hopkins sice program the Hopkins Nanjing Center in Nanjing China where I had the pleasure of working with him for a year from 2003 to 2004 right where we also played soccer together and down in my office here I have a trophy which Denny helped us all win he was the captain of our first ever dragon boat team and we came in third place but that's not why didn't he's here today Denny is here because he is the author of the newly released book China's Great Wall of debt just out from houghton mifflin harcourt and for sale in the lobby when this is over this is a terrific book do not be put off by the title wall of debt now dad is a very important topic in China but I want to read a book that says wall of debt about as much as I want to read encyclopedia of psoriasis it's not a title that really as you win that's not all that this is about this is one of the best books on China that I've read since I returned from there in 2007 and my criteria for that is that it really captures the feel of the place how it works how the economy really seems to operate and the economy's relationship to politics social issues and cultural issues from Jiangnan high the leadership compound down to the back alleys it's right here in narrative form and the book contains just to take two examples the best clearest explanations that I've read as a non economist for what a real estate bubble actually is how it forms how it operates and the threat that it poses to China it put it also has a paragraph the best I've read on what the shift to a consumption based economy would actually mean in policy and real terms for China so it's a narrative look at the Chinese financial system and the various sorts of challenges that face it and while it contains interviews with policy makers I think one of the most striking things about the book is that it is animated throughout by a concern for ordinary Chinese and for the poor in particular and what China's rise and economic policies has meant for them it is as the subtitle suggests the end of the Chinese miracle somewhat skeptical about China's prospects going forward but it is never sneering or as many sort of collapses and this is not a collapses book but as many of the collapses to views of China have been something we're very proud of here and which I think demonstrates what the Wilson Center is for scholarship that can inform policy this book was mostly written here were very honored to have it launched here so please welcome Danny McMann thanks for a very lovely introduction firstly I'd like to thank everyone at the Wilson Center I really can't thank them enough not just the organization but the people here for the support that they gave me while writing this book because I originally thought of the Wilson Center as like you know a good place to sort of think and write but I got so much more just from being around the people here they helped shape the way that I thought about a lot of the things I was writing about and actually see parallels between China's experience and the experience of countries elsewhere in the world and that was incredibly useful because the great focus of my life has been China now I spent 10 years as a financial journalist in China and this book is very much built around that experience but the book is really the product of a 30 year journey I had my first Chinese lesson when I was 9 years old now that might not seem so unusual today particularly for anyone who's seen visit the video of a bunker and Jared's daughters singing to the Chinese ambassador but in 1988 that was extremely unusual even in Australia so my father at the time was a mining engineer and and he was working for one of Australia's big mining giants and he just come back from a business trip overseas and he'd come home and he declared that he found it embarrassing that he only spoke one language that I was going to learn an Asian language and specifically that language was going to be Chinese and so after school every Friday afternoon my long-suffering mother would bribe me with a fruit bar to get me to Chinese class with a bunch of ethnically Chinese kids who all seemed to have a much better grasp of what was going on than I did so it's only really been in recent years that I've started to appreciate just how unusual my experience was and it's not simply because of the age I started studying when I listen to the stories of other foreign journalists around the same age as myself or other peers who've spent a long time sting and working in China I finally have very different stories about how they started learning Chinese a lot of them stumbled into Chinese because they had a requirement in freshman year at college or you know other started learning Chinese so they could better understand Chinese literature or others went backpacking to I taught English there for a year and sort of caught the bug I started learning Chinese and kept learning it all the way through high school and through university explicitly because of the Chinese economy dad says that in 1988 and his trips abroad he was coming across more and more officials from Chinese companies buying up metals and other commodities as he traveled around but I think what really switched him onto the idea was that a few months before my first Chinese lessons sino steel which is one of China's biggest state-owned enterprises made China's first significant overseas state investment when it agreed to develop the chana iron ore mine now China is a speck in the middle of the Pilbara which is a sprawling region of red dirt in Western Australia and it also happens to be one of the richest sources of iron ore in the world the significance of China is to get there you have to fly into Paraburdoo and then drive 20 minutes down the road and my dad used to live in parapa do in fact as mine manager he had built Paraburdoo 15 years earlier to supply the Japanese with iron ore during during their boom and so such aina had suddenly jumped into my father's life and his take was this is going to be the next big economy so someone better learn the language I'd eventually I'd eventually spend my first year in China straight out of high school on a scholarship for an it from an Australian mining company but even as I studied through high school the appeal of China where was never about the culture it wasn't about the beauty of the language I still recall memorizing sentences in Chinese to prepare for my high school graduation exams which were kind of the equivalent of of the SATs things like learning Chinese will help me find a job and China's economic development is good for Australia so what's so amazing is that at that time China is not what it is today today about 90 percent of Australia's iron ore exports go to China and it's hard to imagine that it was any other way but at that time China was still selling more Australia was still selling more iron ore to Japan than it was to China and things only flipped in 2002 so the purpose of this preamble is to say that I was a true believer I believed in the importance of China's economic ascent I felt that it was an unambiguously good thing I felt that learning Chinese as difficult as I found it and as much as I hated learning it made me part of something bigger and most importantly of all I felt as though China's economic ascent was inevitable China's inevitability has since become a global truism if the United States is the indispensable nation than China's become the inevitable nation even though people have been predicting the client of China's economy for at least twenty years or perhaps because of it people around the world tend to see China's uninterrupted ascent to be the world's biggest economy to be Asia's hegemon to perhaps even sort of challenge the United States for sort of global global primacy that's sort of inevitable that sort of ascent has kind of come to be seen as preordained certainly it's something that China cultivates I mean you can't really read Xi Jinping's 32 year plan without thinking that he knows something that we don't however I no longer think of China's ascent sort of regardless of how you define it as being inevitable and that's because the foundations that of that ascent are economic and the economic hurdles that China faces means that the future that we assume to be inevitable while still is possible is much more probably unlikely now I'm going to give you the cliff notes versions of the challenges China faces so firstly China's economic model has reached its use-by date now it's not me saying that I mean the government thinks it as well the economy is currently driven by investment but much of that investment has gone into wasteful projects things like factories no one really needs housing in places where people don't need it and public works where the local governments that funded it are going to sort of struggle to ever pay for it all of that construction has been made possible by the rapid accumulation of debt China's debt levels have ballooned since 2008 and other countries that have experienced a comparably large credit expansion in a comparably short period of time having it evident invariably ended up varying some sort of financial crisis we're now at a stage that China's debt can't continue to accumulate as it has without posing some real risks and so the economic model has to change meanwhile China's traditional comparative advantage that it was a cheap place to manufacture is no longer the case the cost of energy and land is expensive even relative to the United States factories are being forced to reduce their pollution levels the pollution they can generate with it which is unambiguously a good thing but it raises costs and the cost of labor is rising aggressively that's in part because the of the endless supply of cheap labor that journalists like journalists like myself used to sort of refer to regularly in our copy well it turned out not to be endless the volume of migrants moving from the countryside to the city is declining which is a surprise to nobody who's actually been to China's countryside I mean the demographics of villages all over are heavily weighted to children school-aged children on one end and then the retirees who look after them at the other moreover China's working-age population has been shrinking since 2012 which is the fallout from the one-child policy it will decline by tens of millions over the next decade which will send wages higher in coming years while the cost of providing services to retirees will spike but the thing that keeps the leadership in Beijing awake at night is something called the middle income trap a few years back World Bank economists took a look at the hundred or so economies that 1960 could be fairly considered middle income that is your typical developing economy and found that 40 years later only 11 countries like South Korea Singapore and Israel had broken through and become rich nations far more have kind of got to that threshold and then stumbled never to make the transition and so now incomes in China have got to the point where they are reaching that threshold and Beijing is genuinely worried that it might not be able to make the transition but I didn't write a book just to catalogue the problems that China is facing I wrote this book because there were things that I had always struggled to come to terms with as a reporter I think it's fair to say that every financial journalist covering China for them there's always an reconcilable contradiction at the heart of all of your reporting on one hand you can see the excess you can see the waste you can see the risk taking and the laws of economics as they operate elsewhere would suggest that this can only end badly and yet the laws of economics seem to have been suspended in China China has continued to go from strength to strength seemingly without any consequences the reason that is typically given by way of explanation is that China is different and the way that it's different comes from the role that the government plays in the economy specifically and I've heard this so many times before we needn't worry about the problems in the Chinese economy because the government sees them and can fix them whenever the circumstances demand and there's a reason that this exists as an explanation I mean China has averaged 10 percent annual economic growth for almost forty to four decades because at pivotal moments it has been able to just do do just that to fix the problems and that is given rise to a legend of sorts or at least sort of a deeply held belief that China has managed to crack the code and do away with the business cycle because and this is the perception at least that economic management has been placed in the hands of a technocratic elite undistracted by ideology that has been able to make tough decisions in the pursuit of one overriding goal which is growth I think the extent to which that kind of thinking has permeated globally and can be best summed up by something that Thomas Friedman said a few years ago which was what if we could just be China for a day we could actually you know authorize the right solutions now clearly that comment is as much an expression of the frustrations of the gridlock of US politics as anything else but it is also a fair summary or summary of how people typically think about how China works but that's not the China I saw over my years as a journalist a period from 2005 to 2015 China's success was not a function of reform it was the result it was the result of a willingness and ability of the government to be able to paper over the cracks kick the can down the road and any efforts at top-down reform were routinely stonewalled and circumvented one of the earliest insights I got into how China actually worked was about a year or so after I started as a reporter so I started as a journalist three days before China's central bank revalued the currency which was something people had been waiting for for years and so up until that point the news agency I was working for it didn't need a currency reporter and so I just arrived and so I got the job but even though everyone was faster you get very interested what happens to the currency now we've been waiting for this for years once the currency was revalued China's UN barely moved it barely moved for years and so I was always kind of looking for a way to write about it and so when I noticed that the trading volume of the renminbi against other currencies were suddenly increasing I thought fantastic right sure the exchange rate isn't moving but surely this means that a real market is developing so I called up a currency trader that I knew at the Agricultural Bank of China and sort of asked what was happening and he said yeah I wouldn't write about that and I was like but this is it right I mean there's real demand for currency this is the moment that we were waiting for so what's driving it and he said nothing what was going on is that not long prior the Chinese government had started handing out awards things like best foreign exchange trader best market maker and one of those awards was most active currency trading bank and that honor had gone to the Bank of Montreal and so the major Chinese banks had been dressed down by the regulator but not doing enough to support the development of the market and they were told that they should trade more actively the problem with that is that there wasn't any need for them to trade active actively I mean this was at a time that the banks had plenty of foreign currency themselves they didn't actually need to buy it from each other and so as this trader at the Agricultural Bank of China explained to me the reason that trading volumes were going up is because guys like him would call up friends that they had at say ICBC in the morning and would arrange to do a big currency deal they would exchange US currency for the Chinese renminbi and then in the afternoon they would trade the same amount back again at the same price a net net everything went back to the way that things had started at the beginning of the day but as required trading volumes had gone up and when the next awards were handed out ICBC China's biggest bank got the award as most active foreign exchange trader now this is both the magic and the tragedy of the Chinese economy in an incredibly bureaucratic and political society things get done because of the creativity in which people get around the rules a while back I had a friend in foreign air another Australian who moved to Singapore after four years in Shanghai and she was very much looking forward to sort of replacing the constant negotiations of life in China with the order of Singapore but after two months she was going crazy because not only to Singapore have a lot of rules but the rules are actually rules in China the rules are more fluid there's almost this almost always away foreign reporters like to use this old Chinese idiom that I'm sure most of you have heard before heaven is high and the Emperor is far away and it's kind of a way to explain the limits of Beijing's authority outside of the capital but for me there's always been another expression that's had greater resonance the Shang you're drunk saw a old waiter which loosely translated as above there is property above there is policy but below we have ways of implementing policy and really that's what makes trying to work but it is also the biggest impediment to fixing a broken system so case in point is the financial system China's response to the global financial crisis crisis was a massive stimulus program not led by the central government spending as it was in other countries but by banks massively increasing the volume of loans that they made after a year Beijing decided that the stimulus was over and the pace of bank lending slowed accordingly and yet there was no discernible impact on the economy which kept firing on all cylinders so it was a complete mystery to anybody outside of the financial system but after a while it started to leak out that banks were using trust companies which would soon become a pillar the central pillar of the shadow banking system they were using trusts to move their loans off their balance sheet and thereby effectively removing any record of the loans from the official banking statistics and so credit continued to expand rapidly and after a year the banking regular in beta banking regulator in Beijing finally managed to sort of crack down but that sort of behavior set the tone for the rest of the decade the volume of credit being extended by the financial system kept getting bigger and bigger because the shadow banks while complying more or less with each new regulation designed to rein them in managed to innovate around the rules I recall talking to a guy in the investment banking division of one of China's major banks who said that he and his colleagues prepared multiple workarounds in advance of new regulations coming out so that regardless of what the regulator's did they'd still be able to continue extending credit a very similar thing happened with local government debt local governments have traditionally not been allowed to borrow but around 2008 they started they started setting up in great numbers companies not unlike sort of the port authorities and and special districts in the United States companies that could borrow on behalf of the government it soon became clear however that borrowing was completely out of control but each crackdown from Beijing has resulted in innovative workarounds that make it harder to track the debt such that last last year Xi Jinping said that local government debt was to one of the two greatest threats to financial stability and that's despite XI himself initiating what was one of the biggest crackdowns on local government debt and one that was the part of supposed to finally put an end to the issue in 2015 the reason that all this have had all this happens is that the various levels of levels of government are not of one mind when this administration came to power both xi Jinping and Li Keqiang talked a lot about vested interests stonewalling reform the popular assumption at the time was that this was code for corruption but vested interests go far beyond that so perhaps the clearest illustration of vested interest exerting control over government policy was illustrated in pendant documentary there's not many of those in China but this was an independently produced documentary about China's air pollution that was made by a former CC TV reporter in 2015 no doubt a lot of you have probably actually seen it it was called under the dome it was posted in China online for about a week it had over a million views and then was scrubbed from the Chinese internet it was a fascinating program for a lot of reasons but perhaps the most interesting part was when the journalists charging explained that one of the main reasons behind China's chronically bad air is that the most highly refined gasoline produced in China is two to three grades lower in quality than that available in developed economies and that raising the standard by one grade would result in a 10% reduction in emissions the reason China hadn't done so was that almost all of the members of the committee that sets fuel quality standards are from PetroChina Sinopec and cynic China's three national oil companies according to the documentary the three state firms who were all directly owned by the central government they were effectively holding the central government to ransom over money Beijing so this this is the mechanics of how that worked right so Beijing sets diesel and gasoline prices as a way to keep prices low for consumers relative to international levels cleaner gasoline costs money but the oil companies can't claw back high refining costs by charging more at the pump so they've asked the government to subsidize them to do it but they ought but about the oil firms estimates of an appropriate subsidy are an order of magnitude higher than the government's calculations and until an accommodation is reached the oil majors continue to produce lower quality fuel at the expense of the public's health the oil managers oil majors had managed to stonewall reform by arguing that things are arguing pardon me that if things aren't done on their terms it might result in a disruption to the oil supply and lead to instability I've come across similar instances instances of other agencies using exactly the same formula to push back against any reform that dilutes their authority that influence or their resources still people in those agencies and people in those state-owned firms will tell you that they are not anti-reform even though real reform nationwide probably stalled in about 2005 or 2006 reform in China is it a bit is a little bit like motherhood and apple pie in the United States everybody is in favor of it it's just that for state firms they argue that reform should be left to the experts which is them barriers to reform exist because people benefit from the status quo they benefit from the way the currents that they benefit from the way that the economy currently works they benefit from the fast growth they benefit from government subsidies they benefit from the privileged role that state firms have in the economy and they benefit legally whether it be through power or prestige through higher wages or through perks that's not unique to China in any system there are always those who benefit from the status quo but the lesson from my time in China is that those interests have incredible scope to push back to Stonewall and selectively implement reform or to implement the letter of what's required of them but not the spirit that said for the first time in a very long time we're starting to see an effort to overhaul the economy in Beijing but for the reasons I've outlined above I feel that the single most important economic reform being implemented by Xi Jinping is not explicitly economic it's his efforts to centralize political power firstly by imposing greater discipline on the party then by moving government functions over to the party and then consolidating party power in his own hands now no doubt there are a number of reasons behind what he's doing it but from an economic perspective I imagine that he's hoping that this will bestow him with the authority to get the rank-and-file to do what he's asked of them we're still in the early days of this process process so it remains to be seen just to what extent he is able to change the dynamics that I've described above at the same time though that there there are risks that come from this more centralized form of economic management that is lower-level officials may end up going to great lengths to do what is asked of them but at the expense of other things and we so that dynamic at play at the end of last year when officials in the northeast of China was so enthusiastic about transitioning the local power supply from coal to gas that people were left without enough heat through the winter because there just wasn't enough gas to supply of annually installed heating systems also the ham-fisted eviction of migrants from beijing last year led by the city's mayor was likely another example in a more centralized system officials proved their value and loyalty to the leader by overdoing it with unintended consequences anyway in summary China is facing incredible economic challenges at this moment there's certainly a general level of optimism around the world that China will be able to get through those challenges and continue to grow rapidly as it always has but I think that's in large part due to an appreciation of the dynamics that underpin the Chinese economy and what exactly needs to needs to be changed I don't know what's going to happen to the Chinese economy but what I do believe is that the inevitability of China is a long way from a sure thing thank you very much [Applause] thanks Jenny we'll get to general questions in just a minute I'd like to ask you a question first which I think for non economists and even some economists who've been involved with China for decades is the big question and it's related to the story that you told about the currency traders trading back and forth with himself and this sort of shenanigans and working within the rules which you know very much rings true for those of us who've lived in China this does seem to be how things work and that's a good example I want to read a short paragraph this is from page 115 which is it I think is as good a summary as any of the way that you can see things working you're right when an economy is expanding in size by 10% every year middling managers become successful businesspeople and hustlers tune in to feted entrepreneurs loans that can't be repaid at a slower pace of economic expansion aren't a problem when the economy is booming companies can always just grow through their mistakes slower growth exposes the waste mismanagement hubris and fraud that remain hidden during the good times of course maybe none of this matters even without fast growth and even if property prices fall everyone assumes that Beijing will ultimately step in to bail out the financial system so on the one hand all of these descriptions of the problems and the smoke and mirrors ring true on the other hand these are real buildings real mercedes-benz's WeChat is real Xiaomi is real I've those of us who got to China in the 80s or the 70s and know how poor China was you know the concrete is concrete you have you know in two years China poured more cement than that you write about the America did in the 20th century well that again is real so I've always had a hard time reconciling the very reasonable and even true sounding warnings of the sort that you have in this book with the evidence of my senses over 30 years within China it's very hard to bring these two together and so what is your your answer to that sort of the reality of Chinese growth of China's wealth it has a middle class now bigger than that in the United States how do we reconcile these two seemingly true but contradictory views ok well although that's true I mean you know I started going to China the first time I believed in China was in 1997 I went back again in 2000 I went back again in 2001 and moved there for 11 years in 2004 and it's actually seeing the change over that time seeing the concrete poured seeing the infrastructure improve seeing the quality of people's lives just improve from every you know every time you went back I mean it is real but the problem with growth is growth means that you do more next year than you did this year and what China has been doing year-on-year is that a lot of what's being built its investment-led growth isn't needed so you have for example China has built a whole lot of factories to Simpa ticular to support the construction industry but it's built factories that are now capable of producing more steel than China will ever need more cement than China will ever need more ships more excavators more front loaders more plate-glass more wind turbines the government itself or paper that was a no absolutely the government itself at the end that the economic planning agency has a list of something like 20 industries which it recognizes is having industrial over capacity that's not necessarily a full in a full list I write about the textile industry in my book and people in the industry say we're suffering industrial we're suffering over capacity but that's not an industry that's recognized as having over capacity by the government so that's one issue and then you have so much and then you kind of look at the housing industry as well the construction of accommodation China effectively has two housing markets in places like Beijing and Shanghai there is just not enough housing people live underground in windowless no car parks or cubby holes because they can't find affordable housing elsewhere but then you go to the smaller cities while it gets called the third tier the fourth year the fifth year cities and far more has been constructed then we'll ever be needed and then you have Public Works and I think this is the the part that particularly people in the us kind of trip up over because the the vision is that China has spent all this money on infrastructure and when we think about infrastructure we think about high-speed rails high-speed rail we see the you know the new eight lane highways but what China a better way to think about how local governments have been spending money it's not on infrastructure it's on Public Works and when you think about it like that there's a whole lot of waste that's going on that isn't necessarily contributing to the public good so on one layer on one hand you get things like airports airports in and on themselves seem like a pretty good thing particularly if you're in a remote city but they're not a good thing if only one flight arrives or two flights arrive every every week because someone is eventually going to have to pay for having built that that that that that Airport and sort of maintain its upkeep and then on the other side of the perspective you've got things like you know city city authorities building brand new spanking government buildings in many cases having more officers than people to put in them or trying to beautify the cities by you know creating man-made lakes and ornamental hills I mean there were cities out there who making replicas of the Great Wall of China a sort of tourist you know as a tourist destination while you go to a replica of the Great Wall of China when you can go to the real thing is completely beyond me but you see the local governments are spending money on things that don't qualify as the sort of valuable infrastructure that we kind of typically assume that China's been investing on a lot of vesting in I mean a lot has been genuinely wasted so coming back to the question of growth when you're sort of wasting money like that each year to grow the next year you have to do more of the same or you have to find a new way to grow and that's the kind of position that China is in at the moment it can't afford to keep building you know ornamental lakes it needs to kind of find a new way to grow the economy okay final question then we'll go to the audience and I suppose this is a question that comes from the point of view of a kind of Chinese exceptionalism which you debunk very effectively but I'd like to come back to it anyway in relation to the middle income trap because China whether or not it's exceptional it is something new right we've never seen a vast continental nation with the largest population in the world growing as rapidly as it has so that's one reason to think that maybe some of our models may need to be revisited the middle income trap is as I understand it whether how you measure whether China has escaped from it in part relies on per-capita measures of wealth but do per-capita measures matter that much could China not continue to be a country with a great many poor people and there are great many poor people in the United States which is how it contains within it nevertheless the world's largest developed nation they've already got the world's big you know the the highest number of middle class consumers that's increasing it'll probably become the world's largest economy overall certainly strategically from the American point of view and this is something we're looking at the Kissinger Institute in terms of relative power I don't know the per-capita matters that much if China has the industries is the world's biggest nation controls markets and tastes both at the supply and demand side because this vast country with a lot of poor people has the world's wealthiest economy within it so where does middle the middle income trap enter in at least from the point of view of other nations if our concerns about China are driven by not per capita concerns but China's total economic throw-weight how much does the the middle income trap then matter it's a really interesting question the idea that China could happily allow inequality to get worse in some ways and just kind of allow the system to sort of roll over and roll over I think the issue with the middle income trap is the idea that at some point the forces that drove the economy to that point at a point where it is a middle-income nation the point of being a rich nation no longer work in the nation's favor and this comes back to the idea of you know rising wages and and whatnot so I think if China wants to be able to certainly this is regardless of whether you believe in the middle income trap or not certainly the the the leaders in Beijing think it is something that is unavoidable and so and the reason I say that is when supply-side structural reform which is being promoted as the you know solution to sort of you know China's economic problems Leola explicitly called this the solution to China's middle income trap in 2015 or 2016 Logie way who was the finance minister I think he'd just been removed from the post he said that he thought there was a 50/50 chance that China would slide into the middle income trap and the reasons he gave was because of this demographic cliff that China's heading towards so I think it's it's less about I think there are sort of the way that the authorities see things is that the middle income trap is sort of something they can't avoid because of sort of the challenges I sort of outlined in this page and that you know there's the whole point of the reform agenda is trying to work out ways in which they can sort of dodged that bullet so I'm not sure if that was a great answer or not but anyway let's open it up and please wait for the microphone Stefan over on the other side you know debt down yes hi Jack Goldstone George Mason University thanks very much for this to me let me reply briefly to Bob's point about can trying to get richer for the middle income trap you would have to take Shanghai Beijing Chongqing and make them twice as rich as the US if you leave the rest of China alone that's not going to happen or you take the countryside which is mostly retired folks and children and make them somehow as rich as Beijing and Shanghai that's not going to happen either so I don't really see any pathway for this to occur my question though if you Denny is all of these innovations you've talked about in the shadow banking system they remind me of what happened in the US with the development of collateralized debt obligations that is we developed lending instruments because there was a demand for the secured investment credits and bankers were happy to oblige regardless of their quality is there quality in the shadow banking system or is it the same kind of let's make things up because we can make money on it and not worry about the quality for now okay thank you and thank you for that explanation of the middle income trap that was much better than I was ever going to be able to do so thank you in answer to your question about shadow banking the answer is both yes it's the same in certain ways but it's also very different in very important ways so you know there was an expression that used to be used a lot in the United States a few years ago which was one of the reasons that shadow banking evolved the way that it did was because there was a search for yield people wanted higher returns there on their investments than were otherwise available and so the financial system got creative in the ways that they designed financial products something very similar is happening in China as well China's money supply has ballooned since 2008 we often worry about what happened to the US dollar supply because of what the Fed did with quantitative easing we worried about something similar in Europe but if you combine the expansion of the US money supply the Japanese money supply and the Europeans money supply since the global financial it is still less than the expansion the Chinese money supply and so you have all this money and it needs to go somewhere now traditionally in China that wasn't a problem because you had this you have this very strong real economy that is China had this demand for money to build factories that were needed it had demand for money to build new housing and it had demand for money to build infrastructure so this money could be productively used by the financial system but as industrial overcapacity grew as property became an increasing tool for speculation you had a situation where you know the traditional industries didn't really need money to invest in the way that had traditionally had but you still had this increasing volume of money in the economy that still needed to go somewhere and because China but because of China's capital controls it can't flow out of the country it couldn't sort of flow into the US stock market and so it had to find somewhere domestically to be invested and so yeah the quality of a lot of what has gone the money has sort of flown into the shadow banking industry and the sort of investments they've made aren't always particularly safe and so a couple of years ago you had a bubble in the Shanghai Stock Exchange which collapsed but what had inflated the bubble is that people were parking their money in wealth management products and the wealth management products were used to lend to people who could then use credit to buy stocks that's not an unusual an unusual development in in in in China's financial system these days I'd say most of the money still flows into property but at the end of the day the shadow a banking system has expanded so much because there has been this sort of search for yield this demand for higher yield and really nowhere productive to actually put it now that kind of sounds like it is a sort of a just a massive problem that can only end badly it will sort of collapse in on itself however China's financial system is very different from our own because to say the United States their financials the financial system here is based on trust in the individual financial institutions it's about banks trusting each other it's about the public trusting the banks and about trusting the specific banks and so for example Lehman Brothers collapsed because all the other banks no longer trusted them they no longer felt that they had the money to be able to honor their obligations whereas the foundation of the Chinese financial system is not trust in the individual institutions it is trust in the government and it is trust that the government will always be there with a safety net to ensure the stability of the system to ensure that financial institutions do not fall over and more importantly it's a belief that the government will not let individual investment products go bad and that sort of attitude permeates the entire system it's not just faith that the big four banks have this implicit backing it's not even a belief that rural commercial banks are much smaller type of institution have these implicit backing people even assume that peer-to-peer lenders or online lenders privately owned companies that have kind of you know been set up very recently are chronically under regulated people the public still assumes that there is a certain degree of government safety net there because they are the belief is the fact that these sorts of institutions are even allowed to operate in the first place means that they have tacit government support and so if something goes wrong it's not my problem I didn't have to do my due diligence this is a responsibility to the government now this is both a good thing and clearly a bad thing at the same time it's a good thing because it makes the system safer it's a bad thing because it encourages risk and there comes a point where the system can't keep getting bigger and bigger and this is something that lyoha said a couple of years ago I can't remember whether he penned it under his own name or whether it was anonymous essay everyone assumed was written to by him but his expression was we can a tree cannot grow a tree cannot grow to the sky we can't you know we can't let them you know our economy be driven continuously by monetary expansion so certainly the current administration recognizes the problems it's just a question to the degree to which they're willing to rain things in because as I said before the economy is driven by debt and there comes a point when you start raining in these sort of debt mechanisms that it will affect growth question down front gray school thank you for interesting dialogue here so there is obviously a observation that china has consistently moved up the manufacturing chain from the very low end to very high end and in age of machines and robots and artificial intelligence there is even a view that a dictatorship and because of the ability you know for any company to tap into private information is in a huge advantage over a economy like the US where everything is highly regulated so china has basically made a lot of strikes in the kind of artificial intelligence space and might even be one of the leaders if not the leader in that area so how do you guys think about you know the technology advancement in china you know in relation to the problems and that problem that you're talking about okay so this comes to the question of what does an advanced rich economy look like and so the the the strategy that that Xi Jinping administration has outlined for you know what are going to be the new drivers of growth how are we going to get through these these economic challenges is that it's going to be a forced march up to the value-added chain in Industrial Management factoring so in in the earlier part of this century China aggressively moved into heavy industries though the list I gave before of industrial overcapacity industries they didn't exist in a in any sort of significant form in China until probably about the early 2000s early 2000 and 2005 in the 1990s Chinese industry was very much dominated by light industry so you've kind of seen this gradual transformation and the idea is now that the way China avoids a middle income trap the way that it becomes richer the way that it can afford to pay people higher salaries is to be able to move into industries that generate more value and so to give you a short list we're talking about things like robotics we're talking about electric vehicles we're talking about semiconductors now there's two things to keep in mind here first is to a certain extent that's what a developed rich economy looks like you produce more high-value content products I mean that's kind of how tired Taiyo to the Taiwanese economy did it that's what South Korea did but there's another question here it's like what really does a developed economy look like and there is a propensity to think that you know the Chinese government's got this under control they've come up with this amazing vision of the future but the thing is there was a lot of debate for a very long time to settle on what was the best potential driver of growth so I write a fair bit but in the book about urbanization because when she didn't ping and Li Keqiang came to power in 2013 that was going to be the driver of economic growth there were no hits and butts urbanization was going to be the new driver of Chinese growth into the future and then it became apparent that there was already so much waste in the system you know China has already mint had Peak migrants and so that wasn't going to be the driving force but there's also been other theories as well so Logie way for example the finance minister I meant before he was one of the great liberalizing voices and what he advocated wasn't sort of liberalisation for its own sake he advocated liberalizing the Chinese economy to inject competition and to make the economy more efficient the Chinese economy isn't hugely efficient its strength has been has come from being cheap so you still have this ability to sort of wring out efficiencies in the economy and make it more competitive by liberalizing fair that various parts of the economy and the sort of things he advocated were things like land reform so to give you an example you take things like cotton you know China has a significant cotton industry but the way that it props it up is by imposing quotas on and on its use so textile manufacturers in China have to buy Chinese produced cotton and that's the only thing supporting the industry because the price of Chinese produced cotton is significantly higher than the global price cotton produced in the United States is so much more productive because it has grown on large plots of lands and it is heavily mechanized whereas in China you cut it's very difficult to actually put together or you know it's very difficult to find a sufficiently large plot of land to be able to do this sort of thing because you you have a land ownership system where you know a whole lot of farmers own very small amount of land they don't actually own the rights they can't sell it they can't lease it and so you can't actually aggregate the land to actually get large plots so that's kind of one of the things the finance minister was talking about another thing was breaking the monopolies because once you break down state government Appa Lee's then you have productive pressures that will drive down prices and create more efficient industries so this was kind of another voices as well it's like you know there is another direction to actually become a richer and more successful you know economy the problem with liberalisation and this goes back to this vision that we have of Chinese technocrats being able to make tough economic decisions the difficulty with liberalisation is that it is genuinely difficult to liberalize as you actually come across vested interests at every step of the way to break down the the current land ownership system you come in to later you come in contact with vested interests to break the state loans firm monopolies more vested interests the this vision of supply-side structural reform in some ways is the easy route because what it does is it's using the same sort of techniques that allow China to aggressively build up a steel industry in a paper industry using those same techniques and applying them to new industries and so it's providing you know domestic protection it's providing subsidies it's providing government funding to be able to go overseas and buy foreign technology and so this isn't the sort of policy that makes enemies it's the sort of policy that state firms love it's the state firm it's a sort of policy that sort of reinforces some of the sort of the structural qualities of the sort of the pre-existing system now the point of saying over all of that is that this might turn out to be an incredibly successful and visionary approach but it is just one of a number of directions that China could have taken and might not necessarily end up the way that you know many people assume it will and if I could make one last point about this as well one of the the things one of the things that will make this particular model of growth difficult is because it is about moving into industries which developed economies like the US Japan and EU C is being strategically important to their own economic development and so you know the US published I think it was the last thing the Obama administration did before the Trump presidency was published a report on China's attempts to dominate the semiconductor industry and explain how much money the state was actually throwing and this was something this was something that the US for security purposes had to do something about you see what's going on in Europe and Germany has been blocking the acquisition by Chinese companies of high-quality robotics companies and so you can see that the China's vision of growth for the future is starting to butt heads directly to with developed countries who are increasingly taking a harder harder stance on international trade which I think will add a degree of complexity in the ability to actually realize the success of supply-side reform let's go to the other side sir right all right in the middle yeah great presentation thank you along with the fast Columbia grocery in China there comes with the bubbles where do you see the most of bubbles in wish' sector you know that's an incredibly difficult question to answer because bubbles are any bubbles once they pop and people have been calling China's property market a bubble for years and it certainly looks like a bubble certainly and yet it still manages the the government still manages to kind of keep it in that sort of Goldilocks range sometimes it gets a little bit too frothy and they rein things in and sometimes it looks like they're going to kill the Golden Goose and they open things up I think certainly at times you get mini bubbles in in in specific property markets around the country and you get mini bubbles in the most obscure of asset classes all the time one of the things that I write about in the book is a bubble in aged by Jo so this was a market that didn't even exist a few years ago I mean people kind of all of great stories like that this is one of the notes ballpoint pens and lavender stuffed teddy bears from Tasmania there's a lot of good stories so the amazing thing about age by Jo and aged mal ty in particular as though there was market for this thing at all prior to I think it was 2011 I mean people in China always kind of had this knowledge that you know if you had a bottle of malt I and you kept it for 20 years you know it tastes a little bit different it's quite nice but it wasn't like Bordeaux it was like people who didn't have cellars full of the things they didn't kind of leave it on the shelf and kind of waited for somebody's graduation and so it was just by fluke that a guy that I met who was working at an auction house was asked to auction off a regular customers aged by joke collection to kind of see what they got for it and the prices were just so much higher than anyone could possibly imagined and so the next year he started doing regular twice a year by Joe by Joe auctions and I to the chairman of the company before the first auction and he had a vision that one day this this this the value of a 1982 bottle of malt I would be the same as a 1982 bottle of Lafite because that was kind of the gold standard of Chinese red wines a few years back I'm not sure if it's still the case and at the time it was selling for about that first auction it sold for about a third about three years later it was selling for twenty percent more than Lafitte in that first year and the price of Lafite had fallen by half so which is interesting because the feat prices were driven by Chinese demand and then it got to a point that the bubble popped and then the money moved elsewhere so you get this in all sorts of obscure asset classes you had it in Vancouver prop big van Cooper property very much driven by Chinese prices last year or the year before you had it in European soccer places soccer players Chinese Chinese teams were just inflating the price where they were willing to pay for the top Chinese soccer global soccer players to come out late it was a porti bubble there was a yeah that was one of the first there was a garlic bubble so it's it's really a case of and comes back to the question before about you know there is a real search for yield in China it has been there for years because there's always been limited places to invest in money but now the issue is that there is so much money and people are getting creative with where they put it and so you kind of have this revolving cycle of mini bubbles in obscure asset classes is the country over just as a point of fact Mao multi White Lightning actually doesn't get better with age but if you ages if you aged at 50 years enough of your taste buds have died that it becomes palatable we have time let's go to this story I'm going to decide the room yet and go to the back sir yeah I'm a prophet in Canadian University I'd like to ask you Denny you mentioned about Chinese companies going art knives they become more integrated into the global economy in the context of financial institutions you know that Chinese banks Chinese insurance companies expanding aggressively overseas but at the same time you know that foreign banks and foreign insurers in China have been severely restricted less than 2% market share for the foreign banks less than 5% for the foreign insurance companies much talk about reform in the sector do you think it's sincere and will it happen in the next five years 10 years I'll believe it when I say it I think the insurance companies the foreign insurance companies in particular have really had a rough time of it because the barriers to expanding have been less about explicit barriers and it's more been administrative I mean the the I think the insurance regulator perhaps more than any of the other financial regulators has kind of been a cheerleader for the domestic insurance companies and it's really hurt the ability of the foreign companies to expand now I know you know at the end of last year the NGO the Chinese government said that it was going to start allowing greater investment by foreign foreign companies and Chinese financial firms maybe this does represent the moment where they start opening things up but there are certain stories that as a journalist I wrote time and time again in China and every one of them was like this reform is going to happen now a real estate tax was one of them the merging of the financial regulatory bodies was one of them and you know you write them time and time again and then nothing happens but then sometimes reform eventually does happen so I want you know for example the merging of the regulatory agent we finally saw a partial manifestation of that reform at this MPC finally the insurance regulator has been merged with the banking regular regulator there's still a lot more to be done I mean there is still regulatory there are sort of regulatory gaps between the securities regulator in the banking regulator there's still a whole lot of financial regulatory functions which fall to local governments that are sort of under-resourced to be able to actually properly regulate it but this is kind of the repartee reform we've been waiting for for a very long time so things do change but it's you can't kind of take sort of top-down policy pronouncements as gospel it's really a case of I believe it when I see it time for one more very quick question sir right up front sorry moving the microphone a lot sorry ray right we're all the way sorry ray all the way all the way front and the other side gotta do a full lap Chris McRae's so if I hear correctly all all the free really you know big nation blocks China European Union US have an awful lot of waste in the old financial system so maybe the question I'd really be interested in is what is the future which one really needs to innovate my hypothesis is its total change to education because people like Jack Ma say wherever you go all around the world half of youth will be unemployable unless we get beyond the classroom and we actually do experiential stuff so I'm wondering what what what what is the future that that we all need to connect to and you know it's China ahead or behind in what what you might see is that future to be honest I think you've probably thought more deeply about this and I have when it comes to making policies prescriptions that was something I do currently avoided in this book and the reason was I was writing at the Wilson Center and I thought well look you know this is something I should be doing I should be kind of like how do you change how how should the future look and then I kind of realized that I've been listening to economists talk about China for 20 years and you know they have interesting perspectives on how the Chinese economy should change but whatever those that advice might be the Chinese system the political system works so radically different from our own in ways that we can't properly understand because it's so opaque we don't understand the inner machinations of the party or how party the party sort of imposes its will on the rest of the economy and so in the end I decided not to kind of suggest what what should be done because I think it's kind of whistling into the wind the Chinese government has a clear vision of sort of you know the problems that needed need to be solved I mean you listen to Xi Jinping's speeches over the last year I mean he talks about reducing poverty allowing the people who haven't enjoyed the fruits of growth for the last thirty years to finally enjoy it it's talking about you know dealing with the the the pollution issues which were a real threat to the quality of people's lives and their health I mean these are the fundamental issues of people's lifestyles the current government is like right we've got to deal with this stuff now but to kind of make a policies prescription as an outsider it's just not worth it because the their system works so differently that the kind of the ideas and the implementation are kind of beyond my ability to kind of make recommendations well thank you Denny happy st. Patrick's Day to everybody the book is China's Great Wall of debt and Denny will be signing these books out in the lobby beginning in 30 seconds and then he has to run off to the State Department so we have to do this very efficiently but again thanks to everybody for coming and Denny thank you for coming back

Channel: WoodrowWilsonCenter

Views: 52,244

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Keywords: Wilson Center, foreign policy, international affairs, foreign affairs

Id: uT3PzJlVxb8

Length: 61min 25sec (3685 seconds)

Published: Fri Mar 23 2018