CHRISTOPHER BALDING: I’m Christopher Balding. I’m a professor at Peking University Shenzhen
Graduate school. I’ve been living in China for nine years and
consider myself in America a Los Angelino. So from a big perspective, I think what is
driving a lot of this issue is that China is responsible for a majority of our large
share of global growth. If you’re looking at changes in commodity
consumption and things like that, that’s really where China in many cases is 50 plus percent
of growth in these areas. There was a chart, just recently, that if
you look at the growth in money supply since the global financial crisis, China’s responsible
for about 65% or so of money growth globally since that time. So when we’re talking about why does China
matter, you know, these are all the issues as to why. Investment is flowing out of China in still
relatively significant ways, even after the imposition of strong capital controls, so
that you’re now seeing large amounts of investment in Europe and Australia, and even the United
States, to a lesser degree from China, that is really changing how goods are flowing,
how investment is flowing. And this is accompanying with a lot of strategic
implications. The key strategic implications are, in some
different ways, is that Beijing is really looking to project its influence in different
ways, whether this is political influence in specific countries. Just recently we’ve seen a report released
by the Australian government about the level of influence that Beijing is trying to project
on both major political parties in Australia. We’ve seen, just recently, that New Zealand
may be so compromised that they may be removed from what is called the Five Eyes Security
Alliance, which is Australia, New Zealand, the United States, Canada, and the UK. We’re also seeing this play out in the United
States with regards to concerns about Chinese influence in the tech sector, and how much
data they may have access to. For instance, this is largely why the MoneyGram
acquisition by AMP financial was rejected by the US government, over concerns that this
is going to give the Chinese government access to US consumer data. And so this is really changing, quite broadly,
alliances that have long been in existence, all the way through to what do we what are
industries that we consider as national security, such as tech and consumer data. One of the reasons why this is important is
that these are areas that people have not generally considered as national security. Historically, the United States has taken
a pretty narrow view of what constitutes national security type industries. We were typically talking arms dealing, military,
you know, pretty narrow specific industries that I think everybody could agree were national
security industries. That began changing in the Obama administration,
and is carried forward pretty clearly into the Trump administration. And so I think more than anything, a lot of
people are changing not just their view of China, but a lot of how this relationship
is unfolding. For the past, let’s say post WTO entry, it
was largely considered a very symbiotic relationship. Both parties were getting something out of
it and they were moving towards more friendly relationship. And just even within the past year or so that
has changed very dramatically. And so even though people may have complaints
about how President Trump is handling various things, I think it’s pretty fair to say that
across Republican and Democratic circles, politicians and policy wonks, you’re seeing
this change as to how do we rethink the US-China relationship. I think one of the things that is really driving
all of this forward is that there was kind of the assumption, after China joined the
WTO in 2000– and this has been said explicitly over the years and generally assumed– is
that as China continued to develop they would slowly liberalize their markets. And I think what has dawned on people in the
past few years, is that China really is not opening its markets. And as best we can tell right now, it has
no real intention to open its markets. And again, we’re not talking even loosely
defined national security industries, we’re talking industries as basic as salt, and not
some type of high grade chemical compound salt that might be used to de-ice roads or
things like that, but plain table salt. Even if you look at artistic dance troupes
and other very mundane type of industries, there’s anywhere from discouragement to prohibition
on foreign investment and trade in these sectors. And China has shown no interest in, or willingness,
to even slowly liberalize its markets. To take one simple example of what we’re talking
about, and this is an investment example, but the same applies in many trade areas. When China joined the WTO in 2000, they had
part of that agreement included, opening up their payments market so that companies like
Visa and MasterCard could access the Chinese market. They lost a WTO case to the Obama administration
in 2012. And we’re in the middle part of 2018, and
they still have not allowed a foreign company to enter the Chinese market, specifically
in payments. American Express may be allowed to enter within
the next year. There’s still no word on whether or not Visa
and MasterCard will be able to. So this has prompted a lot of people to question
quite openly, if China is not going to be changing in all reality over the past, let’s
say, a year to three years, they have actually gone in reverse, what we would consider market
opening reforms from trade or investment? It’s caused a lot of people to say, we need
to rethink what is happening. Even as President Trump could rightfully draw
criticism on a lot of what he has done, as this issue has come under more scrutiny, a
lot of people have begun to realize just how closely locked the Chinese market is. So there’s been a sea of change in how people
are viewing these issues. And so one of the things I think that is quite
clearly happening, is a lot of companies, a lot of industries, are torn between facing
the recriminations they would expect from Beijing when they support Trump in pushing
change in the trade and investment market, all the way through to, we don’t necessarily
like how Trump is going about, but we support the general goals that he is pursuing. And you can see this in the data. This is not just hypothetical. As an example, one of the things is that since
most of this decade foreign investment, as the economy in China has grown by, let’s say,
about 8% to 9% annually in real terms, this decade, foreign investment into China has
actually increased by only about 3%, annually. That’s the equivalent of foreign investors
voting with their pocketbook. One of the things, though, that I think is
important to note is that trade, in a lot of ways, is really less important than the
investment market. And the reason that that is when most companies
are making these types of decisions, unless there’s a reason to locate in the United States–
and for instance with soybeans there is because there’s a lot of empty land in middle of America. However, a lot of companies the Chinese market
is big enough that they’re actually locating operations there to serve the Chinese market. They have better access to local talent to
tell them what types of goods and services Chinese consumers want. So there’s a real benefit to locating that. But with the investment regulations in China,
there’s a real prohibition on even mundane types of investments. And so we see a lot of this. And so there’s this sense that the focus on
bilateral trade deficits that the Trump administration has, isn’t accurately capturing a lot of how
firms are behaving. At the same time, there is a degree of logic
to it. Even the Obama administration and Bush administration,
in years, felt that they were not being treated fairly or honestly, by the Chinese government
in a lot of these negotiations. And so what has happened, the Trump administration
has said very pointedly that they want verifiability and observability in any type of agreement
that they have with China. And so their focus on trade deficits morphed
from this obsession by Trump on bilateral trade deficits into, hey, this is a very observable
and verifiable means, we can see that China is actually meeting any agreement that we
have with them, because we do not trust them if they make promises to open up their markets
that they won’t create other barriers to trade after we have the agreement. So there is some logic to it, but longer term,
I think a lot of people have come to the realization that we need a broader rethink of what we
mean and how the US-China relationship should unfold. We’ve heard discussions about a lot of US
companies need to change their supply chains, and how they in how they import and export. And so this is really changing a lot of people’s
perceptions of what is happening. And there’s not a lot of good answers right
now as to how this relationship should unfold over the next few years. So I think the China deleveraging story is
decidedly more complex, has really become more complex over the past year to two years
than what a lot of people are historically used to. The concern about Chinese leverage ratios
grew out of this explosion in corporate debt that we saw in the post global financial crisis,
say between 2009 and 2015. But that story has really changed, decidedly,
over the past year, but really began about two years ago. So there’s a couple of things that I think
are very important to note. The first is, is that beginning in about late
2016 and carrying out throughout most of 2017, corporate debt ratios actually began to slow,
and really kind of leveled off in 2017. Some industries actually saw a fall in debt
levels. And debt levels across the entire corporate
sector in China grew slower than corporate revenues or nominal GDP. So there was actually a slight deleveraging
in the corporate sector. And so when people talk about China deleveraging,
and they’re positive, that’s what they’re focusing on. But really what’s happened over the past,
say, two years, and even a little bit longer for households, is that actually debt has
now been spread more widely to other sectors. Let’s say between about 2012 and, let’s say,
the middle part of 2017, there was a rapid growth in the financial sector debt. You saw this especially in shadow banks. And you saw this in, let’s say, the other
investments category of banks, where they were selling and purchasing, themselves, a
lot of these wealth management, various trust products, things like this. And so this was a very rapid area of growth. Another very rapid area of growth it began
a little bit later, let’s say 2012, 2013, was the growth in household debt. And this has been a very rapidly growing area,
also. And so, even now, household debt is growing
at about a little over 20%, say 20% to 24%, year to date and stock numbers. So this is really causing concern. And the thing that people are forgetting at
this point is, for a long time the corporate death debt sector was probably, let’s say,
65%, 70%, of debt in China. And so people could just take it for granted
that corporate debt was that was the driver, and that was the number they needed to focus
on. However, household, and these other sectors
have been growing so rapidly that now those sectors added together are actually now a
majority of the debt picture in China. So to give you an idea of how important these
other sectors are, household debt now in China, as a percentage of household income, is actually
now, according to official numbers, above 100%. This would put Chinese households, with regards
to household debt, on par with really every major economy, even ahead of many developed
economies. This is the problem, is that before, where
it was concentrated in the debt sector, the debt sector or the corporate sector has largely
leveled off. But what we’ve now seen is that debt in these
other sectors has grown rapidly enough that we’ve seen a tightening of, let’s say, debt
absorptive capacity throughout the entire economy. And this is really what is concerning. So if we look at the debt picture as the total
economy, let’s say over the past 18 months to two years, the debt to GDP ratio has probably
slowed where it’s increasing very negligibly. But the problem is that now, basically every
sector of the Chinese economy is now heavily indebted, whereas, let’s say, a couple of
years ago it was just the corporate sector. And even in the corporate sector, it’s not
that you’ve seen any specific any significant fall in the debt ratio, you’ve just really
seen a flattening of those debt ratios. And so what this is telling us is that, basically,
there’s much less absorbing of capacity in the entire economy if there is a specific
shock to a sector. So the good news is that this debt to GDP
ratio has really has flattened quite significantly. The bad news is that the entire system is
a little more is more stressed than it was previously. The final issue of note, specifically in this
debt picture, is that a lot of this in 2017 was driven by inflation much more than any
drop in debt. Basically, what has been happening is that
since about 2017, China instituted a one to one bank rule and has implemented very, very
strict capital controls. So even companies that are making import purchases
in China that have to send out FX they’re under very, very strict reporting requirements. Banks, for every import dollar that they send
out of the country, they have to bring one back in an export earning. And so what we see is actually small capital
outflows but nothing of any significance. What is noticeable, as of recently, is they
seem to have quietly changed the weighting of the RMB basket. And that has caused the RMB to diverge from
the predicted value of the RMB-US dollar exchange rate. We’re not exactly sure how they’ve changed
the basket but it does appear to be happening. The best guess right now is that is political
influence, to try and keep the army stronger as the US dollar appreciates, to keep Trump
happy, for lack of a better term. But that is definitely going to be something
to watch very clearly, going forward, because as there is outflow pressures that have not
changed, fundamentally, any change in the RMB value is going to place a lot of pressure
on outward flows. Yeah, so basically, even though China has
a very rapidly burgeoning tech sector and is really doing some very interesting things,
there’s this idea that because China has more people, they’re going to have an advantage
in AI, or big data, or machine learning, some of these buzzwords that are floating around. But that’s really a poor understanding of
how this data is analyzed, how it is used, and things like that. And really a lot of it still comes down to,
what is the engineer, what is the data scientists ability to use models or create our algorithms
that use the data. If we think of, for instance, of the very
popular Chinese app, WeChat, that has more than a billion users– even if we take an
example like Twitter, with 300 million users– there’s very little statistical difference
between analyzing such a large number of users. If you have 300 million users, you’re going
to be able to get statistical significance, you’re going to be able to create the models. It’s much more about the engineers or data
scientists ability to use that data. One of the things that is also very important,
is the type of data that is being used. I know somebody in China that runs a credit
analytics firm and was explaining to me how they are now able to parse the data that they
have in China, with regards to credit analytics. So if you were using WeChat and you fill out
an application through a WeChat platform to get a loan, what happens is that credit analytics
firm has access to where you spend your money, who you spend it with, where in China you
go, all of these kinds of things. If you are filling out a credit application
for a credit card company in the United States, and they get the credit report from one of
the three major credit reporting bureaus, they have much blunter information. And what I mean by blunt is, they will see
that you have an existing credit card with HSBC, or Wells Fargo, or something like that,
and that you have a $5,000 balance. They will not see all of the different places
that you have used that credit card at. They will not see who you’re spending it with. They may not see second sources of income
that are reported off the books, or something like that. There’s a lot of data that they’re not going
to have, that a credit provider on WeChat will have. That talks to the data quality, but we need
to be very clear in distinguishing, it is very important how people use this data, what
type of data is being generated. So how justified is the pessimistic China
story of doom and gloom? I agree with their analysis. And I disagree pretty strongly with the conclusions
they draw. And here’s what I mean by that, everything
that the China pessimists talk about with regards to overcapacity, excess debt, all
of that is true. And, in fact, it’s probably, in reality, worse
than even what they say. They’re entirely right about what that typically
leads to. Here’s where I differ significantly, I see
a potential financial crisis as the last possible outcome in the China story. And there’s a very simple reason for that. And it has nothing to do with finance or economics. And it’s this, if there is a China crisis,
of what you and I would mutually agree upon is a true financial crisis, 2008, you know
something like that, that is what would become the once a century event. That would be D-day, that would be the communists
rolling into Moscow, that would be 1989, all rolled into one event. Beijing knows this, OK? Beijing will do everything possible to prevent
a financial crisis from taking place. Now, I need to be perfectly clear, that doesn’t
mean that they’re going to make good policy decisions. It most definitely does not mean that they’re
going to make good policy decisions. But it does mean that their objective is to
prevent a financial crisis, at all costs. When the US government was looking at some
of the decisions it made in 2008, it made a very clear, conscious decision, we are not
going to rescue some of these firms, we are not going to rescue specific asset holders
in the decisions they’ve made. Now we can debate whether or not that was
the right decision, but there was a very clear decision, we’re not going to do this, we’re
not going to allow specific pain or events to unfold. Beijing does not have that option. Someone I trust quite seriously on these issues
said, it is Beijing’s objective to become Tokyo, not Thailand. And what they mean by that is, they are very
willing to turn it into a long, grinding mess, but they are absolutely, under no uncertain
circumstances, willing to let it become a financial crisis. Because if it is a financial crisis, that
changes everything we know about China, overnight. That is the once a century event, and Beijing
is going to do everything they can to prevent that from happening.

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