Chinese Economy and the new Leadership
Q: What do you think of China’s economic performance in the past year?
A: Since 2008, when the financial crisis started in the US, China became the motor of the global economy. It became the driving force moving global economy forward. China’s economy is much smaller still than the US. It is smaller than the US consumer [economy]. Therefore, the growth has been slower since 2008 than it was before. So I rate China’s contribution quite high.
Q: What are the main threats to the Chinese economy?
A: They are partly external, because of the slow growth, and the inability of the global economy to continue to absorb the ever-increasing Chinese exports. And internal, because China has to change its growth model. China has to reorient itself from export and investments to domestic consumption.
It is going to be a very difficult transformation, because the household consumption is only 1/3 of the Chinese economy. Exports and investments are 2/3. The growth of 1/3 cannot make up for the slower growth in the 2/3. Therefore, the overall growth rate will have to be significantly slower than it has been up to now. That is a very important point.
I don’t have enough knowledge to have an estimate [of China’s GDP growth rate this year], but the official estimate is 7.5 per cent. The important point is that it is less than the 8 per cent which was considered sacrosanct until now. It was in fact significantly exceeded in reality. That means significantly lower growth.
Q: What will China’s economic transformation be like in a few years?
A: I think the period of rapid growth when the overall economy was growing more than 10 per cent in reality is over, and it is unlikely to recur. It is a phase of growth that occurs at the early stage of economic transformation, and it does not occur in the more mature phase that China is today entering.
Q: What do you expect from the new government after the new leadership took power?
A: I believe they are aware of the need to make this change. I should have said earlier that this change doesn’t necessarily have to occur today -- the old model can last for another year or so, but it cannot last another 10 years. Therefore, the new leadership that has to think in terms of 10 years must embark on this change, especially that, in my opinion, the change was already delayed by the previous leadership which only had one or two years to go, and therefore they extended the life of the old model. That actually creates additional problems for the new leadership because with the extension, some serious imbalances have developed in the last year or so.
Q: What are the imbalances?
A: By stimulating investments, the capacity of industry increased, but the market didn’t increase enough. Therefore, the profitability of production, both of export and of investment themselves, declined. That creates financial problems -- it increases the bad loans that banks have made. And also, the government has started cutting back on the availability of cheap credit. Therefore, particularly the real estate companies were forced to borrow in the quasi-bank markets. And that borrowing cost is much higher, at a time when the investments were less profitable. When it comes to repaying the loans, there may be some difficulties in collecting the money.
The quasi bank market is mainly in the hands of state-owned banks, which have wealth management subsidiaries. And there is an implicit guarantee by the banks, so when the wealth management companies have difficulties in collecting the loans, the state-owned banks will have to make up for the difference.
On a few occasions when this has occurred so far, the state-owned banks have always made up for the losses. But if they are very big, maybe one of the non-state-owned banks cannot meet its obligation, and then you could have a run on that bank.
So this is somewhat similar to what happened in the United States with the subprime mortgages that eventually, of course, led to a serious financial crisis.
Now, I think the authorities are aware of the problem, and they also have very substantial resources available to deal with the problem. They also know what happened in America in 2008. So I think they will be able to deflate this incipient bubble without a serious financial crisis. This is the problem the new leadership now faces.
China’s Financial Regulation
Q: What is your assessment of how China’s policies worked in 2008-2009? Were they successful?
A: China was very successful in 2008 when there was a very large, sudden drop in export of more than 25 per cent, to stimulate the economy. And they had the resources to do it. So China sailed through the crisis of 2008.
Q: Do you think China’s financial regulatory system operates effectively?
A: I hold China’s financial regulatory system in very high regard. And I have actually met them in the past, so actually know them. I think they understand the problems, and they have learned lessons from the mistakes that were made in the West.
I think the Chinese regulators have a much closer and more intimate knowledge of what goes on inside the banks. The lack of detailed knowledge in the West is quite amazing. And that was the reason why things went so wrong.
Chinese Stock and Real Estate Markets
Q: What are your views on the Chinese stock market?
A: It is not surprising that the market did not go up in line with the overall growth of the economy, because that growth was actually accompanied by a lack of profits. And stock markets generally reflect the growth of earnings, not the growth of output. Because too much went into investment and export, they were not profitable. In fact they even created problems for the banks. Naturally they also created problems for the stock market because there is a lack of earnings.
In five to 10 years, if the authorities are successful in changing the growth model, and there is more production for consumption, not for export and investment, then the profits of the companies that cater to the consumer could increase, particularly those winners who can innovate and fulfill the needs and the taste of the consumers, could become very good investments.
And of course that would mean a larger portion of the economy would be in the hands of private enterprises rather than state-owned enterprises, and the private enterprises would be more independent from the state, and would not have to pay rent to the bureaucracy. That would be a big improvement in economic performance.
Q: What about China’s real estate market? Do you see bubbles?
A: I think real estate is rather vulnerable in China, because it has been a favourite form of savings. People bought more than one apartment, particularly state employees who have financing which enables them to buy more than one apartment. So there has been a large accumulation of apartments which are empty and are like savings in gold or in a bank.
I think it’s part of the transformation that at least the empty apartments will have to be sold, or maybe taxed. I think they are now a risky investment.
I think imposing a property tax would be very effective, but it would have to be done very gradually, exactly because they are so effective, they could create a crash. If, say, a state employee who has five apartments, of which four are empty, he would have to pay tax for five apartments. He couldn’t hold them, he would have to sell them. Then the market would be flooded by apartments for sale. That is something that has to be done very gently. So far I don’t think it has been done except in some pilot schemes, but I don’t know the details.
If you have to pay just five per cent or three per cent tax every year whether you sell it or not, that would have the effect of pushing some people to sell.
Urbanisation and Planning
Q: What do you think about the Chinese leadership’s urbanisation policies? Is it realistic to expect urbanisation to continue to drive the Chinese economy in the years to come?
A: I think it is very realistic. Urbanisation is likely to occur whether authorities plan it or not. And the fact that they are planning it makes it easier for them to prepare properly. If you don’t prepare for it, you would have, for instance, no services for the people rushing or being drawn to the cities, and you’d have slums. They occur all over the world -- you have very fast-growing, large cities all over the world. I think it is definitely going to happen. And I think in this respect, China is in the forefront of planning for it.
Q: What do you think of the Chinese government’s economic planning capabilities?
A: It may be too rigid. I visited the new cities planned for Tianjin, and there is a plan showing individual houses, and what they would be used for in 20 years time. I don’t think anybody has enough foresight to be able to predict what the demand would be in 20 years’ time. It would be very interesting to see how close the actual development would be to the plan.
Pudong had this plan, which was very impressive, and the reality came very close to what was planned. But I have my doubts whether the next one would be equally successful. It is too rigid in my opinion.
Obviously there is a middle ground, and particularly the United States has relied too heavily on private enterprise, and now is paying a heavy price. China has been at the forefront of economic planning, and very successful at it. But maybe Chinese planners are becoming overconfident in their ability to design the future. There is a danger that they may overdo it.
I think the initial signs are very encouraging, but it is too early to form an opinion. On the balance, I am optimistic because there is already a tradition in China of recognising the need to change the business model, switching from one to another. The existing model has produced positive results. The government has quite substantially accumulated reserves, such as the foreign reserve. That gives them the need to correct shortcomings.
Long or Short on China?
Q: If you were an active investor now, would you describe yourself as long or short on China?
A: I am also aware of the exceptional difficulties that the transition is going to bring, and therefore, if I were an investor, I think I would be very cautious in the near term – the next year or so. Because you have this situation when 2/3 of the economy has to slow down, and 1/3 has to expand. That already makes it very difficult. What makes it even more difficult is when there is an overall slowdown, the households’ first reaction may be to become more cautious, and their propensity to save would increase – they would be afraid that their job is not safe, and they would not be so confident in spending money. And then all three of the sectors would slow down at the same time. That would create a hard landing.
Q: On many occasions people have spoken about a hard landing in China, but there never has been one.
A: I think to some extent, the hard landing has already occurred, but it hasn’t been so hard. Automobile sales slowed down, and housing market slowed down, in the last year. Then the authorities gave another shot of stimulus which was very much like the old style, relaxing monetary conditions, and then housing recovered.
I am sorry to say, but the jury is out.
On Local Government Debts
Q: What about local government debts? How big a threat are they?
A: The business model of local authorities depended on selling property at ever rising prices. That is not sustainable. And you will need to actually make houses available at affordable prices, so you need social housing. That doesn’t give local authorities the revenues they are used to. Actually, it may involve expenses. And so, the local authorities would be under considerable pressure.
I don’t think there is any risk of large-scale defaults, because there will be re-allocational burdens from the local government to the central government. Maybe it would increase the control of the central government over local governments, but I can’t imagine the central government allowing local governments to default, just as it is most unlikely that the state-owned banks would allow one of their wealth management companies to default. The consequences would be too severe.
Q: What do you think about the internationalistion of the RMB? Will it become a world currency in the future?
A: At sometime in the future, yes. But the government is eager to see the RMB being used in international transactions, but not to allow the international market to be too closely connected to the domestic market. And I actually approve of that policy because it has protected China from external shocks creating too much trouble internally. And I think it is quite a wise policy. But the domestic market will have to become much more mature and the international markets will also need to be better controlled, become more stable, before the RMB would become a global currency.
Q: What is your view on gold?
A: That’s a complicated question. It has disappointed the public, because it is meant to be the ultimate safe haven. But when the euro was close to collapsing in the last year, actually gold went down, because if people needed to sell something, they could sell gold. Therefore they sold gold. So gold went down together with everything else.
Gold was destroyed as a safe haven, proved to be unsafe. Because of the disappointment, most people are reducing their holdings of gold. But the central banks will continue to buy them, so I don’t expect gold to go down. If you have the prospect of a crisis, you will have occasional flurries or jumps. So gold is very volatile on a day-to-day basis, no trend on a longer-term basis.
China and the European Financial Crisis
Q: What role do you imagine for China in the European financial crisis?
A: China has just made a gesture of contributing 1 billion euros to the rescue of Cyprus. This is a symbolic gesture because China has an interest in maintaining the euro as an alternative to the dollar. And it has large holdings of the euro that it doesn’t want to see lose value. It is a defensive contribution.
Q: What advice would you offer in terms of philanthropy to the increasing number of rich people in China?
A: People who have become rich in China show real interest in philanthropy, which I think is very praiseworthy because I think it is appropriate for those who have benefited disproportionately that they should return some of it to those who are less fortunate. I think it will contribute to social harmony.
I think the natural instinct is to engage in charity. But that has some negative side effects, because charity can turn the recipients into objects of charity, who become dependent instead of depending on themselves. There are people, like the sick and the old, who need to be taken care of. But particularly in the case of children and young people, it is much more important to enable them to improve themselves, giving them opportunities to learn. Scholarships are better than charity.