Odd Lots - Just How Bad Is the Economy Getting in China?

Episode Date: September 5, 2022

In the wake of the Great Financial Crisis, China arguably led the world out of the downturn. Its gigantic fiscal stimulus not only boosted domestic growth, it also created an incredible amount of demand for commodities all around the world. Today the story is different. The government's Covid Zero policies have been a drag on growth and the real estate sector is deeply troubled, with a rise in homebuyers refusing to make mortgage payments. On top of that, the country is experiencing searing heat and drought. So how bad is it? Are things meaningfully worse than in previous downturns? To understand more, we speak with Tom Orlik, Chief Economist at Bloomberg Economics and author of the book "China: The Bubble that Never Pops." See omnystudio.com/listener for privacy information.

Hello, I'm Michelle Hussein, and for more than 20 years, I was at the BBC. But all the time I was delivering the headlines, I wanted to go further than the news of the day, to spend more time with the people shaping our world. And that's what I'm doing here on this podcast, speaking to people from Nigel Farage. To love you trying ever so hard. Russian needs to be taught a lesson. To tech journalist Karaswisher. And the tech industry is running wild.

You know, they've gotten what they wanted and they've seen a huge run-up in their stock prices. This will be a place where every weekend you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to the Michelle Hussein show from Bloomberg weekend, wherever you get your podcast. You certainly ask interesting questions. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthal.

Joe, what is going on in China right now? That is a good question. And it's a question we actually haven't been talking about enough. Lots of focus on energy, lots of focus on Europe, backroad, the Fed, recession. But my understanding is that things aren't great in China either. I feel like in a normal year where everyone wasn't distracted by domestic U.S. inflation and the question of whether or not interest rate hikes are going to spark a recession, I feel like, China would be taking center stage with everything that's going on. But it feels like it's sort of been tangential. Like you hear a little bit about what's going on, but people like aren't really focused on it.

Well, I would say it feels contained in a way, you know, so obviously one of the big stories is the country's ongoing commitment to COVID zero, which obviously has a negative impact just on sort of economic activity, sort of measured broadly. But then there are other things happening. The The real estate sector seems very troubled with more and more people basically refusing to pay mortgages on houses that have yet to be completed. Right. I know that's a big story. There's a big drought happening, a really intense heat wave. So they're having their own weather climate stress.

But yeah, I still don't totally get how it all fits together. Right. I feel like people have been warning of a Chinese property bust for so long. And it hasn't happened that we've all sort of become inert to the idea that it could. actually happen and maybe we're seeing the beginnings of it. But again, maybe we're not because China is very good at coming in and rescuing a particular sector is when it needs to. That's the key thing. And of course, we've talked about, say, Evergrand, a few times on the show. So there are these busts that happen and there are all these troubles. But it always seems like

in the past that the government has been able to use its balance sheet to prevent some like wholesale collapse. Yeah, but now, of course, we know that Xi Jinping is on a mission to pop a lot of bubbles in the Chinese economy to crack down on certain sectors that he thinks are not economic or efficient. And so maybe it's different this time, but maybe it isn't. So let's see. Let's find out. I have to say, we really do have the perfect guest to discuss this. We are going to be speaking with Tom Orlik. He's the chief economist at Bloomberg Economics. He is also the author of China the bubble that never pops. So we get to ask him if it is going to pop this time. There is a second edition of the book coming out in September. So it really is a great time to catch up with him. Tom,

thanks for coming back on all thoughts. Great to be here. Thanks for having me, Tracy, Joe. So maybe just to set the scene, let's start with the big question, which is, I think most people at this point know that China's economy is heavily, heavily reliant on real estate and property, something like 30% of total GDP is accounted for it by real estate. How did that come to be? Why is China's economy so leveraged to this one particular sector? That's a really good question, Tracy. And there's a bunch of factors at work. So the first thing to think about is the strength of fundamental demand. So remember that in the 1980s and early 1990s, China did not have a private property market. If you lived in a city, you almost certainly lived in a dilapidated government,

apartment or dingy house. And so when the private market sprang into life in the late 1990s, there was enormous pent-up demand for real estate. Adding to that, China's households have enjoyed decades of strongly rising incomes. And of course, when your income rises, one of the first things you want to do is buy somewhere nice to live. And China has had an urbanization boom with hundreds of millions of people moving from the countryside to the cities. So the first reason why real estate has been so important in driving China's growth is just that there's been enormous demand for real estate. The second contributing factor is that speculators got in on the game. China's investors don't have brilliant options. There isn't much of a kind of retail.

financial market, there aren't a lot of money market funds and things like that, you can park your cash in. If you put your money in a bank deposit, very often the interest rate is below the level of inflation, so you're essentially losing money. If you put your money in the stock market, it's a roller coaster. So a lot of investment funds went into real estate and that speculative demand added substantially to the fundamental demand. By some estimates, as much as 30% of property in China is sold to speculators who hold it empty, hoping for capital gains. So those factors together drove China's real estate boom and pushed its contribution to GDP,

taking account of all the construction activity, all of the impact on steel and concrete and home electronics and furniture and a car to put in the garage up to that 30% of the, percent number, which Tracy mentioned. So my understanding, and this is just that we've had, you know, we've talked about Ever Grant a few times last year, but my understanding is that there's this broader problem of real estate developers essentially running into financial trouble, running into operational trouble, having a difficult time delivering on houses that it's sold, that they pre-sold essentially. And now the people who bought those mortgages saying, look, you haven't delivered the house that I bought. I'm not sure the timing of when you're going

to deliver those homes, so I'm not going to pay. Is that an accurate characterization of it? And how big is this movement that we're seeing where people are saying, we're not paying our mortgage right now? Yeah, I think that's completely right, Joe. For the last few decades, given the very strong demand, given the continually rising prices in China's real estate sector, the best strategy for real estate developers was just to build as much as possible, as quickly as possible. And in executing on that strategy, many of China's real estate developers engaged in some sharp practices. One of those sharp practices was selling homes off the plan, so not selling a home they'd already built, but selling a home they were promising to build, and then taking the funds from those prestales, and instead of using

them to complete the project, using them to buy land to start another project. Now, as long as the demand was there, as long as they could sell that second project, and as long as they could get access to bank finance, as long as the banks were willing to loan the money to fill in any short-term shortfalls, that strategy worked really well. But what's happened in the last two or three years, is that the government has stepped in and said, no, this is not a sustainable trajectory for the real estate sector. We need real estate developers to get their finances in order. And we're going to cut off sources of finance for real estate developers that we think have engaged in too many sharp practices that have borrowed too much money, that have too much leverage.

At the same time, the fundamental demand story, which has driven China's real estate boom, has kind of come to an end. China's demographics have become a drag, and of course when you have less people, you need less accommodation. China's urbanization story, it's not quite over, but it's not delivering the same impetus that it was 10 years, certainly not the same impetus it was delivering 20 years ago. And what that means is that real estate developers who took money to build a project and then use that money to start another project, now find they don't have enough funds to finish the houses they promise to finish. So this actually leads into a question I wanted to ask.

So we have the situation where something like 70% of all Chinese property sales are presales, so for units that are going to be constructed. And people have pinpointed that or pointed to that as a source of weakness for a while. And even the Chinese government, as you just mentioned, basically started cracking down on it and saying this is problematic. So how much of the current situation where you have this mortgage boycott people refusing to pay the money that they owe to developers for houses that are under construction and you have house prices deteriorating and you have property developers under pressure? How much of that is engineered by the Chinese authorities themselves as part of property sector reform versus things that are maybe a little bit more macro, maybe outside of their control, such as the impact of the pandemic or, you know, interest rates and things like that?

So it's a complicated picture, Tracy. And I think you have to give China's government some of the blame for allowing the situation to get to the point which it has. some of the credit for attempting to move ahead of a crisis, right, to try and tamp down the problem before it really blows up. And of course, like all governments in the world, they've been the victims of bad luck. The COVID pandemic hasn't made anything easier. It certainly hasn't made dealing with a real estate crisis any easier. So it's not easy to put a sort of size and scope on this problem. China's government has clearly decided that the mortgage boycott is a sort of

of extremely sensitive issue and so they're actually making it rather hard to get a handle on it. There aren't good numbers from private real estate information companies, for example, who would be positioned to tell us exactly how many delayed projects there are. But we've put a super smart team on the ground and they've done some fancy footwork with the data that is available to try and put a magnitude on the size of the problem. So the starting point of their calculations is the fact that on average it takes about three years to finish a property project. And if we look at the historical data, in general, if you have 100 projects started in year

one, then in year four, three years later, 80 of those projects will be completed. So three years in, there's an 80% completion rate. when we look at the data for 21 and 2022, what we see is that completion rate has dropped all the way down to 50%. And because we know how much it costs to build a house, and because we know, on average, how much of house purchases are paid for with mortgages, we can then use that drop from an 80% completion rate to a 50% completion rate to calculate the magnitude of the problem. And what that calculation tells us is that the value of mortgages attached to unfinished properties right now is around 1.6 trillion yuan. That's about 1.4% of China's GDP. Now, that's already

really big, certainly big enough to make this a systemic issue for China's economy and financial system. If the problem is left unaddressed and that 50% completion ratio holds until the end of 2024. The size of the problem is going to go up to 4.4 trillion yuan, which will be close to 4% of China's GDP. Wow. Why is the completion rate fallen? How much is the change in finances and how much, you know, I don't know, are Chinese developers? Are they also facing supply chain and commodity constraints like basically everywhere else in the world? So I think it is a substantially a financing issue for China's developers. In 2020, China's government introduced something they called the three red lines policy, essentially a set of constraints on access to credit for China's

property developers. One of the red lines, for example, was if you don't have enough cash or liquid assets to cover all of your short-term debts, you're not allowed to borrow any more money. And that clamped on access to finance for developers, it kind of made it really hard for them to continue with that game where they sold projects on plan and then used the funds to start another project, but that was okay because they could always go to the bank to borrow any extra funds they needed

to make sure everything was completed. So I think access to finance has been a really big part of it, but of course there are other factors coming into play as well, COVID-0, China's insistence, keeping the COVID rate right down in the sort of low single digits obviously means that at different points in different parts of the country, it's just hard to get things done because you can't leave your apartment. Just real quickly, though, so if it's largely a finance problem, what are the drawbacks

of yet another sort of government intervention telling, having the banks open the taps and say, here's the money, get the apartments built? So I think there's a couple of things going on, Joe. So the first is a kind of a recognition that the fundamental demand story in China's real estate sector has changed. The demographics, the end of the urbanization boom, mean we're just not going to go back to the years of rapid growth in real estate construction, contributing to rapid growth in China's GDP. So that's the first reason China's central government are reluctant to turn the financial taps back on. The second reason is that in part, the real estate boom has been underpinned by moral hazard. The belief by real estate developers and investors in real estate that they can take any risk they like,

and if it pays off, they're going to make massive profits. And if it doesn't pay off, don't worry, the government's going to be in there to backstop our borrowing. and make sure we stay solvent. So China's government is very keen to address that problem of moral hazard. That's why they allowed Evergrand to go into default. That's why they've allowed another quite large set of property developers to go into default. That said, China's government are not crazy. I remember reading Timothy Gaynor's book on his experience in the financial crisis.

And he says, people who worry about moral hazard in a financial crisis are like people who would allow a house to burn to the ground without calling the fire brigade to teach people about the importance of not playing with matches. And I think China's government very much sort of hold to that general philosophy. They don't see this as a one round game. They see it as a multi-round game. They've imposed a bunch of pain on China's property developers. and China's property investors by allowing the defaults which have taken place so far, I don't think they're going to pursue their campaign against moral hazards so far that they tip the entire Chinese economy and financial system into crisis.

They're not arsonists. So just on this topic, I mean, we have seen China announce quite a few stimulus measures just in the past week. And I should mention we are recording this on August 29th, And I think it was August 24th or something like that. They announced, I think, 19 new measures to stimulate the economy that are worth more than one trillion UN, which is about $150 billion. And one of the things that's in there is allowing local governments to raise more money, issue more special bonds, raise more money, and allowing them some more leeway to potentially allocate that to housing, to try to feel. figure out this pre-sale problem. So how effective will that measure be? And to the point of this tension between stimulating the economy and re-inflating a bubble, is there a possibility that local

governments just start unleashing a torrent of credit that makes the problem worse? Maybe one way of thinking about this is thinking about two extremes, right? So one extreme is do nothing. Allow the mortgage boycotts to continue increasing, allow more and more real estate developers to go into bankruptcy, allow that to spill over into a massive increase in non-performing loans in the banks, and allow that ultimately to sort of metastasize into a Chinese version of the US subprime crisis and great recession, right? So that's one extreme. At the other extreme, you've got something which looked like China's response to the great financial crisis, the global financial crisis in 2008, where they opened the credit taps and delivered that massive stimulus, which got the Chinese economy going again and got the global economy going again, but put them on this unsustainable trajectory where they had to keep on borrowing more and more money to pay for more and more overcapacity in real estate, overcapacity, in industry. So neither of those extremes are particularly attractive.

What's China trying to do right now, they're attempting to find a kind of a middle path between the two. And that's why we're having this sort of drip drip of what I would call sort of relatively small stimulus announcements. PBC cutting interest rates a little bit. Local governments being able to issue a few more bonds to pay for infrastructure and perhaps provide a little bit of support to the real estate sector. It's not what the market wants to hear. They want to hear that kind of shock and awe stimulus announcement, like they heard from Wen Zhao Bao at the end of 2008.

They're not going to get that shock and or stimulus announcement. China doesn't want to restart another unsustainable boom. But neither is the kind of nightmare scenario of a do-nothing Chinese government, which allows the real estate sector to melt down going to play out. You mentioned the banks. What position are the banks in to recognize these types of losses? And one of the things that I occasionally hear from people in China is that, oh, it's not such a big deal because a lot of the pre-sales lending was done by regional banks or a lot of the property lending, I should say, was done by regional banks, which no one ever really regarded as safe anyway. So it's not that much of an issue. So this is potentially a big problem for China's banks. If we think about the history of financial crises, real estate often plays a very significant role. It was real estate which kicked off

the 1989 meltdown in Japan's economy, which ended Japan's development miracle and pushed them into that lost decade of low growth and falling prices. Of course, it was the subprime crisis here in the United States, which kicked off the Great Recession, and real estate also played a big role in the Asian financial crisis back in 1997. So problems in real estate do have a track record of spilling over into the financial system. And China's financial system is heavily exposed to real estate. There are a lot of loans to households, to buy homes, there are a lot of loans to property developers,

and a lot of loans which are not directly to the property sector are collateralised by property or land, which means a drop in property prices or land prices would affect those loans as well. So there's a substantial risk there. How should we think about how that risk is going to impact? I think it's useful to think about two different types of Chinese banks. At the top of the kind of chain, you've got the big state-owned banks, the ICBCs and CCBs and ABCs of the world. They are extremely well funded and they have a huge capital buffer.

They are also diversified around the country, which means that problems in a particular city or a particular province aren't going to be good news for them, but they're not going to affect their entire loan book. I don't think we're going to see problems for China's big state-owned banks. At the other end of the spectrum, you've got small city banks. Now, small city banks tend to have a much less stable funding base. They tend to have a smaller capital buffer,

and they tend to be heavily exposed to lending in their own city. And that means it's pretty easy to imagine a scenario where you've got a city with a bunch of stalled property projects, with a bunch of mortgage boycotts going on, with a city bank that doesn't have good funding, that doesn't have a strong capital buffer, and which runs into problem. We're not quite there yet, but I wouldn't be surprised if in the next one, two, three years, we saw a bunch of small city banks that needed a capital injection.

On April 4, 2023, around two in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 16. I want to pivot off of real estate a little bit and talk about, you know, the story of the world right now is clearly commodity scarcity and most of the attention is focused up. Europe and this soaring price of power there. But it's really, it's not just a Europe story. A lot of developed markets. Every day there's stories about some sort of rationing or export curbs or

rolling blackouts or surging price of food. I feel like, you know, just sort of big picture. What is China's commodity position? How much is that story affecting the Chinese economy right now or to what degree is China insulated from it? You know, Joe, I would almost flip that question round and think about how what's happening in China right now is impacting the global commodity story. So let's imagine that China was running a repeat of its 2008 massive stimulus play and getting the economy back growing at 6% a year.

Now, if that happened, it would drive enormous demand for energy, enormous demand for metals, enormous demand for agricultural commodities, and the biggest problem for the rest of the world right now, high inflation driven in part by high commodity prices, would be a lot worse. China's not running a repeat of its 2008 stimulus play. That means growth is very weak.

Second quarter, we had actually a contraction in GDP. Most people think the rebound in the second half of the year is going to be tepid at best. And what that means is China's commodity demand just isn't where the markets expected it to be a few months ago. That's one of the factors weighing on energy prices, metals prices, agricultural commodity prices. So that's actually making the biggest problem for the rest of the world right now, the inflation problem, a little bit easier to grapple with. Tracy, you know, to Thomas' point, something I've been thinking about is, you know, all these U.S.

retailers talk about how much excess inventory they have right now. And in a way, you know, with these hard lockdowns that we saw in China. It's almost like kind of comes almost at a fortuitous time in the sense that this is not a time where retailers want to have a lot of like inventory or stuff coming in from China. Well, this was actually going to be my next question, which is how does the Fed's inflation fight and the fact that they seem to be even more explicitly now trying to take a chunk out of consumer demand to bring down prices? How is that going to impact the Chinese economy at a time when it's already quite fragile?

Yeah, it's a great question. I think you kind of hit it in your introduction to the whole podcast. In normal circumstances, if China's economy contracted like it did in the second quarter of the year, if China's real estate sector was in crisis, like it is, then we'd all be waking up every day and seeing that on the top of our Bloomberg terminal and the front page of Bloomberg.com. Checking the UN fixings, all of that. Exactly.

And we're not, right? We're wondering what Jerome Powell's going to say at Jackson Hole. We're wondering if the European Central Bank's going to deliver an outsize hike. So at least on the sort of the PR front, the sort of the inflation challenge which the US and the rest of the world is facing and which is absorbing all the attention of the global financial markets is actually doing China a bit of a favor. They're in a crisis. No one's watching. In a broader sense, though, it is not good news for China. China's going to spend certainly the rest of this year and very likely several years ahead working through the problem of overcapacity in the real estate sector, also grappling with COVID-0 and how ultimately to exit from COVID-0.

All of these things are going to be bad news for domestic demand. Now, what do you want when domestic demand is weak? You want external demand. You want export demand to be super strong to provide a buffer. Clearly that's not going to happen. The Fed is very aggressive. focused on tightening to bring inflation under control. Very likely, that's going to tip the U.S. economy into recession. Same story in Europe. China's two biggest export destinations are both going to be contracting at exactly the moment China really needs them to be booming. Talk to us a little bit more about the COVID-Zero restrictions, because I feel like these are the things, the backdrop against which all of this economic drama is actually happening.

And this is a choice made by the Chinese authorities to have very, very restrictive COVID-zero policies to prevent free movement of goods and people to be very gung-ho when it comes to lockdowns and things like that. What's the motivation there? And at what point would you expect those to start to ease off a bit? So if we were having this conversation at the end of 2020 or the end of 2021, China would look pretty clever on its management. of its domestic COVID outbreak. They contained the virus, saved a bunch of lives, and they got the economy growing again. They were the only major economy in the world to have a V-shaped recovery.

From where we are heading further into the second half of 2022, China's looking much less clever. Here in the US and in Europe, at enormous expense in human life, the population has a measure of immunity from the virus, partly because many people have got sick and then recovered, so they have natural immunity, partly because we have the sort of more advanced and effective MRNA vaccines. So normal life has resumed.

I'm recording this Oddlots podcast from the Bloomberg office. I dropped my children off in school this morning. In China, because the population hasn't experienced a wave of COVID infections, and because they've stuck with their domestic vaccines and not imported or developed their own version of MRNA, the population is COVID-naive. That's just a really big problem for China's government. But now, the decision has been to prioritise public health. So they're sticking with the COVID-Zero strategy.

Even when they see a handful of cases break out in a particular city, that city is locked down. That's pretty successful at saving lives. It's a bit of a catastrophe for the economy. We saw a contraction in the second quarter of this year. it's entirely possible looking into the second half that we'll see more cases in more major cities. Those cities will be locked down and we'll see a further blow to growth. Looking forward, I think the kind of the consensus expectation is that at the party Congress in the fall,

President Xi Jinping will get a third term in charge of the country, and at that point, with that third term secured, the attention of the government will shift towards how to exit from COVID-Zero. One reason to kind of query or have some questions about that consensus view is what's happening with vaccines. As far as I'm aware, China hasn't moved to secure the 1.4 billion MRNA doses it would need to give its population the maximum protection ahead of opening up. Neither do they seem to have their own domestic alternative. And that failure to sort of move ahead aggressively on the vaccine front raises some questions

about what their end game is on COVID-0. can it be sustained just the economic damage that comes from retailers or restaurants or anything in person in major cities seeing their demand get crushed the way it is or to have so much uncertainty. Like, does this do permanent supply side damage to the Chinese economy to have like such a long? I mean, we're facing it in the U.S. And as you mentioned, we took a major loss of human life and a lot of people got sick. But that's because. because we sort of made the choice to reopen very quickly and we're still feeling the shocks of it would intuitively seem like a very long-term damaging thing to have this much supply-side

degradation and halt of so many businesses. Yeah, I think that's completely right, Joe. So when we think about sort of China's economy broadly understood, we think about a bunch of imbalances that have to be addressed. So too much emphasis on industry, not enough emphasis. And on services. Too much investment and exports, not enough consumption, too much debt. The state sector is too big. The private sector, small private sector firms are too small. COVID lockdowns make all of those imbalances worse. COVID lockdowns are a disaster for the services sector. COVID lockdowns hammer consumption whilst they leave industrial output to broadly untouched. COVID lockdowns require an increase in debt to keep businesses solvent.

And state-owned enterprises, which tend to be bigger and have better access to finance, a better place to survive COVID lockdowns than their smaller private sector rivals. So is the Chinese economy going to fall over tomorrow because of COVID lockdowns? I don't think so. I think one of the lessons of the last two or three years is that actually pretty resilient can be locked down. and reopened, but certainly the longer this goes on, the worse those imbalances are going to get, and the higher the cost ultimately of unwinding those unbalances will be. So I have a big picture question based on that, which is how much of the problems that we've been

discussing, so the impact of COVID restrictions, the impact of lockdowns and COVID-zero policies, and the influx of money that has gone into the real estate sector, as you described at the beginning of this conversation, how much of that could be fixed by strengthening China's social safety net, such that people didn't have to put all their savings into property because there was a government-funded retirement option or national health care and things like that, or stronger healthcare services, I should say. So one of the fundamental imbalances in China's economy is the imbalance in the drivers of demand. Consumption plays a relatively small role in driving demand. Investment and exports play a

substantially larger role in driving demand. Now, why is consumption weak? Well, an important reason, as you suggested, Tracy, is because of the absence of a social safety net, because Chinese households feel like they need to protect themselves against the risk of unemployment or illness or provide some funding to fall back on when they retire, they save a substantial share of their income. That saving goes into paying for investment and it also means they have less money to pay for consumption. Now, there are other factors at work as well. The one charge of the one charge of the policy has been an important driver of that imbalance. If you have only one child, you just spend less because you don't need such a big house, you don't need to buy so many clothes, you don't

need to buy so much food, you don't need to spend so much money on tutoring and so on, and because you only have one child, you're worried they won't be able to support you in your old age, so you also save more. Financial repression has played a role as well. So we mentioned earlier on that interest rates were often lower than the level of inflation. That's been a kind of deliberate government policy aimed at making it cheaper to invest. But it also meant that Chinese households needed to save more if they wanted to reach their target for retirement. So all of these factors are at work.

The lack of a welfare state is one of them. To China's government's credit, over the last 20 years, they have been kind of progress. progressively moving into place the kind of the elements of a welfare state. So education is not perfect, but it is now free and universal up to the end of high school. The entire country has at least basic health insurance provided by the state. So it's still a problem, but policy, at least in that respect, is moving in the right direction. I'm June Grasso, inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal stories that shape the nation and the world. Listen for complete analysis

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That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. I brought up the commodity and power question earlier. And as you noted, in a way, the world is fortunate that Chinese demand for a lot of industrial or energy commodities or even ag commodities is not as high as it might have been in an alternate policy scenario. One commonality, however, and this seems to, this is a story that's getting a lot more attention, is the effect of simply extreme weather on the production of energy itself. And that also is worsening things in Europe. and there's a terrible heatwave and drought, or certainly a heat wave happening in China right now. How much is this adding to the pain?

How significant is this? How much are you watching the effective extreme weather and climate change on China's own ability to provide for itself? So China is one of the countries in the world, which is most at risk from climate change. Most of the population or the plurality of the population live on the East Coast, which means they're exposed to the risk of rising sea levels. A large share of the population still work in agriculture. Agriculture, of course, is one of the sectors, which is most at risk as temperatures rise. So thinking on a kind of multi-decade trajectory, China faces some significant risks from climate change, and that's why climate change is one of the few areas where China still wants

to do business with the United States and get some stuff done. The situation right now with very high temperatures, meaning that there's not enough water supply to power hydroelectricity, and that's contributing to power shortages, that's an additional negative for China's economy at a moment where with real estate in crisis, with COVID zero, imposing some costs, they don't need an extra problem to deal with. I wouldn't say it was the kind of the dominant narrative or the biggest problem that they're facing right now. So there is a very big event coming up, which is the National Party Congress, the big gathering of China's policymakers. And traditionally, when that happens, you often see the government start to say or do things that would be.

expected to boost the economy and push up stocks so that everyone is fairly happy going into this big event. What do you expect from this year's Congress? So Tracy, you are out in Hong Kong at the same time as I was in Beijing. So you know as well as me that ahead of these big political events, what China's policymakers won, what the Communist Party wants is stability. They want stability in the economy, they want stability in the financial markets, and this time round, they're not going to have it. The real estate crisis, I think, is going to run for certainly months and the drag from real estate is going to last for years. There's no sign so far that the government is willing to exit from COVID-0, and when they do ultimately exit from COVID-0,

that's going to be a very messy and very costly process. So my expectation ahead of the Party Congress is that we're going to see a sort of a continued drip drip of stimulus measures. The government is going to want to bring a measure of stability to the real estate sector, a measure of stability to the bond and equity markets, but they're not going to be able to deliver the kind of massive stimulus, which would be needed to kind of significantly turn the situation around and create that kind of feel-good factor, which they normally like to have heading into these big political events. So I'll just ask one more big picture question, but your book, China, the bubble that never pops and the second edition is coming out. And of course, the people have been talking about the China bubble collapsing for years and years, certainly for as long as our career in Tracy's. And as your book notes, it never seems to happen. I mean, is it, does it feel different this time or is this like, look, China has these periods where there's lots of stress, like many other countries, like Europe, like the U.S.

And eventually it muddles through and finds a way out. Does it feel different this time? Well, how does it feel compared to other periods of stress and turmoil for China's economic history? So it feels worse, Joe. I think there's a confluence of factors which are sort of coming together right now and which will also weigh on China's growth going forward. So we've talked about real estate. China has had real estate busts in the past, but this one looks more severe.

We've talked about COVID-0. That's already a drag on growth, and there's the big unanswered question of how they exit from it. One thing we haven't talked about, but which is also really important, is China's kind of growing international isolation. China's a big exporting country. China is a net beneficiary of technology transfer. Big driver of China's growth has been learning from, or if we're less charitable, stealing advanced technologies from other parts. of the world, that's just going to be much more difficult in the years ahead as hostility to China in the US, in big European countries, increases. So all of these factors are sort of

hitting China right now and threatening to weigh on China in the years ahead. At the same time, I think it's important to recognize that China retains pretty significant resources for resilience. China is at a relatively low stage of development. GDP per capita in China is still just the third of GDP per capita in the United States. That means China has continued and substantial room to grow, not by sort of doing anything particularly innovative or inventive, but just by continuing to kind of move up a technology ladder, which it can already see in front of it. Don't forget that Japan fell over in 1989 when its GDP per capita was 80% of the level in the United States. So China has a long way to go before it reaches that level. Secondly, because China's policymakers remain ingenious in their capacity to think about inventive solutions to economic and financial problems. They continue to have a certain amount of space, certainly less space than they did in the past, but still some, space for maneuver as they address those problems. And philosophically, China's policymakers

don't want to see everything burned down. They would sooner see a bit more in balance than a lot of collapse. All right, Tom, or like chief economist at Bloomberg Economics and the author of China, The Bubble that never pops. Thank you so much for coming back on all thoughts. That was great. Great to be here. That was great, Tom. Thank you. So, Joe, clearly a lot of things to pull out of the conversation. But I think the overwhelming one is just this tension between solving the problem versus recreating the problem in some respects or accepting those imbalances that Tom was describing. Like there does seem to be that fundamental tension there.

That was actually the most interesting or one of the interesting ideas that I hadn't thought about before, the degree to which COVID-0 policies push back reforms, the degree to which they favor SOEs over smaller companies, the degree to which they favor industry over services, the degree to which they force the private sector into deeper debt, the degree to which it diminishes consumption. I hadn't thought about like all of these structural imbalances that we've talked about for years with several guests, the degree to which COVID zero is like this huge setback on those. And COVID zero in exacerbating the economic problems that we've just described seems to be creating this double whammy, right? So,

on the one hand, it stops some of the reforms that the Chinese government might want to see, like the shift to services. And on the other hand, it also means that you have to enact stimulus measures. And most of Chinese stimulus, you know, it tends to be large-scale infrastructure projects or more credit to build more houses, which is problematic in the current situation. You know what, at the end, he gave, I thought, a follow-up podcast that we should do with someone that I don't think has gotten enough discussion is the long-term or medium-term effects of geopolitical isolation for China, which I hadn't really thought of. But as he mentioned, whether it's technology transfer, however you want to use that term, other aspects of just being a country that's heavily dependent on exports, et cetera. like what does it mean for China in 10, 5, 15 years to have this sort of, you know, basically de-globalization in a sense from the Chinese perspective. Yeah, I would be totally into that. I think it's an interesting question because on the one hand, yes, it's an export-based economy. They don't want to be completely disconnected from the global economy.

But on the other hand, there are ways in which isolation could benefit China's economic reforms by building up technology self-sufficiency, as you just mentioned, or even keeping capital more in the country versus having outflows. It's a really interesting question. Yeah, let's follow up on that. All right. Shall we leave it there for now? Let's leave it there.

Okay, this has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at The Stallwork. Follow our guest, Tom Orlik. He's at Tom Orlik. and check out his book, which a new edition is coming out of, China, The Bubble That Never Pops.

Follow our producer, Carmen Rodriguez, at Carmen Armin, and check out all of the Bloomberg podcasts on Twitter under the handle at podcasts. Thanks for listening.