Odd Lots - Michael Pettis on Persistent Imbalances in Post-Pandemic China

Episode Date: March 11, 2021

By some measures, the Chinese economy did better in 2020 than just about anywhere else. For one thing, it actually grew last year. Also because of the country's success at virus containment, it returned to normalcy faster than elsewhere. But the Chinese economy maintains persistent imbalances, and if anything, the pandemic may have accelerated them. On this episode, we spoke with Michael Pettis, a Finance Professor at Peking University and Senior Fellow at the Carnegie-Tsinghua Center, on where things stand now.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Eisenthal. So Joe, it has to be said that there are many ironies to come out of the coronavirus crisis. But one of the big ones has to do with the fact that the outbreak started in China, you know, early 2020 and yet China had the best performing economy that year. Yeah, I think it was the only major economy that actually grew overall in 2020, which is pretty extraordinary. And I don't really know if it's true or if it will be

durably true. But I do think there's this sort of meme out there that like China won 2020 in some way that it came out ahead. And I don't actually, I'm not, I haven't yet necessarily been convinced of it, but because of China's growth and the quick rebound and its successful suppression of the virus, that is like a thing people say. Yeah. So China's GDP grew, I think it was 2.3% last year, which means it was the only major economy, as you mentioned, to escape contraction, which is pretty amazing. And then, of course, people have been pitching China's experience in 2020 as sort of like proof of the benefit. benefits of a command economy, when you have something like an outbreak in a country with a very strong government, you can control the population, you can put in place restrictions and things that are ultimately going to make it easier to fight the virus. And of course, you can

pull a bunch of levers to boost economic activity as well. So most people have been talking about what an exceptional year it was for China sort of proves that their economic model might might be more resilient than some people think. But there are people out there who think that actually 2020 wasn't as good a year for China as it's been portrayed and that if anything, China is coming out of 2020 in a more vulnerable position. Yeah, I don't think there's, you know, it seems too early to know, right? So yes, it grew.

I'm thinking back to our episode with Dan Wong from a few weeks ago where he said like his lessons from 2020 were A. that on some level the government is more tough and brutal than he appreciated, but also in his view that there's a can-do spirit to Chinese business and the economy that he thinks is unmatched elsewhere. But I still think that, you know, regardless of what the situation is right now, it's very much a jump ball, open question of what the long-term economic ramifications are going to be from this extraordinary past 12 months, basically.

Right. Of course, time will ultimately tell. But given that we are coming up to the one year anniversary of, or by the time we release this episode, we'll probably be in the midst of the one year anniversary of the big market selloff and the virus really sort of expanding in the rest of the world. I think the China experience is worth discussing. And of course, we can talk about whether or not the strength that we saw in 2020, A, exists and B will continue into 2020. 21. So I'm happy to say we have the perfect person on to talk about this, someone who's been on All Thoughts before. It's Michael Pettis, finance professor over at Peking University and a senior fellow at the Carnegie Chingwaw Center. Everyone enjoys his thoughts on China. He's probably one of the best China commentators out there. So we're really grateful to have him on the program again. Michael, thanks for coming on. Thank you. So great to be back. So did we get that right? China had 2.3% GDP growth in 2020. Lots of commentators described that as proof of Chinese exceptionalism, proof of the economic model. But you've written that you saw it slightly differently. What was China's year like for you? How strong was the economy actually? Well, the first point that I make pretty often and probably the last time we spoke is that GDP and China means something very different.

than it means in other countries. GDP in China is an input, and in other countries, it's a measure of output. And that makes it non-comparable. What happened last year in China is that there are basically two types of growth that Beijing focuses on. There is what we call a high-quality growth, which is really the growth in consumption, the growth in business investment, which is closely tied to the growth in consumption and growth in exports. And then there is the growth that everyone recognizes is low quality growth, which Beijing has pledged to reduce. And that's the growth that arises from increases in public sector infrastructure spending, much of which is really nonproductive and in real estate development. And it's not a big secret that China has one of the fastest

this growing debt ratios, debt burdens in the world, mostly generated by this investment in public sector infrastructure and real estate development. So what matters is how growth developed last year, and it's no big surprise, it's no big secret, that the quality growth, that is consumption and business investment were down quite substantially. Exports were up, but collectively they were net down. And the only reason China had 2.3% real GDP growth is because of a 7% surge in real estate development and I forget the number, but more than more than 3 or 4% growth in public sector infrastructure spending. And you can see that in, you know, the soaring steel prices, copper prices, sales of machinery, etc.

etc. Now, if this stuff was good growth, there wouldn't be a big debate about trying to restrain it. You know, if you spend $100 to build the bridge and it makes you $150 richer, there shouldn't be any debate about whether or not you should build the bridge. The fact that there is such a bridge is a recognition that it's really not worth $100. It's worth less than that. And that's the growth that was generated. That's what took China from a negative growth rate to a positive growth rate. And the corollary of that, of course, is that China's debt to GDP ratio went up 25 percentage points last year. The year before that was pretty bad. It went up six percentage points. So that really gives you an idea of how China generated growth this year. You could argue that that was a great accomplishment, but you could also argue that it left the economy worse off, not better off. you know, on this question of disaggregating high quality growth and low quality growth. I mean, one of the things that, you know, since I've been following markets and economics for a little over a decade now professionally,

I remember like 2009, 2010, and they posted those videos on YouTube of the so-called ghost cities or, you know, all these apartment towers that were completely unoccupied. They're like, oh, look at all this wasteful spending. or there would be like a train station but no city around it. And then it seems like years later, those cities did actually end up becoming occupied and those train stations that seemed like they were in the middle of nowhere looked like actually people are using them. So A, is that true that a lot of what was characterized as malinvestment

did become productive investment? And B, how can one identify in real time that what you characterize as bad growth or mediocre growth, low quality growth, is in fact going to be unproductive public investment. The answer to your first question is that China is a huge country. It's really, I don't like to use specific examples because you can prove anything you want. There certainly are areas that were considered to be overbuilt that filled up. There are even more areas that have never really filled up. If you go to Chenjin, for example, they decided that they wanted to become one of the

leading financial centers of China. There's about 10 cities that want to do that. And the way you become a leading financial center, according to Chenjin, is you build an entire Manhattan worth of office buildings on the outskirts of the city, and they did that. That area is quite visited, but it's visited by tourists. Nobody actually lives there. And it's really spectacular. You've got all these beautiful buildings, just thousands of them, they're all empty. So you can, you know, it's easy for you to find examples or counter examples. That's why I look at the aggregate numbers. And China has had the highest investment growth rate in history for 40 years and the highest investment share of GDP of any country in history, 10 percentage points higher than number two, which was South Korea for a brief

period. But China's had it for 30 or 40 years. And that alone should worry you. But more importantly, is the debt trajectory, because when you borrow money to fund investment, if the investment is productive, by definition, your debt to GDP ratio can't go up. Because while your debt goes up, your GDP should be going up at least as quickly. Chinese debt rose very quickly in the 1990s, but nobody noticed it because GDP rose even more quickly. It was only during some period around the first decade of the century where suddenly the growth in debt picked up and accelerated while the growth in GDP slowed down.

Because most of the debt goes to fund investment, that cannot possibly. happen if the investment is productive. In theory, if you invest in kindergarten, you don't get the results for another 20 or 30 years, but that's a tiny part of the investment. Most of it is bridges and subways and things like that, and we haven't seen the benefits yet. So in my mind, there's no question that much of this investment is misallocated. But what I think doesn't matter. clearly Beijing is very worried about this. This is why they're having this huge debate about how much growth they need. If the growth was good, you shouldn't debate it. If you can get 8%, get 8%, if you can get 10%, get 10%. But they're not trying to get 8% or 10%, which they easily could. They

have the debt capacity because clearly they don't believe in that growth. And that's why you have all of this talk about rebalancing and dual circulation. This is a clear. clear recognition that there is a serious problem with the quality of growth. Could you dive into that a little bit more? So Beijing is obviously looking at a trade-off between economic growth and more debt accumulation. How are they thinking about that? And what are the political calculations that you see them making at the moment? Well, in a couple of weeks, we'll start the famous two sessions. Typically, that's when they set out the plans for the year and for people like you and me, the most important part of the two

sessions is that they announced the GDP growth target for the year. Most years, we know by December what the GDP growth target is. Last year, there wasn't one. And this year, there probably won't be a GDP growth target. But it's clear that there is a ferocious debate about growth versus debt. So you have one group of people saying it is really important to keep the rate as high as possible by which, you know, a lot of people are saying GDP growth this year in China will be 8 to 10%. I don't think that's the case. I think they're more likely to go either between 6 and 7% of the debt guys have the upper hand or 7% and 8% of the growth guys have the upper hand. But either way, that's the nature of the debate that we're hearing.

On the one hand, you have the Politicos, the provincial leaders, and some of the military and foreign affairs guys saying we need to keep growth rates as high as possible. On the other hand, there's almost unanimity among academics, the central bank, people in the Ministry of Finance and the banking regulators, almost unanimity, not complete, saying that, no, we absolutely have to get debt under control. And so that's really what the discussion is going to be. But it's very hard to do. You cannot get debt under control, in my opinion, unless you're willing to accept growth rates of two to three percent or maybe even lower. And I don't think even the hardest core debt warriors are willing to see growth drop that quickly. So, you know, thinking back pre-virus, and I think I don't remember when we had you on before, but it's been a consistent theme of your work. should of course mention the book that you published this last year with Matt Klein,

Trade Wars or Class Wars, which seem very timely. But this idea that Chinese growth has sort of come at the expense of household buying power, that it's so heavily focused on investment, not much consumption. Chinese households are forced to, or de facto, forced to save a lot. You know, when the crisis hit, it made me wonder. it's like, well, is this going to change? Is there going to be an increase in the social safety net so that households don't have to spend more? Will there be more public health spending?

Will that infrastructure get built out? Also sort of allowing consumers to spend more? It seemed like that could be a catalyst for some meaningful change along that dimension. And I'm curious, you know, in the short term, yes, okay, lots of the growth has been, you know, government spending on infrastructure. But is there any shift afoot in the sort of rebalancing of the economy that you've been talking about for a year? Well, there's certainly a lot more a focus on it. And it's become very fashionable now for local government officials to make one announcement after another that they're boosting consumption or upgrading consumption was the was the fashionable phrase. But the problem is that we know why the consumption should.

share of GDP in China is so low. It's just arithmetic. Households, ordinary households, they retain the lowest share of GDP of any country, probably in history. And as a result, since most consumption is household consumption, if you have a low household consumption share, a low household income share, then you're going to have a low household consumption share. So how do you resolve that problem? Well, there's really only two ways. And again, this is just arithmetic. You can keep shops open later at night, which they're proposing to do. You can, you know, make shopping malls more beautiful and you can improve online delivery, et cetera, et cetera. But none of that has an impact on consumption. Because basically the way you consume is you have an income. And out of that income, you serve a certain, you save a certain amount. And then, you know, the rest is your consumption. consumption budget. If you spend more money late at night, you're going to spend less money in the day. There's only two ways to get you to consume a bigger share of GDP. One way is to encourage lots of

consumer debt. And that happened in the last five or six years. Household debt surged to, by some measures, higher than it is in the U.S. And then the other way is to increase the household income share. And that's what you're talking about by strengthening the social safety net, raising wages, you know, all of these various measures. But the problem is that if I increase your share of GDP, by definition, I have to reduce somebody else's share. And that's the part that's never discussed. But we know basically, again, it's just arithmetic. You have to reduce the share retained by local governments and the local elites in order to increase the share retained by ordinary households. You could also do it by screwing the business sector, but they don't want to do

that because the business sector is the best part of the economy. But this is politically really tough to do. And again, it's something new. We've known this for a while. It's just politically extremely difficult to manage these transfers. And that's what they have to resolve. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond market. are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders.

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for so long now, you know, moving more of its economy towards consumption, how much of that actually got undone in 2020 and how difficult is it going to be to kind of reverse that dynamic? Well, first, Tracy, let me tell you, I'm a little bit skeptical about the traditional argument for the surge in China's trade surplus. I don't think it was because people bought lots of masks and things like that. Because had that been the story, the increase in Chinese export earnings would normally have led to an increase in Chinese imports, and it didn't. Imports were actually down. So my view is a little bit different. If you look at how China responded to COVID-19, not just China, there were a few other countries in Asia that did the same thing.

It was very different from the way the U.S. and Europe responded. In the U.S. in Europe, this was treated mainly as a demand-side problem, and most of the policy responses were aimed at boosting demand, and basically by distributing income to households. So what you see in Europe and in the U.S. is that the proxy for consumption recovered quite strongly. the proxy for industrial production was still negative for the year. But in China, the response was very different. There was very little demand side boost, basically nothing.

It was all supply side boost, cutting taxes on corporates, improving logistics, subsidizing, manufacturing, etc. So last year, industrial production recovered very strongly. It was positive. The proxy for consumption was negative. I think, don't quote me on this, but I think it was five or six percent negative. So there's only one way or there's only a couple of ways you can resolve it. If your industrial production recovers much more strongly than your consumption,

then the only ways to resolve it is either with a significant increase in investment, which we saw. Or if the rest of the world has the opposite reaction, you can also resolve it with a significant increase in your trade surplus. And that's what happened in China. Export surged. Imports actually dropped last year, which shouldn't happen when exports surge. But the result was China is now running some of the biggest monthly trade surpluses that it has in its history. Now, this is a problem because the reason the U.S. and Europe boosted the demand side is, of course, they want that increase in demand to feed.

into a boost in supply side and employment at home. And part of it did, but part of it leaked abroad to Asia. And I know some of our friends at Treasury are looking at this very, very closely. Now, I don't know how long it can go on that China can run these huge trade surpluses, but I would guess that this is going to create increasing tensions during the year, which means that China has to find a different way of resolving this. Either more important, which it doesn't want to do, or much more pressure on rebalancing income, which, as I said, is easy to explain, but politically really hard to pull off. I'm glad you brought in the international tension because I was curious your take.

It seems like the U.S. is really in the middle of a pretty serious ideological policy pivot in terms of its appreciation of the power of fiscal stimulus. And of course, we saw one of the biggest fiscal package. of all time with the CARES Act, basically a year ago. We saw another round of checks go out at the end of 2020. It looks like we're going to get yet another pretty substantial stimulus, perhaps almost as much as $2 trillion. Again, lots of checks. And we might get another spending plan, even after that, later in 2021. If Biden can push forward the build back better plan, which would presumably be more long-term and infrastructure-based. But you mentioned this idea of the fiscal

stimulus leaking and ultimately turning into income for China. And I'm curious, A, how you see that emerging as we get further rounds of stimulus. And B, just in your view, how you as policymakers should be thinking about using fiscal firepower in the most effective way such that it actually has its desired goal of making the U.S. economy more robust? Well, I think you're right, Joe. In the 70s, we decided that fiscal policy doesn't work. It's all monetary. And I think now we're reversing.

We're figuring that monetary policy no longer works. It's got to be fiscal. And I think that makes a lot of sense. It seems to me that there are a couple of things that the U.S. can do that would be quite positive for U.S. growth. First of all, if you believe that there is a demand side problem and that the reason businesses aren't investing is not because the cost of capital is too high, but because there is no demand.

Then it seems to me that if you can create demand, for example, by increasing the income of ordinary households, then businesses will begin to invest. And the cost of those transfers to the household sector becomes self-liquidating. Because while we increase either through debt or monetary creation, the income of the household sector, there's no inflationary or debt impact because the supply side will automatically adjust. Americans will produce more stuff or they'll produce the same amount of stuff with less household debt. So there will be no net cost to the U.S. It's a self-liquidating process. The other self-liquidating process, in my opinion, and I know there's some controversy about this,

I'm surprised that there is, but the U.S. has really bad infrastructure. It has enormous opportunities to upgrade the infrastructure, in which case, again, if you fund it by debt or if you fund it by money creation, it doesn't really matter because whatever increase on the demand side, the increase on the supply side is even greater. Obviously, if you repair the roads in New York City, the savings to American car owners is much greater than the cost of repairing the roads and on and on and on. So the U.S. can do both of these things, and I think they're the right things to do. And the long-term infrastructure is probably more important. But in the short-term, boosting household income for the poorest is extremely important. And the point is that in either

case, it's not going to create a burden for the U.S. because in either case, it'll boost the supply side at least as much as it boosts the demand side. The problem is that the U.S. is also acting, and it's not a problem for the world, that's a problem for the U.S., is also acting as, again, the consumer of last resort, that is supplying demand for many other economies. And I think if the U.S. were able to address that problem, either in some sort of multilateral convention or unilaterally, if necessary, it would get a much greater bang for its domestic buck. So I have what might be a stupid question, but Joe described this ideological shift underway in the U.S. in how people, and Certainly politicians think about fiscal stimulus.

And we've been talking about some of the weaknesses of China's own stimulus measures in 2020 and this idea that a lot of them went into unproductive corners of the economy rather than directly into workers' pockets so as to boost consumption. Why doesn't China just do stimulus through direct payments or, you know, a system similar to the checks being written in the U.S. Like, in many ways, you would think that that would fit into China's professed ideology of communism. Like, you know, the idea that they're helping workers, why don't they just give people

money? It's an interesting question. I mean, some people argue that China has really never developed an institutional framework for doing that for 40 years. The only thing that's really known how to do is to boost the supply side. when they tried to boost household incomes, again, they didn't do it by transferring income to the household sector. They did it by subsidizing employment costs, which if they work, work by increasing supply more than demand. The other argument is that there are huge political implications to these

types of transfers. To give you an idea that I often use, household income in China is roughly 50% of GDP. So one way you can think about it is that there is a parity between the household sector and the non-household sector, non-household being businesses and government. For most countries, household income is 70 to 80 percent of GDP. So even for China to get halfway to normal in terms of the distribution of income, we have to shift from an economy in which households are roughly the same size as non-households to an economy in which households are two to three times the size of non-households. And if you don't want that shift to be paid for by businesses, then by definition, it's got to be paid for by governments. And I would submit to you that

that huge shift in relative income must have a political implication, a pretty significant political implication, which I think is very, very hard for China to deal with. I have another perhaps stupid question, but it's something that you brought up, that you brought up, and also I think you brought up on the last episode, and I meant to ask it, and I felt dumb at the time, so I'm just going to ask it now. When you talk about the income that's gained by local governments, why is that such a difficult source of income to touch? And, Who is actually benefiting from that? Are there local politicians that in some way or another end up pocketing it?

Are there projects that extend their power? Talk to us about why that, because that's not so much of a thing here. Like, why is that such a politically difficult thing to fight? Well, that's a little politically sensitive. But I'll talk about a case that happened a few years ago under Bo Shilai, because, you know, he's a bad guy, so we're allowed to say this. But one of my former students worked in a private equity fund in his city. I think when he was the mayor, was it of Harbin before he became the mayor of Chongqing,

and invested in a company that makes locks. And the principal of this company was very close to some senior people in the government. Three months after they invested in the company that makes locks and keys, the city announced that for security. reasons, all locks and keys in government buildings were going to be changed. And I don't need to tell you who got the mandate to do that. I think there is a very strong connection between local elites and local governments. And even in China, that's been discussed. Remember in 2007 when Wen Xiaabao gave his famous speech about how we need to rebalance the economy, within a few months of that speech, you started to see in the

Chinese press, the phrase vested interest. These were the terrible groups that were opposing measures that Beijing was trying to make to rebalance income. And then it didn't work until 2012 when Xi Jinping became secretary. And that's when you started to see this very strong anti-corruption campaign, which many people argued was as much about politics as it was about corruption. Again, I don't want to, you know, speak too openly about it because these are sensitive topics. But I think there is a perception in China, a very clear perception, that the ability of local governments to control enormous amounts of assets is closely allied to the wealth of local elites. Got it. So it is sort of like, it's still, it's kind of business income, even though we,

sorry, just to clarify. So when you talk about like, okay, there's local government income, and there's business income, and if we're going to increase buying power of the household sector, one of those has to get touched. It's kind of also business income. It's just perhaps a little bit more politically connected business income. Sure. Today there was an announcement by several large cities in which they're changing the land auction system. And I don't pretend to be an expert on it, but several of my friends have told me that this new

system will benefit the largest real estate developers at the expense of the smaller one. You know, it's really useful to have some control over these kinds of policies. Again, I'm speaking sort of euphemistically, but, you know, you know what I mean. Yeah. Some of it also, I think, is just the problems of execution in a country as big as China and this idea that you get an edict that might be handed down from Beijing, but local governments will carry it out in different ways, not necessarily always because of corruption, but maybe because of incompetence or something like that. like that. Like, there's a wide, well, there's a huge room for, for interpretation on a lot of these. Also just institutional rigidities. Any mayor can very quickly build a new bridge, but he won't necessarily know how to distribute income to the household sector. Yeah. This is the,

I think this is an underappreciated thing because people think, oh, China has this command economy. If Beijing says, you know, flip a switch and start lending, like more lending from banks, for instance, people think that's really easy to do, but actually we find that often, like, the banks have to think through this stuff. Sometimes the mandate isn't exactly clear. And so it's not as easy as it seems. But anyway, since Joe and I seem to be in asking stupid question mode, I have another one for you, which is we've been talking about how the policy response in 2020 has probably led to a further accumulation in debt. We've seen lots of investment in things like the real estate sector. You just mentioned another land reform effort. We have seen Beijing take a lot

of steps to prop up the property sector recently. What's the downside of China accumulating more debt? Because at the moment, in other parts of the world, like the U.S., for instance, people seem to be growing more comfortable with the idea of the government taking on debt in order to fund stimulus. Why is it a bad thing for China? Well, the simple answer is that if it weren't, it'd be very easy to put together a policy that made everyone a real millionaire overnight, and clearly that makes no sense. But we don't really know where are the limits of debt, but we know a couple of things. First off, when debt levels rise quickly enough that there is really,

uncertainty about how debt payment, debt servicing costs are going to be allocated. You know, basically there's two types of debt. You can borrow money that's self-liquidating. In other words, you use the money to create the value that pays off the debt, and then you can borrow money for projects that are not self-liquidating. And in that case, the only way you can repay the debt is through implicit or explicit transfers. You can tax the people. You can lower wages.

You can expropriate wealth. You can default, you know, there's all these different ways you can inflate it away. And those are just ways of assigning the cost of servicing the debt. The problem with that is that we all know that. And once uncertainty levels are high enough, we've seen this in country after country, economic agents change their behaviors in ways designed to protect themselves. For example, flight capital, which we've seen in China. Private sector businesses disinvest, which again we're seeing in China.

Maybe you see workers organized. Maybe you see the middle class take their money out of the banking system. We're not seeing that yet. But once you reach that point, it becomes self-reinforcing and you want to avoid that point. That's true for any country. And I would say that in China, with debt growing so much faster than GDP and real skepticism, with real skepticism about the true value of that GDP, that's a real risk. You don't want to find out where the limit is, but there has to.

be a limit. The second thing, and this is where China is very different from other countries, is that when you borrow money and spend it on something that doesn't create value, from an accounting point of view, you should expense it. But in China, it isn't expense. It's capitalized. So if I borrow $100 and spend it on something that's worth 20, I should take an $80 right down, but I don't. I carry the whole thing at $100. That means that there is $80 of recorded wealth that isn't real wealth, right? The total wealth of the country is overstated on paper relative to the real wealth of the country. And that has to be amortized. That is automatically amortized over time, but you don't see the amortization as long as debt continues to grow more quickly than the

amount that is implicitly amortized. But that requires an acceleration in the growth rate of debt. And at some point, when you can no longer accelerate the growth rate in debt, you start implicitly amortizing all of these costs, which means basically you start to take losses. And they subtract from the GDP growth number, as well as setting off what we call financial distress costs. I apologize if it's a little bit pedantic. But basically, we know that you don't have infinite debt capacity, but we don't know when you reach your limit. We also don't want to find out. And I think that's the problem with the rise in debt in China.

So I do think to your last answer that one of the strengths of your approach, and I would say the approach of a lot of sort of more heterodox economists, is the sort of deep understanding of accounting. And not that accounting is everything, but that if you don't understand accounting, you miss a lot of this stuff. But that being said, there is more than accounting. And we have, you know, we mentioned we had a recent episode on the rise of Chinese semiconductor industry

and some other domestic industries, things that actually, you know, technological improvements increases in productive capacity as the country gets richer and has more. How do you see that developing? Just, you know, accounting aside this sort of the boom in sort of world class or the attempt to achieve sort of world class corporations that whether on a tech basis or sort of cultural export basis. I mean, we see it with TikTok are really bite dance are really emerging in China. And how much is that sort of changing the equation, so

Well, you're right about accounting. Accounting doesn't tell you the truth, but it tells you things that are clearly not true, and it allows you to dismiss a lot of stuff. On the issue of investment in high tech, that gets a huge amount of attention. It's very sexy. Everybody loves it. But we have to, you know, we have to make two points here. First of all, it's very, very small. And when you compare it to total investment in China, it's tiny. If you want, you know, for years and years China has said, don't worry about the investment problem. All we have to do is shift out of that investment into productive good investment, for example, high tech. And that's that problem solved. Well, they've been talking about this for 10, 15 years, and it hasn't really happened. And I liken that a little

bit to, you know, don't worry about your child getting an education. All she has to do is win the lottery ticket and she won't need an education. Yeah, it's true, but winning the lottery ticket is quite hard, and so far, very few countries have been able to pull this off. It's a huge amount of new investment that has to replace this old less valuable investment. But the other problem is that we don't really know how to cost a lot of this. I think Chinese online retail is a miracle. I think it was also created when nobody was watching because basically all these very smart kids leapfrog a terribly creaky retail distribution system. But I'm not sure all these other areas, you know, the super fast computers, the satellites, the high speed rail network. I'm not sure how economically successful they are.

They are great programs, right? There's spectacular technology. but it's only sustainable if the economic value added of that technology is greater than the cost. And it's very easy to come up with cases in history where a lot of trophy investment in technology in the long run turned out not to be sustainable. So we just don't know. But for me, the key problem is that, you know, this is great stuff, but it's just not big enough to replace all the railroads and bridges and empty buildings.

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app, Apple Podcast, or wherever you get your podcasts. So given the investment in unproductive or less productive industries, given the debt accumulation and given, I know you took some issue with this idea, but given the idea that strong manufacturing probably helped China offset some weaknesses in 2020 and we can debate by how much. But how vulnerable do you see the economy, the Chinese economy in 2021 this year? As things presumably start to normalize, maybe as the spending boom in the U.S. starts to die down a little bit, what's going to happen to China? Well, I think 2021 is going to be a very good year for China in which it looks like it will have achieved many of its objectives. but it'll only be really, by 2020, it'll start to change again. And the reason is because in China, like in most other countries,

we saw a huge increase in the household savings rate last year. You know, we can debate about the reasons. Parvett had to do when you're locked in and locked up in home. You can't go out and shop. It's much harder to shop. Obviously, you're not going to restaurants, et cetera, et cetera. So a lot of that increase in savings was simply because I wanted to spend money but I couldn't. Part of that increase in savings was probably, again, not just in China, but in the whole world, COVID-19 scared us all. And I think all of us decided that we're going to be better prepared for the next crisis and probably we'll save a little bit more money than we normally do. Now, we don't know the breakdown, but at least some of the increase in savings last year is going to be reversed this year in China. And my guess is that between,

the increase in consumption, which could be 8 or 9% this year, maybe even a little more, and the increase in business investment aimed at consumption. Let's ignore what happens to the export sector, because that could go either way. But those two things should generate, in my opinion, between 6 to 7 percentage points of growth this year. This is all healthy growth. Now, if China is satisfied with 6 to 7% growth, then that means, We won't need significant growth in real estate development or in public sector infrastructure spending in order to achieve that implicit growth target. There'll probably be some.

But I would argue that this year, the debt to GDP ratio will probably only increase by one or two percentage points and 100% or nearly 100% of the growth will be generated by the good stuff. But it's important to remember that this is mostly a reversal of last year. Last year, the debt to GDP ratio went up by 25 percentage points. If it goes up by only one or two, that's still roughly 12, 13% a year for two years, which is double the rate of previous years. So this year will look quite good, but it's mainly a reversal of how bad last year looked.

And then once that reversal in consumption has worked its way through, then we're back to the same old problem. which is that consumption is too low a share of GDP for China to give up on nonproductive investment to generate growth rates much above 2 or 3%. So I want to just go back to the sort of very question that we set up at the beginning. And I don't even really like the question or something like, but it's like this idea, it's like, okay, did China win? Like it was this year like did it improve China's trajectory and standing in the world?

And I guess part of the question is, and again, it goes to your book, is obviously some of it, the question has to do with China's own domestic policy, its own success at fighting COVID, but also in the changing policy stance of other countries. And it goes back to the U.S. and whether the U.S. will continue to be the consumer of last resort. Also, we had yesterday we're recording this February 25th, but yesterday we had Biden coming out and talking about focusing on rebuilding. the U.S. semiconductor industry and not being as dependent on China for complex supply chain needs, which raises the question of whether maybe there will be a meaningful change. So looking down the road, is it possible that things that in the end that were catalyzed by COVID by 2020 end up really not playing to China's favor the way people are imagining right now? Well, you know, I think China's response to COVID-19 was incredibly, impressive. You know, a month ago when there was that new outbreak, they moved really, really quickly.

I got tested several times. They reset up all of the barriers into my neighborhood, into every neighborhood. You had to check your status constantly, et cetera. It's very inconvenient, but it's incredibly effective. Now, I think for institutional reasons, it's very difficult for countries in the U.S. and Europe to replicate that. But still, the Chinese responded really well to COVID-19. But the way I think about COVID-19 is a little bit differently. I don't think it changed everything. I think what it did is it accelerated everything. All of the underlying problems in the global economy, income inequality, trade imbalances,

rising debt, et cetera, were seriously exacerbated by COVID-19. So for me, the answer to the long-term question is that COVID-19 made adjustment all the more urgent for China, for the U.S., for Europe, for Brazil, for everybody. So the question is, which types of systems are better at adjusting? And this may just be the American in me speaking, but, you know, I also think the historical precedents are pretty clear. For all of their faults, democracies are pretty good at adjusting. And when they adjust, it's always such a messy, ugly process, but that's precisely when democracies lose their prestige, like in the 1970s or in the 19th, or in the 19th, 30s. The irony is that they lose their prestige exactly when they're doing what they do best.

Autocracies have much more difficulty adjusting, and you can see in China. China responded to COVID-19 by exaggerating its previous supply-side responses. It's very difficult for autocracies to make that adjustment. Now, it's not impossible, and history isn't a perfect map of the future, but I would say the answer to your question, Joe, we're only really going to know over the next three to four years. And the answer will be those systems that did a better job of adjusting to the acceleration COVID-19 created ultimately will be the quote-unquote winners. And those systems that had trouble adjusting are going to be worse off because of COVID-19. Does that make sense? Yeah. That was great. All right, Michael Pettis on All Thoughts yet again.

Thank you so much. Really appreciate it. My pleasure. Thank you. Yeah, that was great, Michael. Thank you so much for coming back. Sorry, can I just ask one question? What's the mood like in Beijing at the moment?

And I'm curious, like, are people going out? I know you had some interest in nightclubs. Like, are people going out to clubs at the moment? Are they allowed to? Well, things completely opened up around September. A lot of my bands were touring around China. it was amazing, sold out shows everywhere they went, et cetera, et cetera. And then about a month ago, because of the new outbreak in Hebei province, which surrounds us,

all the shows in Beijing were canceled, and they haven't been reopened, but we're expecting them to reopen fairly soon. So, you know, you go outside and everything is packed. What's your favorite band right now that we should check out? Oh, God, it's like asking, you know, who's your favorite son or daughter? Yeah, I know, it's not fair. There is a lot of them. You know, what's interesting is that there was this new TV show that came out.

You know, and all of our indie bands were indie bands. You know, the most famous one, Car Sick Cars, could play and, you know, could draw an audience of 200. Now, when they announce a tour in three months, within a minute, half of the tour is sold out, and within a day, the entire tour is sold out. And these are venues of 2,000, 3,000 people. So we're really starting to see a sea change in the, you know, the attitude towards what was a very indie underground music scene. So that's pretty exciting. I'm going to have to listen to some Carson cars. Carcars, Trey Wan.

I see they're on Spotify. PK14, ourselves besides me, lonely Leary, a dream can. There's so many, Joe. Great. I'll have to start adding them to my morning rotation. Thank you. There you go. And at some point, maybe we'll have to have you back for just a discussion on Chinese Indian punk bands and just talk about... I'd love to do it. That would be great. We'll do that as well. Thanks, Michael. Thank you. So, Joe, there's obviously a lot to go through from that conversation, but one of the things that definitely struck me was Michael repeating this idea. that COVID basically exacerbated existing trends. So if we saw China having some difficulty

rebalancing its economy before, difficulty with inequality and things like that, 2020 really hardened that trend. Yeah. I mean, it's sort of like this big macro thing that's beyond China. And of course, I would say like in the middle of next, in the middle of last summer, there was probably more of COVID is going to change ever. thing and some things that probably will change, but I also think a lot of things are going to get even more, are clearly getting more extreme. And this sort of like Chinese macro imbalances certainly looks like it's one of them. Yeah. The other thing that I thought was interesting was his description of adjustment periods in democracy and how when democracies are going through

a period of volatility or uncertainty, everyone starts writing articles about, how, you know, the Chinese model is winning and command economies have benefits and that sort of thing. But actually, what's happening is that the Chinese economy just isn't adjusting very well while democracies are in the process of doing that adjustment. I'm not, sorry, I'm not nearly as lucid as Michael was on this, but you know what I mean. Yeah, no, I thought that was really interesting. Also, like, his point about tech, like, obviously, it is really impressive in many, cases what some big these tech giants have done. But on the other hand, like in a country and economy as large as China, how much do they really move the needle yet in terms of like sort

of macro discussions? And you know, it's even like here, you know, even in the U.S., like of course, we have a handful of these like incredibly successful startups and tech giants. But for the vast majority of Americans, that it's not like they're working for them, or it's not like they've seen like some huge economic benefit from them other than perhaps as consumers. And so, you know, you can imagine how in China it's even, that phenomenon is even more extreme, where it's interesting, a lot of people making money, world class tech in some cases, but whether they actually move the macro dial is sort of another question. Right. Well, that was another thing in Michael's conversation that struck me, this idea of attention between,

consumers and businesses and that you can't necessarily rebalance towards consumers without taking something away from business. And I guess it seems kind of obvious in retrospect, but you can see how that would be really politically sensitive for the Communist Party. Yes. And I was, I'm glad he clarified what he's talking about when we, when people talk about income that goes through local governments. Because of course, for the the most part, like local governments in, you know, of course, any regional government in the U.S. wants more tax revenue, et cetera. But that's not, it's clearly a different dimension and his explanation of why that would be a

very sort of politically sensitive thing to rebalance income from local government to the everyday household sector. That was extremely helpful. I didn't really get that before. Yeah. All right. Well, we'll have Michael on on again to talk, I guess, the economics of Chinese indie rock bands? Does that work?

Yeah, or maybe we don't even have to talk ego. Why don't we just like have him play some of his favorite songs and then chat about it? Like, we could do like, we could just be like a real music episode, you know? Just let's listen to bands together. Oh, well, we maybe we should save him for like the, uh, the variety show or something like that or have it. Yeah. Oh, my God. Variety show. That'd be good. That's actually a really good idea. Maybe we could, oh, that's a good idea. We should for or maybe our next live show, whether maybe online, What if we, like, talk to Michael, we did a little like eco-chat, and then we had him introduce one of his bands and they could play a few songs. I think that would be fun.

Be like, Odd Lots, the China Club experience. Yeah. Oh, this is a good idea. All right. This is definitely what. This is what we have to do. Okay. Well, we recorded all of that.

So Odd Lots listeners, you just had an insight into our work process for planning. Shall we leave it there? Yeah. All right. Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway.

And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Follow our guest Michael Pettis on Twitter. He's at Michael X. Petis. Follow Laura Carlson, our producer. She's at Laura M. Carlson. Followed the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts.

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