RAOUL PAL: Welcome, everybody. I'm here today with a good friend of mine, Louis Gave, the CEO of Gavekal. Gavekal is an independent research company, really well respected. And Louis is one of my go-to people when it comes to trying to understand what's going on in the outside world in Asia where he spends enormous parts of his career.
And the news flow over the weekend, and over the last few weeks, has been an increasing focus on Hong Kong and China. So, welcome, Louis, I'm looking forward to digging into a few things.
LOUIS-VINCENT GAVE: Always, good to catch up Thanks for having me.
RAOUL PAL: And you're in Whistler right now. Is that right?
LOUIS-VINCENT GAVE: I am. I am, where there's no snow.
RAOUL PAL: Yeah. I landed in Miami. And it's warm at least.
LOUIS-VINCENT GAVE: Yeah.
RAOUL PAL: So the news over the weekend of the election seems like a landslide victory in the pro-democratic movement. What does that all mean, and what does it mean for the-- all of the kind of-- the movement that's been going on, you know, the protests and everything else. How does this all sort into place? And what-- what's the effect here?
LOUIS-VINCENT GAVE: Well, you're absolutely right. It is a landslide victory made all the more powerful since the turnout was huge. So, first, you know, these guys are the district elections in Hong Kong. So it's-- you know, the political power that evolves from district elections is minimal.
And, usually, for these elections, you typically have about a 40% turnout. I mean, in essence, you know, you're voting for the dogcatcher. But given-- given the background, this was seen as a referendum for-- you know, on the government. And you ended up with a 70% turnout, which is, you know, enormous.
It's-- it's like blown out any previous turnout. So it was a very strong message from the-- from the Hong Kong population. And here, I have to admit, I-- you know, I got this one completely wrong. I thought-- I thought you'd get a very high turnout. But I thought a lot of people would come out and vote a pro-government ticket, if only because, you know, people are tired of the riots. People are tired of the-- you know, the past-- everything that's unfolded.
But the fact that the government has done so badly is obviously a reflection of how angry people are at-- at the current leadership in Hong Kong. So I think there's-- now, concretely, there are consequences to this election, even though the district counselors in and of themselves don't have a lot of political power, as a group, they do vote for the next chief executive.
And so I have about-- you know, there's 1,200 people that vote the chief executive. And now the district-- the district counselors have about 100 votes out of that 1,200. That 100 vote used to be always pro-government. Now, all of a sudden, ti's swung to pro-democracy, which are basically the two camps.
You're either pro-government/pro-Beijing be slash pro-democracy. And within that, there's different parties. But each party will be part of an alliance that's either pro government or pro democracy. So now, all of a sudden, and to be able to run candidates for the chief executive, you need to have 120 votes, at least.
And so, now, it almost means-- now that we have this, it almost means that there will be a democratic candidate next time around. It doesn't mean that the democratic candidate will win. But at least there will be, most likely, a democratic candidate. Concretely what this means is that, obviously, the pro-democracy camp won and won very big.
And the government will thus have-- and China, Beijing, will have to make some changes into-- into both how it deals with Hong Kong and, frankly, perhaps how it deals with Shanghai and Shenzhen. Let me explain. I think if you're China at this point, you-- you've always-- you've always known you needed deep capital markets.
You have this big growth strategy, China 2049. You have you big One Belt, One Road program. You basically want to become this empire and project your power further and further afield. And you know that to keep growing, you need to have capital markets. And you'd always assume that Hong Kong could be that capital markets.
Now of course you might want Shanghai or Shenzhen to be it. But Shanghai is still very far. You know, look at the Alibaba IPO as an example, right? You had the Alibaba IPO. And Shanghai tried to do everything it could. The government pushed and shoved Alibaba to make it in Shanghai. And at the end of the day, even with the riots, it's still happening in Hong Kong.
And so, you know, if you look for deep capital markets in Asia, it is still Hong Kong. Now, if you're China, all of a sudden, the lesson you learned in the past six months is China-- Hong Kong hates us. Most people in Hong Kong hate us. And they really don't like Beijing.
That's if you're Chinese. That's the message you take. And if you fast forward to this election, this message is basically the message that comes loud and clear through the election. So now if you're Beijing, you'll-- I think you'll go down two paths.
One path is you have to give more leeway to Hong Kong. That means a different choice-- a different chief executive. Carrie Lam's days are most likely numbered. And it also means finding some kind of working compromises around the question of democracy. And it probably means giving-- giving some way in terms of the police inquiry.
RAOUL PAL: And you don't think there's a risk that they could get more hardline on this--
LOUIS-VINCENT GAVE: No, I think-- I actually think--
LOUIS-VINCENT GAVE: No. I think this is actually a pretty good result in terms of riots. Basically, the rioters have now proven we've got-- we've got the support of the-- of the wider population. So the ball is in your camp. We've made our demands. Our demands our police inquiry. Our demands are an amnesty for the violence done by the students and, basically, some pathway towards democracy.
So now the ball is on the other camp. The thing that will have to happen, I think, following this vote is Carrie Lam will most likely need to go and, you know, find some candidates that is agreeable for both sides. Now that's-- that's a huge-- that's a very tall order.
RAOUL PAL: Yeah.
LOUIS-VINCENT GAVE: So that'll be-- that'll be the challenge. If they can come up with some candidates that, you know, is a decent compromise candidate. And then, you know, obviously I think that compromise candidate, his first move will say OK, fine, we will do a police inquiry. And on that front, you know, you've seen inquiries in Britain that last 20 years, right?
You accept that there'll be an inquiry. You accept that it'll take 20 years. And by the time it comes out with its findings, maybe some of the passion has died down. The other thing that could happen is simply, you know, just like South Africa did, some kind of truth and reconciliation committee, where people, you know, speak their truths.
And it allows the nation to come together because the big challenge in Hong Kong today is that, you know, you might think that Trump is divisive. You might think that Brexit has been divisive for Britain. But the yellow versus blue conflict in Hong Kong, you know, it's split apart families. You've got brothers who don't talk to each other. You have parents that don't talk to their kids.
It's been-- it's been genuinely devastating. So having something like a South African Truth and Reconciliation Commission could go a long way. And it-- you know, what happened in South Africa, there were no jail terms, right? It was people came out, spoke the truth, and then moved on. You know, a new executive could come in, announce something like this, would allow Hong Kong to move on.
RAOUL PAL: But does that-- does that feel in line with how Xi operates--
LOUIS-VINCENT GAVE: No.
RAOUL PAL: Because, now, he's quite a tough guy, right?
LOUIS-VINCENT GAVE: No, no. It doesn't.
RAOUL PAL: He doesn't sound like reconciliation guy.
LOUIS-VINCENT GAVE: No.
RAOUL PAL: He's more like people disappear and go get extradited through the back door back to China. I mean, what's-- what's your view, I mean, because that's-- that's the criticism that others will say is, yes, I mean, it'd be nice if they could-- they could come up with a smooth way of-- of solving this. But the authorities don't seem that particularly smooth in how they like to solve. these things.
LOUIS-VINCENT GAVE: Well, yes, but in fairness, they haven't done that yet, right?
RAOUL PAL: Right.
LOUIS-VINCENT GAVE: You know, they haven't gone out and kidnapped Joshua Wong. And, really, you know, I think if you're Beijing, yes, at this point, you're really pissed off, I think. You know, if you're Xi Jinping, I think your view is, I've basically been hands off on Hong Kong.
You know, I let these guys manage themselves. And what we in essence had is the tycoons and a lot of-- and the Civil Service making a hash of it. And, you know, I let-- I did let them manage themselves. And now I've got the US Senate passing laws condemning me for intervening when, you know, really I haven't.
And so I think if you're Xi Jinping, you can take one of-- one of two tacks here. You can say, OK, I know I still need capital markets. And I know Shanghai and Shenzhen aren't there yet. Now, over the next five years, I'm going to push pedal to the metal to get Shenzhen and Shanghai at a level where they can start competing with Hong Kong.
So that's the most first obvious conclusion. The first track they're going to go down is, you know, really try to promote Shanghai. Really try to promote Shenzhen. Now of course you could tell me you can't get a proper capital market without freedom-- without capital-- with capital controls. You have to get rid of capital controls.
So, you know, the first-- you know, if you're Xi Jinping, you're now facing a sort of dilemma where it's either I reduce my capital controls in a bid to boost up Shanghai in Shenzhen over the next few years, or, alternatively, I give Hong Kong what they want. Now, there is a third path, which is I crack down on Hong Kong really hard and hope that it manages to stay a big proper capital market.
But I think yesterday's vote, you know, with a 70% turnout means that this option of cracking down really hard will be tough. I think if-- if--
RAOUL PAL: Is the international-- the international community will be in uproar if that's the case, right?
LOUIS-VINCENT GAVE: I don't think-- I don't think it's even the international community. I think it will be just-- look, the students in Hong Kong have shown they were, you know, decently courageous, right, and that they were willing to take to the streets, et cetera.
Now, you know, here the challenge-- one of the challenges is, imagine you're a policeman in Hong Kong. Yesterday's votes would've been pretty depressing for you, right? You've been standing the line, you know, holding-- the forts-- for six months. You've been getting insulted. You've been, you know, having Molotov cocktails thrown at you.
You've held the line. And now, basically, you've got 70% of the Hong Kong population coming out to vote. And 60% of them saying, you know, we-- we don't trust you in essence. It's-- you know, it's got to be depressing. So-- and you know that the end result, if you're a Hong Kong policeman, is that the Hong Kong government is most likely going to throw you under the bus.
So, you know, you look at all of this. And if you're Xi Jinping, yes, you're stuck in a situation where you know that if you send in the army into Hong Kong, it creates-- it basically is the end of Hong Kong, number one. And number two, it actually-- you know that the next day, Chuck Schumer and Marco Rubio will be standing on the US Senate saying, we must embargo China and now more trade with China.
And so it could create an economic shock for the world that would be greater than Lima and greater than 9/11 because, you know, the level of integration of supply chains and the level of integration we have with China is just enormous. Now, in '89, you know, when following Tiananmen, people embargoed China, China was this much of the global economy.
Now it's 15%. So, you know, I think, Xi Jinping, the option of sending troops really isn't one. So, you know, Xi Jinping doesn't have a lot of great options, I think. The obvious option for him is promote Shanghai and promote Shenzhen and--
RAOUL PAL: But you said with that that he needs to get rid of capital controls.
LOUIS-VINCENT GAVE: Yep.
RAOUL PAL: So the problem is is getting rid of capital controls is a big devaluation of the currency, which nobody wants.
LOUIS-VINCENT GAVE: This is where you and I disagree. I'm not sure it leads to a big devaluation of the currency. I know-- I know, look, I know the theory. You get rid of capital controls. You have all this money flowing out, et cetera. The reality is, money has been flowing out for decades.
You know, look at the real estate prices in Vancouver. Look at the real estate prices in London, in Sydney, or elsewhere. It's not as if Chinese money has made its way out. Chinese money-- Chinese money has-- I'm sorry, my dog is barking away. I don't know if you can hear.
RAOUL PAL: Don't worry. Don't worry.
LOUIS-VINCENT GAVE: Chinese-- Chinese money has been flowing out forever. You know, just as money-- there is, of course, if you're a rich Chinese guy, you want to own foreign assets. If you're-- by the same token, if you're a, I think, a foreign institution, one of the issues you've always had in pulling capital in China is you never know. I put my capital in. How do I get it out?
And that's why every large institution in the world is massively underweight China. You know, China is the second biggest economy in the world. It's now the second biggest bond market in the world. Yet most pension funds around the world, most endowments, not a single one of them owns a Chinese bond.
RAOUL PAL: No. I think your-- I think your view has definite validity for that. I just think of the path of getting there. You know, there is a likelihood, and justifiable, because of the banking system and the dollar funding situation within China. If they were to allow the currency to grow, they were going to clean up some mess first. Does that in the long run do them a favor? I think--
LOUIS-VINCENT GAVE: Deng Xiaoping's famous saying is, we'll feel the stones as we cross the river. Whatever China does is always little incremental steps, which is why I said, you know, this will be over the next five years that they'd-- they'd gradually get there. And by the way, you know, they have been doing that, right?
You know, they've created the south-- southbound-northbound connect. You've seen a lot of-- you have seen a lot of measures to ease the flow of capital in and out of China. You know, you mentioned the-- you know, they do have all their issues around, you know, the bad debts, the shadow banking, et cetera. But the reality is, you've seen three years, really, for the past three years, they have been, you know, attempting to clean that up.
RAOUL PAL: Yeah, but they've been taking some pain, which people can expect them to do.
LOUIS-VINCENT GAVE: Yeah, they've been-- they've been taking some pain. And they have this ability to take some pain because, at the end of the day, they do control the entire ecosystem. You know, most of the bad debt is at the provincial level. And a lot of it sits on state-owned banks.
So at the end of the day, it is all part of the bigger government balance sheet. And it's a question of how quickly do we recognize that pain, and who wears it, and, you know, how do-- how do we--
RAOUL PAL: You saw--
LOUIS-VINCENT GAVE: Yeah?
RAOUL PAL: You saw that-- some news over the weekend, I think it was over the weekend, or maybe just today, that one of the state-owned enterprises is looking to restructure its dollar debts, which isn't it interesting thing.
LOUIS-VINCENT GAVE: Absolutely, no, no, look, and you've had--
RAOUL PAL: --this is the damage. I mean, there is a dollar funding problem we know. But it'd be interesting to see how far Beijing goes with this.
LOUIS-VINCENT GAVE: But so, on-- on this point, you know, if you're going to open up capital accounts gradually, very gradually, and if you're going to say, look, we know we-- we know that either we have to rely on Hong Kong, which creates political issues for us, or we have to rely on Shanghai and Shenzhen, which creates economic issues for us.
At the end of day, that's-- you know, that's the choice that they confront. And by the way, you know, they can go down both paths at the same time. It's on mutually-exclusive routes. They're obviously going to try to go down both paths.
But if you're going to go down the path of, OK, let's gradually open up capital controls, what's a better time to do it than when the Fed is doing-- is back to doing QE? Now, I know, as Grant said, you know, we should-- you know, it is not called QE. And if-- if a Fed program was to self identify as non-QE, we should be respectful of that choice.
So the-- so, you know, on this front, but, you know, if you are going to be-- today, China, at the end of the day, we have Fed, ECB, BOJ all doing QE together for the first time ever, you know, for the first time. They've done it all. But never at the same time,
China has not. China is now basically the one out of the four major central banks, the one that's not doing QE. At the same time, China's the one country-- if you look at US is massively fiscally expanding. Europe is back to fiscally expanding. And so is Japan. And so, really, China is now the one outlier that's not fiscally expanding and not expanding its monetary policy. And it's doing so, of course, because it needs to clean up, to your point, the problems of bad years-- of previous years.
But it also means that, you know, when you see everybody else, you know, go pedal-to-the-metal monetary policy, pedal-to-the-metal fiscal policy, then perhaps this is a good time for China to gradually open capital controls because that means that you're going to get a lot less capital outflows than, let's say, if the Fed was tightening and China was easing.
RAOUL PAL: Yeah, it's interesting there's been that report on the kind of financial risks within China that just came out as well. And, I mean, again, they're pretty clear to admit, we know we've got risks. We know we've got problems. And we're trying to manage it.
I think-- you know, I think the foreign investors don't give them enough credit for that. I mean, they-- I mean, if you look at shadow lending growth or loan growth across China in general, it's been really, really low or negative most of the time. I mean, they aren't trying to take the medicine. The question is is can they do it without something blowing up in the meantime.
LOUIS-VINCENT GAVE: Well, you know, waiting for that blow up has been a little bit like waiting for Godot, right?
RAOUL PAL: Yeah.
LOUIS-VINCENT GAVE: For the past 10 years, we've been being told, oh, China is going to implode. They've got this bad debt situation, et cetera. Now, you know, I think two, three years ago, you had the Fed tightening. And you-- so you had A, Fed tightening, and, B, you know, China was, you know, hadn't even started to tackle the issue really.
Here we are, you know, three years later, Fed is easing. And there-- and we're three years into the consolidation of balance sheets. So, you know, I--